A retiree can earn the same average investment return as someone else and still face a very different financial outcome. The difference may come down to when the market declines and when retirement withdrawals begin. That is the heart of sequence of returns risk explained: poor returns early in retirement can put lasting pressure on a portfolio, even if markets recover later.
This risk is not a reason to avoid investing or assume retirement requires predicting the market. It is a reason to build a retirement income plan that recognizes a simple reality: once you are taking withdrawals, timing matters. A thoughtful plan can help you make decisions from a position of preparation rather than fear.
What Is Sequence of Returns Risk?
Sequence of returns risk is the risk that the order of investment returns will negatively affect a retirement portfolio when you are withdrawing money from it. Investment returns are rarely delivered in a neat, predictable line. Some years are strong, some are flat, and some bring meaningful declines.
For an investor who is still working and contributing regularly, a down market may be uncomfortable, but there is often time to recover. Continued contributions can even purchase investments at lower prices. For a retiree drawing income from a portfolio, however, a market decline can require selling investments while their values are down.
Those shares are no longer available to participate fully in a later recovery. This combination of market losses and withdrawals can shrink the portfolio faster than many people expect.
The risk is most significant in the first several years of retirement, when your account balance is generally at its highest and withdrawals may continue for decades. It also matters during any period when you rely on portfolio withdrawals for essential expenses.
How the Same Returns Can Produce Different Outcomes
Consider two retirees, each beginning with a $1 million portfolio and each withdrawing $50,000 per year, before taxes and inflation adjustments. Over a 10-year period, both experience the same collection of annual market returns. One encounters several negative years near the beginning, while the other receives positive years first and the negative years later.
The first retiree has to sell more shares in the early down years to create the same $50,000 of income. Even if the market rebounds, the reduced number of shares has less opportunity to grow. The second retiree may build a larger base during the positive early years, making later downturns less damaging to the overall plan.
Average return alone does not tell the entire story. A portfolio that averages 6% annually does not actually grow by 6% every year, and retirement expenses do not pause when markets decline. This is why retirement planning should evaluate cash flow, taxes, healthcare costs, and risk exposure together rather than treating investment performance as an isolated number.
A Simple Illustration
Imagine a portfolio falls 20% in the first year of retirement. A $1 million balance becomes $800,000 before withdrawals. If $50,000 is then withdrawn for income, the balance falls to $750,000. To return to $1 million, that portfolio now needs to gain more than 33%, not merely 20%.
Markets can and do recover, but the retiree may have spent several years taking withdrawals along the way. The practical concern is not whether a recovery will eventually occur. It is whether your income plan can support your lifestyle while you wait for it.
Why This Risk Feels Different in Retirement
Retirement changes the job your money must do. During your working years, the primary objective may be long-term growth. In retirement, your assets may need to provide dependable income, address rising expenses, cover unexpected healthcare needs, reduce taxes where possible, and support the legacy you hope to leave.
That does not mean every retiree should move entirely to cash or conservative investments. Holding too little growth-oriented investment exposure can create another challenge: inflation. Over a 20- or 30-year retirement, the purchasing power of money can decline substantially. A portfolio that is overly cautious may struggle to keep pace with future costs.
The appropriate balance depends on your income sources, spending needs, time horizon, tax situation, health, family priorities, and comfort with market fluctuations. The goal is not to eliminate all risk. It is to understand which risks you are taking and ensure they fit your life.
Ways to Help Manage Sequence of Returns Risk
A coordinated retirement plan can reduce the need to make emotionally driven decisions during market volatility. There is no single product or allocation that solves sequence risk for everyone, but several planning approaches can work together.
Build a Reliable Income Foundation
Start by identifying your essential monthly expenses: housing, food, utilities, insurance premiums, healthcare, and other costs that must be paid regardless of what the market does. Then consider which predictable income sources may cover those expenses, such as Social Security, pensions, annuity income, or other reliable sources.
When core expenses are supported by dependable income, you may be less likely to sell long-term investments during a market decline. Portfolio assets can then be positioned more intentionally for discretionary spending, future income needs, inflation protection, and legacy goals.
Maintain Purposeful Cash Reserves
Keeping a reasonable reserve for near-term spending can provide flexibility when markets are down. Rather than withdrawing from investments after a decline, you may be able to use cash set aside for planned expenses.
The right amount is personal. Too little liquidity may force unwanted sales. Too much cash held for too long may lose purchasing power to inflation and limit long-term growth. The point is to align reserves with your spending plan, not simply choose a round number.
Diversify Beyond a Single Market Outcome
Diversification cannot prevent losses, and it does not guarantee a profit. It can, however, reduce reliance on one type of investment, one sector, or one market environment. A portfolio designed for retirement may include a mix of investments with different roles, rather than relying exclusively on assets that may move in the same direction at the same time.
Diversification should also be considered alongside your full financial picture. For example, a household with substantial real estate holdings, company stock, or business interests may have risks that are not obvious by looking only at an investment statement.
Use a Flexible Withdrawal Strategy
Some retirement expenses are fixed, while others can be adjusted. A plan that distinguishes between needs and wants can create valuable flexibility. In a difficult market year, delaying a major vacation, reducing discretionary purchases, or postponing a large gift may help preserve long-term assets.
This does not mean retirement should feel restrictive. It means planned flexibility can help protect the experiences that matter most over time. A withdrawal strategy should also account for required minimum distributions, charitable giving intentions, and the tax treatment of different accounts.
Coordinate Investments With Taxes and Healthcare
The amount you withdraw is not always the amount you keep. Withdrawals from certain retirement accounts can increase taxable income, affect Medicare premium brackets, and influence how long assets last. Selling investments in a down market can also have tax consequences depending on the account and the investments involved.
For many families, managing sequence risk is not only about investment allocation. It is about deciding which accounts to draw from, when to take Social Security, how to plan for Medicare-related costs, and how to use tax-efficient withdrawal strategies over multiple years.
Common Mistakes to Avoid
One common response to a market decline is moving an entire portfolio to cash after losses have already occurred. While cash may offer short-term stability, permanently stepping away from the market can make it difficult to participate in a recovery or keep pace with inflation.
Another mistake is assuming a generic withdrawal rule will work in every market environment. Rules of thumb can be useful starting points, but they cannot fully account for your tax situation, guaranteed income, estate goals, spending flexibility, or changing health needs.
It is also easy to focus only on the account balance. A strong retirement plan is measured by more than a statement value. It should answer practical questions: Can your income support your lifestyle? Can you respond to a market decline without abandoning your plan? Are your loved ones protected if circumstances change?
Sequence of Returns Risk Explained in Your Plan
The most useful way to address sequence of returns risk is before a major downturn forces difficult choices. A retirement income analysis can model different market conditions, withdrawal rates, inflation assumptions, and longevity scenarios. It cannot predict the future, but it can reveal where a plan may be vulnerable and where more flexibility may be available.
For pre-retirees in Buffalo Grove and throughout the greater Chicago area, that conversation may be especially valuable as retirement approaches. The transition from earning a paycheck to creating income from your assets deserves more than a one-time investment recommendation. It deserves an organized strategy that connects investments, taxes, insurance, healthcare, and estate priorities.
A well-designed retirement plan does not promise that markets will always cooperate. It gives you a clearer path for responding when they do not, so you can spend more energy on the people, experiences, and memories you worked to make possible.
