Sequence of Returns Risk: The Retirement Concern You’ve Never Heard Of

By Kate Redden, CFP®, ChFC®, CKA®, Vice President of Client Experience, Wealth Manager, Partner, and Brian Andrew, CFA®, Chief Investment Officer

The strength of your retirement account depends not only on your contributions during your career, but also on the market conditions at the time you retire. It’s a primary reason why the stock market’s recent record highs are creating both optimism and concern for the 4.1 million Americans who will turn 65 this year.

Timing matters, and history shows us why. Those who retired in 2000, followed by a market downturn and a decade of flat equity returns, faced a very different outcome than those who retired in 2010 and experienced strong market growth. It’s called sequence of returns risk.

Fortunately, advisors have several strategies designed to address such risks.

What is the sequence of returns risk?

While you may have never heard of the term “sequence of returns risk,” it’s likely something you’ve thought about. Sequence of returns risk refers to the risk that poor investment performance early in retirement, combined with the timing of withdrawals, can significantly reduce a portfolio. Financial planning considers long-term returns, but not always their specific sequence. For example, assuming a consistent 8% return does not reflect the reality that one decade could yield zero returns while the next delivers 12%.

It’s a common concern among retirees, but it can be mitigated by proper financial planning and working with a financial advisor.

What kinds of events would precipitate this risk?

Sequence of returns risk is triggered by market volatility, which can result from geopolitical, economic, or headline risks. Major global conflicts or widespread economic disruptions can have significant impacts. Liquidity issues also play a role; when many investors try to exit the market simultaneously, prices can fall sharply. This occurred in 2008, again briefly in 2020 during the onset of COVID, and in 2022, leading to short-term declines of 20% and above.

What strategies do advisors employ before and during retirement to mitigate risk?

Understanding your cost of living is essential for making informed financial decisions, including determining how much to allocate to short-term reserves, regardless of your overall wealth.

Bucket strategies can help, and those allocations depend on each client’s risk tolerance and outlook. Typically, the short-term bucket holds one to two years of safe, liquid assets to cover unexpected events. The intermediate-term bucket covers three to ten years and consists of income-producing assets, focusing on dividends and interest rather than price growth. The long-term bucket, for periods beyond ten years, contains more aggressive investments, as markets generally recover over such timeframes.

Retirement age matters greatly. If you retire at 52, your investment horizon spans several decades, making equity volatility less concerning when using the bucket approach. Retiring at the age of 70 shortens this horizon, so bucket allocations may need to be adjusted accordingly.

Annual reviews are an opportunity to assess allocations across short, intermediate, and long-term buckets. Withdrawals are made from the most appropriate bucket based on market conditions. If funds are drawn from the short-term bucket during downturns, advisors look to replenish it as markets recover. This active approach helps maintain financial stability.

Is there anything investors should do to prepare themselves adequately?

You may worry about retiring during market downturns and reconsider your plans. In these cases, your advisor’s financial planning software can model worst-case scenarios, such as several years of zero or negative returns, demonstrating that your advisor has planned for such risks.

Rather than being fearful, be proactive. Feel empowered to review retirement timing and current market conditions with your advisor to understand how you are protected against market events. A good advisor will share the strategies they use, such as maintaining adequate short- and intermediate-term reserves or incorporating guaranteed income products, which can provide additional security. As always, collaborating with an advisor to implement a strategic plan helps keep retirement on track and provides peace of mind.

Curious about how your portfolio is protected against sequence of returns risk? Merit Financial Advisors offers complimentary consultations to help bring clarity and structure to your financial life. Let’s start the conversation today.