Why sequence-of-returns risk matters in the real world

Sequence-of-returns risk happens when negative or below-average returns arrive in the early years after you begin withdrawals. Even if average returns over the full retirement period are acceptable, early losses combined with steady withdrawals can permanently reduce portfolio longevity. The phenomenon is well documented in retirement research (see Bengen and the Trinity studies) and in practical advisor work. A bad first 5–10 years can force deeper cuts to spending or make you rely on more conservative assets later—exactly when you want upside to recover losses (Bengen, 1994; Trinity Study, 1998).

In my practice, I’ve seen two retirees with the same starting balance end up in very different financial places depending on whether their allocation protected early withdrawals. That difference commonly comes down to how allocation and liquidity were handled before retirement.

(Authoritative sources: SEC and Morningstar explain the basics of risk, return, and the role of allocation in retirement planning — see the SEC’s investor guides and Morningstar research for background.)

Core principles of a real-world allocation that reduces sequence risk

  • Create a durable income floor. Use conservative assets or guaranteed income (Social Security timing, immediate/longevity annuities, TIPS, short-term Treasury ladders) to fund essential spending for the first 5–10 years.
  • Preserve growth potential. Keep a portion of the portfolio invested in equities (domestic and international) and real assets so the portfolio can recover from downturns over the long run.
  • Maintain liquidity for withdrawals. Avoid selling growth assets at depressed prices—hold cash or near-cash reserves sized to cover near-term withdrawals (the “bucket” approach).
  • Manage taxes and fees. Tax-aware withdrawals and low-cost implementation materially affect sustainable withdrawal rates (see tax-aware asset-location practices).
  • Rebalance and monitor. Rebalancing enforces discipline: it helps you buy low and sell high and maintain your intended risk exposure.

Common real-world implementations (practical options)

  1. Bucket strategy (short-, medium-, long-term):
  • Short-term bucket: 2–5 years of cash and short-duration bonds to cover essential withdrawals and guardrails.
  • Medium-term bucket: 5–10 years of intermediate bonds, bond ladders, or conservative ETFs.
  • Long-term bucket: the growth sleeve—equities, REITs, international stock exposure—for inflation protection and long-term growth.
    The bucket approach reduces forced selling during market downturns and is one of the most commonly used advisor tactics (see FinHelp’s Creating a Flexible Withdrawal Path: Buckets, Gates, and Triggers).
  1. Bond/CD/Treasury ladder:
  • Build a ladder of individual bonds, CDs, or Treasury securities that mature in years when you expect to withdraw principal. A ladder provides predictable cash without selling equities in a down market.
  1. Partial annuitization (floor-and-upside):
  • Buy an immediate or deferred income annuity to cover essential expenses (a durable floor), leaving the remainder invested for upside. This reduces sequence risk because part of spending is no longer dependent on market returns.
  1. TIPS and inflation protection:
  • Allocate a portion to TIPS or Treasury Inflation-Protected instruments to protect purchasing power while maintaining a conservative profile.
  1. Dynamic spending and guardrails:
  • Use rules-based spending (percentage-of-portfolio, guardrails, or glidepaths) to adjust withdrawals after large market moves. Many advisors implement a spending band (e.g., +/− 10–20% adjustments) to reduce the risk of early depletion.
  1. Tax-aware sequencing and Roth conversions:
  • Coordinate withdrawal sequencing across taxable, tax-deferred, and Roth accounts to reduce taxes and preserve after-tax portfolio value. Strategic Roth conversions in low-income years can improve tax efficiency later on (see FinHelp’s Tax-Efficient Asset Location and Roth conversion guidance).

Sample allocation frameworks (illustrative only)

Below are three illustrative starting points. These are not one-size-fits-all — your allocation should reflect goals, time horizon, and risk tolerance.

  • Conservative floor-focused (for near-retirees who value stability):

  • 25–35% equities (broad U.S./international blend)

  • 45–55% bonds (mix of short/intermediate, TIPS)

  • 10–20% cash/short-term ladder

  • 0–10% alternatives/REITs

  • Balanced (typical retiree target):

  • 40–60% equities

  • 30–45% bonds

  • 5–10% cash/short-term

  • 0–5% alternatives

  • Growth-with-safety (for those with long horizons and other income sources):

  • 60–70% equities

  • 20–30% bonds

  • 5–10% cash/short-term

These numbers are for illustration. Implementation matters more than the exact split: duration of the bond sleeve, the quality and term of the cash bucket, and the rebalancing rules all affect outcomes.

How to choose among strategies: a practical checklist

  • Identify essential vs discretionary spending. Protect essentials first with guaranteed or very conservative assets.
  • Calculate a sustainable starting withdrawal rate based on your goals and risk tolerance. Classic rules (e.g., the 4% rule) come from historical simulations (Bengen, Trinity). Modern research and market conditions suggest flexibility—plan for 3–4% ranges depending on portfolio composition and expected returns.
  • Build a 3–10 year liquidity reserve to avoid selling equities in a downturn.
  • Consider partial annuitization if longevity risk is a concern and you want predictable income.
  • Model stress scenarios: run a few worst-case early-retirement sequences to see how your plan holds up (sequencing simulations are available in many advisor tools; see FinHelp’s Modeling Sequence-of-Returns Risk in Retirement Portfolios).
  • Factor taxes and fee drag—use tax-aware location and low-cost funds.

Real-world examples (anecdotes from advisory practice)

  • Case A: Clients aged 62 with $1.2M and no pension. We set aside 5 years of spending in short-term Treasuries and laddered municipal bonds to cover withdrawals; kept 50% in diversified equities and rebalanced annually. They retired through a market drop but avoided selling equities at depressed prices and resumed normal withdrawals with only modest lifestyle adjustments.

  • Case B: A client chose a small annuity to cover essential expenses and used a growth sleeve for discretionary spending. The annuity reduced anxiety and made the withdrawal plan resilient to early-market shocks.

Pitfalls to avoid

  • Overconfidence in historical returns: past 20–30 year returns may not repeat; don’t assume long-term averages solve short-term sequence risk.
  • Ignoring costs and taxes: high fees and poor tax planning reduce withdrawal sustainability.
  • Over- or under-allocating to cash: too much cash erodes long-term growth (inflation risk); too little creates forced selling risk.

How this ties into other planning areas (internal resources)

Quick implementation checklist (first 90 days)

  1. Run a retirement cash-flow test with downside scenarios (5–10 year negative-start sequences).
  2. Size your liquidity reserve to cover essential withdrawals for at least 2–5 years; extend to 7–10 years if risk-averse.
  3. Decide on partial annuitization or guaranteed income for essential spending.
  4. Rework asset allocation across account types with tax-aware placement and low-cost vehicles.
  5. Set rebalancing rules and a spending guardrail policy.

Closing thoughts and evidence base

Sequence-of-returns risk is not theoretical—it’s a practical, visible threat in retirement planning. A real-world allocation that combines a conservative income floor, intelligent liquidity planning, and continued growth exposure gives you the best chance to preserve lifestyle through bad starts and long retirements. The academic literature (Bengen; the Trinity Study) and practitioner research (Morningstar, advisor analyses) all point to the same conclusion: the order of returns matters, and allocation plus withdrawal design is the lever you control.

Professional disclaimer
This article is educational and does not constitute personalized financial advice. Implementing the strategies above requires understanding your full financial picture. Consult a certified financial planner or tax advisor before making changes.

Authoritative sources and further reading

  • William Bengen, “Determining Withdrawal Rates Using Historical Data” (1994) — origin of the 4% rule concept.
  • The Trinity Study (Cooley, Hubbard, and Walz) — historical sequence-of-returns research.
  • U.S. Securities and Exchange Commission (investor guides on risk and allocation): https://www.investor.gov/introduction-investing/what-are-risks
  • Morningstar research on asset allocation and retirement planning: https://www.morningstar.com

If you want a worksheet or a modeled example tailored to common starting balances and spending patterns, tell me the retirement age, portfolio size, and annual spending goal and I can provide a basic scenario analysis.