Overview

Sequence of returns risk (sometimes shortened to SORR) describes how the timing — not just the average — of investment returns matters for retirees who are withdrawing money. Two portfolios with the same average return can produce very different outcomes depending on whether the early retirement years produce gains or losses. Selling investments to meet living expenses during down markets compounds losses and shortens portfolio life.

In my 15 years as a financial planner I’ve seen clients with identical balances and long-term returns end up in very different places because of when withdrawals happened. A modest, practical shift in withdrawal order, liquidity planning, or income layering often made the difference between needing to cut spending and staying on track.

(For research on retirement distribution risk and historical analyses, see the National Bureau of Economic Research and investor guidance from the U.S. Securities and Exchange Commission.)

Why sequence of returns matters — the mechanics

The core problem is simple math: a portfolio that falls 20% must gain 25% to return to its prior level. If you take money out of the account during the decline, you reduce the base that can benefit from later gains. That negative compounding is most harmful early in retirement because there is less time for markets to recover before withdrawals deplete principal.

Example (simplified):

  • Two retirees each have $1,000,000 and plan to withdraw $50,000 annually.
  • Retiree A experiences +8% the first five years, then -2% the next five. Retiree B experiences -2% first five years, then +8% next five.
  • Even if average returns are the same, Retiree B’s portfolio will be smaller after 10 years because withdrawals during the early negative returns lock in losses.

That difference is sequence of returns risk.

Who is most affected

  • New retirees beginning systematic withdrawals.
  • Early retirees with long time horizons and high withdrawal ratios relative to portfolio size.
  • Those with concentrated equity exposure and little short-term liquidity.
  • Couples or single retirees who must meet fixed spending obligations with portfolio withdrawals.

Less affected groups include younger savers still in accumulation phase, or retirees whose spending is fully covered by guaranteed income (pension, Social Security, lifetime annuity).

Practical withdrawal and planning strategies to reduce sequence risk

Below are tested approaches I use with clients. They can be combined; no single tactic eliminates risk.

1) Build a cash reserve (the “income floor”)

  • Keep 1–3 years of living expenses in cash or short-term bonds so you don’t sell risk assets in a downturn. This simple buffer is one of the most effective, low-cost ways to reduce sequence risk.
  • In practice I recommend tiering the reserve: 6–12 months in easy-access cash, an additional 1–2 years in short-term Treasury or high-quality short-term bond funds.

2) Use a bucket strategy (time segmentation)

  • Divide assets into near-term (cash/bonds), intermediate (short-duration bonds, conservative balanced funds), and long-term (stocks).
  • Draw from the near-term bucket first during downturns while long-term assets remain invested to recover with the market.

3) Adopt flexible withdrawal rules

  • Avoid rigid dollar withdrawals if markets are weak. Consider rules tied to a percentage of portfolio value, inflation-adjusted formulas, or dynamic methods that reduce withdrawals after large market drops.
  • Examples: the “guardrail” approach (reduce withdrawals if portfolio falls below a threshold) or a variable-percent rule that adjusts the payout annually to balance income and longevity risk.

4) Layer guaranteed income

  • Purchase partial lifetime income (immediate or deferred annuities) to cover core living costs. Even a modest annuity purchase (e.g., covering 30–50% of essential spending) can remove a large portion of sequence risk.

5) Delay Social Security or stagger benefit start dates

  • Postponing Social Security increases guaranteed income and reduces reliance on portfolio withdrawals early in retirement. For many clients, delaying Social Security by a few years acts like a sequence-risk hedge.

6) Reconsider asset allocation for sequence risk (not just return)

  • While stocks offer higher expected returns, increasing equity exposure immediately before or after retirement can heighten sequence risk if a major bear market occurs. Consider a gradual glidepath or a portion of equities reserved for long-term growth while the near-term bucket supports spending.

7) Tax-aware sequencing

  • Coordinate withdrawals between taxable, tax-deferred, and Roth accounts to manage tax brackets and required minimum distributions (RMDs). Thoughtful sequencing can reduce forced sales at bad times and lower tax drag (see our guide on sequencing withdrawals between account types).

8) Work, part-time income, or expense flexibility

  • Earning part-time income or temporarily reducing discretionary spending in early retirement significantly lowers withdrawal pressure and gives investments time to recover.

Testing and modeling for sequence risk

  • Run scenario and stress tests: use historical worst-case sequences (e.g., 1929–1932, 2000–2002, 2007–2009) and Monte Carlo simulations that model low-return environments.
  • Ask your planner to measure portfolio shortfall probability (chance your plan runs out of money) and to show the plan’s sensitivity to early negative returns.
  • Use software that shows “snake plots” or distribution bands for simulated outcomes so you can see how sequence affects outcomes, not just average return.

Example: two withdrawal approaches compared

  • Fixed-dollar withdrawal: $40,000 annually from $500,000. If a bear market hits early, withdrawals consume principal and recovery is harder.
  • Hybrid approach: maintain $80,000 in cash for first two years, withdraw $30,000 from portfolio, and delay discretionary spending. The portfolio faces fewer forced sales during early declines and recovers more robustly.

This example mirrors client cases I’ve worked with: a small cash buffer plus a temporary spending reduction often preserved decades of retirement income versus sticking rigidly to a pre-set dollar amount.

Common mistakes and misconceptions

  • Relying solely on the 4% rule without stress testing. The 4% guideline (popularized by the Trinity Study) is a starting point, not a guarantee; it assumes particular return and inflation environments that may not hold over every future decade (see research and updated analyses).
  • Ignoring tax and sequence interactions. Selling from taxable accounts vs. tax-deferred accounts can have very different tax consequences and should be part of the withdrawal plan.
  • Overreacting to short-term market moves. Knee-jerk trading can worsen outcomes; instead, follow the pre-planned guardrails for when to reduce or resume withdrawals.

Action checklist — first steps to reduce your sequence risk

  1. Calculate a realistic withdrawal rate and stress-test it for early bear markets.
  2. Set a cash buffer to cover at least 6–24 months of essential expenses.
  3. Build a withdrawal policy statement that describes when you will cut spending, draw from which accounts, and when to buy guaranteed income.
  4. Review Social Security timing and consider partial annuitization for the income floor.
  5. Revisit your plan at least annually and after large market moves.

Further reading and tools

Authoritative sources and studies:

  • U.S. Securities and Exchange Commission, Investor Bulletin: Creating an income plan for retirement (sec.gov).
  • National Bureau of Economic Research: analyses on retirement income risks and longevity (nber.org).
  • Classic research on withdrawal sustainability: the Trinity Study and subsequent updates (various financial research outlets).

Professional note and disclaimer

In my practice I routinely combine cash reserves, flexible withdrawal rules, and partial guaranteed income to protect clients from sequence risk. Every retiree’s situation differs—age, health, tax status, and risk tolerance change the right mix.

This article is educational only and is not personalized financial, tax, or legal advice. Consult a qualified financial planner or tax professional before making changes to your retirement income strategy.