Sequence of Returns Risk: Why Your First Five Retirement Years Matter Most
Two Retirees. Same Average Return. Very Different Retirements.
Imagine two retirees who each begin retirement with $1 million. Each one withdraws $50,000 a year, adjusted for inflation. Over their first ten years, both experience the same average annual return of 6 percent.
One runs out of money in their late 80s. The other passes away with $1.5 million still in their account.
How is that possible when the average return is identical?
The answer is sequence of returns risk, and it is one of the most important and least understood ideas in retirement income planning.
What Sequence of Returns Risk Actually Means
Sequence of returns risk is the risk that the order in which your investment returns occur will damage your retirement, even when the average return over time looks perfectly fine.
Here is why it matters. When you are still saving and contributing to your retirement accounts, the order of returns does not change your outcome very much. You keep contributing whether markets are up or down, and time is on your side. But when you are actively withdrawing from your savings, a bad year early in retirement causes permanent damage. Every dollar you take out during a downturn is a dollar that cannot participate in the recovery when markets eventually rebound.
A significant market decline in the first year or two of retirement, while you are also drawing income from your savings, can meaningfully shorten how long your money lasts even if the average return across your entire retirement looks healthy on paper. This is the core of the sequence risk problem and it is one of the most important dynamics that a retirement income distribution plan needs to account for.
Why the Early Years Matter Most
Retirement planning professionals sometimes call the first five to ten years of retirement the retirement red zone. There are several reasons the math is most vulnerable during this period.
Your savings are typically at their largest balance in dollar terms when you first retire, which means percentage declines translate into the largest absolute dollar losses. You are actively withdrawing, which locks in those losses rather than allowing them to recover passively. You have not yet had decades of compounding to buffer against downturns. And the behavioral response to early losses, the impulse to make reactive decisions during a downturn, can compound the mathematical damage if it leads to locking in losses or disrupting a well-structured plan.
A retiree who encounters a significant bear market in year three of retirement is facing a fundamentally harder financial math problem than someone who encounters the same bear market in year twenty-five. Same market, very different consequences. This is what makes the income structure you enter retirement with so consequential.
Three Planning Concepts That Address Sequence Risk
You cannot predict markets. But sequence of returns risk is not something you simply have to accept without any planning response. There are several approaches that retirement income planning specialists commonly discuss in this context.
The first concept is maintaining a spending buffer. Keeping a portion of your savings in a stable, accessible form so that near-term living expenses do not require drawing from long-term savings during a market downturn is one of the most widely discussed approaches to managing sequence risk. This is the foundational idea behind the bucket strategy, which we cover in depth separately. The investment structure of that buffer and the longer-term portions of savings are decisions made with independent investment advisors who are licensed to address those specifics.
The second concept is a flexible withdrawal approach. Rather than drawing the same inflation-adjusted dollar amount every year regardless of market conditions, a flexible or dynamic approach adjusts spending modestly in response to how the overall retirement savings picture is performing. In stronger years, some plans allow for somewhat more discretionary spending. In more challenging years, modest adjustments to discretionary spending may reduce the long-term impact considerably. Small adjustments made early in a downturn can prevent much larger problems later. Whether and how a flexible withdrawal approach fits a specific household is a conversation worth having with a retirement income planning advisor and an independent investment professional.
The third concept is building a reliable income floor from sources that are not dependent on market performance. If a meaningful portion of your essential monthly expenses is covered by Social Security, pension income, or insurance-based income solutions, a difficult market period matters less to your monthly retirement paycheck. Your savings portfolio can become the source for discretionary and lifestyle spending, which is far easier to flex during a challenging market period than essential expenses. Any guarantees associated with insurance-based income products are backed by the claims-paying ability of the issuing insurance company.
A well-considered retirement income plan often draws on all three of these concepts in some combination, sized and structured around each household’s specific situation.
The Social Security Lever
One of the most overlooked tools for managing sequence of returns risk is the Social Security claiming decision.
Delaying Social Security from 62 to 70 may increase the monthly benefit by approximately 8 percent for each year of delay past Full Retirement Age. That increase results in a larger, inflation-adjusted, lifetime income stream that continues regardless of market conditions and includes survivor benefits for a surviving spouse.
For a retiree focused on sequence risk, delaying Social Security and drawing from savings during the early retirement years can actually serve an important purpose. You are drawing from the market-exposed portion of your savings during a period when it is most vulnerable, and replacing it over time with a reliable income stream that grows the longer you wait. Rather than seeing early portfolio withdrawals as a negative, the strategy reframes them as funding the delay period in exchange for a stronger lifetime income floor.
That said, this approach is situational. For someone in poor health or with a family history suggesting a shorter life expectancy, the math around Social Security timing may point in a different direction. This is one of the decisions we work through carefully with every client as part of a complete retirement income analysis.
What Does Not Solve the Problem
It is worth addressing a few things people sometimes assume will protect them from sequence risk that do not actually solve it.
Simply investing more conservatively does not eliminate sequence risk. A very conservative portfolio carries its own risks during extended periods of poor returns, and being too conservative may actually increase the risk that inflation erodes purchasing power over a long retirement.
Trying to time the market by moving out of investments before a decline and back in afterward requires being right twice and doing so consistently. This is extremely difficult even for professional investors and can create more damage than it prevents when the timing is wrong.
A high starting withdrawal rate creates significant vulnerability in a bad sequence regardless of how the portfolio is otherwise structured. The withdrawal rate and the sequence of returns interact directly, which is one reason why building reliable income from non-market sources is such an important complement to investment-based withdrawals.
Ryan's Perspective
“The reason we spend so much time thinking about the income structure in the first few years of a retirement plan is not because those years are more important to enjoy. Every year matters. It is because those years are mathematically more vulnerable if the income foundation is not built correctly. Once you have the right structure in place and make it through that early window with the plan intact, the math becomes considerably more forgiving.” Ryan Skinner, Founder, Apex Retirement Services
How Apex Approaches This
At Apex Retirement Services, conversations about sequence of returns risk are a standard part of every retirement income consultation we have. Because this is not an abstract concern. It is a real planning question with real consequences that deserves to be addressed before retirement begins, not after the first difficult market period has already tested an unprepared plan.
Every retirement income structure we help build is reviewed against the question of what happens if markets move against the plan early. Not as a prediction of what will happen, but as a way of understanding whether the income foundation is resilient enough to hold up under conditions that have happened before. The investment components of that stress testing are addressed in coordination with independent investment advisors and CPAs who can model the full picture.
Ryan’s focus is on the insurance-based income layer, including solutions that may help provide a reliable retirement paycheck regardless of what markets are doing, which is often the most direct way to reduce the exposure of essential expenses to sequence risk.
If you would like to explore how your retirement income structure might hold up under different market scenarios, we would be glad to start that conversation.
Frequently Asked Questions (FAQs)
They are related but distinct. Longevity risk is the risk of living longer than your savings can sustain. Sequence of returns risk is the risk that poor market timing early in retirement permanently damages your savings before you have a chance to recover. The two interact closely because sequence risk can shorten how long your money lasts, which then creates or worsens a longevity problem. Addressing both in a coordinated retirement income plan is important.
It diminishes over time. After the first ten to fifteen years, sequence risk fades as a primary concern because the portfolio has either grown meaningfully through compounding or the overall plan has already adapted to the actual returns experienced. The early years carry the greatest vulnerability, which is why the income structure you enter retirement with matters so much.
For some households, yes. Certain annuity and insurance-based income products may convert a portion of market-exposed savings into a more predictable income stream, which removes the sequence risk question for that portion of the retirement income plan. Whether this fits a specific household depends on their overall income structure, essential expense coverage, and long-term goals. It is not the right fit for every situation. Any guarantees associated with these products are backed by the claims-paying ability of the issuing insurance company.
Social Security timing is one of the most direct and accessible tools for managing sequence risk because it does not require predicting or reacting to markets at all. Delaying claiming may increase the monthly benefit and strengthen the non-market income floor before retirement savings are stressed by a downturn. How Social Security timing interacts with your overall retirement income structure is one of the most important planning conversations to have before you retire.
If you are already in retirement and concerned about how your income structure would hold up in a difficult market period, the most productive step is to review your retirement income plan with professionals who can evaluate the full picture. Understanding how much of your essential spending is covered by non-market sources, what flexibility exists in your discretionary spending, and whether any adjustments to the income structure make sense for your situation are exactly the kinds of questions the Apex team works through with retirees in the Greater Boston area.
Your retirement journey starts here. Connect with Ryan and explore your options today.
