Sequence of Returns Risk: Why Two Retirees With the Same Portfolio Can End Up in Very Different Places
Imagine two people. Same age. Same career. Same savings habits. They retire on the same day with identical portfolio balances — $1,000,000 each — and they both withdraw $50,000 per year to cover their living expenses. By every measure that matters going into retirement, they are in exactly the same position.
Ten years later, one of them is financially comfortable. The other has run out of money.
Same starting balance. Same withdrawal amount. Same average return over the decade. Different outcome — because the order in which those returns arrived was different.
This is sequence of returns risk, and it is one of the most consequential and least discussed threats facing retirees today.
The Math That Changes Everything
To understand why order matters, consider a simplified example. Suppose Retiree A experiences strong market returns in the early years of retirement followed by a significant downturn later. Retiree B experiences the exact same returns in reverse — the downturn comes first, followed by the recovery.
Over the full period, both portfolios produce the same average annual return. On paper, they look identical. In practice, the outcomes are dramatically different.
Retiree A, who experienced gains early, had a larger portfolio base during the growth years. The later downturn was painful, but the portfolio had already compounded significantly and the withdrawals during the down years represented a smaller percentage of a larger balance.
Retiree B was not as fortunate. The downturn hit in the first few years of retirement, when the portfolio was at its largest and the damage was greatest. Each annual withdrawal of $50,000 was taken from a portfolio that had already declined in value. Those shares were sold at depressed prices and were no longer available to participate in the eventual recovery. By the time the market rebounded, the portfolio had been drawn down to a level from which it could not fully recover.
The average return was identical. The ending balance was not even close.
This dynamic does not exist during the accumulation phase of investing. When you are still working and contributing to your portfolio, a market downturn is actually an opportunity — you are buying more shares at lower prices. But the moment you begin withdrawing, the math reverses. Selling shares to fund living expenses during a downturn locks in losses and permanently reduces the portfolio's ability to recover.
Why the First Decade of Retirement Is the Most Critical
Research on retirement income consistently points to the same conclusion: the returns experienced in roughly the first ten years of retirement have an outsized impact on the long-term sustainability of a portfolio. A significant downturn in this window — particularly in the first three to five years — can put a retirement plan on a trajectory it never fully recovers from, even if the subsequent decades produce strong returns.
This is not intuitive. Most people think of their retirement portfolio as something that simply needs to average a certain return over time. If it averages 6% or 7% over thirty years, the math should work out. And it would — if returns arrived smoothly and predictably each year. They do not. The volatility itself, combined with the timing of withdrawals, creates a risk that average return calculations simply do not capture.
The practical implication is that the years immediately surrounding retirement — what some call the retirement red zone — require a fundamentally different approach to risk management than the accumulation years that preceded them.
What You Can Do About It
Sequence of returns risk cannot be eliminated, but it can be meaningfully managed. Here are three strategies worth understanding.
The Bucket Strategy
The bucket strategy is one of the most intuitive frameworks for managing sequence of returns risk. The concept is straightforward: rather than treating your portfolio as a single pool of assets from which you withdraw annually, you divide it into separate buckets based on time horizon.
A short-term bucket — typically one to two years of living expenses — is held in cash or cash equivalents. This is the money you live on in the near term, and it is insulated from market volatility entirely. A medium-term bucket holds more conservative investments designed to replenish the short-term bucket over the next several years. A long-term bucket holds growth-oriented investments intended to compound over a decade or more.
The psychological and practical benefit of this structure is significant. When markets decline, you are not forced to sell growth assets at depressed prices to fund your monthly expenses. You draw from the short-term bucket while the long-term bucket recovers, breaking the destructive cycle that makes sequence of returns risk so damaging.
Flexible Withdrawal Strategies
Another layer of protection comes from building flexibility into your withdrawal strategy. A rigid approach — withdrawing the same dollar amount regardless of market conditions — means you are selling more shares in down markets to raise the same amount of cash, accelerating the depletion of your portfolio.
A flexible approach adjusts spending modestly in response to market conditions. In years when the portfolio has declined significantly, reducing discretionary spending — travel, large purchases, gifts — by even 10 to 15% can meaningfully extend the life of a portfolio. This does not mean living in austerity during downturns. It means building a retirement income plan with enough structure to distinguish between non-negotiable expenses and adjustable ones, giving you room to respond when markets are working against you.
This kind of flexibility is easier to execute when it is planned for in advance rather than improvised under pressure.
Roth Conversions and Tax Diversification
A third layer of protection comes from the tax side of the ledger. Having assets spread across taxable, tax-deferred, and tax-free accounts gives you flexibility in how you generate retirement income — including during down markets.
When markets decline, Roth conversions become strategically attractive. Converting Traditional IRA or 401(k) assets to a Roth during a down year means you are paying taxes on a lower balance, potentially at a lower rate, while repositioning those assets into a tax-free account that will benefit fully from the eventual recovery. Withdrawals from a Roth IRA are tax-free, which also means they do not count toward the income thresholds that trigger IRMAA surcharges on Medicare premiums or the taxation of Social Security benefits.
Maintaining assets in a Roth IRA also provides a source of tax-free income that can be drawn upon strategically in years when taking additional taxable income would push you into a higher bracket or cross a meaningful threshold. That flexibility has real value during a market downturn, when every dollar of unnecessary tax is a dollar that compounds against your portfolio's ability to recover.
Putting It All Together
Sequence of returns risk is a reminder that retirement planning is not simply about accumulating a large enough number. It is about building a structure around that number — a withdrawal strategy, an asset allocation, a tax plan, and a set of contingency responses — that can withstand the inevitable volatility that retirement will bring.
The two retirees at the beginning of this article had identical portfolios and identical intentions. What separated their outcomes was not luck alone. It was whether the plan they built going into retirement was designed to absorb a bad sequence of returns without derailing their financial security.
That kind of plan starts with understanding the risk. From there, it is a matter of putting the right structure in place before retirement begins, not after the downturn arrives.
If you are within ten years of retirement and have not stress-tested your withdrawal strategy against a difficult early sequence of returns, that conversation is worth having sooner rather than later.
