Most people understand, in general terms, that markets go up and down over time, and that a long-term investor can typically ride out a downturn as long as they don’t need to sell. But that logic changes the moment you start withdrawing from your portfolio for income. A downturn that happens in your first few years of retirement can affect your long-term financial security very differently than the same downturn happening a decade into retirement — even if the average return over both periods is identical.
This is called sequence-of-returns risk, and it’s one of the more counterintuitive concepts in retirement planning. Many pre-retirees have never heard the term, even though it directly affects how a nest egg should be managed once withdrawals begin. This article explains why the order of returns matters, what it means for your withdrawal strategy, and how a coordinated retirement income plan is built to respond to it.
What Is Sequence-of-Returns Risk?
Sequence-of-returns risk refers to the danger that the order in which you experience investment gains and losses — not just the average return over time — can significantly affect how long your money lasts, once you’re withdrawing from your portfolio rather than adding to it.
Here’s the conceptual reason why order matters so much. While you’re still working and contributing to your accounts, a market downturn is arguably a good thing in the long run: you’re buying more shares at lower prices, and you have years for the market to recover before you need the money. But once you’re retired and withdrawing income, a downturn forces you to sell more shares to generate the same dollar amount of income, permanently reducing the number of shares you have left to benefit from the eventual recovery. Withdrawing from a shrinking balance during a downturn can do lasting damage that withdrawing the same amount from a growing balance would not.
Two retirees who experience the exact same average annual return over a 20- or 30-year retirement, but in a different order — one with strong returns early and weaker returns late, the other with weak returns early and strong returns late — can end up with dramatically different outcomes. The retiree who experiences poor returns in the first several years of retirement, while also taking withdrawals, is generally in a more precarious position than the one who experiences poor returns later, even though both retirees “averaged” the same return over the full period.
Why This Matters Most in the Years Right Around Retirement
Sequence-of-returns risk is often described as being most acute in the years immediately before and after your retirement date — sometimes called the “retirement red zone.” The logic is straightforward: your portfolio balance is typically at or near its largest point in your lifetime right around retirement, and a downturn during this window has an outsized effect for two reasons.
First, you no longer have new contributions offsetting the loss the way you did during your working years. Second, you’re beginning to withdraw from the very balance that just declined, which means you’re selling more shares than you would have needed to sell if the balance hadn’t dropped — locking in some of the loss in a way that’s harder to recover from.
This is part of why the years just before retirement are not simply about “how much have I saved,” but also about how that balance is positioned and how a downturn in year one or two of retirement would actually be handled, in practice, by your income plan.
Withdrawal Flexibility: A Key Defense
One of the most direct ways retirees manage sequence-of-returns risk is by building flexibility into how much they withdraw in a given year, rather than committing to a fixed withdrawal amount regardless of market conditions.
You may have come across the concept of a “safe withdrawal rate” — a general guideline some planners use for thinking about how much can be withdrawn from a portfolio annually with a reasonable expectation that the money will last. It’s a useful starting concept, but it isn’t a guarantee, and it doesn’t account for the sequence in which returns actually occur. A retiree who mechanically withdraws the same amount every year, adjusted only for inflation, regardless of how the portfolio performed, is more exposed to sequence risk than a retiree willing to adjust.
Some approaches to building in flexibility include:
Adjusting withdrawals based on portfolio performance. Some retirees plan to reduce withdrawals modestly in years following a market downturn, and potentially increase them in strong years, rather than treating the withdrawal amount as fixed.
Maintaining a cash or short-term reserve. Holding a portion of assets in cash or short-term, more stable investments can give you the option to draw from that reserve during a downturn, rather than being forced to sell portfolio assets at a low point.
Delaying discretionary expenses in down years. Some retirees build a plan that distinguishes between essential and discretionary spending, so that in a downturn year, discretionary withdrawals can be reduced or postponed without affecting essential income needs.
None of these approaches eliminates market risk, and none guarantees a particular outcome — but building flexibility into your plan tends to reduce the odds that a poorly timed downturn permanently damages your retirement security.
Income Buffers and Diversified Income Sources
Another common defense against sequence-of-returns risk is reducing your portfolio’s role as your only source of income. The more of your essential expenses that are covered by income sources that aren’t directly tied to market performance — Social Security, a pension, or certain types of annuities — the less pressure a market downturn puts on your investment withdrawals in any given year.
This is sometimes described as building an “income floor”: covering your essential expenses with more predictable income sources, so that portfolio withdrawals are primarily funding discretionary spending, which is easier to adjust in a down year. Annuities are one tool some retirees use as part of this approach, though whether an annuity makes sense depends heavily on your specific goals, costs, and overall financial picture — our annuity review page walks through the considerations in more detail.
The timing of when you begin Social Security also interacts with sequence-of-returns risk, since delaying Social Security in favor of portfolio withdrawals in your early retirement years shifts more sequence risk onto your portfolio, while claiming earlier shifts more of your income onto a source that isn’t affected by market performance. Our article on Social Security timing explores this trade-off further.
How a Coordinated Plan Responds to a Downturn
The real test of a retirement income plan isn’t how it looks on paper during calm markets — it’s how it actually responds when a downturn happens. A coordinated plan generally addresses this in a few ways before the downturn ever occurs, rather than reacting after the fact:
Stress-testing the plan against downturn scenarios in advance. Rather than hoping for the best, a thorough retirement income plan typically models what would happen if a significant downturn occurred in the first year or two of retirement, so there are no surprises about how the plan would respond.
Establishing withdrawal guardrails ahead of time. Deciding, before a downturn happens, what adjustments you’d make if your portfolio dropped by a certain amount — rather than making that decision emotionally in the middle of a decline — tends to lead to better outcomes.
Coordinating withdrawals across account types. In a down year, it may make more sense to draw from cash reserves, a Roth account, or other sources rather than selling depressed portfolio assets, depending on your full account picture and tax situation. This is one of the reasons RMDs, taxable accounts, and tax-advantaged accounts need to be considered together rather than separately — our RMD planning page discusses how required withdrawals fit into this coordination.
Revisiting the plan regularly, not just once. Retirement isn’t a “set it and forget it” event. A plan built five years before retirement should be revisited as markets move and circumstances change, so adjustments can be made proactively rather than reactively.
Sequence Risk Isn’t a Reason to Avoid Investing
It’s worth being clear about what sequence-of-returns risk is not. It isn’t an argument for abandoning a long-term investment strategy or moving entirely to cash the moment you retire — doing so introduces its own risks, including the risk that your money doesn’t grow enough to keep pace with your spending needs over a retirement that could last 20, 30, or more years. Sequence risk is a reason to plan for downturns thoughtfully, not a reason to avoid market exposure altogether.
The goal of managing sequence-of-returns risk isn’t to predict when the next downturn will happen — nobody can do that reliably — but to build a plan resilient enough that when a downturn does happen, you have a predetermined, sensible response rather than a panicked one.
Bringing It Together With a Full Income Plan
Sequence-of-returns risk doesn’t exist in isolation — it interacts with your Social Security timing, your tax strategy, your Medicare planning, and how your various income sources are structured to work together. Our retirement income planning page walks through how these pieces are typically coordinated for Colorado retirees.
Your Next Step
Understanding sequence-of-returns risk conceptually is one thing; knowing how your specific portfolio, withdrawal needs, and other income sources would actually respond to a downturn is another. This article is educational and isn’t personalized advice — your own plan should reflect your specific accounts, timeline, and risk tolerance. If you’d like to see how your retirement income plan would hold up against a market downturn in your early retirement years, consider a Colorado Retirement Clarity Review, a complimentary opportunity to look at your income strategy through this lens. Schedule your review today to get started.
This article is for educational purposes only and is not individualized investment, tax, or legal advice. Please consult your tax professional regarding your specific situation.