As investors near retirement, their focus naturally shifts from building wealth to protecting it. In retirement, the order in which returns occur can be just as important as the returns themselves. Experiencing negative market years early on, while taking withdrawals, can significantly shorten the lifespan of a portfolio. 

This phenomenon is called sequence of returns risk. Even retirees with identical average returns can have very different outcomes depending on when gains and losses occur relative to withdrawals. 

Discover how to mitigate sequence of returns risk with three key strategies and bolster your retirement financial planning.

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What is sequence of returns risk?

Sequence of returns risk, or sequence risk, refers to the danger that the timing of investment returns will negatively impact the longevity of a retirement portfolio. It primarily affects those who are nearing or in retirement who rely on their investments for income, without new contributions to offset losses. If markets decline early in retirement, retirees may need to sell more shares to cover expenses, leaving fewer assets to recover during future upswings. 

This differs from focusing solely on average return risk, which only looks at long-term performance without considering timing. When calculating your rate of return for retirement planning, it’s important to consider not just the average return but the sequence in which those returns occur. A portfolio that earns an average return of 8% over 30 years might seem healthy, but when those returns happen can determine whether your savings last through retirement. 

How does sequence of returns risk affect your retirement plan?

To effectively manage sequence of returns risk, it’s important to understand how it interacts with other key retirement factors. Here’s an overview.

Withdrawals

One of the biggest challenges in retirement is that income needs often stay constant, even when markets don’t. If you need $50,000 a year from a $1 million portfolio and it drops to $850,000 in year one, your withdrawal rate rises from 5% to nearly 6%. This can accelerate portfolio depletion unless offset by new contributions, higher returns, or reduced spending.

Longevity

Sequence risk amplifies the danger of outliving your savings. In the example above, a $100,000 market loss equals two years of living expenses and, if volatility persists, the effect compounds. While reducing expenses helps, a more reliable approach can be building guaranteed income streams, such as fixed annuities, before retirement.

Inflation

Rising prices can erode purchasing power, forcing retirees to withdraw more from their portfolio to maintain their lifestyle. When higher withdrawals coincide with poor early investment returns, you’re selling a larger portion of a smaller portfolio. 

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Asset allocation and timing: Your first line of defense

Smart asset allocation — how you organize your portfolio across stocks, bonds, annuities, cash, and other investments — helps mitigate sequence of returns risk. As you approach retirement, it can be important to shift from aggressive growth toward a more conservative mix, since riskier assets can be more susceptible to market volatility. 

While you don’t want to eliminate growth potential, it could be wise to safeguard a portion of the savings you’ll need during the first few years of retirement. Some investors implement a bucket strategy, keeping conservative assets, such as high-yield savings accounts and certificates of deposit (CDs), to cover expenses early on. Over time, intermediate and long-term buckets take on more risk, and retirees periodically sell from them to replenish short-term funds.

Including income-producing investments in your asset allocation can also help. Dividend-paying stocks can generate regular income, while annuities that provide guaranteed payouts for a set period or for life can help maintain reliable cash flow regardless of market performance. 

Managing sequence of returns risk: 3 strategies

Retirement planning typically requires a strategic approach to preserve income even through periods of lower investment returns. Here’s an overview of three strategies that can help protect your portfolio from sequence of returns risk.

1. Establish an emergency fund

During market downturns, liquidity can be essential, giving retirees access to cash without having to sell investments at a loss, which can erode long-term returns. Maintain an emergency fund equal to several months up to a year of retirement expenses in liquid holdings, such as a savings account or short-term CD ladder. This buffer helps you cover expenses and remain invested when markets fluctuate.

2. Diversify your portfolio

Diversification goes beyond owning different stocks — it involves holding a variety of assets across and within classes. For example, combining blue-chip dividend payers with growth stocks and balancing market exposure with non-correlated assets. When stocks fall, guaranteed income solutions like annuities can provide stability.  

3. Regularly review your strategy

You should continue to monitor and adjust your retirement plan over time. This can include selling assets to replenish cash reserves, reassessing your withdrawal rate, and rebalancing your portfolio once or twice a year. Periodic reviews help identify risks early and align your strategy with current conditions. To see how small variations in timing can influence results, consider using a sequence of returns risk calculator to model potential scenarios for your portfolio. 

Protect your retirement income with Gainbridge

Gainbridge offers a range of various annuities that can provide guaranteed income designed to help mitigate market volatility and preserve your capital. By integrating annuity products into your portfolio, you can maintain a predictable cash flow and reduce your reliance on market timing. Our innovative digital-first annuity platform puts transparency first, with no hidden fees or commissions. 

Explore Gainbridge today and create a secure retirement strategy that works for you.

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This article is intended for informational purposes only. It is not intended to provide, and should not be interpreted as, individualized investment, legal, or tax advice. For advice concerning your own situation please contact the appropriate professional. The GainbridgeⓇ digital platform provides informational and educational resources intended only for self-directed purposes. Guarantees are backed by the financial strength and claims-paying ability of the issuer.

Investing involves risk, including the possible loss of principal. Past performance is not indicative of future results.