The Sequence of Returns Risk
One of the biggest threats to retirement success isn’t average market returns—it’s the sequence in which those returns occur. A market downturn in the first few years of retirement can have a devastating impact on portfolio longevity, even if markets recover later.
This phenomenon, called “sequence of returns risk,” means that two retirees with identical portfolios and returns can have vastly different outcomes based solely on when those returns occurred.
Consider this example: A retiree experiencing a 20% market drop in year one while taking withdrawals will be far worse off than someone who sees the same drop in year fifteen, even if both experience the same average returns over time.
Why Volatility Matters More in Retirement
During your accumulation years, market volatility is actually beneficial—you’re buying more shares when prices are low. But in retirement, the dynamic reverses:
- You’re selling shares to fund expenses
- You have less time to recover from downturns
- Portfolio withdrawals amplify losses
- Behavioral risks increase with shorter time horizons
This makes volatility management crucial for retirement success.
Strategic Approaches to Managing Volatility
1. The Bucket Strategy
Many retirees successfully use a “bucket” approach to manage volatility:
Cash Bucket (1-2 years): High-liquidity funds in savings or money market accounts to cover immediate expenses
Bond Bucket (3-7 years): Conservative fixed-income investments providing stability and near-term income
Stock Bucket (8+ years): Growth-oriented equities for long-term appreciation
This approach lets you avoid selling stocks during downturns, drawing instead from more stable buckets while equities recover.
2. Dynamic Withdrawal Strategies
Rather than withdrawing a fixed percentage regardless of market conditions, consider dynamic approaches:
- Guardrails method: Reduce spending when portfolio drops below certain thresholds
- Income floor approach: Cover essential expenses with guaranteed income, adjust discretionary spending based on portfolio performance
- Percentage of portfolio: Withdraw a consistent percentage, allowing spending to flex with market values
3. Tax-Loss Harvesting
Market downturns create opportunities to harvest losses that can offset gains and reduce your tax bill. In retirement, strategic tax-loss harvesting can:
- Lower your taxable income
- Help you avoid IRMAA surcharges
- Improve after-tax returns
- Provide flexibility for Roth conversions
The Role of Asset Allocation
Your asset allocation should evolve as you move through retirement:
Early Retirement (60-70)
- Can maintain higher equity exposure
- Longer time horizon for recovery
- Sequence risk is highest here
Mid Retirement (70-80)
- Gradual shift to more conservative allocation
- Balance growth needs with stability
- Adjust based on portfolio performance
Late Retirement (80+)
- More conservative positioning
- Focus on preservation
- Maintain enough growth to combat inflation
The key is finding the right balance between growth (to combat inflation and longevity) and stability (to weather downturns).
Income Layering for Stability
Creating a stable income floor can reduce your exposure to market volatility:
Guaranteed Sources:
- Social Security
- Pensions
- Annuities (if appropriate)
Variable Sources:
- Portfolio withdrawals
- Part-time work
- Rental income
The larger your guaranteed income base, the more volatility you can tolerate in your investment portfolio.
Practical Actions During Market Downturns
When markets turn volatile, consider these strategies:
1. Review But Don’t React
Check your portfolio less frequently during downturns. Daily monitoring increases stress and can lead to poor decisions.
2. Rebalance Opportunistically
Market volatility creates rebalancing opportunities. When stocks fall, consider buying more at lower prices rather than selling.
3. Delay Major Purchases
If markets are down significantly, postponing discretionary expenses can give your portfolio time to recover.
4. Tap Alternative Income
If you have flexibility, consider part-time work, delaying Social Security, or using home equity to reduce portfolio withdrawals during downturns.
5. Optimize Withdrawal Sources
During downturns, be strategic about which accounts you tap:
- Consider drawing from bonds or cash instead of selling stocks low
- Use required minimum distributions (RMDs) strategically
- Think about tax implications of different withdrawal sources
Using Technology to Model Volatility
Modern planning tools make it easier to prepare for market volatility:
- Stress test your plan with historical bear markets
- Model different return sequences to understand range of outcomes
- See how spending adjustments impact portfolio longevity
- Test recovery strategies before you need them
With ReadyAimRetire’s OnTarget™ planning engine, you can instantly see how different market scenarios affect your retirement plan and adjust your strategy accordingly.
The Behavioral Challenge
Perhaps the biggest challenge during volatile markets isn’t financial—it’s behavioral. Common mistakes include:
- Panic selling at market bottoms
- Abandoning your plan during downturns
- Overreacting to short-term noise
- Making major changes without considering long-term impact
Having a written plan and stress-testing it against volatility before you experience it can help you maintain discipline when it matters most.
Building Your Volatility Management Plan
To protect your retirement from market volatility:
- Establish your income floor from guaranteed sources
- Create liquidity buffers to avoid selling in downturns
- Plan flexible spending that can adjust to market conditions
- Diversify across asset classes and income sources
- Stress test your plan against historical downturns
- Document your strategy before volatility strikes
- Review and rebalance regularly but not reactively
Conclusion
Market volatility is inevitable in retirement, but it doesn’t have to derail your financial security. By understanding sequence risk, implementing strategic buffers, maintaining appropriate asset allocation, and having a clear plan before volatility strikes, you can weather market storms while maintaining your retirement lifestyle.
The key is preparation and discipline. Test your plan against volatility scenarios, establish clear strategies for different market conditions, and stick to your plan when emotions run high.
Model your retirement plan against market volatility and see exactly how different strategies protect your financial future.