Sequence of Returns Risk: How to Protect Your Retirement Portfolio from Early Market Downturns

Planning for retirement is one of the most important financial goals for Americans. While many focus on how much to save or what investments to choose, one often overlooked but critical factor is the Sequence of Returns Risk (SORR). This risk can significantly impact your retirement portfolio, especially if market downturns occur early in your retirement years. In this article, we’ll explore what SORR is, why it matters, and how you can protect your retirement savings from its effects.

What is Sequence of Returns Risk?

Sequence of Returns Risk refers to the danger that the order in which you experience investment returns—particularly negative ones—can dramatically affect how long your retirement savings last. This is especially true when you begin withdrawing from your portfolio.

For example, if the market drops significantly in the first few years of your retirement, your portfolio may lose value just as you start drawing income. Because you’re withdrawing funds during a downturn, you’re locking in losses and reducing the amount of capital that can benefit from future market recoveries.

Why Sequence of Returns Risk Matters in Retirement

Unlike during your accumulation years, when you’re adding to your investments and can ride out market volatility, the decumulation phase (retirement) is more vulnerable. A few bad years early on can have a compounding negative effect.

According to research from the Center for Retirement Research at Boston College, retirees who experience poor market returns early in retirement are more likely to outlive their savings—even if the average return over time is the same as someone who had better early returns.

Real-Life Example of Sequence of Returns Risk

Imagine two retirees, both with $1 million in retirement savings and both withdrawing $50,000 annually. Retiree A experiences strong market returns in the first 5 years, while Retiree B faces a market downturn during the same period. Even if both retirees average the same annual return over 30 years, Retiree B is far more likely to run out of money early.

Strategies to Mitigate Sequence of Returns Risk

There are several effective strategies to reduce the impact of SORR:

1. Build a Cash Reserve: Maintain 1–3 years’ worth of living expenses in cash or short-term bonds. This allows you to avoid selling investments during a downturn.

2. Use a Bucket Strategy: Divide your portfolio into different “buckets” based on time horizon—short-term (cash), medium-term (bonds), and long-term (stocks). This helps manage withdrawals and reduces the need to sell volatile assets during a downturn.

3. Consider a Dynamic Withdrawal Strategy: Instead of withdrawing a fixed amount, adjust your withdrawals based on market performance. For example, reduce withdrawals in years when the market is down.

4. Delay Social Security: Delaying Social Security benefits until age 70 can increase your guaranteed income and reduce the pressure on your portfolio.

5. Work Part-Time or Delay Retirement: Working a few extra years or transitioning into part-time work can give your investments more time to grow and reduce the number of years you’ll need to rely on them.

Importance of Diversification and Asset Allocation

Diversification and proper asset allocation are foundational principles in protecting against SORR. A well-diversified portfolio spreads risk across different asset classes such as U.S. stocks, international stocks, bonds, and real estate. Rebalancing your portfolio annually ensures that your risk level remains aligned with your retirement goals.

The U.S. Securities and Exchange Commission (SEC) emphasizes that diversification can help reduce the volatility of your portfolio over time, which is especially important during retirement. [Source: https://www.investor.gov/introduction-investing/investing-basics/how-invest/diversification]

Utilizing Annuities and Guaranteed Income Products

Some retirees consider using annuities to provide a guaranteed income stream, which can reduce the need to withdraw from investment accounts during market downturns. While annuities are not suitable for everyone, they can be a valuable tool when used appropriately.

Fixed indexed annuities, for example, offer a combination of market-linked returns and downside protection. However, it’s important to understand the fees, surrender charges, and terms before purchasing any annuity product.

Work with a Financial Advisor

Navigating retirement planning and SORR mitigation strategies can be complex. A certified financial planner (CFP®) can help you develop a personalized plan that aligns with your risk tolerance, income needs, and long-term goals. Look for advisors who are fiduciaries and legally obligated to act in your best interest.

Conclusion

Sequence of Returns Risk is a real and potentially devastating threat to your retirement security. However, with proper planning, diversified investments, and smart withdrawal strategies, you can reduce its impact and enjoy a financially secure retirement. The key is to be proactive and prepare for market volatility before it happens.

Disclaimer

This article is for informational purposes only and does not constitute financial, legal, or tax advice. You should consult with a qualified financial advisor or tax professional before making any financial decisions. The information provided is based on sources believed to be reliable but is not guaranteed for accuracy or completeness. Investing involves risk, including the potential loss of principal.