Stock market fluctuations can pose significant risks for your portfolio, especially in the early years of retirement. This is something investors often overlook, as noted by financial experts. They refer to this as the “sequence of returns risk,” highlighting how withdrawing funds during a market slump can dramatically impact the longevity of your retirement savings.
Amy Arnott, a portfolio strategist with Morningstar Research Services, warns that the first five years of retirement are critically risky when it comes to withdrawing funds if the market isn’t performing well. She emphasizes that taking money from your accounts when values are decreasing leaves less capital in your portfolio to recover when the market rebounds.
Moreover, facing unfavorable sequences of returns raises the likelihood of depleting your retirement savings earlier than expected. For instance, imagine your portfolio takes a hit of at least 15% in your first retirement year while you withdraw 3.3% of its total value. A 2022 report by Morningstar suggests this scenario is six times more likely to exhaust your portfolio within 30 years than if you started with a positive return. Their analysis was based on fixed future annual withdrawals proportionate to the original portfolio.
Fidelity Investments backed this up in a 2024 report, indicating that negative returns are more detrimental in the early retirement years. Retirees thereby lose out on the magic of compounding growth. David Peterson, who heads advanced wealth solutions at Fidelity, acknowledges how challenging it can be to recover from early losses. Conversely, a few years of positive returns from the get-go can align the markets favorably for retirees.
As retirement approaches, maintaining a “balanced asset allocation” emerges as a key strategy to mitigate sequence risk, says Arnott. She suggests a portfolio mix of 60% stocks and 40% bonds to reduce sequence risk as opposed to heavier stock investments. Peterson adds that with the right asset allocation, your portfolio might not experience the same extreme dips as the stock market, although the appropriate mix should reflect your personal goals and risk appetite.
Another strategy is the “bucket approach,” which can help buffer against market turbulence. According to Arnott, this involves keeping cash on hand for one to two years of living expenses, providing accessible funds during downturns. The following five-year period could utilize short- to intermediate-term bonds or bond funds. The third bucket, meanwhile, is aimed at growth and consists of stocks.
This method does require annual maintenance, but it’s designed to offer “peace of mind” by helping to manage sequence of returns risk effectively.
