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Sequence-of-Returns Risk at the Start of Retirement
Key takeaways
- Sequence-of-returns risk arises when large losses occur at the moment you are withdrawing from your portfolio.
- An average annual return of 7% can lead to completely different outcomes depending on when the downturns hit.
- Protection: reduce withdrawals during a crisis, keep part of the portfolio in bonds or cash, and adjust allocation with age.
- The longer you are in the accumulation phase, the less sequence risk hurts — downturns are welcomed as cheap buying opportunities.
- As retirement approaches (5–10 years out), reviewing your allocation becomes critical.
Sequence-of-returns risk is the danger that bad market years arrive precisely when you are withdrawing money from your portfolio to live on.
Why order matters, not just the average
Two investors can achieve the same average annual return and yet one ends up wealthy while the other runs out of money. Why? If a large downturn arrives in the very first year of retirement, you are selling equities at a low price, shrinking your base, and robbing yourself of the recovery. If the downturn arrives ten years later, you have more wealth to absorb the loss.
Example: same average, different fate
Imagine two scenarios with annual withdrawals of CZK 40,000 from a CZK 1,000,000 portfolio:
- Scenario A: first three years +20%, then a –40% drop — the portfolio survives more easily.
- Scenario B: first three years –40%, then +20% — the portfolio may be depleted prematurely even though the average return is identical.
Practical protection tools
- Bucket strategy: first "bucket" = 2–3 years of expenses in cash or short-term bonds. Second = more conservative assets. Third = equity ETFs for long-term growth.
- Flexible withdrawals: in good years take more, in a crisis take less. Research shows that even a 10% reduction in withdrawals during a bad year dramatically extends portfolio longevity.
- Adjusted allocation: the closer you are to retirement, the more bonds — not because they yield more, but as a buffer against sequence risk.
How to think about this during your working years
If you have 20 or more years until retirement, sequence risk actually works in your favour — downturns are opportunities to buy cheaply. Only in the last 5–10 years before retirement is it time to revise your allocation and reduce equity exposure, so that you are not caught at the worst possible moment.
FAQ
What is sequence-of-returns risk?
The danger that a large downturn arrives right at the start of retirement, when you are withdrawing from your portfolio. Unlike the accumulation phase, an early downturn strips away the base you need for recovery.
How do you protect against sequence-of-returns risk?
The bucket strategy (part of the portfolio in cash or bonds covering 2–3 years of expenses), flexible withdrawals (less in a downturn), and gradually reducing equity exposure in the 5–10 years before retirement.
Does the 4% rule account for sequence-of-returns risk?
The 4% withdrawal rule is calibrated to historical data that already includes sequence-of-returns risk. However, it is not a guarantee — in an extreme downturn immediately after retiring it can fail. Flexible withdrawals are an important safeguard.