The Sequence-of-Returns Risk: The Biggest Threat to a New Retiree's Wealth
Why the timing of market returns matters as much as the average return — and how to protect against it
Imagine two retirees who both earn an average investment return of 6% per year over a 20-year retirement. Both start with $1 million. Both withdraw $60,000 per year. One runs out of money before the end of retirement; the other still has a significant balance. The difference? The order in which the returns arrived.
This is the sequence-of-returns risk, one of the most important and least discussed threats to retirement financial security. It explains why two people with identical average returns and identical spending can have dramatically different outcomes, and why managing this risk is a central priority in retirement income planning.
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Why the Sequence of Returns Matters
During the accumulation phase, the sequence of investment returns is largely irrelevant. If you're contributing regularly over decades, poor early returns are actually beneficial. You buy more units at lower prices, and the eventual recovery lifts a larger holding. The order doesn't matter much; only the average return over time.
Retirement flips this dynamic entirely. When you are withdrawing from a portfolio, rather than adding to it. A poor market early in retirement causes real, permanent damage that cannot be recovered from, even if returns normalize later.
Here's why: in a declining market, you must sell assets to fund your withdrawals. Each sale reduces the number of units you hold. When markets eventually recover, you are recovering a smaller base so the gains apply to less. The units you sold at depressed prices are gone permanently.
The Math of Early Losses
A retiree who experiences a 50% market loss in Year 1 of retirement and then earns the long-run average return thereafter may exhaust their portfolio 5–10 years earlier than a retiree who experiences the same average return with the 50% loss arriving in Year 20. The early loss, combined with ongoing withdrawals, creates a compounding deficit that may not be recoverable. This is mathematically provable and profoundly important.
How Big Is the Risk?
The sequence risk is greatest in the first five to ten years of retirement. This is sometimes called the 'retirement red zone'. The period when a large sustained market downturn is most damaging. A retiree who experiences a severe bear market in the first decade of retirement has the least time to recover and the highest withdrawal burden relative to their declining portfolio.
Conversely, a retiree who experiences a strong first decade, even if returns moderate later, generally does quite well. The early positive returns compound on a large base, providing a cushion against later volatility.
Strategies to Manage Sequence-of-Returns Risk
1. The bucket strategy and cash buffer
Maintaining two to three years of expenses in cash, short-term GICs, or T-Bills means you are not forced to sell equities during a downturn. You draw from the cash bucket while waiting for equity markets to recover, preserving your investment portfolio at or near its low.
2. Flexible spending
Retirees who can reduce discretionary spending in a down market. Such as cutting back on travel, dining, or gifts without affecting their core lifestyle. Have a powerful tool for managing sequence risk. Even a 10–15% temporary reduction in withdrawals in a severe bear market can significantly extend portfolio longevity.
3. Guaranteed income floor
Maximizing guaranteed income sources, CPP (especially if deferred to 70), OAS, defined benefit pensions, and potentially annuities create an income floor that doesn't depend on market performance. When your essential needs are covered by guaranteed income, your investment portfolio becomes discretionary. Meaning you can leave it untouched (or even add to it) during market downturns.
4. Conservative initial withdrawal rates
Traditional financial planning often cited a '4% rule'. Withdrawing 4% of the portfolio in year one and adjusting for inflation each year was said to sustain a 30-year retirement in most historical scenarios. More recent research, particularly in a lower-return environment, suggests that 3.0–3.5% may be more sustainable for those with 30+ year retirements. Starting with a conservative withdrawal rate provides a buffer against sequence risk.
5. Asset allocation adjustments in the red zone
Some retirement income specialists recommend a slightly more conservative portfolio allocation in the five years immediately before and after retirement. The height of sequence-of-returns exposure and then gradually allowing more equity exposure as the portfolio grows and the sequence risk window passes. This is sometimes called the 'equity glide path.'
What About Bond Allocation?
Bonds have traditionally been the primary tool for managing sequence risk. Holding bonds reduces portfolio volatility, and bonds can be sold to fund withdrawals when equities are down. However, in a rising interest rate environment, bonds can also lose value. Sometimes substantially, which reduces their effectiveness as a portfolio stabilizer.
A more robust approach typically combines bonds with other diversifying assets. Such as cash, infrastructure, international equities, and real assets to reduce the reliance on any single risk offset.
Have You Stress-Tested Your Retirement Plan?
Sequence-of-returns risk is invisible in good times and devastating in bad ones. We stress-test our clients' retirement plans against a range of market scenarios — including severe early downturns — to ensure their income strategy is resilient regardless of what markets do in the crucial early years of retirement.
Contact us today for a complimentary retirement income consultation.
Disclaimer
This publication is for informational purposes only and has been prepared from public sources which are meant to be reliable. None of the information in this should be construed as investment advice. Speak to your Investment Advisor to learn if this product is right for you. Designed Securities Ltd. (DSL) is regulated by the Canadian Investment Regulatory Organization (CIRO), and a Member of the Canadian Investor Protection Fund (www.cipf.ca). Christopher Burke is registered to advise in securities to clients residing in Ontario. The views expressed are those of the author and not necessarily those of DSL. This report does not constitute an offer or solicitation in any jurisdiction in which such offer or solicitation is not authorized or to any reliable person to whom it is unlawful to make such offer or solicitation. Content is accurate as of the date of publication, and subject to change without notice.
