Strategic Risk Mitigation Protocol
Sequence-of-returns risk is the most preventable retirement mistake. Discover the five structural guardrails that defuse it — for pre-retirees in MN and FL.
For most of the modern history of retirement planning, the conversation focused on average returns. If your portfolio averages 7 percent a year, and you withdraw 4 percent a year, you should be fine.
That sentence is true on average. The problem is that you do not retire on average. You retire on a specific day, in a specific year, into whatever market conditions happen to exist that month.
The risk that the specific year you retire happens to be a bad year for stocks is called sequence-of-returns risk. For decades it was barely discussed. Today it is the most preventable mistake in the five years before retirement — and the one most pre-retirees are not actively defending against. This post explains what it is, why it matters specifically in the years right around retirement, and the five structural fixes that defuse it.
Two retirees can have identical 30-year average returns and identical 30-year average withdrawals — and end up in completely different places.
Consider two pre-retirees, both with $1 million portfolios, both withdrawing $40,000 a year (4 percent of the starting balance, adjusted for inflation), both earning an average of 6 percent a year over thirty years. The only difference is when the bad years happen.
Hits a 20 percent loss in year one. Recovers over the next 5 years. Smooth sailing after that.
Smooth sailing for the first 25 years. Hits the same 20 percent loss in year 26.
Same average return. Same average withdrawal. Different outcomes. Retiree A is far more likely to run out of money, because the early loss happened when they were also pulling withdrawals out of a smaller pool. Every dollar they sold to fund living expenses in year one was a dollar that could not recover when the market came back. The math compounds.
Retiree B never had this problem, because the bad year hit after 25 years of growth — the portfolio was much larger by then, the percentage drop was the same, but the dollar withdrawals were a smaller fraction of the remaining balance. This is sequence-of-returns risk. The same return profile produces different outcomes depending on when the bad years arrive.
There is a window — roughly the five years before retirement through the first five years after — where sequence risk is at its peak. Before that window, you are still earning. A bad market year hurts the portfolio but does not force a sale. The salary continues. The contributions continue. After that window, the portfolio is either large enough to absorb a drop without much damage, or the withdrawal-to-portfolio ratio has shifted enough that a percentage drop matters less.
But in that 10-year window, the portfolio is at its largest, the withdrawals have started or are about to start, and there is no salary backstop. A bad year in this window is a bad year you cannot easily recover from. This is what makes sequence risk specifically a pre-retiree concern. Not a generic investing concern. Not something for 35-year-olds to worry about. The clock starts at roughly age 55.
Here is the part most pre-retirees miss. Markets drop. They have always dropped. Even the worst single-year drops in modern history have been followed, eventually, by recoveries. A pre-retiree who can ride out a 30 percent drop without selling investments at the bottom is usually fine — the portfolio recovers, the plan continues.
The damage from sequence risk is not the drop itself. The damage is being forced to sell investments at the bottom to cover living expenses. If the plan requires $50,000 a year from the portfolio, and the portfolio has dropped 30 percent, the $50,000 you sell is coming out of stocks that are temporarily worth 30 percent less than they were six months ago. Those stocks would have recovered. You will not get them back. This is why the structural fix matters more than the predictive one. You cannot predict the timing of the next drop. You can guarantee that you will not have to sell at the bottom when it happens.
How much of your portfolio is in stocks today? Write the number down. A 30-year-old with 90 percent in stocks is making a reasonable bet. A 63-year-old who is going to retire next year with 90 percent in stocks is making a different bet — one where a bad year would force them to sell stocks at the bottom to fund retirement expenses. The right equity allocation for the years immediately around retirement is a personal answer that depends on other income sources, total assets, spending needs, and risk tolerance. But it is rarely the same as the allocation that got you through your 40s and 50s.
This is the single highest-leverage structural fix. If you are about to retire and you hold 12 to 24 months of living expenses in cash, money market funds, or short-term Treasury holdings, you have given yourself a buffer. A 30 percent market drop in year one is no longer a forced-selling event. You spend down the cash reserve while the market recovers. You do not touch the stocks. For most pre-retirees, building this cash reserve is the work of the last 12 to 24 months before retirement.
Most pre-retirees do not have this written down. The honest answer to "what would change about your plan if the market dropped 30 percent on the day you retire" should not be improvised in a panic. It should be a written contingency. The plan might include: pulling more from cash reserves and less from the portfolio. Delaying a discretionary expense. Pulling Social Security a year earlier than originally planned. Reducing the year-one drawdown rate from 4 percent to 3.5 percent. Any of these is a legitimate response. The point is to decide which ones, in what order, in advance.
The default drawdown order — taxable accounts first, traditional retirement accounts second, Roth accounts last — assumes a relatively normal market. In a downturn, the order may change. For example, if the market is down 30 percent at the start of retirement and you have a substantial cash position in your taxable brokerage, drawing from cash first preserves both the taxable stocks and the tax-advantaged accounts. Or if you have a Roth, drawing from Roth in a down year may make sense because Roth withdrawals are tax-free. The order is not the point. The point is having the order written down before you need it.
Social Security is the closest thing most retirees have to a sequence-risk insurance policy. The check arrives regardless of what the market is doing. A pre-retiree who is on the fence about claiming Social Security at 67 versus 70 may want to know in advance: if the market is down 25 percent on the day I would otherwise claim at 70, would I claim earlier to reduce portfolio withdrawals during the recovery? The answer depends on the specific numbers. The question itself is what most pre-retirees have not thought through.
A pre-retiree couple in Sarasota, retiring at 64 with a $1.6 million portfolio and Social Security claims planned for 67 and 70, looks like this with sequence risk defended:
That is a structural defense. None of it requires predicting the market. All of it requires writing things down in advance.
A pre-retiree couple at the same wealth level, with the same portfolio, but undefended:
If the market cooperates, this couple is fine. If the market does not cooperate, they are selling stocks at the bottom in year one to fund living expenses. The damage compounds. The recovery is partial.
Sequence-of-returns risk is not exotic. It is not a black-swan concern. It is the ordinary risk of retiring into a year that happens to be a bad year for stocks. Bad years happen roughly every five years on a long enough timeline. There is no reason to assume yours will not be one of them.
The good news is that the fix is structural, not predictive. You do not need to know when the bad year will hit. You need to have the structure in place so that when it hits, the plan keeps working. Sequence risk is the most preventable mistake in the five years before retirement. The fix is structural, not predictive.
Sequence-of-returns risk is the risk that the specific year you retire happens to be a bad year for stocks. Two retirees with identical average returns and identical average withdrawals can end up in completely different places depending on when the bad years arrive. An early loss — taken while you are also pulling withdrawals out of a smaller pool — is far harder to recover from than the same loss years later.
The fix is structural, not predictive: you do not need to predict the crash, only to be positioned so you are not forced to sell at the bottom. The core guardrails are knowing your equity exposure, holding one to two years of expenses in cash or short-term reserves, writing a contingency for a 20 to 30 percent drop, setting your downturn drawdown order in advance, and keeping your Social Security claiming decision flexible.
It is roughly the five years before retirement through the first five years after — about a ten-year window where the portfolio is at its largest, withdrawals have started or are about to, and there is no salary to backstop a bad year. The clock starts at roughly age 55.
No — it is specifically a pre-retiree concern, not a generic investing worry for 35-year-olds. Before the risk window you are still earning, so a bad market year hurts the portfolio but does not force a sale. The danger concentrates in the years right around retirement.
Five structural guardrails: know your equity exposure; hold one to two years of expenses in cash or short-term reserves; write down what changes if the market drops 20 to 30 percent next year; know which accounts you would draw from first in a downturn; and understand how a year-one downturn changes your Social Security claiming decision.
The five structural guardrails above are part of the broader work of getting your retirement plan ready to weather any year-one market environment. If you are 5 to 10 years from retirement and want a structured way to see which of the guardrails you already have in place and which ones still need work, our free Pre-Retiree Readiness Checklist walks through this question and four others every pre-retiree should be answering.
If your gap is specific — you know about sequence risk but have not put the structural defense on paper — a 30-minute call with an advisor at Hance Financial is the fastest path to a written plan. No obligation, no pressure. Retire with confidence.