When you are close to retirement, every market decline can feel different than it did decades earlier. At this stage, you generally have less time to recover from major losses. While it may be easy to focus on how far the market falls, the timing of a decline can be just as important. A sharp drop shortly before or during retirement could have a greater effect on your savings than a similar loss earlier in your career.
Same Loss, Different Consequences
Financial planners call this sequence-of-returns risk: A 20% loss at age 50 and a 20% loss at age 66 are the same percentage, yet they can have very different effects. What matters isn’t the size of the drop, but when it happens compared to the time you start pulling money out.
A market downturn may be less impactful early in your career because you typically have more time for investments to recover until retirement. You could also continue making contributions during the decline, which allows you to buy additional shares at lower prices.
In retirement, a similar decline may happen after you’ve started taking withdrawals. This could then put you at risk of selling investments while their value is lower. The timing of the loss, combined with ongoing withdrawals, can make it more difficult for a portfolio to recover than the same decline earlier in your investing years.
What Sequence Risk Could Cost an $810K Portfolio
Let’s assume that two retirees each start with an $810,000 portfolio, withdraw $40,000 per year and experience the same average annual return over three years. The only difference is when a 20% market loss occurs. Here’s how both examples compare.
Retiree One: Loss Hits in Year 1
| Year | Withdrawal | Return | Balance |
|---|---|---|---|
| 1 | $40,000 | -20% | $616,000 ($810,000 − $40,000, ×0.80) |
| 2 | $40,000 | +6% | $610,560 ($616,000 − $40,000, ×1.06) |
| 3 | $40,000 | +6% | $604,794 ($610,560 − $40,000, ×1.06) |
Retiree Two: Loss Hits in Year 3
| Year | Withdrawal | Return | Balance |
|---|---|---|---|
| 1 | $40,000 | +6% | $816,200 ($810,000 − $40,000, ×1.06) |
| 2 | $40,000 | +6% | $822,772 ($816,200 − $40,000, ×1.06) |
| 3 | $40,000 | -20% | $626,218 ($822,772 − $40,000, ×0.80) |
As you can see from the tables, Retiree One and Retiree Two start with the same balance, make the same withdrawals and experience the same average return, but the 20% loss lands in a different year. That single difference in timing leaves Retiree Two roughly $21,000 ahead after just three years.
This is a simplified example intended to show how sequence risk could affect different portfolios, not a projection of actual investment performance. Whether your specific portfolio could withstand a downturn early in retirement depends on specific factors like your balance, withdrawal rate and time horizon, which a financial advisor may help you evaluate.
One Way to Help Manage Sequence Risk
A common strategy to minimize sequence risk in retirement is to hold a cash reserve that is big enough to cover one to three years of living expenses. This could help you pay for spending needs during an early market downturn and potentially avoid selling investments while they’re down.
A cash reserve may also offer you more time to recover from investment losses before you need to sell them. A financial advisor can help you estimate how much of a cash reserve to set aside and whether this strategy fits your retirement savings, expected spending and planned withdrawal rate.
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