Sequence-of-Returns Risk: The Retirement Threat Nobody Explains

Two people retire in the same year, with the same portfolio balance, and follow the same withdrawal strategy. A decade later, one is financially comfortable and the other has run out of money — not because of anything they did differently, but because of when the market declined relative to when they started drawing income. That is sequence-of-returns risk, and for anyone within five years of retirement, it deserves more attention than it typically receives.

What sequence-of-returns risk actually means

The concept is straightforward, but its implications often catch people off guard. Sequence-of-returns risk is the danger that poor investment returns show up in the first few years of retirement, right when withdrawals are starting. Long-term average returns can still look fine in retrospect, even when the sequence has already done significant damage to the portfolio.

During the accumulation phase, a down year is mostly a paper loss. You're adding money to the portfolio, not drawing from it, so a recovery can fully restore what was lost. In retirement, that recovery doesn't undo the same harm — because you've been selling shares at depressed prices to fund living expenses the entire time the market was falling and working its way back. Those shares are gone. The portfolio is permanently smaller, and every subsequent withdrawal comes from a reduced base.

The math is unforgiving. Two retirees with the same $2 million portfolio and the same average annual return can end up hundreds of thousands of dollars apart, depending entirely on whether the bad years came early or late in the sequence.

Why the years around retirement are the highest-risk window

Sometimes this is referred to as the "retirement red zone" — roughly the five years before and five years after your retirement date. During this window, a portfolio faces the greatest damage because withdrawals compound the losses from any downturn. A bear market that a 45-year-old can largely ignore has an entirely different character when you're 63 and writing yourself a monthly check from the same account.

The risk doesn't disappear once a few years have passed, but its severity diminishes. A portfolio that survives the first decade of retirement with its balance relatively intact has typically absorbed the most dangerous phase. Assets have had time to recover before being drawn down, and the base from which future income is drawn remains healthy.

This is why the years immediately preceding retirement are not simply a continuation of the accumulation mindset. The strategy that built wealth may not be the same strategy that sustains it — and recognizing that distinction early enough to act on it is one of the more consequential planning decisions a pre-retiree can make.

What planning approaches can address it

There is no single tool that eliminates sequence-of-returns risk. What exists is a set of strategies that, used in combination, can reduce the portfolio's vulnerability to a bad early sequence. Each carries its own trade-offs, and no strategy should be applied in isolation from the rest of a financial picture.

Building a cash and short-bond buffer. Holding two to three years of expected withdrawals in cash or short-term bonds means you're not forced to sell equities during a downturn to fund daily expenses. The portfolio's growth assets are left to recover while withdrawals come from the stable layer. This structural separation is widely considered one of the most practical defenses available.

Flexible withdrawal strategies. A static withdrawal rate applied regardless of market conditions adds mechanical pressure in exactly the wrong moments. A flexible approach — one that temporarily reduces discretionary spending or lowers the withdrawal amount after a poor market year — gives the portfolio room to recover. Morningstar's 2026 State of Retirement Income report found that retirees who adjust their annual withdrawals based on portfolio performance can sustain higher starting rates without raising the risk of depletion.

Securing a baseline income floor. Guaranteed income sources — Social Security, a pension, or certain types of annuity income — cover essential living expenses without drawing from the investment portfolio at all. When the floor reliably handles necessities, the portfolio's growth assets can be held through market volatility rather than liquidated under pressure. Delaying Social Security to age 70, where applicable, permanently raises that floor and reduces the portfolio's burden from the start.

Reconsidering the withdrawal rate itself. Morningstar's base-case safe withdrawal rate for new retirees in 2026 is 3.9%, applicable to portfolios with 30% to 50% in equities. This figure is meaningfully higher than prior years, which is encouraging — but it still reflects a range of assumptions that may or may not match any individual's actual situation. Your own number depends on your timeline, spending pattern, guaranteed income, and tax structure.

The goal of retirement income planning is not to chase the highest possible withdrawal rate — it is to build a structure that holds together when conditions are unfavorable, so that a bad market year is a manageable inconvenience rather than a permanent setback.

Where this connects to broader planning

Sequence-of-returns risk doesn't live in a silo. The account you draw from first matters — taxable accounts, traditional IRAs, and Roth accounts each have different tax treatment at withdrawal, and sequencing them thoughtfully can reduce the tax drag on the portfolio at the same time it reduces the sequence risk. Similarly, a business owner who exits the same year they retire may face a large liquidity event that reshapes the entire income structure, making the sequencing question more complex and more important to address in advance.

Real estate holdings, concentrated stock positions, and rollover decisions from a company retirement plan all interact with the same set of risks in different ways. That is precisely why this kind of planning benefits from being treated as a coordinated strategy — adjusting one piece without accounting for the others can introduce its own unintended consequences.

If you're in the years approaching retirement and wondering how your current plan holds up under different market scenarios, our team is glad to walk through it with you.

Common questions

What is sequence-of-returns risk in retirement?

Sequence-of-returns risk is the danger that poor market returns arrive early in retirement, at the same time withdrawals begin. Even if long-term average returns are adequate, selling assets at depressed prices to fund expenses permanently reduces the portfolio — and the damage compounds over time in a way that a later recovery cannot fully reverse.

When is the most dangerous period for sequence-of-returns risk?

The five years before and five years after the retirement date are generally considered the most vulnerable window. During this period, the portfolio is large enough that a market decline has significant dollar impact, and withdrawals begin removing shares before any recovery can take hold. Addressing the risk before this window — not after retirement begins — gives the most planning flexibility.

What is a reasonable safe withdrawal rate in 2026?

Morningstar's 2026 State of Retirement Income report set the base-case safe withdrawal rate at 3.9% for new retirees with portfolios holding 30% to 50% in equities. That rate is not universal — it reflects specific assumptions about portfolio construction and time horizon. Retirees using flexible, adjustable withdrawal strategies may be able to sustain a higher starting rate, while those with shorter timelines or less flexibility may want to start more conservatively. A personalized analysis is the only reliable way to find your number.

Sources

• Morningstar's 2026 State of Retirement Income report sets the base-case safe withdrawal rate at 3.9% for new retirees

• Two retirees with the same $2M portfolio and same average return can end up hundreds of thousands of dollars apart due to sequence