Why the First Few Years of Retirement Can Matter More Than the Average Return
When people think about investment performance, they often focus on one number: the average return.
That number matters.
But once you begin withdrawing money from a portfolio, when those returns occur can matter almost as much as how much you earn over time.
This is the idea behind sequence-of-returns risk.
Two retirees can begin with the same amount of money, earn the same average return over a period of years, and still end up with very different outcomes simply because their good and bad investment years happened in a different order.
That is one of the reasons retirement investing works differently from investing while you’re still accumulating wealth.
The Same Average Return Can Produce Different Results
Imagine two retirees with identical portfolios.
Both experience the same mix of strong and weak market years over the next decade.
The difference is the order.
One retiree experiences several strong years early in retirement and weaker years later.
The other experiences the weak years first.
If neither person were withdrawing money, the difference between those two sequences might be less important over the long run.
But retirees are usually taking money out of their portfolios.
That changes the system.
When a portfolio declines while withdrawals are also being taken, more shares may need to be sold to generate the same amount of income. Those shares are no longer invested when markets eventually recover.
The loss is not simply the market decline.
It is also the future growth those withdrawn assets can no longer participate in.
Retirement Changes the Math
During your working years, a market decline can actually create an opportunity.
If you’re contributing regularly to a 401(k), IRA, or investment account, lower prices allow new contributions to purchase more shares.
You have time.
You have employment income.
And you’re generally adding money rather than removing it.
Retirement reverses that relationship.
Your portfolio may now be helping replace your paycheck.
Instead of buying during downturns, you may need to sell investments to pay for housing, travel, healthcare, taxes, or everyday living expenses.
That means the same market decline can have a very different effect depending on whether you are accumulating or distributing assets.
This is why the transition into retirement deserves special attention.
Why the Early Years Can Be So Important
A poor market year at age 85 and a poor market year during your first year of retirement are not necessarily equivalent.
Early in retirement, more of your portfolio is still expected to support many future years of spending.
A significant decline at that point can reduce the amount of capital available to recover and compound later.
Add withdrawals to that decline, and the effect can become more pronounced.
This is sometimes called the retirement “danger zone”: the years immediately before and after retirement, when the combination of market volatility and portfolio withdrawals can have an outsized influence on the long-term plan.
The goal is not to predict whether a downturn will occur during those years.
No one knows that in advance.
The goal is to build a plan that does not depend on markets cooperating at exactly the right time.
Average Returns Can Hide the Path You Took
Suppose someone hears that a portfolio historically averaged a certain annual return.
It can be tempting to imagine retirement unfolding smoothly:
Growth each year.
Withdrawals each year.
A steadily declining—or perhaps even growing—account balance.
Real markets rarely behave that way.
Returns arrive unevenly.
One year may be strong. Another may be flat. Another may produce a significant decline.
An average smooths all of that into one number.
Useful? Yes.
Complete? No.
Retirement planning has to account for the path between the starting point and the average.
That path matters because withdrawals happen along the way.
Cash Can Play a Different Role in Retirement
One way retirees may manage sequence risk is by maintaining a portion of their plan in cash or other relatively stable assets.
The purpose is not necessarily to avoid investing.
It is to create flexibility.
If spending needs can temporarily be met without selling growth-oriented investments after a significant market decline, the portfolio may have more time to recover.
How much liquidity is appropriate depends on the individual.
Someone with a pension and substantial Social Security income may need less portfolio income than someone relying heavily on investments.
Again, the right answer comes from looking at the system rather than one account.
Spending Flexibility Can Matter Too
Another potential tool is flexibility.
Not every retirement expense is equally fixed.
Housing, utilities, food, and healthcare may leave little room for adjustment.
Travel, major purchases, gifts, or discretionary spending may offer more flexibility.
That does not mean retirees should stop enjoying retirement whenever markets fall.
It means that a plan with some adjustable spending may be more resilient than one requiring the exact same portfolio withdrawal regardless of market conditions.
Small changes made temporarily can sometimes have a larger long-term effect than they appear to in the moment.
Diversification Still Has a Job
Sequence-of-returns risk is also one reason diversification remains relevant in retirement.
Different investments serve different purposes.
Some assets may be positioned for longer-term growth. Others may provide stability or income. The goal is not necessarily for every part of the portfolio to perform well at the same time.
It is to avoid depending on one source of return for every financial need.
That can create more options when markets become unpredictable.
And options matter.
A resilient retirement plan is often one that gives you several reasonable choices rather than forcing one decision.
The Solution Isn’t Simply “Take Less Risk”
It would be easy to conclude that sequence risk means retirees should become extremely conservative.
But that creates another problem.
Retirement may last decades.
A portfolio that becomes too conservative may struggle to keep pace with inflation and long-term spending needs.
So the question is not:
How do we eliminate market risk?
It is:
How do we manage market risk while still giving the portfolio an opportunity to support a long retirement?
That balance will look different for every household.
Retirement Income Is a System
Sequence-of-returns risk reveals something broader about retirement planning.
Investment returns cannot be considered in isolation.
They interact with withdrawals.
Withdrawals interact with taxes.
Taxes can influence which accounts you use.
Social Security and pension income affect how much you need from investments.
Cash reserves can influence whether investments must be sold during difficult markets.
Each decision changes the environment for the next one.
That is why retirement income planning is less about finding one perfect investment and more about coordinating the different pieces of the system.
At Swan Retirement Planning in Ventura, CA, we help individuals and families think through how investments, income, withdrawals, and risk work together throughout retirement.
Because the goal is not to predict the order of future market returns.
It is to build a plan that can adapt when the order is not what you hoped for.
To discuss your retirement income and investment strategy, contact Swan Retirement Planning at (805) 570-3765 to schedule a complimentary consultation.
Frequently Asked Questions
What is sequence-of-returns risk?
Sequence-of-returns risk is the possibility that the order in which investment gains and losses occur can affect how long a retirement portfolio lasts. It becomes especially important when someone is withdrawing money from investments during periods of market decline.
Why is sequence risk greater near retirement?
The early years of retirement can be especially important because a retiree may be withdrawing money while still depending on the remaining portfolio to support many future years. Large early losses combined with withdrawals can leave fewer assets available to participate in a later recovery.
How can retirees prepare for sequence-of-returns risk?
Strategies may include maintaining appropriate cash reserves, diversifying investments, creating flexibility around discretionary spending, coordinating income sources, and periodically reviewing the withdrawal strategy. The appropriate approach depends on individual goals, resources, and income needs.
Investment advisory products and services made available through Impact Partnership Wealth, LLC (IPW), a Registered Investment Adviser. Neither the firm nor its agents or representatives may give tax or legal advice. Individuals should consult with a qualified professional for guidance before making any purchasing decisions. Investing involves risk, including the potential loss of principal.
