Sequence of returns risk can make or break a financial plan that hasn’t accounted for it.
Most people spend decades building a portfolio, and then spend the last few years before retirement terrified that one bad moment is going to undo all of it.
And honestly — that fear is not irrational. Because the timing of a market crash, relative to when you retire, is really, really important.
A crash when you're 45 is painful, but a crash in your first year of retirement is one of the biggest financial risks retirees face.So let's talk about why it happens— and more importantly, what you can actually do about it.
Why Early Retirement Is the Danger Zone
When you're still working and the market drops, it hurts to look at, but you’ll recover if you keep contributing. You’re buying shares at lower prices, and you're not selling anything — so the loss is mostly on paper. The math is working in your favor even when it doesn't feel that way.
The moment you start withdrawing money to fund your living expenses, that dynamic flips completely. Now those down-market shares aren't just sitting there waiting to recover — you're being forced to sell them at the worst possible time. And every dollar you sell at a loss is a dollar that can never participate in the recovery.
The math that used to work for you is now working against you.
This is what people mean by sequence of returns risk. It's not just about what the market does over time. It's about when those bad years hit. The same average return over 30 years can produce wildly different outcomes depending on whether the bad years came first or last.
If they came first, you may be permanently impaired even if the market fully recovers.
So the first few years of retirement — the early years of withdrawal — those are the most vulnerable. That's the danger zone.
Let's Look at Real Numbers
Say you retire with $1 million and plan to withdraw $40,000 a year — which is a pretty standard 4% withdrawal rate. Then in year one, the market drops 50%. Now you've got a $500,000 portfolio.
But you still need your $40,000 to live on. So now you're withdrawing 8% to keep the same dollar amount, thats double the recommended 4% rule.
And if the market bounces back 50% the next year, which sounds great, you're not back to where you started. The withdrawal in the bad years already happened, your portfolio will stay reduced, and the hole gets harder and harder to climb out of.
You didn't do anything wrong. The market did exactly what markets do sometimes. But the timing made a bad year into a potentially permanent impairment.
This has actually happened to people. The retirees who left work in 2000 and immediately hit the dot-com crash, then 9/11, then started to recover just in time to get hit by 2008 — that sequence was brutal.
People who looked like they were on track, on paper, got severely impaired in terms of actual outcomes. Not because they had a bad plan. Because the sequence went against them.
So What Do You Actually Do About It?
The good news is that this is a plannable risk. It's not comfortable to think about, but it's something you can prepare for.
A cash buffer. One of the simplest strategies is keeping one to two years of expenses in cash or a money market account before you retire. If the market drops in year one, you pull from the cash buffer — not from the portfolio. You give the investments time to recover without being forced to sell at the bottom. Yes, it costs you some return on that cash. But that's really the cost of the insurance, and when you consider what it protects against, it's worth it
The bucket approach. This takes it a step further. Bucket one is cash — one to two years of expenses you never touch during a downturn. Bucket two is three to ten years of expenses in bonds and more conservative assets. Bucket three is long-term equities that you leave alone and only draw from when the market is healthy. The idea is you always have something to pull from that isn't tied to where the stock market is today.
Flexible spending. This one's harder psychologically, but it's powerful. If you're willing to spend a little less in the bad years — reduce spending by 10 or 15% temporarily when the portfolio drops below a certain level — your survival odds improve dramatically. This doesn't mean poverty. It might mean skipping the big vacation one year, or restructuring a little. But that flexibility shows up in a big way on a balance sheet over 30 years.
Want to Know If You're Prepared for This?
We're fee-only CFP® advisors in Austin, TX, specializing in financial plans and asset management for clients nearing retirement. If you haven't stress-tested your plan against a bad sequence of returns, that's worth a conversation.
Schedule A Free Call
What Not to Do
The behavioral traps here are real. People panic, sell at the bottom, lock in losses permanently, and miss the recovery. Some people stop contributing to anything, make drastic changes based on a moment that ends up being temporary, or pretend the math isn't as bad as it is because it's too stressful to confront.
This stuff is emotional. But the decisions made in that panicked state are often the ones that hurt the most. And you can’t time the market. The overwhelming data shows that people try, they fail, and they lose. Heres a chart showing what happens to your total returns if you only miss 10 of the best market trading days.
Ultimately, you don't want to be in a position where a bad market in year one has you making emotional decisions about a 30-year plan. That's the whole point of thinking about this before you retire — not after.
Ultimately
The market doesn't care when you retired, if crashes happen its on you to work with a professional or have a good plan to account for these crashes, be proactive instead of reactive.
A sequence of returns problem isn't something most people see coming — it's not flashy, it doesn't make the news the same way the market drop itself does — but it's one of the most serious risks a retiree can face.
The solution isn't to avoid the market. It's to build a plan that doesn't require you to sell at the worst moment.
Thanks for reading.
FAQ
What is Sequence of Returns Risk?
Sequence of returns risk is the danger that the timing of investment losses — specifically, early in retirement — can permanently damage a portfolio even if the market eventually recovers. When you're withdrawing money to live on, a bad early stretch forces you to sell at low prices, leaving fewer shares to participate in any recovery.
Does sequence of returns risk affect everyone who retires?
Sequence of Returns risk can impact almost all retirement plans, but when you retire if the stock market has good returns early in your retirement then you are not at risk.
What is the 4% rule and does sequence of returns risk change it?
The 4% rule is a general rule of thumb that states to not run out of money you should only take 4% of your investments per year. If you had a large loss in one year then you would have to take out more than 4% to have the same amount, putting your portfolio at risk.
How much cash should I keep in retirement to protect against a market crash?
It depends widely person to person. Each situation is unique and you should take time to understand your situation or work with a financial advisor.
What is the bucket strategy in retirement?
The bucket strategy breaks your investments into multiple buckets to withdraw from. These are typically short term needs and cash, intermediate needs in bonds, and long term holdings in stocks.
How do I know if my retirement plan accounts for sequence of returns risk?
It depends and there is no one size fits all answer to this. In general for portfolios with large cash reserves or investments in conservative investments like bonds you are safer than holding all equities.
Sources and recent readings:
Recent blog:
https://hamiltonfinancialplanning.com/blog/when-to-know-you-should-work-with-a-financial-advisor/
Schwab article:
https://www.schwab.com/learn/story/timing-matters-understanding-sequence-returns-risk
If you have any questions head to HamiltonFinancialPlanning.com to find out more and schedule a free call with our fee only CFP fiduciary advisors who specialize in building financial plans and investment management for clients nearing retirement in Austin and Houston TX.
Scott Hamilton is founder and chief financial officer at Hamilton Financial Planning, a wealth management firm that specializes in providing comprehensive financial planning for retirees. With over 20 years of experience in the financial industry, and having completed over 250 financial plans for retirees across all industries, Scott is passionate about providing his clients with the tools and insight they need to achieve their financial goals. He has a Bachelor of Business Administration in finance from Texas State University and an MBA in international finance from Pepperdine University. Scott has also been happily married to his wife, Gayle, for over 25 years. To learn more about Scott, connect with him on LinkedIn.