Sequence of Return Risk: How to Protect Your Retirement from Early Market Downturns

Did you know that two retirees with the exact same retirement nest egg, taking the same annual distribution, and experiencing the same long-term annualized return could have dramatically different outcomes? It's true. In fact, one could run out of money while the other is totally fine. The reason is today's topic: Sequence of Return Risk (SORR).

Many investors know that the long-term historical returns of the stock market, as measured by the S&P 500, have been about 10% a year. But achieving those returns involves lots of bumps along the way. During your working years, when you’re accumulating assets, those market bumps aren’t much to worry about. However, as you transition from living on a paycheck to living off your investments, the timing of those market declines can have a fatal impact.

Here's an interesting fact:

From 1995 – 2024, the S&P 500 returned 10.9% on an annualized basis. But in only two calendar years during that 30-year period did the S&P 500 post a return that was within +/- 2 percentage points of that average.

The lesson? Your calendar year returns are rarely close to the historical average. The order in which those returns occur is what matters most for retirees.

Defining Sequence of Return Risk: Why Timing Your Retirement Matters

Sequence of Return Risk (SORR) is the danger that you’ll encounter a down year or several down years just as you start drawing money from your retirement nest egg. It's the risk that a market decline forces you to sell assets at reduced prices, locking in losses and leaving less capital to participate when the market inevitably recovers.

The Bob and Joe Case Study: Same Returns, Different Results

Let’s look at the example mentioned at the start—two friends with identical initial portfolios and the same annualized return over 20 years, yet they had vastly different outcomes because they experienced their returns in a different order.

Joe’s retirement failed because the negative returns hit just as he started making withdrawals. He was forced to sell a larger percentage of his remaining portfolio, which devastated his future compounding potential. This illustrates why early retirement market volatility is the biggest threat to your withdrawal strategy.

The 4% Rule & Stress-Testing Your Retirement Plan

The famous 4% rule is a widely accepted guideline, but it’s just a starting point. While academic research is robust, there are no guarantees about the future. We view 4% (or Bengen’s recently updated 4.7%) as a reasonable starting point, but a true financial plan must stress-test your specific situation.

We use advanced tools like Monte Carlo simulations to illustrate the range of potential outcomes for our clients, helping them visualize the risk and ensuring their sustainable withdrawal rate is protected.

A Monte Carlo is a dashboard indicator, like the speedometer of your car—it is NOT your financial plan.

The reality is that markets, the tax code, and your personal life require constant modification and adjustment to your plan. A good financial advisor acts as your coach, making proactive adjustments based on the conditions on the field.

Three Proven Strategies to Reduce Sequence of Return Risk

When it comes to maximizing your retirement nest egg, we focus on making sure you draw from the right assets, in the right accounts, in the right order. This disciplined approach allows us to reduce SORR:

1. Build a Cash Reserve (The Royal Reserve Strategy)

We encourage clients to have a cash reserve of 18–24 months of expected living expenses as they enter retirement. We call this the Royal Reserve account.

If your portfolio value declines by 10% or more, we can suspend distributions from your investment portfolio and replace them with cash from your reserve. This buffer helps you avoid selling assets at reduced prices, a critical defense against early-retirement SORR.

2. Use a Reasonable and Flexible Withdrawal Rate

While academic research supports a draw rate in the 3-5% range as sustainable, a truly effective plan is flexible. For example, we might encourage a higher withdrawal rate (5–7%) for a few years to cover expenses before a delayed Social Security claim begins, then drop the withdrawal rate to 3–4% later. Flexibility is the key to long-term retirement sustainability.

3. Implement a Dynamic, Tax-Efficient Withdrawal Strategy

Efficient planning of retirement withdrawals requires constant monitoring. We maximize tax efficiency and reduce SORR by:

• Non-Proportional Selling: When raising cash for distributions, we selectively sell asset classes that have performed well (or declined the least), allowing underperforming assets more time to recover.
• Account Sequencing: We adjust which type of accounts to draw from (Taxable, Tax-Deferred, Tax-Free) based on market returns, changes in the tax code, and your personal cash flow needs. This is what we mean when we say we help you maximize your retirement by drawing the right assets, in the right accounts in the right order—a powerful strategy for tax-efficient retirement income.

Conclusion: Secure Your Retirement Income

Sequence of Return Risk is a very real challenge, but it's not an insurmountable obstacle. The good news is that with a solid plan and a knowledgeable Certified Financial Planner, you can significantly reduce its impact. A comprehensive retirement plan is more than just a number; it requires a strategic, proactive approach that includes:

• Building a cash reserve buffer against market volatility in retirement.
• Adopting a flexible, dynamic safe withdrawal strategy.
• Having a tax-efficient plan for retirement income sequencing.

At Ark Royal Wealth Management, our role is to be your financial coach, helping you make smart, informed decisions so that you can navigate the bumps in the road and enjoy a secure, confident retirement.

If you’re ready to build a retirement plan that is prepared for sequence of return risk and other real-world challenges, we invite you to book a complimentary consultation.