4 Ways to Manage Sequence of Returns Risk in Retirement

Sequence of returns risk, or sequence risk for short, is the risk that you will need to take distributions from your investment portfolio when the market has recently declined. Taking distributions when the market has gone down effectively “costs” more than at other points in time because you are forced to sell your investments at a lower price. Managing your sequence risk is a crucial part of your retirement income planning process. There are four general techniques for managing sequence risk in retirement.

1.  Spend Conservatively

The first way to manage sequence risk in retirement is to spend conservatively. Retirees often aim to maintain consistent, inflation-adjusted spending throughout retirement.

With a total returns investment portfolio, an aggressive asset allocation provides the highest probability of success if spending exceeds what bonds can safely support and annuities are not otherwise considered. However, this requires spending to be low enough to ensure assets last—a challenge when combining market volatility with concerns about outliving savings.

Ultimately, a fearful retiree may spend less with an aggressive investment strategy than they might have had they focused more on fixed income assets. While this approach seeks to mitigate sequence of returns risk, it can actually increase it, as there is no lever to provide relief after a market decline. The only solution is to sell more shares to keep spending consistent.

2.  Maintain Spending Flexibility

The next approach maintains an aggressive portfolio but introduces flexible spending, which mitigates sequence risk by reducing spending after a portfolio decline. This preserves assets for potential recovery.

Such a strategy results in volatile spending amounts, so most practical approaches to flexible retirement spending seek to balance the tradeoffs between reduced sequence risk and increased spending volatility by partially linking them to portfolio performance.

3.  Reduce Volatility (When It Matters Most)

A third way to manage sequence risk is by reducing portfolio volatility, especially when it matters most. A portfolio free of volatility eliminates sequence risk, making constant spending possible.

For retirees seeking stable spending, de-risking the portfolio can be achieved by holding fixed-income assets to maturity or using income annuities.

Other strategies to reduce downside risk include:

• Rising Equity Glide Path: Starting retirement with a low equity allocation and gradually increasing it over time to minimize the impact of early stock market declines.
• Funded Ratio Approach: Using aggressive asset allocations only when assets exceed what’s needed to meet spending goals.
• Income Guarantees: Leveraging contractual guarantees to set a floor on portfolio losses, trading some upside for downside protection.

These strategies seek to balance risk reduction with the potential for sustainable retirement spending.

4.  Buffer Assets - Avoid Selling Investments at a Loss

The final approach to managing sequence risk involves using non-correlated assets outside the financial portfolio to fund spending during market downturns.

A rule of thumb is to keep a cash reserve of 2–3 years’ expenses, providing a safety net when the portfolio declines. However, this comes at the cost of missed growth opportunities, as cash typically earns lower returns.

Other alternatives have gained attention in recent years as potentially more efficient solutions. These techniques can be used individually or combined to address sequence risk effectively.

These four techniques can be used independently or in conjunction with each other, to deal with sequence of returns risk.