Sequence Risk in Retirement: When Clients Should Draw From Fixed Income First

Sequence of returns risk is the danger that a market downturn early in retirement will permanently damage a portfolio, even if long term average returns turn out fine, because withdrawals taken from a shrinking account lock in losses that compound over decades. Understanding it changes how retirees should draw down savings.

Why the First Years of Retirement Carry the Most Risk

The move from a paycheck to a withdrawal plan is, financially speaking, the shakiest moment in a person's life. If markets fall right as someone stops working, pulling money out of a shrinking account does real harm. Selling shares that have already dropped in value means fewer shares remain to participate when prices eventually recover.

Morningstar research has shown that two portfolios can post identical average returns over a 30 year stretch and still produce wildly different outcomes. One might run out of money more than ten years earlier than the other, purely because of when the losses hit relative to when withdrawals began.

Benjamin M. Howarth, a financial advisor and Special Care Planner, put it bluntly: without a structured plan, sequence risk often decides whether a retirement succeeds or whether the money runs out before it should. He compares selling depreciated stocks for cash flow to grabbing a falling knife. The larger the withdrawal taken from a portfolio in a downturn, he says, the lower the odds that the money lasts through retirement.

Using Bonds and Cash as a Buffer Instead of an Emergency Fund

The fix advisors point to is not complicated in concept, even if it takes discipline to run. Cash, short duration bonds and stable value funds act as a buffer that absorbs day to day spending needs so that stocks are never forced to sell during a downturn. Howarth describes it less as a switch flipped during a crisis and more as a constant, running practice: the fixed income bucket funds withdrawals continuously, not just when trouble hits.

The two five year windows straddling the retirement date, sometimes called the