Two portfolios can experience the same set of returns in a different order and have different outcomes when money is being withdrawn. The withdrawals change how much remains to participate in later results. This is sequence-of-returns risk, and it helps explain why an average-return assumption alone is not a retirement-income plan.
Why it happens
When regular spending is funded by selling investments after a decline, more units may have to be sold to raise the same dollars. Those units are no longer present for a later recovery. Someone still making contributions can have a different experience, but a market decline does not automatically benefit every saver or force every retiree to sell.
A hypothetical units example
Imagine 100 investment units worth $10 each. Raising $100 would require selling 10 units. If their price were instead $5, the same withdrawal would require 20 units. If the remaining units later returned to $10, the first case would hold $900 and the second $800, ignoring everything else. This is simplified arithmetic about units sold, not a forecast, a complete two-portfolio simulation or a recommendation for a security.
Strategies people use
A cash reserve can fund near-term expenses without an immediate investment sale. Its tradeoff is that cash may lag inflation and forgo other returns. The appropriate amount depends on the household; there is no universally correct number of years to hold.
A bucket approach assigns money to different time horizons. It can clarify which assets support upcoming expenses, but the label alone does not remove market risk or establish how to refill a depleted bucket. Diversification can reduce concentration in one source of risk, but it does not guarantee against losses.
Flexible spending means reviewing withdrawals when results or circumstances change. It may be easier to adjust travel than housing or healthcare. The plan needs practical rules the household can follow rather than a vague promise to spend less if necessary.
A dependable-income floor uses sources such as Social Security, pensions and eligible contractual annuity income to help address essential expenses. These sources have different rules, inflation treatment, survivor benefits and issuer risks. Committing money to an insurance benefit can reduce liquidity, and a guarantee does not make every contract suitable.
Trade-offs
Each approach gives something up. Cash can lose purchasing power, guarantees can restrict access, flexible spending can affect lifestyle and rebalancing decisions require an appropriate investment review. Combining tools is not automatically better unless their roles and costs are clear. Skyway provides insurance education; securities allocation and individualized investment advice belong with the appropriately qualified professional.
A simple test
Ask how essentials would be funded if markets declined early in retirement while a major repair was also needed. Identify the source of those dollars and the consequences of using it. Also consider a longer retirement and a surviving spouse. The answer should not depend entirely on a favorable average-return assumption.
Start with the retirement-paycheck worksheet approach and official retirement resources. If insurance-based income becomes part of the discussion, compare current contract tradeoffs rather than treating an annuity as a cure for every portfolio risk.
Sources and further reading
- Investor.gov — Managing Lifetime Income
- Social Security — Retirement planning considerations
- FINRA — Understanding Annuities
- Schwab Center for Financial Research — Sequence-of-returns risk
Continue exploring
- Continue to the related page
- Three ways to draw income in retirement
- Retirement and Longevity Planning
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