Planning for retirement
Sequence of Returns Risk: What a Market Drop Near Retirement Means
A market drop lands differently when you're about to start living off your savings. The losses aren't any bigger, but the timing is worse, and timing matters a lot.
What this comes down to
- Market drops happen, and no one can reliably predict when.
- Losses in the first years of retirement can do more lasting harm than the same losses later. That's sequence-of-returns risk.
- The damage comes mainly from selling investments while prices are down to pay the bills.
- The usual defenses are a cash cushion so you aren't forced to sell, a diversified mix, and spending you can trim in a bad year.
- Nothing removes risk entirely, and every safer-feeling asset has trade-offs of its own.
Why a drop near retirement is different
While you're working, a market drop stings, but you usually don't have to sell anything. Your paycheck covers the bills, and the money you're adding to your workplace plan every payday quietly buys shares at lower prices, which is about the only nice thing anyone can say about a falling market.
Retirement flips all of that. Now you're pulling money out every month or every year, and if prices have fallen, you have to sell more shares to raise the same amount of cash. Those shares are gone for good, so they can't recover when the market does.
That's the whole idea: losses are hardest to climb out of when you're also taking money out.
Sequence-of-returns risk is the name for this: the risk that bad years show up at the wrong time, early in retirement, while you're withdrawing. Two people can earn exactly the same returns over a period, just in a different order, and end up with different amounts of money. With no withdrawals, the order doesn't change the final number. Once regular withdrawals start, it does.
Watch it happen: two retirees, same returns
Take two retirees, Retiree A and Retiree B. Each starts with $500,000 and withdraws $30,000 at the start of every year. Over three years, both get the same three returns: one year of minus 20% and two years of plus 10%. Only the order differs.
- Retiree A gets the bad year first: minus 20%, then plus 10%, then plus 10%.
- Retiree B gets it last: plus 10%, then plus 10%, then minus 20%.
| Year | Retiree A: return | Retiree A: end of year | Retiree B: return | Retiree B: end of year |
|---|---|---|---|---|
| Start | $500,000 | $500,000 | ||
| Year 1 | −20% | $376,000 | +10% | $517,000 |
| Year 2 | +10% | $380,600 | +10% | $535,700 |
| Year 3 | +10% | $385,660 | −20% | $404,560 |
Both took out the same $90,000 and got the same three returns, yet Retiree A finishes with about $19,000 less, because A had to sell right after the drop, leaving less money in the account to ride the recovery.
Stretch that over a real retirement of 20 or 30 years, with bigger swings, and the gap can grow much wider, though it can also shrink if spending adjusts. The example is only there to show the mechanism.
What you can actually do
You can't control the market. What you can control is how much you depend on selling at a bad moment. Below are approaches retirees and planners lean on, and none of them is a guarantee.
Keep a cash cushion
Some people hold enough cash or very short-term savings to cover one to two years of the spending their other income doesn't cover. When the market drops, they spend the cash and give their investments time to come back.
Say you need $30,000 a year from savings and the market falls 20% the spring you retire. With a cushion, you pay the bills out of cash and leave the stock funds alone until prices recover. Without one, you're selling low. The catch is that cash has usually earned less than stocks over long periods and can lose ground to inflation.
Try a "bucket" setup
A bucket plan splits savings by when you'll need the money:
- Near-term bucket: cash and similar savings for the next year or two.
- Middle bucket: bonds or other steadier assets for the next several years.
- Long-term bucket: stocks and other growth assets for later on.
You refill the near-term bucket from the others, ideally from whichever has done well lately. It's an organizing tool, and on its own it doesn't change the total risk of what you own.
Diversify, and check for concentration
Diversification means spreading money across kinds of assets that don't all move together, so when one falls another can hold steady or rise. It won't prevent losses. In a real panic, like the worst weeks of a financial crisis, plenty of assets that normally go their own way can tumble together, and the cushion you were counting on turns out thinner than it looked.
It also means looking for concentration. A big position in one stock, your employer's shares for instance, can pile a lot of risk onto an otherwise balanced plan.
Keep spending flexible
This one's underrated. Some retirees plan to trim spending a little in the years after a big drop, putting off a trip or a new car. Even small cuts in bad years reduce how many shares you sell at low prices.
Lean on guaranteed income
Social Security, a pension, or an annuity pays income that doesn't depend on what the market did that year, so the more of your basic expenses those three cover, the less you'll need to sell in a downturn, and the less a bad year early in retirement can knock your plan off course. Delaying Social Security raises your monthly benefit, and some people delay for exactly this reason. Annuities, though, come with costs and terms you'll want to read very carefully.
Bonds, cash, and gold: where do they fit?
Close to retirement, people start looking harder, sometimes for the first time in decades, at assets that might behave differently from stocks. Each one has a role, and each one has drawbacks.
| Asset | Why people consider it | Trade-offs |
|---|---|---|
| Cash and savings | Stable value, and you can spend from it directly | Low long-term growth; inflation can erode it |
| Bonds | Interest income; steadier than stocks much of the time | Prices fall when interest rates rise; credit risk in some bonds |
| Gold | Has at times moved differently from stocks; some see it as a diversifier | Pays no interest or dividends; price can swing sharply and stay low for years; storage and dealer costs if held physically |
Gold has had strong years and long weak stretches, and neither tells you what comes next. To decide whether a small gold allocation belongs in your plan, read how a gold IRA works, gold IRA vs. gold ETF, and when a gold IRA is not a fit. The short quiz below can help you sort out your thinking.
Mistakes we see
- Not knowing how much of your spending depends on withdrawals.
- Holding far more risk than you could live with if a drop came the year you retire.
- Making changes inside retirement accounts without understanding the costs or tax rules.
The SEC's investor education site, Investor.gov, has free tools on asset allocation and diversification.
Where to start
Do this part early, because the time to prepare is before a drop, when you can think calmly. First, figure out how much you need from savings each year. Then decide how much of that you'd keep in cash or steadier assets, and how much can stay invested for the long haul. Our retiring-in-5-years checklist is a good next step for organizing the rest of your plan.
Common questions
Is sequence-of-returns risk only a problem in the first year of retirement?
The first several years matter most, since that's when your balance is largest and you've got the most withdrawals ahead. A bad stretch just before retirement counts too, because it lowers the balance you start with.
Should I sell my stocks before I retire to avoid a crash?
We wouldn't. No one can reliably time the market, and selling everything risks missing a recovery and losing ground to inflation over a long retirement. A more common path is adjusting your mix gradually and keeping a cash cushion.
How much cash should I keep?
There's no single rule, but one common approach is to hold one to two years of the spending your other income doesn't cover. Where you land depends on your comfort level, your costs, and how much other income you have.
Does gold go up when stocks go down?
Sometimes, but not reliably. Gold has at times moved differently from stocks, and at other times it's fallen right along with them. Don't treat it as a guaranteed hedge.
Can I hold cash or bonds inside my IRA?
Yes. Most IRAs can hold money market funds, CDs, bond funds, and individual bonds, and shifting between investments inside an IRA doesn't create a tax bill.
We base our guides on primary sources such as the IRS, the Department of Labor, and federal regulators. Read our editorial policy. Spot an error? Tell us.
