You’ve had your retirement party, turned in your badge, and finally stopped worrying about deadlines and meetings. Having saved and invested for decades, you’re ready to make the switch from accumulating money to actually living off of it.
Even better? Your plan looks solid. As such, with a $1 million nest egg, you plan to withdraw about $40,000 each year using the 4% rule. It’s a strategy you’ve heard endorsed countless times.
Then, out of nowhere, the market drops 20%. As a result, we tend to comfort ourselves with an old saying: the market will always recover.
Historically, that’s true, but the process isn’t guaranteed, immediate, or linear. The S&P 500, for example, usually bounces back within a few years after a bear market. But the timing and severity of these drops vary widely, making bounces a longer-term trend rather than a short-term guarantee. This reassurance can be dangerously inadequate for retirees.
In retirement, the order in which market returns occur is just as important as the returns themselves. It’s known as sequence-of-returns risk, and it’s a major reason why well-funded retirement plans fail.
Why Retirement Changes the Rules of Investing
Market downturns can be frustrating while you’re working. However, it’s often beneficial.
That sounds counterproductive. As long as you make regular contributions, though, you can buy more shares at lower prices. As a result of those extra shares, growth is accelerated when markets rebound. This is the quiet power of dollar-cost averaging.
This dynamic is flipped when you retire.
Rather than adding money, you’re withdrawing it. As markets decline, you may need to sell investments at depressed prices to generate income. If you sell those shares, your portfolio will have a limited chance of regaining what you lost.
Sometimes, this reversal is called dollar-cost ravaging. Basically, it’s what drives sequence risk. In the same way that a market decline benefits workers, it can seriously harm retirees as well.
Two Retirees, Same Returns—Very Different Outcomes
Let’s take a look at two hypothetical retirees to see how this works in practice.
Each retires with $1 million. Every year, both withdraw $50,000. Over 25 years, both have earned an average annual return of 6%.
On paper, they’re identical. The only difference? Timing.
During the first few years of retirement, the first retiree experiences strong market gains. Their portfolio grows faster than withdrawals, creating a cushion to absorb future downturns. Years later, when markets decline, the damage is manageable.
The second retiree is unlucky. In the first two years, the market drops sharply. Now withdrawals are coming from a shrinking portfolio, rather than a growing one. For the same income, shares must be sold more frequently, affecting the portfolio’s ability to recover permanently.
Despite identical long-term averages, the outcomes are completely different. Upon retirement, the first retiree has substantial assets remaining. In the second case, the money runs out years before it should.
This is the danger of sequence risk: average returns don’t tell the full story.
The Compounding Problem That Makes Early Losses So Dangerous
The sequence risk is particularly destructive because withdrawals interact with market declines.
Let’s say you start retirement with $1 million and expect to withdraw $40,000 a year, which is a 4% withdrawal rate. When the market falls 20%, your portfolio immediately falls to $800,000.
To maintain the same income? Withdrawals of $40,000 now represent a 5% draw on remaining assets.
As a result of that higher effective withdrawal rate, a compounding problem arises. When the economy is in a downturn, every dollar that is removed does not have the chance to recover or compound in the future. It’s not just that the portfolio shrinks, it’s also less resilient.
This is why financial planners often emphasize the importance of the first few years of retirement. An early loss can permanently derail a plan, whereas later losses are less likely to do so.
Why the First Five Years Matter More Than the Last Five
In the first five to ten years after retirement, planners often refer to this period as the “red zone” for sequence-of-returns risk.
At this time, your portfolio is at its largest and most exposed. As a result, withdrawals begin immediately, since you haven’t had time to build a buffer from market gains.
In most cases, a market downturn in retirement can be handled. However, when a downturn occurs soon after retirement, it can be devastating.
It’s for this reason that retirement planning isn’t just about long-term growth. It’s about being resilient during the most vulnerable times.
How Retirees Can Reduce Sequence Risk in 2026
While you cannot control the stock market, you can control your exposure to it. The following is how modern retirees are protecting their portfolios this year.
The “cash bucket” strategy.
In a cash bucket strategy, two to three years of living expenses are held in liquid, high-yield investments, such as HYSAs yielding 4.00%-4.35% APY as of January 2026, to avoid being a “forced seller” during downturns. In bull markets, stock gains are withdrawn; in bear markets, withdrawals shift to cash buckets, allowing equities to recover.
Key components of the strategy.
- Cash bucket. For immediate needs and to avoid selling assets during a downturn, hold 1–3 years’ expenses in cash or cash equivalents.
- Defensive bucket. Usually held for 3–7 years, bonds or fixed-income assets are part of this portfolio.
- Equity bucket. Aim for long-term growth (7+ years) to combat inflation and replenish other buckets.
The flexible withdrawal method.
Rigid withdrawal rules are falling out of favor. In today’s retirement landscape, flexibility matters more than precision.
With flexible withdrawal strategies, spending can be adjusted based on market conditions rather than committing to a set amount each year. Suppose the market drops 10%, for example, a simple “guardrail” might mean skipping your cost-of-living adjustment or trimming discretionary spending by 10%. These small, temporary changes can significantly impact portfolio longevity.
Morningstar’s research for 2026 confirms this shift. Based on its analysis, a traditional “safe” fixed withdrawal rate of 3.9% is calculated, assuming a 30-year retirement, a stock allocation of 30%–50%, and annual inflation adjustments. However, dynamic spending strategies can allow retirees to withdraw more upfront safely.
Under the right market conditions, withdrawals can be adjusted to reach 5.2% to 5.7%, cutting back during downturns and increasing during strong periods. There are times when it’s possible to approach 6% without significantly increasing the risk of running out.
In order to implement this, guardrails make sense as one of the most practical approaches. As portfolio values fall, inflation increases are slowed, or withdrawals are reduced modestly. Withdrawals can increase, often by as much as 10%, when markets perform well.
The takeaway? Although fixed, inflation-adjusted withdrawals may feel predictable, they’re often inefficient. Adapting spending to market realities can not only reduce risk but also provide a higher, more sustainable income in retirement.
Diversify into “non-correlated” assets.
As a result, traditional 60/40 portfolios, with 60% stocks and 40% bonds, have come under increased pressure in recent years. When markets are stressed, stocks and bonds tend to move in the same direction, reducing diversification for retirees.
In 2026, more retirees will adopt a “buffer” strategy: investing in income-producing assets not closely tied to the S&P 500. A dependable cash flow will reduce the need to sell stocks when the market declines, not for higher returns.
Common buffer assets include:
- Fixed Indexed Annuities (FIAs). In addition to protecting principal, FIAs can offer limited participation in market gains, typically with a 0% downside floor. In 2026, higher interest rates have improved income features, but returns are capped, and liquidity is limited.
- Dividend growth stocks. In addition to providing ongoing income, they do not require shareholders to sell their shares. Rather than chasing the highest yields in 2026, investors are looking for companies with long histories of increasing dividends.
- Real estate and REITs. Rental income generated by real estate investments and REITs is often less affected by short-term market fluctuations. Due to rising rents and property values, they can also offset inflation.
- Private credit. Unlike traditional bonds, private lending provides an alternative source of income. While public fixed-income markets offer inconsistent diversification, private credit can offer additional income stability.
The ultimate purpose of this diversification is risk management, not the elimination of total risk. By creating a “buffer” of income-generating assets, retirees can avoid the “sequence of returns” risk—liquidating stocks at the exact moment the market is down.
Why “Average Return” Can Be Misleading in Retirement
One of the biggest misconceptions about retirement planning is focusing on average returns.
When losses occur early and withdrawals remain constant, even a portfolio that averages 7% per year can fail. Meanwhile, a portfolio with lower average returns but better timing and flexibility may succeed.
During retirement, sequence matters more than averages. This is why retirement planning needs to change. Even though growth remains important, it can no longer be the sole priority. Equally important are income stability, flexibility, and protection.
The Bottom Line
Even when retirees do everything right, the sequence-of-returns risk is the hidden cause of their financial plight.
Whenever you retire, your biggest threat isn’t losing out on gains. It’s suffering major losses at the wrong time.
Diversifying your income sources, building cash reserves, and remaining flexible with withdrawals can help you protect decades of savings from a bad year.
It’s not about timing that makes a retirement successful. It’s about timing, not ruining the plan.
FAQs
How is sequence risk different from normal market risk?
Market risk refers to the possibility that investments will lose value. In sequence risk, losses occur when assets must be sold during the withdrawal phase, when selling assets is inevitable.
Is the 4% rule still reliable in 2026?
It’s a good benchmark, but Morningstar suggests 3.9% is a safer bet for a 30-year horizon, given today’s valuations. A flexible approach, however, can often lead to a higher start point.
Why are the first five years of retirement so critical?
Because your portfolio is at its maximum size. If a $1M balance drops 20%, that’s a $200k loss. If a $200k balance drops 20%, that’s a $40k loss. In terms of “weight,” early losses are more significant.
What is a rising equity glidepath?
This strategy gradually increases equity exposure over time while reducing early vulnerability, thereby preserving long-term growth.
Does holding cash hurt returns?
Yes, slightly. When it comes to retirement, avoiding forced selling during downturns can often be more important than maximizing average returns.
Image Credit: Nataliya Vaitkevich; Pexels
