Sequence-of-Returns Risk at the Start of Retirement
A market decline combined with early withdrawals erodes capital: plan a reserve for the first years.
Published 2026-07-21
Two retirements with identical average returns can end hundreds of thousands of dollars apart, on the order of the years alone: that is sequence-of-returns risk, concentrated at the drawdown's start, when capital sits at its maximum and every sale during a decline crystallizes a permanent loss, units liquidated at a discount no longer joining the recovery. The defence is not predicting markets but reducing forced sales: a reserve of two or three years of withdrawals in liquid deposits and short-term instruments, funding the withdrawals while a decline rights itself; guaranteed income covering the essentials, shrinking the mandatory withdrawals accordingly; a flexible rule postponing postponable spending after a bad year. The allocation keeps equities — a thirty-year retirement needs growth — but is never forced to sell them at the wrong moment. This article prices the risk on twin cases and guides the building of the three defences.
Identify the withdrawals of the first years
Sequence risk rests on a simple fact: two retirees earning the same average return over thirty years can end up in opposite places depending on the order in which those returns arrive. Bad years at the start, combined with withdrawals, deplete capital in a way no later return recovers. The first five years of drawdown therefore concentrate most of the risk. Pricing the withdrawals planned for those specific years, in dollars, is the first step: it is that amount, not the portfolio's total value, that is exposed to the bad scenario.
Understand why selling deepens the decline
A portfolio that falls twenty percent recovers if left alone. The same portfolio from which forty thousand dollars is withdrawn during the trough sells units at depressed prices, and those units never take part in the recovery. The remaining capital is then durably smaller, and each subsequent withdrawal represents a higher percentage of the balance, accelerating the depletion. That mechanism, absent from the accumulation phase where you buy rather than sell, explains why the same investment strategy behaves differently before and after retirement.
Build a reserve that avoids selling
The most direct defence is holding, in cash or very short-term investments, the equivalent of two to three years of withdrawals. That reserve funds the drawdowns during a decline, which lets the rest of the portfolio recover untouched. It gets replenished in positive years, out of the gains. The reserve has a cost: the lower return on that portion. That cost is the price of insurance against the one risk capable of permanently compromising an otherwise reasonable retirement plan, and it is easy to calculate.
Adjust the allocation without predicting markets
The second defence is structural: reducing the equity share in the years surrounding retirement, then letting it rise again gradually once the critical period has passed. That path, counterintuitive since it increases risk with age, protects precisely the window where vulnerability peaks. Flexible withdrawals complete the arrangement: cutting discretionary drawdowns by ten or fifteen percent during a bad year produces an effect comparable to a reserve. None of these measures requires forecasting markets, which is exactly their appeal. They are also cheap, which is unusual for protection against a risk this consequential.
Quebec scenario: compare before confirming
Two colleagues in Trois-Rivières retire one year apart with twin $600,000 portfolios and identical $30,000 annual withdrawals. Ten years later, one still holds $580,000, the other $390,000 — and neither made a mistake: only the sequence of returns differs, the second having absorbed a 25% drop in his first two years. The demonstration, presented by a planner to a future retiree from the same plant, illustrates the risk specific to the start of drawdown: selling during a decline turns a temporary dip into a permanent loss, every unit liquidated at a discount no longer participating in the recovery, and the first years weigh disproportionately because the capital is then at its maximum. The defence is not predicting markets but reducing forced sales. His plan takes shape accordingly: three years of withdrawals in liquid deposits and short-term instruments, a reserve that buys the right to wait out a recovery without selling equities; guaranteed income — public plans and an employer pension — already covering essential expenses, the reserve only has to carry the discretionary lifestyle; and a flexible withdrawal rule, postponable spending getting postponed after a bad year. The allocation, reviewed without a crystal ball, keeps equities for the twenty-five years still to fund. The future retiree leaves with a sentence worth framing: return averages come true over thirty years, but retirement is decided by the order in which they arrive.
Checklist
- Price the first years' withdrawals
- Build two or three years of liquid reserve
- Cover the essentials with guaranteed income
- Write the postponable-spending rule
- Postpone the postponable after a bad year
- Keep equities for the decades still to fund
- Refuse any forced sale into a decline
- Draw from the reserve during troughs
- Rebuild the reserve during recoveries
Frequently asked questions
Why are retirement's first years so sensitive?
Because the capital is then at its maximum and every sale during a decline crystallizes a permanent loss: units liquidated at a discount no longer participate in the recovery. Two retirements with identical average returns diverge by hundreds of thousands depending on the order of the years.
How do I reduce forced sales without predicting markets?
Through a reserve of two or three years of withdrawals in liquid deposits and short-term instruments: it funds the withdrawals while a decline rights itself. Guaranteed income covering the essentials shrinks the mandatory withdrawals accordingly, and a flexible rule postpones postponable spending after a bad year.
Should stocks be abandoned in retirement?
No: a twenty-five or thirty-year retirement needs growth, and an overly cautious portfolio creates its own risk — running out. The defence against sequence risk is not eliminating stocks, but never being forced to sell them at the wrong moment.