Recently, I talked about the 4% rule and how it’s historically conservative, with average withdrawal rates potentially as high as 7% annually. But here’s the kicker: averages hide the risk of when bad returns happen.

This is what we call sequence of returns risk. Imagine retiring at the end of 2007 with $2 million saved. You’re ready for the good life, ready to enjoy retirement. Then the market drops 51%. Suddenly, that $140,000 withdrawal doesn’t look very safe anymore. 

In today’s article, we’ll highlight some major market downturns over the last few decades and discuss seven real strategies to help you protect against this dreaded sequence of returns risk. 

What is Sequence of Returns Risk? 

Sequence of returns risk is the danger that the timing of withdrawals from your retirement account could negatively impact your portfolio’s overall rate of return. This risk becomes particularly significant when you begin withdrawing funds from your investment portfolio in retirement. 

The sequence of returns in the first few years of retirement can determine whether your savings last a lifetime. Unlike pre-retirement years, when you’re accumulating assets, the sequence of returns matters significantly once you start withdrawing money. 

For example, two retirees with identical portfolios and withdrawal rates can have dramatically different outcomes based solely on when they retire. If you retire just before a market downturn, your portfolio may never recover, even if the market eventually rebounds. 

Historical Market Downturns: A Look at Bear Markets 

To understand the real impact of sequence of returns risk, let’s examine some significant market downturns that could have affected retirees. 

The Dot-Com Bubble (2000-2002) 

This period was particularly painful because there were actually two separate bear markets in a three year span: 

• In March 2000, there was a total drawdown of 36% over 18 months 
• After a brief rally from January 2002 through October 2002, prices dropped another 33% 

This means you had two 30+ percent drops in basically a three-year period. This is why this time is often called “the lost decade.” The markets were flying in the 90s because of the dot-com boom. Anything with a dot-com at the end of its name was soaring in price, and people were feeling euphoric. 

I guarantee some folks tried to retire around 2000 after seeing their 401(k) grow to $2 million. They were feeling confident until they experienced a 36% drop at the beginning of 2000 and then another 33% drop in 2002. 

The Great Recession (2008-2009) 

From October 2007 through November 2008, prices dropped 51%. Then, after a brief rally at the end of 2008, from January 2009 through March 2009 (ultimately hitting bottom on March 9, 2009), prices dropped another 27%. 

I’ve talked to people who retired around this time. Thankfully, many stayed retired, which was great. But I also know people who were planning to retire in 2008, 2009, or 2010 who couldn’t. They wanted to retire but weren’t able to, whether because of fear or their portfolios dropping significantly.  

COVID-19 Sell-Off (2020)

Who would have predicted a pandemic at the beginning of 2020 and the markets dropping 30% over just five weeks? For me, this was the most dramatic sell-off because of its speed.

I remember talking to a friend who worked at Google whose coworker’s wife was a doctor. At the beginning of the pandemic, she knew what was happening and moved their 401(k) to cash.

They were right for a period—the 30% drop happened. But the crazy part was that we hit bottom on March 23, 2020, and the markets fully recovered all those losses by May, only 2 months later. The S&P 500 ended that year up 18% after being down 30% in March. 

This illustrates why I caution people against trying to time the market. You can’t predict these things, which is why you shouldn’t get too high in the highs or too low in the lows. 

The Triple Bear Market (2022) 

The 2022 downturn was different from anything I’d experienced in my career. I call it the “triple bear market” because it affected stocks, bonds, and cash: 

• Stocks were down 25% over about nine months 
• Bonds were down 15% due to aggressive interest rate hikes 
• Cash was essentially returning a negative yield because interest rates on cash lagged behind inflation 

This triple threat created a challenging environment for retirees, as all three major asset classes were negatively impacted simultaneously. 

7 Strategies to Protect Against Sequence of Returns Risk

Retiring into these markets is largely uncontrollable. What you can control is having a plan for your portfolio management and withdrawal strategy to protect against sequence of returns risk. Here are seven effective approaches: 

1. Implement Guardrails (Dynamic Withdrawals) 

One of my favorite strategies is the concept of guardrails or dynamic withdrawals. Instead of sticking to a fixed percentage rate like the 4% rule, you adjust your withdrawals based on portfolio performance. 

Guardrails, made famous by Guyton and Klinger, establish decision rules for when to make adjustments to your withdrawal rate. There are four primary decision rules: 

1. Portfolio Management Rule: Pull funds from overweight asset classes. If stocks are up, trim stocks to get back to your target allocation. If stocks are down and bonds are up, trim from bonds.
2. Inflation Rule: Give yourself an inflation raise every year, similar to the traditional 4% rule.
3. Capital Preservation Rule (Portfolio Rescue Rule): If your withdrawal rate increases by 20% because your portfolio value decreased, cut your spending by 10%. 
4. Prosperity Rule: If your withdrawal rate decreases by 20% because your portfolio value increased, give yourself a 10% raise. 

By implementing these four rules, you can potentially increase your starting withdrawal percentage by 20-25% while maintaining the same or better probability of success compared to the traditional 4% rule. 

This strategy works best for those with flexibility in their spending. If you break down your expenses and find that 50% is discretionary, you could be a great candidate for guardrails because you have the capacity to cut spending during market downturns. 

2. Create a Bucket Strategy 

The bucketing concept involves having a dedicated pool of assets you tap into for withdrawals. This might include: 

• Cash reserves 
• CDs 
• Short-term bonds 
• Individual bonds like short-term treasuries 
• Short-term bond funds or ETFs 
• Intermediate-term bond funds 

There’s no scientific formula for how much to keep in these buckets. Some advisors recommend 1-2 years of expenses based on the average duration of bear markets. Others suggest up to 5 years of expenses, considering that the Great Recession took about five years to fully recover from the bottom in 2009. 

The right amount depends on your risk tolerance. Someone with higher risk tolerance might be comfortable with just 1-2 years in cash or cash equivalents. Someone more concerned about market volatility might prefer 5 years in a CD ladder or individual bond ladder. 

For our clients, we use a combination of money market funds, individual bonds, short-term bond ETFs, and intermediate-term bond ETFs. This typically provides liquidity for 2-5 years of expenses, depending on risk tolerance and other income sources. 

3. Categorize Your Spending (Needs, Wants, Wishes) 

Breaking your spending into three distinct categories—needs, wants, and wishes—helps identify what you can potentially cut during market downturns. 

This approach helps determine: 

• How much of your spending is truly discretionary
• Whether you have the flexibility to cut spending by 10% if needed 
• How much to allocate to your bucketing strategy 

For example, I recently worked with a couple planning to retire in their 50s with a 7% initial withdrawal rate until they begin Social Security. By analyzing their spending, we determined they had enough discretionary expenses to implement guardrails successfully. 

4. Consider Partial Annuitization 

Annuitization involves turning some of your assets into a lifetime income stream. While annuities can be a controversial topic, they have a place in retirement income planning when used appropriately. 

The benefit of partial annuitization is that it puts less pressure on your volatile assets (stocks and bonds). This allows those investments to potentially grow at a higher rate because you’re withdrawing less from them while maximizing income from the annuity. 

I’ve said this before: you will not out-withdraw an annuity in your lifetime. I recently had a client with TIAA who received an annuitization schedule showing a payout rate close to 8% annually. Few advisors would recommend withdrawing 8% from a portfolio due to sequence of returns risk. 

To determine if annuitization makes sense for you: 

1. Identify your essential spending needs. 
2. Compare those needs to guaranteed income sources like Social Security or pensions. 
3. If there’s a gap, consider annuitizing enough assets to fill that gap.

5. Earn Additional Income 

Similar to annuitization, earning part-time income early in retirement can significantly reduce sequence of returns risk. This strategy can be implemented reactively to a market downturn—if we enter a bear market, you could work part-time and reduce your portfolio withdrawals. 

This works best if you: 

• Enjoyed aspects of your career
• Are willing to work a couple of days a week 
• Would consider consulting or a completely different field 

I’m working with a couple who initially planned to retire several years from now, but after seeing friends get sick or pass away, they want to retire sooner. The wife has a side hustle, and they’re considering renting out an ADU (additional dwelling unit) on their property through Airbnb. These two income sources could potentially allow them to retire 4-5 years earlier than planned. 

6. Adjust Your Social Security Strategy 

You may have plans to delay Social Security as long as possible to maximize lifetime benefits. However, if you’re experiencing a significant market downturn early in retirement, starting Social Security earlier than planned could reduce pressure on your portfolio. 

While this might reduce your lifetime Social Security income, it could be worth considering if it helps preserve your portfolio during a critical period. What’s helpful is that if you start Social Security before your full retirement age, you have a one-time option to stop it at your full retirement age and then delay until 70 (or as long as you want) to receive delayed credits. 

7. Implement an Asset Allocation Glide Path 

Different phases of retirement have different income needs and sources. Your investment strategy should be dynamic, not set-it-and-forget-it. 

Early in retirement, during what I call the “bridge period” (from retirement until you start Social Security), you may have no guaranteed income and might be less risk-tolerant. During this phase, you might have more in your cash bucket—perhaps that five years in cash, cash equivalents, or short-term bonds. 

Once you start Social Security, you’ll have guaranteed income covering your fixed expenses. At this point, you can potentially take on more risk because your withdrawal rate might drop significantly—from 5% to 1%, for example. This increased risk capacity could allow for a more growth-oriented portfolio allocation. 

Preparing for the Next Downturn

I don’t know when the next market downturn will be—I don’t have a crystal ball. If I did, I probably wouldn’t be working at all! But the most important thing is to have a plan in place before the next downturn occurs.

Right now, markets are looking pretty good. This is the perfect time to set your plan. We may be heading into a recession, the Fed may be too late with cutting rates, unemployment might tick up with tariffs and uncertainty—I don’t know. But set up your plan before the next downturn so you can implement it unemotionally rather than reactively. 

Be proactive instead of reactive. What are you doing to reduce your sequence of returns risk? If you’re approaching retirement or already retired, now is the time to review your strategy and ensure you’re protected against this significant risk to your retirement security. 

Remember, sequence of returns risk can devastate your retirement savings if you don’t have a protection strategy in place. The strategies outlined above—guardrails, bucketing, spending categorization, partial annuitization, part-time income, Social Security timing, and dynamic asset allocation—provide a framework for building that protection. 

By implementing these approaches before market volatility strikes, you’ll be better positioned to enjoy a secure retirement regardless of what the markets do in those crucial early years. 

At Imagine Financial Security, we help individuals over 50 with at least a million dollars saved navigate these complex retirement decisions.

If you are looking to maximize your retirement spending, minimize your lifetime tax bill, and worry less about money, you can start with our Retirement Readiness Questionnaire linked on our website at www.imaginefinancialsecurity.com. Click the “Start Now” button to learn more about our process and how we might be able to help you achieve a more confident retirement.

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This is for general education purposes only and should not be considered as tax, legal or investment advice.