Reducing Sequence-of-Returns Risk — Defending the Early Years of Retirement

Sequence-of-returns risk is the risk that, when you're withdrawing money after retirement, the result changes greatly depending on "the order in which returns arrive."

When you're accumulating (the saving phase), the order doesn't matter much. But when you're withdrawing (the spending phase), it's different. If a crash comes early in retirement, you have to draw living expenses from already-lowered assets, so the very seed capital for recovery shrinks. Even if the market rises later, the portion you sold off can't ride that rise.

So even for the same 30-year average return, if the bad years cluster at the front, funds run dry much faster. This is why the first 5-10 years after retirement are called the "danger zone (red zone)." (For the detailed principle, see the separate article.)

The most intuitive defense is not selling stocks in a crash. To do that, you need "money to live on without selling stocks" available in advance.

So a widely used method is a cash buffer. You separately secure 2-3 years of living expenses in cash or safe short-term bonds and the like. When the market crashes, you leave the stocks alone and draw living expenses from this cash. It buys time for the stocks to recover.

The bucket strategy systematizes this further. You divide assets into "short-term (cash), medium-term (bonds), long-term (stocks)" buckets, live from the short-term bucket during a crash, and leave the long-term bucket (stocks) untouched while waiting for recovery. It's a device to prevent the mistake of selling stocks at fire-sale prices at the worst time.

The second is adjusting the withdrawal amount according to circumstances. Instead of unconditionally withdrawing a set amount each year, you cut withdrawals a bit in a bad-market year.

For example, in a year the market crashed, if you postpone travel and big expenses and cut back to essential spending to lower your withdrawal, you draw less from lowered assets and preserve your recovery capacity. Conversely, in a year the market did well, you can spend a bit more.

This method of adjusting with upper and lower limit lines is called "guardrail" withdrawal. It lowers the risk of running out of funds compared with a completely fixed, level withdrawal. The key is "draining less from assets in bad years."

The third is a bit counterintuitive. People usually say "reduce stocks as you age." But retirement researchers Michael Kitces and Wade Pfau proposed the opposite direction.

You keep the equity share low (e.g., 30%) "early" in retirement to reduce the shock of a crash, and slowly raise the equity share (e.g., up to 70%) as you move toward the "later" part of retirement, past the danger zone. This is called a rising-equity glide path. In their research, this 30%→70% path came out favorable for lowering both the probability and the magnitude of running out of funds.

Viewing the same idea from the bond angle gives you a "bond tent." You raise the bond share convexly like a tent just before and after retirement, then lower it again as you pass the danger zone. It's a strategy that aims for both early-crash defense and later-stage growth capacity.

All three defenses aim at one goal: "draining as little as possible from assets during an early-retirement crash."

The cash buffer keeps you from selling in a crash, flexible withdrawals make you draw less in bad years, and the rising-equity glide path sets risk low from the start. Combine the three and you can greatly ease the shock of the first few years of retirement.

What matters is that none of them is magic that "eliminates" losses. The market still falls, and the maximum drawdown and loss duration exist. The key is to manage the order and timing so that shock doesn't topple your entire retirement.