If there is a single article of faith in the personal finance world, it’s you’ve gotta worry! IRMAA! RMDs! Widow’s Tax Trap!
You’re rich? Great, start worrying! There’s plenty to worry about.
Hopefully most long time readers and YouTube viewers know I’m kidding since I’m a glass half-full type. Today I tackle one worry that sometimes dwarfs the previously mentioned three. Sequence of returns risk. People wonder if they should hold years of cash at retirement because of sequence of returns risk.
What is Sequence of Returns Risk?
Broadly defined, sequence of returns risk is that during the early part of a lengthy retirement, one or more bad years will hit the stock market. The early retiree is no longer accumulating, drawing down, and losing equity value. If the market takes years to recover, this could significantly hamper the early retiree’s chance of financial success in retirement.
Karsten Jeske, known as Big Ern online, discusses sequence of returns risk here.
Below I discuss five reasons I don’t worry about sequence of returns risk much as applied to well diversified retirees.
Diversification
We tend to think our portfolio exists in a vacuum. It doesn’t.
As Rick Ferri has observed, a well diversified equity portfolio rapidly declining will be accompanied by several offsetting things in the world. Policy makers and central banks are likely to take action, perhaps significant action. As the economy is down, layoffs are up and fellow retirees are feeling the pinch.
What’s happening to prices in that environment? Fewer businesses are paying for work travel and fewer retirees are staying at hotels. Fewer workers are getting bonuses and bidding up the price of grass-fed ribeyes at the supermarket. In environments where the entire economy is hurting, prices for goods and services are likely to be stable or themselves falling.
Will it be good for the early retiree to have their well diversified equity portfolio tank in early retirement? No. But Rick Ferri’s observation that related factors reduce the adverse impact of significantly falling equity prices is very instructive as to the importance, or lack thereof, of sequence of returns risk.
Where sequence of returns risk worries me greatly is a situation where an early retiree has a very undiversified portfolio. Imagine Sean retires today and 80 percent of his equity portfolio is in Apple stock. Apple stock can drop for a host of reasons while the rest of the economy is booming. The price of steak, travel, accommodations, etc. could care less about the stock price of Apple.
For the undiversified early retiree, sequence of returns risk is one of many very significant risks in early retirement and one worthy of spurring on major changes to a portfolio.
Social Security
Many early retirees will receive significant Social Security benefits. Those benefits are not too far out in the future for the early retiree. Social Security benefits are not subject to sequence of returns risk. Further, Social Security benefits reduce the retiree’s reliance on their equities and bonds.
You Won’t March Off the Cliff
People worry about financial failure caused by things like sequence of returns risk. Here’s the thing: you will not blindly march off the cliff when it comes to your spending, as Michael Kitces observed on the BiggerPockets Money podcast.
Both subconsciously and consciously, retirees will adjust their spending in down markets. A 14 day vacation becomes a 10 day vacation. You eat out one less meal a week. A new Camry becomes a new Corolla or becomes a used Corolla.
Spending adjustments during down markets can mitigate sequence of returns risk with little impact on lived experience quality.
Market Bounce Backs
When discussing the sequence of returns risk issue, we need to consider two issues. First, how much of the portfolio does an early retiree need at any one moment in time? Yes, this year’s withdrawal at reduced equity prices hurts the early retiree. But the rest of the portfolio declining this year is not at detrimental this year. Further, the rest of the portfolio might bounce back spectacularly, as I’ll discuss below.
Second, what is the investment horizon for an early retiree? For the 55 year old retiree, it could easily be 35 years.
Let’s picture Amelia. Amelia is retiring today (congratulations!) and is currently 60 years old. According to the most recent Social Security Trustees’ Report actuarial data, Amelia is expected to die, on average, a bit before her 84th birthday. Obviously most Americans do not do financial planning to account for living only to their average life expectancy. Amelia easily has a 30 year or more investment time horizon today.
If Amelia is invested in a well diversified portfolio (including both an equity allocation and a bond allocation), she has plenty of time to ride out a very significant dip in the stock market. Imagine the S&P 500 is down 38.49 percent during the first year of her retirement. That’s what happened to the S&P 500 in 2008. According to the Social Security Trustees’ Report actuarial data, she has about 22.65 years over which to make up for that loss.
How many 22.65 year periods over the past 100 years has the American stock market not made up that sort of loss?
Let’s consider a retired couple that has already battled through sequence of returns risk. On December 31, 2007, Mark and Mary retired at age 50 with a well diversified equity and bond portfolio. The S&P 500 was at 1,468.36. A year later it was at 903.25. Since then, Mark and Mary have been through March 2020, the year 2022 when the S&P 500 was down 18.1%, and the March/April 2025 stock market decline.
How are Mark and Mary doing today? Well, the S&P 500 is at 6,000.36 (June 6, 2025 close) and now Mark and Mary upgrade their airfare to first class.
Is the market always guaranteed to bounce back? Surely not. But you might want to refer to the 110 year Dow Jones Industrial Average graph that JL Collins shares several times in the new version of The Simple Path to Wealth, including on page 52.
Cash is Not a Free Lunch
Let’s discuss the most commonly applied technique to mitigate sequence of returns risk: holding significant amounts of cash and spending it down first in retirement.
This tactic has drawbacks. Cash is subject to inflation risk. It’s a store of value, and storing value is increasingly difficult, in my opinion. Further, by investing in cash the retiree foregoes the chance to invest in equities or bonds, potentially reducing future expected return (sometimes referred to as “cash drag“). Lastly, in a taxable account significant cash balances generate inefficient ordinary income in the form of interest payments.
Conclusion
When it comes to retiree portfolio construction, I view sequence of returns risk as being similar to the prospect that the New York Jets will finish in last place in the AFC East.
Are both risks real? Yes
Are both unpleasant? Yes
Do both present significant risks of financial failure in retirement for well diversified retirees: No!
Yes, I exaggerate by equating sequence of returns risk with the performance of the New York Jets. But for the five reasons I stated above, I do not believe that sequence of returns risk should be a significant factor in portfolio construction for most well diversified retirees.
Further Reading
If you’ve gotten this far, I suspect you might be thinking to yourself, “Sean, you’ve convinced me on sequence of returns risk. But I’m still losing sleep over RMDs, IRMAA, and the Widow’s Tax Trap!”
Don’t worry. Cody Garrett and I have you covered in Tax Planning To and Through Early Retirement, our forthcoming book likely to be published later this year. Sign up to find out when the book will be published here.
FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com
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This post is for entertainment and educational purposes only. It does not constitute accounting, financial, investment, legal, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, investment, legal, and tax matters. Please also refer to the Disclaimer & Warning section found here.