Sequence-of-Returns Risk: Why the First Five Years of Retirement Matter Most

Two retirees in Mesa, call them Bob and Carol, retired in different years with the exact same $2 million portfolio and the exact same plan to withdraw, for example, $80,000 a year. Over their first thirty years of retirement, both portfolios even earned the same average annual return. You'd assume they ended up in the same place. They didn't. One ran out of money in his 80s and the other died with more than he started with. The only difference? The order in which the good and bad years arrived.

This is sequence-of-returns risk, and it's one of the most under-appreciated dangers in retirement. If you're in Scottsdale, Phoenix, Tucson, or anywhere in Arizona and you're within a few years of retiring, this is the risk I'd want you to understand more than almost any other.

Why the Order of Returns Matters So Much

While you're still working and saving, market downturns are almost a gift, you're buying shares on sale, and you have years for them to recover. You're adding money, so a bad year early in your career barely registers by the time you retire.

Retirement flips this entirely. Now you're withdrawing money instead of adding it. And here's the cruel math: when you sell investments to fund your lifestyle during a down market, those shares are gone for good. They can't participate in the eventual recovery. You've locked in the loss.

Take a steep market drop in your very first year of retirement, while you're also pulling out $80,000 for living expenses. Your portfolio gets hit from both sides at once, the market decline and your withdrawal. The portfolio that has to recover is much smaller, and it may never catch up. The same bad year happening fifteen years later, after a long stretch of growth, does far less damage because your portfolio is larger and you have fewer withdrawal years ahead of it.

The First Five Years Carry Outsized Weight

Research on this topic consistently points to the same conclusion: the returns you experience in roughly the first five years of retirement have a disproportionate influence on whether your money lasts a lifetime. Get a rough start and you may spend the rest of retirement playing defense. Get a good start and you build a cushion that protects you against later turbulence.

That's what separated Bob and Carol. The one who retired into an early downturn was permanently set back; the one who happened to retire into a few strong years built a lead that compounded for decades. Neither of them controlled the timing, which is exactly the point. You don't get to choose what the market does in your first five years, so you have to plan as if those years could be ugly.

You can see this dynamic for yourself by stress-testing different return sequences against your own withdrawal plan in our sequence-of-returns risk analyzer.

How to Defend Against It: The Cash Buffer and Bucket Strategy

The encouraging news is that while you can't control returns, you can control how exposed you are to them in those critical early years. The two main tools are a cash buffer and a bucket strategy, and they work hand in hand.

The cash buffer

The idea is straightforward: keep a meaningful amount of your spending needs, for example, one to three years' worth, in cash or very stable, liquid investments. When the market drops, you spend from this buffer instead of selling stocks at a loss. You give your growth investments time to recover rather than locking in losses. Then you refill the buffer in better years.

The bucket strategy

This extends the same logic across your whole portfolio, often into three buckets:

• Bucket 1 (now): Cash and short-term reserves to cover the next one to three years of spending. This is your sleep-at-night money, immune to market swings.
• Bucket 2 (soon): High-quality bonds and conservative holdings for roughly years three through ten. Moderate growth, moderate stability.
• Bucket 3 (later): Stocks and growth investments for the long haul, money you won't touch for a decade or more, giving it time to ride out volatility.

The psychological benefit is just as important as the mathematical one. When you know your next couple of years of grocery, golf, and property-tax money is sitting safely in cash, a scary market headline is far less likely to spook you into selling at the worst possible moment, which is how so many people permanently damage their retirement.

Pairing Buffers With a Sensible Withdrawal Rate

A cash buffer protects you in the short term, but your withdrawal rate determines the long-term odds. If you're pulling too much from the portfolio, no bucket structure will save you from an early downturn. This is where the classic guidelines, often a starting withdrawal rate in the neighborhood of 4%, come in, though the right number for you depends on your age, other income, and flexibility.

One powerful tactic is building in spending flexibility: trimming withdrawals modestly in down years, perhaps skipping an inflation raise or postponing a big trip, dramatically improves your odds of lasting decades. Retirees who can flex their spending weather sequence risk far better than those locked into a rigid budget. You can test how different starting withdrawal rates and flexibility assumptions hold up using our safe withdrawal rate simulator.

Where a Fiduciary Earns Their Keep

Managing sequence risk is exactly the kind of unglamorous, ongoing work that doesn't generate a commission, so it's often neglected by advisors paid to sell products. There's no annuity or fund to push here, just thoughtful structuring of your buffer, your buckets, your withdrawal rate, and your behavior in a downturn.

A fee-only fiduciary advisor is positioned to do this work well, because their only incentive is your plan succeeding. The decision of how much cash to hold, when to refill it, and how to adjust spending in a rough year is precisely where good, conflict-free advice pays for itself many times over.

The Bottom Line

Sequence-of-returns risk means that when bad markets hit can matter as much as whether they hit at all, and the first five years of retirement are the most fragile. You can't control the markets, but you can build a cash buffer, structure your portfolio into time-based buckets, keep your withdrawal rate sensible, and stay flexible. Together, those steps let you spend from safe assets during downturns and give your growth investments room to recover.

If you're nearing retirement in Arizona and want to know how your plan would hold up against a rough start, stress-test it in our sequence-of-returns risk analyzer and connect with a fee-only fiduciary advisor in Arizona who can build the buffers and structure to protect you.

Important Disclosures

This material is intended for informational and educational purposes only and should not be construed as individualized investment, tax, or legal advice. Consult your own qualified advisor before acting on anything discussed here.

Investing involves risk, including possible loss of principal. Tax rules change and outcomes vary by individual circumstances. Arizona Fee Only is a directory and does not provide investment, tax, or legal advice.