Sorry, you need to enable JavaScript to visit this website.
Skip to main content

Annuities & Retirement Risk Management, Part 2: Sequence of Returns Risk

DPL Financial Partners
June 14. 2024

Guaranteed income can help protect against poor market performance as you head into retirement 

Note: This is the second article in a two-part series that discusses strategies for managing key retirement risks, including longevity, cognitive decline, and market volatility.  

Beware the fragile decade. It’s the period that begins five years before retirement and ends five years after retirement. During this time, portfolios are susceptible to a pernicious threat that can derail your retirement plan.  

Sequence of returns risk is the chance that a portfolio will experience poor investment returns as retirement nears or soon after. When that occurs, an investor’s ability to generate enough income to live comfortably throughout retirement can change dramatically.  

The order and timing of investment returns matters  

While planning for retirement, advisors and investors often focus on investment performance in terms of averages. They may find comfort, for example, in the fact that from 1957 through 2023, the average annual return for the Standard & Poor’s 500 Index was about 10%. 1

Average annual returns can be a helpful datapoint for investors who have relatively long investment horizons and can weather the ups and downs of stock and bond markets. However, average returns become less helpful – and annual returns become more important – during the transition from working to retirement.

Consider the following example that includes fictional retirees and real market returns.  

Sam and Diane are the same age. They have:

  • Saved $500,000 for retirement,
  • Invested in identical portfolios,
  • Forecasted that retirement will last for about 30 years.  

A stock market downturn begins the year Sam retires, and Sam must sell assets at a loss to generate income. Sam’s nest egg (Portfolio 2) never recovers from the one-two punch of market losses and portfolio withdrawals. Fifteen years into retirement, Sam’s portfolio has been completely depleted.  

Graph showing the impacts of sequence of returns risk

In contrast, Diane retires four years later when stocks are moving higher. Diane’s portfolio (Portfolio 1) experiences positive stock market returns for several years, gaining value even as she makes withdrawals. Fifteen years into retirement, and despite experiencing a significant market downturn several years into retirement, Diane’s portfolio value is higher than it was at retirement.  

The bottom line is that the order and timing of investment returns matters for a retiree, who has less time to recover from a market shock and is further depleting the portfolio through income withdrawals. A stock market downturn just before or early in retirement can have a significant effect on how long your retirement savings will last and may leave your portfolio, and income, depleted. It is impossible to plan with certainty as no one knows how stock or bond markets will perform in any given year.

Strategies for managing sequence of returns risk

Fortunately, there are strategies that can help investors mitigate sequence of returns risk by limiting the effect of portfolio volatility on their ability to generate retirement income. These include: 

  • Keeping ample cash available. Some investors choose to keep one or two years of living expenses in money markets or very short-term investments. Having cash available lowers the chance that they will need to sell assets at a loss to generate retirement income. Of course, cash typically offers lower potential returns than a diversified investment portfolio. One popular alternative is to put some cash into a high-yielding fixed annuity, a simple, CD-like product with competitive rates and short durations.  
  • Building an “income floor” under your retirement. An income floor is a predictable stream of guaranteed lifetime income that will cover essential expenses throughout retirement – no matter how the market performs. Typically, the floor is built using income from Social Security benefits, pension benefits (if you receive them), and/or annuities. Building an income floor can provide peace of mind and help investors resist the natural urge to sell assets during a market downturn (If unlucky Sam in the sequence of returns risk illustration had sold when the market was down, his portfolio would have been depleted even sooner).  
  • Participating in market returns while reducing exposure to losses. Fixed index annuities (FIAs) give owners the opportunity to participate in the performance of a stock market index, while providing complete protection from market losses. FIAs often are used to supplement or replace bonds in retirement portfolios. That’s important because, as we saw in 2022, stock and bond markets sometimes move lower at the same time. FIAs also can deliver efficient, guaranteed lifetime income through optional living benefits.

Annuities can be valuable additions to retirement plans to help reduce the impact of a negative sequence of returns on income. Today, a new breed of annuities is available that are commission-free. These products are designed to deliver guaranteed lifetime income and are built without some of the steep embedded sales fees that have historically contributed to the high cost and complexity of conventional annuities.

If you have questions about how annuities can help you manage risks in retirement, contact your financial advisor or reach out to a DPL Consultant at 1-877-625-5544.  We can help. 



1 Investopedia

Index annuities are not a direct investment in the stock market.  They are long-term insurance products with guarantees backed by the claims-paying ability of the issuing insurance company.  They provide the potential for interest to be credited based in part on the performance of the specified index, without the risk of loss of premium due to market downturns or fluctuations. Index annuities may not be appropriate for all individuals.