When people think about risk in retirement, the first thing that usually comes to mind is the stock market. They worry about volatility, downturns, and whether their investments will perform well enough. While market risk is certainly important, in our experience, it is not the biggest risk retirees face. The bigger risk is how and when you take income from your portfolio.
The transition into retirement is one of the most significant financial shifts you will ever make. You go from contributing to your accounts and letting them grow, to relying on them to provide income. That shift introduces a new risk that many people are not aware of, known as sequence of returns risk.
Sequence of returns risk refers to the timing of market performance relative to when you begin taking withdrawals. Two retirees could earn the exact same average return over time, but if one experiences negative returns early in retirement while taking withdrawals, their outcome can be significantly worse. I often compare this to burning a candle at both ends. You are not only experiencing market losses, but you are also withdrawing from the portfolio at the same time. This reduces the base that is left to recover when the market rebounds, and over time it can have a meaningful impact on how long a portfolio lasts.
This is where having a structured income strategy becomes critical. One approach we use is called the Bucket Plan, which is designed to create stability in the short term while allowing for long-term growth.
The first bucket is what we refer to as the now bucket. This typically consists of bank balances and funds set aside for short-term needs or unexpected expenses. This is the money that provides immediate liquidity and peace of mind. It is not exposed to market risk because it is meant to be there when you need it.
The next bucket is the soon bucket. This portion of the portfolio is invested more conservatively and is designed to cover income needs over the next several years, often up to about ten years. The purpose of this bucket is to provide a reliable source of withdrawals so that you are not forced to sell more volatile investments during market downturns.
By having a now and soon bucket in place, you are effectively creating a buffer between your day-to-day income needs and the stock market. This allows the later bucket, which is invested more heavily in stocks, to be positioned for long-term growth. Because you are not relying on this portion of the portfolio for immediate income, it has time to recover from market fluctuations.
This structure helps protect against sequence of returns risk. When markets are down, you can rely on your more conservative buckets for income. When markets are up, you can rebalance and refill those buckets. This disciplined approach can significantly improve the sustainability of a retirement plan.
Retirement planning is not just about achieving a certain rate of return. It is about creating a system that supports your income needs through different market environments. By focusing on how your money is organized and how withdrawals are managed, you can reduce risk in a way that is often overlooked.
At the end of the day, a successful retirement is not just about growing your assets. It is about turning those assets into a reliable and sustainable income stream.