Sequence of Returns: The Serious Consequences in Retirement

By Bud Kasper, CFP®, AIF®

June 5, 2020

Sequence of Returns: The Serious Consequences in Retirement

I’m guessing that most everyone has seen the movie Good Will Hunting. It starred Matt Damon as Will Hunting and the late great Robin Williams played the role of his psychiatrist Dr. Sean McGuire. You’ll recall that Damon’s character is a 20-year-old janitor from South Boston who was an unrecognized genius. To avoid jail time for assaulting a policeman, Will is invited into therapy with William’s character by professor Gerald Lambou (played by Stellan Skarsgård). Lambou is a winner of the “Fields Medal” which recognizes the world’s top mathematician. At the end of the film, Dr. McGuire finally breaks through Will’s tough and hard to reach feelings as Will breaks down and cries on William’s shoulder. The words William’s uses to crack open Will’s deeply suppressed guilt: “It’s not your fault Will, it’s not your fault!”

Sequence of Returns: It’s Not Your Fault

What does the movie “Good Will Hunting” have to do with the title of this paper? Not much, except that the sequence of returns, or series of returns, investors experience when beginning your retirement years are “not your fault!” It’s just the luck of the draw. We have what I will call a predetermined time as to when we retire. Our point here is that most of us plan to retire sometime between the ages of 60 and 70. Most of us will likely retire between 65 to 70, with a smaller group retiring after 70.

Retirees need to recognize that when we retire is based on highly reliable demographic facts. When you parallel that with stock market cycles, it raises the question “Am I lucky enough to be retiring at the beginning of a bull market, in the middle, or at the end?” No one can predict whether they’ll retire at the beginning or end of a favorable period for stocks or bonds. So, you can now understand why we started this paper with our Good Will Hunting because “It’s not your fault!”

Will I Be Okay If Retire During a Bear Market?

What if you’re unfortunate enough to start your retirement at the beginning or the middle of a bear market? What can a retiree do? First off, get some education and professional help. Many people have retired at a statistically challenging time of a market’s cycle and are successfully enjoying their retirement today. That said, you better understand your portfolio’s allocation risk and the possible impact risk of your sequence of returns. Retirees must learn to plan and manage this potential risk. This is where you need to understand the advantages of working with a competent financial planner.


CERTIFIED FINANCIAL PLANNERS® (CFP®) truly understand the various types of risks retirees face in retirement. They have a command of both retirement and investment planning. A CFP® also understands that tax reduction strategies can better manage the various consequences of a retiree’s sequenced returns regardless if they’re favorable or unfavorable. Retirees deserve an intelligent way to better engineer their outcomes, irrespective of the market conditions a person retires into. At the end of this paper, I will explain what was Will Hunting’s fault!

Understanding Sequence of Returns Risk

“Is it possible to create a predictable income strategy by building a ladder of income-producing bonds that mature sequentially in different years? The answer is yes.”

– Bud Kasper

The sequence of return risk analyzes the order that investment returns occur. It’s necessary to understand how various stock and bond market returns can affect retirees as they systematically withdraw money from retirement accounts. In retirement, as you’re taking distributions, an unfortunate sequence of returns means you might not have enough return to cover the distribution. In a bad sequence, a retiree would have suffered a lower or negative rate of return. When you couple this poor return with the amount and timing of withdrawals from a retirement account, the result is negative compounding.

The specific returns of a portfolio for any given time frame will ultimately determine whether your retirement account(s) finished even at the end of the year, finished short of breakeven, or you made more money than the amount of distributed. If you had a choice as to whether you received higher portfolio returns at the beginning of let’s say a 25-year period of time, in the middle or last years (based on the concept of the sequence of returns), which would you select for yourself? If you answered the earlier years, you would be spot on! The more damage occurring at the beginning of a sequence of returns, the harder it is to breakeven at the end of the 25 years.

Market Cycles & Sequence of Returns

Markets have always moved up or down in cycles. History shows that there have been four long-term secular bull markets and four secular shorter-term bear markets in modern history. For our purposes, a secular market trend is a long term cycle ranging in general from 5 to 25 years. It can start with a series of short term (cyclical) up-markets that can also include down years, but continues to grow for a more extended period and until it becomes a secular bull market if it lasts ten years or longer. At any point, if the market suffers a decline that exceeds -20%, it now becomes a bear market.

What is a Bear Market?

To repeat, the universally accepted definition as the starting point of a bear market is a drop of -20% from any prior market high. Observing this year’s market action and acknowledging this year’s stock market high, based on the S&P 500, occurred on February 19th when the S&P 500 was up +5.08%. On March 11th, the market fell to a negative -14.83% which, when added to this year’s market high on February 19th, is a decline of slightly more than a -20% making the total S&P loss at that point an official a bear market. If you track the peak to trough decline of our current bear market, you would see that the S&P 500 at its worst was down from February 19th to March 23rd -35.41%.

The 4% Rule

The risk of premature portfolio failure, whether from an unfortunate sequence of returns or poor investment performance due to a dreadfully created investment allocation model, has an additional burden of withdrawals during retirement. Withdraw patterns (distributions) that occur earlier in retirement was a significant part of the research conducted by Bill Bengen in the 1990s. His work concluded that a safe distribution rate of 4% while utilizing a portfolio mix of 50% large-cap stocks combined with 50% in bonds would support a retirement distribution rate of 4% per year through a retiree’s 30-year lifetime.

The Problem with the 4% Rule

The problem with Mr. Bengen’s conclusion is that he didn’t take into account the “sequence of returns,” which could impair or deplete a retirement account more quickly over time. A lot of retirees use Mr. Bengen’s 4% rule as a “distribution benchmark.” Quite frankly, there is nothing wrong with that as long as retirees understand that the sequence of portfolio returns, taxes, and inflation will ultimately determine whether it’s working for them or not. Remember the old investment caveat, “past performance is not a guarantee of future returns!”

So, is it possible to create a predictable income strategy by building a ladder of income-producing bonds that mature sequentially in different years? The answer is yes. But bond yields are so low right now that it would be challenging to create an income stream that is enough to cover a retiree’s monthly income needs. There is nothing fundamentally wrong with this approach, except that it most likely won’t keep up with inflation. In today’s world, it would be very challenging to find high quality bonds yielding 4 % or more, assuming 4% was your income distribution target. It may also be a problem to be able to buy the bonds at par value ($1,000 invested returns $1,000 at maturity).

Bucketing Strategies

Could bucketing strategies popularized in the 1980s be a solution to the sequence of return risk? The answer to this question is the same as it is with bond laddering. It can work but bucketing has the same issue of any portfolio. The more stocks in the bucket, the more exposure you would have to a bad sequence of returns. In bucketing, you segregate assets into let’s say four buckets.

What’s in the buckets?

The first bucket holds your least aggressive assets such as money markets, short term treasuries, CDs, or short term “A” rated or better corporate bonds. The first bucket (an income bucket) could be built to hold two years of absolutely safe money investments specifically targeted for monthly cash flow. Bucket two might hold intermediate-term bonds and/or higher dividend-paying stocks.

Bucket three holds dividend-paying stocks and some growth or value stocks. Finally, bucket number four should hold the riskiest investments because the money in this bucket might never be needed, but it is designed to be the last bucket to be used for income if needed. A four bucket approach functions so that when bucket number one is empty (say in two years), then bucket number two slides down to take over bucket one’s spot.

Bucket number two (now number one) is now redefined as a conservative bucket just as it was for the original bucket one and so forth for buckets three and four. In a perfect world, only three buckets would be consumed in a retiree’s lifetime with number four, the last bucket, becoming the family’s legacy bucket. These strategies have worked when a retiree happens into a good sequence of returns.

Time in the market has proven to work over more extended periods, and that’s why buckets three and four are the last to be accessed for income in the later years of a retiree’s life. That said, any strategy can quickly become challenged by a bad sequence of returns, taxes, and inflation. Understanding these three factors and applying them to an effective portfolio strategy is the best way to control these potential risks.

Get the Right Help with Sequence of Returns

In the opening paragraph of this paper, I mentioned that I would point out what or could be Will’s fault. Let’s transfer Will’s name to yours. The truth of the matter is that retirement planning isn’t easy, and it’s incredibly complicated! Unfortunately, there are too many charlatans out there who claim to be financial planners, but they are NOT! They most likely don’t have any certified planning credentials, nor are they held to a legal fiduciary standard that requires that the client’s interest always come first.

Some will send to their corporate headquarters the answers to the ten questions they asked you and pump them into a program that spits out a one size fits all result. These people attempt to mimic real financial/retirement planners like a CFP® who is authorized by a National Board of Standards to represent the profession of financial/retirement planning. The board also requires all CFP®s by law to serve their clients as a fiduciary that is a legal obligation that requires that their clients’ interest must always come first! Why would you ever work with someone or some firm that doesn’t legally obligate themselves to put their client’s interest first?

Beware the Product Salesperson

Retirement is a relatively easy game to talk about. Retirees want the same things: No loss of principal, guaranteed income, uninterrupted growth, easy access to their money, and more. As you might expect, some will tell you they can do all of those things in one, “Guaranteed product!” These are product salespeople who will do whatever they can and try to convince you that your worries are over, but is that the truth, and more importantly, what’s in it for them? Very high commissions that usually start at 7% of the invested amount! What does the retiree get? Surrender charges!

This means you most likely will have to pay a penalty to get your own money back if you need it to become the surrender period is up, which is usually 7 to 15 years! These penalties are in addition to the annual and typically excessive internal charges that retirees in these types of products have to pay annually. Be smarter than that! Only work with professionals who serve their clients as a fiduciary. Understand the importance of the fiduciary standard. This is a crucial element of the retirement/investment planning process and should never be compromised when it comes to your retirement security!

Get Educated & Get Help with Sequence of Returns

In conclusion, become better educated about the retirement process. Understand the significant impact that tax planning can have on your retirement success! You can control taxes if you’re working with a CPA who understands optimizing your various income sources in the least taxing way possible. Planning will also help you in deciding when the best time is to file for Social Security. Who should file first the husband or the wife? How do you optimize between the two? How will Medicare affect my taxes? Good firms have CPAs on staff to work hand in hand with a CFP® to create the best results. This relationship can often afford retirees the clarity, confidence, and control all retirees want.

So, in conclusion, it might very well be your fault if you haven’t made an effort to understand how retirees should approach the serious business of retirement! Hopefully, it is not too late! However, if you don’t explore the information discussed, it will be on you. An easy way to make sure you are on track is to contact Modern Wealth Management. You can request a phone call, virtual meeting, or an in-office appointment with one of our Advisors. Schedule a complimentary consultation or call us at 913-393-1000 and request your appointment today.

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The views expressed represent the opinion of Modern Wealth Management an SEC Registered Investment Advisor. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Modern Wealth Management does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.