A steep market downturn in the first years of retirement can drain portfolios years faster than most investors realize, even if average returns later recover. Schwab's research reveals how sequence-of-returns risk can devastate withdrawal plans.
Sharp market declines in the initial years of retirement withdrawals can permanently shorten the lifespan of a nest egg, according to new research from Charles Schwab. Even when long-term average returns remain positive, the timing of losses-known as sequence-of-returns risk-can force retirees to exhaust their savings far sooner than projections based on averages suggest.
Wade Pfau's research indicates that returns in the first 10 years of retirement account for approximately 77% of a portfolio's final outcome, underscoring the critical importance of early market performance.
This sequence-of-returns risk means that the order of gains and losses can matter more than the average return itself. When withdrawals occur during a downturn, retirees must sell investments at depressed prices, reducing the base that could benefit from any future recovery. The risk is most acute in the first decade of retirement, when portfolios are most exposed to market shocks.
Macro Data and the Sequence Risk Catalyst
Independent research supports Schwab's findings. Wade Pfau, Ph.D., at the American College of Financial Services, has shown that returns in the first ten years of retirement explain about 77% of a portfolio's final outcome. Dana Anspach, CEO of Sensible Money, calls the five years before and after retirement the "retirement red zone"-a period when big market swings can have outsized effects on future spending power. Morningstar's 2026 State of Retirement Income report set the baseline safe withdrawal rate for new retirees at 3.9%, up slightly from the previous year, but warned that higher stock allocations can lower that safe rate.
Schwab emphasizes that the damage from early losses is amplified because retirees are forced to sell assets at depressed prices, making recovery much harder. To mitigate this, Schwab recommends structuring savings into 'time-segmented buckets' and maintaining a liquidity reserve, especially during the first 10-15 years after retirement when portfolios are most at risk.
Mitigation Strategies: Buckets and Withdrawal Flexibility
Schwab recommends a three-bucket approach to help retirees avoid selling stocks during a downturn. The first bucket holds one year of living expenses in cash or liquid assets, after accounting for Social Security and other guaranteed income. The second bucket covers two to four years of expenses in short-term bonds or certificates of deposit, designed to hold value during market turbulence. The remainder stays invested in stocks and higher-yielding assets for long-term growth.
However, even this structure has limits. Schwab's research shows that if a retiree cuts withdrawals to 2% after a 15% early loss, the portfolio can recover its starting value in about 11.5 years of 6% annual returns. At a 4% withdrawal rate, full recovery would require 28 years of uninterrupted growth-longer than most retirements last. This underscores the need for flexibility in spending as well as asset allocation. Retirees who stick rigidly to the 4% rule after an early loss may never recover their original balance.
Withdrawal Rate: The Decisive Factor
The starting withdrawal rate is the single biggest factor in how much sequence risk can erode a portfolio. Morningstar's 3.9% baseline on a $1 million nest egg produces about $1,000 less in annual spending than the traditional 4% rule, but offers a better chance of making the money last. Schwab's bucket strategy helps by providing cash and short-term bonds to cover expenses during downturns, but only if retirees are willing to reduce withdrawals when markets fall.
Withdrawal flexibility is critical. Schwab's modeling shows that two retirees with identical average returns can end up decades apart in financial security, depending on whether they adjust spending after early losses. The first ten years of withdrawals set the trajectory for the rest of retirement. What matters most is how much is withdrawn, how much is kept in cash or bonds, and whether spending is cut when markets drop.
Editorial Verdict
For U.S. retirees, the evidence is unequivocal: sequence-of-returns risk is a practical threat that can undermine even the most carefully constructed retirement plan. Relying on average returns or fixed withdrawal rules is insufficient. Retirees must build cash reserves, maintain flexible spending, and be prepared to adapt when markets turn. Ignoring sequence risk can lead to premature depletion of savings, while proactive planning offers a real chance for portfolios to endure. Withdrawal discipline, not market timing, is the lever retirees can control. For further analysis of how market cycles affect financial outcomes, see this review of valuation gaps and investor protections in major IPOs at Financial Sumo.
Sequence-of-returns risk is a core concept in retirement planning that highlights the danger of withdrawing funds during market downturns. Unlike average annual returns, which can mask the impact of timing, sequence risk shows that losses early in retirement can have a compounding effect, making it much harder for a portfolio to recover. This is why many financial planners recommend building a cash buffer and maintaining flexibility in spending, especially in the first decade after leaving the workforce. Understanding this risk can help retirees make more informed decisions about how much to withdraw, when to adjust spending, and how to allocate assets for both growth and protection.
