The stock market’s stellar long-term performance might mask sequence-of-returns danger, which could be an unpleasant surprise for those who have retired or are about to.

“A retiree’s greatest risk may be a bear market that reduces the portfolio right before and just after withdrawals begin,” says Josh Mellberg, president and founder of J.D. Mellberg Financial in Tucson, Ariz.

A client with a stock-heavy portfolio might have to cash in shares to cover retirement expenses.

“When there’s a drop in share prices, retirees must sell more shares in order to produce an adequate amount,” says Mark Lumia, a CFP and the founder and chief executive of True Wealth Group in Lady Lake, Fla.

Then the retiree would have fewer shares to profit from a subsequent rebound.

Suppose Jane Smith retires with $100,000 in equities.

She withdraws $5,000 in year one, dropping her balance to $95,000; a 10% gain raises her portfolio to $104,500. Jane takes $5,200 from the portfolio in year two, with a 4% increase for inflation.

Then a 10% bear market leaves her with $89,370.

Alternatively, John Jones starts with $100,000 in equities and a $5,000 withdrawal, but a 10% market skid leaves him with $85,500. If John withdraws $5,200 in year two, to $80,300, a subsequent 10% gain brings his stocks back to only $88,330.

Thus, an unfortunate sequence of similar returns can lead to accelerated portfolio depletion.


“To avoid these threats, we diversify portfolios as retirement approaches,” Lumia says. “That can shield clients’ money from market volatility when it’s most important.”

As alternatives to equities, Lumia mentions money market accounts, certificates of deposit and various types of annuities.

“We also could overfund an old-fashioned dividend-paying whole life insurance policy from a mutual company,” he says.

Traditionally, moving away from stocks means moving into fixed income.

“We use an institutional money manager for income,” says Bryan Slovon, founder and chief executive of Stuart Financial Group in Greenbelt, Md. “However, the income market has been very tough in the last few years, in this low interest rate environment.”

Thus, Slovon might deal with sequence risk by setting up “personal pensions” that give clients lifetime income without counting on the stock market.

“Although immediate annuities can be suitable, most individuals prefer more flexibility with their assets,” he says. “Moreover, annuity payouts have been lowered due to recently revised life expectancy tables.”

More cash flow may be produced by deferred fixed annuities: clients invest sooner and later receive larger monthly checks during retirement.


Mellberg advocates a ladder approach.

“Put money needed in the first five years into short-term vehicles that probably won’t produce a loss,” he says.

Higher on the ladder can be more volatile holdings with higher return potential.

“For the last rung on the ladder, you can use a Qualified Longevity Annuity Contract in an [individual retirement account]. Minimum distributions are not required on the amount invested,” Mellberg says.

“The annuity payout can be deferred, up to age 85, to ensure income later in life,” he says. “Up to 25% of an IRA -- not exceeding $125,000 -- can be invested in a QLAC.”

This story is part of a 30-30 series on preparing for retirement.

Donald Jay Korn

Donald Jay Korn is a New York-based financial writer who contributes to Financial Planning and On Wall Street.