Average annual return is one of the most misleading numbers in retirement planning. Two portfolios can post the exact same 7% average return over 25 years and produce dramatically different results for the retiree drawing income from them — not because of what they earned, but because of when they earned it. This is sequence of returns risk, and it is arguably the single most underappreciated threat to a retirement plan built during the accumulation years.
Why Order Matters More Than Average
During accumulation, sequence doesn't matter much. A 35-year-old contributing steadily to a 401(k) has decades to recover from a bad market year — the losses happen on a small balance, and the gains that follow compound on top of new contributions. But retirement inverts that dynamic. Once a retiree begins withdrawing income, a market downturn in the first few years does two things simultaneously: it shrinks the portfolio, and it forces withdrawals to be taken from a smaller base, permanently reducing the capital available to recover when markets rebound.
This is why two retirees who each retire with $2 million, each earning the same long-term average return, can end up in entirely different positions 15 years later — simply because one retired into a bull market and the other retired the year before a downturn. The retiree who front-loads withdrawals into declining markets faces a mathematically diminished capacity to recover, regardless of how strong the eventual rebound is.
The First Five Years Carry Outsized Weight
Financial research consistently points to the first five to ten years of retirement as the period of greatest vulnerability. This is sometimes called the "retirement red zone." It's the reason a plan that looked bulletproof in a Monte Carlo simulation can unravel quickly if a recession coincides with a retiree's first few years of distributions. The damage isn't theoretical — it shows up as a portfolio that never fully recovers its purchasing power, even after markets return to prior highs.
Building a Buffer Against Bad Timing
The answer isn't to avoid the market — long-term growth still requires equity exposure for most retirees. The answer is structuring income sources so that market-dependent assets aren't the first dollars spent in a downturn. This is where a bucket strategy becomes useful: segmenting assets into near-term (cash and short-duration bonds), intermediate (balanced allocations), and long-term (growth-oriented equities) buckets, so that spending needs in a down market are met without liquidating depressed assets.
Some families also layer in principal-protected vehicles — fixed indexed annuities or cash value from permanent life insurance policies — specifically to serve as a non-correlated income source during market downturns. The purpose isn't to chase returns; it's to have a lever to pull that doesn't require selling equities at the worst possible moment. A policy loan against accumulated cash value, for instance, can bridge an income need for a year or two while the equity portfolio is given room to recover, rather than being tapped at a loss.
Stress-Testing the Plan
Any credible retirement income plan should be stress-tested against a downturn occurring in year one or two of distributions — not just against long-term averages. Ask what happens to the plan if the S&P 500 drops 25% in the first 18 months of retirement. If the answer involves selling growth assets at a loss to fund living expenses, the plan has a sequence risk problem that no amount of long-term average return will fix.
The Bottom Line
Retirement income planning is not about predicting the market — it's about building a structure resilient enough that the order of returns stops mattering. Families who diversify not just their assets but their income sources give themselves the flexibility to ride out a bad sequence without being forced into permanent, avoidable damage.