The Biggest Retirement Risk Isn’t a Market Crash. It’s When the Crash Happens
A stock-market decline is uncomfortable at any age, but it can be especially dangerous during the first few years of retirement. Someone still working can usually wait for markets to recover while continuing to contribute to a 401(k), but a retiree may be withdrawing money from the same portfolio that is falling in value. That combination can turn an otherwise temporary bear market into a permanent reduction in retirement wealth.
This is known as sequence-of-returns risk, and it is one of the most important challenges in retirement investing. Two retirees can earn the same average investment return over 30 years and still experience dramatically different outcomes depending on when the bad years occur. The retiree who suffers major losses early while simultaneously withdrawing money may run out of assets much sooner than the one who experiences those same losses later.
The Order of Returns Matters Once Withdrawals Begin
Before retirement, investors are generally focused on accumulating as much as possible. Market declines can even help long-term savers because regular contributions purchase more shares at lower prices. The mathematics change once the portfolio becomes a source of income.
Imagine a retiree who needs $50,000 from a $1 million portfolio during a major market decline. If the account falls 20%, it drops to $800,000 before the withdrawal is considered, and removing another $50,000 leaves only $750,000 available for the recovery. The portfolio now has to gain substantially more just to return to its original level.
Fidelity illustrates the problem with a hypothetical example in which two retirees experience the same annual returns but in opposite order. The retiree who experiences poor returns early exhausts the portfolio during the 30-year period, while the retiree who gets the stronger returns first finishes with substantial assets remaining. The average return is the same; the sequence is what changes the outcome.
The First Few Years Can Be Especially Important
Morningstar’s latest retirement-income research found that retirees experiencing poor investment returns during the first five years of retirement were significantly more vulnerable to exhausting their portfolios if they did not reduce spending. High inflation early in retirement created a similar risk because retirees were forced to increase withdrawals while investments were under pressure.
That is why a retirement portfolio cannot simply be treated like the accumulation portfolio someone used at age 45. The retiree now has two competing objectives: producing enough growth to support decades of future spending while also having enough stability to fund near-term expenses. Too much risk can create severe losses at the wrong moment, while too little growth can allow inflation to gradually erode purchasing power.
The challenge is finding a structure that allows both objectives to coexist. One popular solution is the retirement bucket strategy, which separates money based on when it is expected to be spent rather than treating the entire portfolio as one pool.
Bucket One: Money You Expect to Spend Soon
The first bucket is designed primarily for stability. It can contain cash, money-market funds, high-yield savings, Treasury bills or other short-duration investments intended to cover near-term portfolio withdrawals. The purpose is not maximizing returns but reducing the likelihood that retirees will have to sell stocks immediately after a market decline.
There is no universal rule requiring one, two or three years of spending in cash. The appropriate amount depends on Social Security, pensions, household expenses, risk tolerance and how flexible the retiree can be during market downturns. Someone whose guaranteed income covers nearly all essential expenses may need much less cash than someone whose portfolio funds most of the household budget.
Holding too much cash also creates a cost because cash typically has less long-term growth potential than stocks. The goal is therefore not to eliminate market risk entirely but to create enough breathing room that a temporary decline does not force an immediate sale of long-term investments.
Bucket Two: Stability and Income for the Middle Years
The second bucket generally contains investments intended to provide greater return potential than cash without carrying the full volatility of an equity-heavy portfolio. Intermediate-term bonds, high-quality fixed income and diversified stock exposure can all play roles depending on the retiree’s circumstances. This bucket can help replenish the near-term spending reserve as investments mature, generate interest or are rebalanced after stronger market periods.
It is important not to assume dividends alone will reliably refill the first bucket. Dividends can be reduced, bond prices fluctuate and income-producing investments can decline at the same time as stocks. A more robust approach treats interest and dividends as part of total return rather than relying on them as guaranteed retirement paychecks.
Rebalancing can also provide a disciplined way to move money among buckets. After strong stock-market years, retirees may sell some appreciated assets and restore cash reserves. During weak stock markets, they may rely more heavily on cash and bonds rather than selling equities at depressed prices.
Bucket Three: Growth for the Years Ahead
The final bucket is designed for money that may not be needed for many years. Stocks generally play the largest role because retirement can last 20, 30 or even 40 years, leaving retirees exposed to the risk that rising prices gradually reduce their purchasing power. Growth assets provide the portfolio with an opportunity to outpace inflation over longer periods.
That does not mean the growth bucket must consist only of small-cap stocks, emerging markets or other aggressive investments. A broadly diversified equity portfolio can include U.S. large companies, smaller companies and international stocks without concentrating the retirement plan in the most volatile areas. The goal is long-term growth rather than maximum possible return.
An all-stock retirement portfolio can create its own problems. Morningstar’s recent research found that an all-equity portfolio supported a lower starting withdrawal rate under its fixed real-spending assumptions than more balanced allocations because higher volatility increased sequence risk.
Retirees Still Need Stocks Because Inflation Never Retires
A portfolio designed only to avoid short-term losses can create a different long-term danger. Inflation gradually raises the cost of groceries, utilities, travel and health care, meaning a retirement income that feels comfortable at 65 may buy substantially less at 80. Holding too much cash or very low-return fixed income can therefore protect principal while allowing purchasing power to decline.
Stocks have historically provided stronger long-term growth potential than cash and high-quality bonds, which is why retirees generally continue owning equities even after employment income stops. The appropriate allocation depends on the household’s spending needs, time horizon and tolerance for volatility. Retirement should usually involve managing investment risk rather than trying to eliminate it completely.
Inflation-protected bonds can provide another tool. Treasury Inflation-Protected Securities adjust their principal with inflation, and Morningstar notes that a TIPS ladder can provide a predictable stream of inflation-adjusted income over a defined period. The trade-off is reduced flexibility and potentially less upside than a portfolio retaining significant equity exposure.
The Bucket Strategy Also Solves a Behavioral Problem
The mathematical benefits of buckets are only part of their appeal. Market declines can be emotionally difficult for retirees because the portfolio is no longer simply future money; it is paying today’s bills. Watching a retirement account fall while simultaneously withdrawing from it can create an intense temptation to sell everything and move to cash.
A clearly defined spending bucket can make it easier to resist that reaction. If the next year or two of expected portfolio spending is already available in stable assets, retirees may feel less pressure to make dramatic changes when the stock market drops. The strategy creates a visible reason for leaving long-term investments alone.
Behavior matters because even a theoretically perfect portfolio can fail if the investor abandons it during the worst possible moment. A strategy that someone can follow through both bull and bear markets may ultimately be more useful than a mathematically optimized plan that causes panic whenever volatility rises.
Buckets Are Not Automatically Better
The bucket approach sounds intuitive, but investors should not assume that dividing accounts into three sections necessarily improves portfolio returns or retirement success. Morningstar’s 2026 research compared several bucket strategies with a systematic withdrawal approach and found that some versions of the three-bucket strategy actually produced weaker results. The research found that differences among several approaches narrowed under many scenarios, while a time-bucket strategy performed better in some adverse conditions.
One reason is that holding large cash reserves can reduce the portfolio’s overall return. Another is that selling assets according to rigid bucket rules may produce results similar to ordinary portfolio rebalancing once the transactions are viewed across the entire account. The labels themselves do not create investment returns.
That means buckets are best understood as an organizational and behavioral framework rather than an investment trick. They can help retirees visualize which assets are supporting today’s expenses and which are intended for future growth. The underlying asset allocation, withdrawal rate and spending flexibility still determine much of the long-term result.
A Flexible Withdrawal Plan Can Reduce Sequence Risk Too
Buckets are not the only way to address an early bear market. Retirees who can temporarily reduce discretionary spending when markets decline may substantially improve the durability of their portfolios. Cutting travel, delaying a vehicle purchase or skipping an inflation increase for one year can reduce the amount of depressed assets that need to be sold.
Morningstar’s 2026 retirement research estimates that a new retiree using a fixed, inflation-adjusted withdrawal approach could begin around 3.9% under its base-case assumptions for a 30-year retirement and 90% success rate. More flexible strategies can support higher starting withdrawals because retirees agree to reduce spending when investment conditions deteriorate.
That does not make 3.9% a universal retirement rule. The appropriate spending rate depends on age, asset allocation, guaranteed income, longevity expectations and willingness to adjust expenses. The research is more useful as evidence that spending flexibility can be just as important as investment selection.
Guaranteed Income Changes How Much Risk the Portfolio Needs to Carry
Social Security, pensions and annuity income can reduce the pressure placed on an investment portfolio. A retiree whose guaranteed income covers housing, food, insurance and most essential expenses may be able to tolerate more fluctuation in discretionary withdrawals. Someone dependent almost entirely on investments may require greater stability.
Morningstar’s research found that guaranteed income can work particularly well alongside flexible withdrawal strategies. When essential expenses are covered by predictable income, portfolio withdrawals can be adjusted more easily during unfavorable markets without threatening basic living standards.
This is why retirement income planning should begin with cash flow rather than asset allocation. The investor first needs to understand what Social Security and other dependable sources will cover, then determine how much the portfolio must provide. Only then does it become possible to decide how large each bucket or asset category should be.
The Goal Is to Avoid Selling Because You Have To
A retirement strategy cannot prevent the stock market from falling. It can, however, reduce the chance that a retiree is forced to sell large amounts of stock while prices are depressed. That distinction is at the heart of sequence-of-returns planning.
Cash reserves, high-quality bonds, flexible spending and diversified stocks can all contribute to that goal. The right combination will vary by household, and there is no evidence that every retiree needs exactly three buckets or a predetermined number of years in cash. The strategy should reflect the actual spending plan rather than an arbitrary formula.
The most important question is simple: if stocks fell sharply tomorrow and remained weak for two years, where would the money for living expenses come from? A retiree who already knows the answer is less likely to make a panicked decision when the downturn arrives.
Retirement Investing Requires a Different Mindset
Accumulation is primarily about growing a portfolio. Retirement investing has to accomplish something harder: provide current income, survive bad markets and still grow enough to support spending decades into the future. That requires balancing safety and growth rather than choosing one over the other.
A bucket strategy can make that balance easier to understand. Near-term money can remain relatively stable, intermediate assets can support future withdrawals and long-term investments can pursue the growth needed to fight inflation. The structure also gives retirees a framework for deciding what to sell instead of reacting to whatever market headline happens to dominate the day.
The biggest retirement risk is therefore not simply that stocks will fall. Markets have always fallen and recovered at unpredictable times. The real danger is being forced to fund years of retirement spending from declining investments before they have time to recover.
Intended for educational purposes only. Opinions expressed are not intended as investment advice or to predict future performance. Past performance does not guarantee future results. Neither the information presented, nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. Consult your financial professional before making any investment decisions. Opinions expressed are subject to change without notice.
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• Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance.
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