It is not enough to simply avoid selling when the market is down, you must also keep buying the down asset at the lower price. Image: William Potter/Shutterstock.com
Conceptually, saving for retirement is pretty straightforward: save early, save often, let the power of compounding do the heavy lifting. But, spending down your nest egg? That can get tricky. Aside from the emotional toll of seeing your savings dwindle (as they should, right?), there is the sheer terror of the voice in your head constantly repeating, “What if I run out of money?”
And with that recurring drumbeat of worry in your mind, we arrive at what investment planning professionals call “sequence of return risk.” In short, when you are adding to your retirement savings over time, you can be indifferent to the ups and downs of the market. But when it comes time to make withdrawals – the decumulation phase – then it can make quite a bit of difference if you are selling assets in a down market, particularly early in your retirement.
A simple example: You own 10,000 shares of ABC. Your plan was to raise $40,000 to fund your lifestyle by selling 400 shares of ABC at $100 each. This leaves you with 9,600 shares for the future. But then, the market tanks! You still need $40,000 but now, with a price of only $80, you must sell 500 shares, reducing your balance to only 9,500 shares. Even when the market recovers, you simply own fewer shares than you intended, and if this downward trend continues over years, your retirement security could be threatened. This is sequence of return risk.
One way that retirees seek to mitigate this risk is the popular “bucket” strategy. That is, they segregate their savings between stocks, bonds, and cash. Each year, the retiree will draw their living expenses from whichever bucket is performing best in that moment (stocks or bonds); if both are doing poorly, then cash it is. It is an appealing strategy on an intuitive, emotional level.
The problem for TSP-ers is that it is difficult to execute this scheme as TSP withdrawal rules do not allow one to select which fund their distribution comes from. That is, if your portfolio consists of 30% G Fund, 50% C Fund, and 20% S Fund, your hypothetical $40,000 will be drawn pro rata from all three funds. If the stock market is down, you cannot direct TSP to draw the disbursement only from the G or F Fund.
That sounds…bad. But does it matter? Maybe not. Research published in 2014 by Michael Kitces, a well-known financial planner and writer, suggests that there is no mathematical difference between a bucket strategy and drawing distributions pro rata from a balanced portfolio of cash, bonds, and equity, as one would have if they were invested in a TSP Lifecycle Fund. The reason is that the second leg of the bucket strategy is rebalancing. In our hypothetical example above, the bucket strategy retiree must later refill the bucket that was diminished by selling shares from the other bucket(s) to re-establish their desired asset allocation.
Kitces argues that the active rebalancing that an investor must do to execute the bucket strategy fully will leave you in the exact same place as what he terms a “total return” approach, whereby distributions are simply taken pro rata from a balanced portfolio.
In terms of sequence of return risk, as Kitces graphically shows, the real problem occurs when one repeatedly experiences bad equity returns but fails to rebalance along the way. It is not enough to simply avoid selling when the market is down, you must also keep buying the “down asset” at the lower price. A TSP Lifecycle fund is continually rebalanced so as to maintain a specified balance between asset classes; doing so implies that winners will be sold when they are riding high in order to purchase more of the asset that is down.
In short, rebalancing is the superpower to employ against sequence of return risk. You can get there by actively bucketing (periodically rebalancing your portfolio yourself), or you can simply draw your distributions from a continually rebalanced Lifecycle Fund. Maybe this decumulation phase isn’t as tricky as we thought?
After an 18-year career as a Foreign Service Officer with the United States Agency for International Development (USAID), Lisa Whitley switched gears and became a personal finance coach in 2019. Since then, as a financial guide with an employee wellness company, she has counseled hundreds of persons on topics such as budgeting, debt, retirement, housing, paying for education and more. She has established her own firm, MoneyByLisa, a Registered Investment Advisor domiciled in the District of Columbia. Lisa is an Accredited Financial Counselor (AFC®) and Chartered Retirement Planning Counselor (CRPC®).
Deferred Resignation Periods about to End for Many; Overall 12% Drop
Retirement Surge Likely as Deferred Resignation Periods End
Senate Rejects Bills to Defer Shutdown; Familiar Process Lies Just Ahead
Senate Bill Would Override Trump Orders against Unions
Report Describes Impact of Shutdown on Employees, Agencies
TSP Adds Detail to Upcoming Roth Conversion Feature
See also,
Legal: How to Challenge a Federal Reduction in Force (RIF) in 2025
How to Handle Taxes Owed on TSP Roth Conversions? Use a Ladder
The Best Ages for Federal Employees to Retire
Best States to Retire for Federal Retirees: 2025
Retention Standing, ‘Bump and Retreat’ and More: Report Outlines RIF Process