Asset Allocation Strategies To Attenuate Sequence of Returns Risk.

In the preceding post, I described the sequence of returns risk – the risk that you will get unlucky around the time you switch from accumulating money and starting to draw upon it.

Let’s say that we decide that we don’t want to take the chance of having an unlucky sequence of returns at our financial destination and potentially running out of money. Since the sequence of returns risk is magnified by volatility, one way to attenuate it is by reducing the volatility of our portfolio as the destination approaches and for a few years after.

How can we do that? What could the impact look like? What are the downsides?

How: add bonds to dampen volatility

It is common advice to add more bonds to our asset allocation as we age or if our risk tolerance decreases. We add those bonds to dampen volatility. Mid-duration government bonds may be particularly effective in this role. Because bonds still produce income and their price tends to move opposite to equity, the return is only slightly reduced by adding bonds, while the volatility is greatly reduced.

Using the Canadian Portfolio Historical Returns & Volatility Visualizer, moving from a 100% equity to a 60:40 equity:bonds portfolio attenuated the max historical drawdown from -30% to -15%. The potential downside of adding a higher bond allocation is that it does decrease the expected return slightly.

Comparing bond allocation strategies to reduce sequencing risk.

As mentioned, the biggest reason for holding bonds is to reduce our behavioral risk from volatility. If our risk tolerance from a behavioral standpoint is high, then a secondary consideration would be to reduce the sequence of returns risk.

If that secondary mathematical risk is the only reason why we are increasing our bond allocation and it is highest around the time of retirement, then it may make sense to simply increase bonds around that “risk window”.

How does a strategy of adding bonds just for that “risk window” compare to simply increasing bonds and leaving that higher bond allocation until death? Let’s model it.

Parameters for lucky vs unlucky sequence of returns simulation.

Cashflow: contributions and withdrawals

For a theoretical comparison, let’s take two investors. Both contribute $25K/yr to their portfolios for 30 years. They then withdraw $128K/yr for 30 years in retirement. Retirement will be labeled as year zero.


An all equity portfolio in our model returns a random annual return of +20%, +10%, and -10% while a 60:40 stocks:bonds portfolio randomly returns +12%, +7%, -5%.

Sequence of returns

These random returns are identical for both investors except for a 10-year window (5yrs before to 5yrs after retirement). During that “risk window”, the lucky investor gets good returns around retirement and experiences a bear market towards the end of the risk window. The unlucky investor has the same average returns, but their sequence has the poor returns around their retirement year and a bear market in their first year of retirement.

Two bond allocation strategies

Again, the stock:bond allocation should be primarily driven by investor risk tolerance. However, to make the simulation illustrative and simple, the two investors will either use 100% stocks or a 60:40 stock:bond allocation. They will simply flip allocations in a single year instead of the smooth transitions (like a glide path) that we’d see people use in real life. Taxes triggered by doing that are also ignored. This is to illustrate basic concepts and not get mired in the weeds.

The first strategy represents the conventional glide path of adding bonds as you approach retirement and then keeping that allocation. The second strategy is closer to a rising equity glide path. The rising equity glide path increases the equity allocation again after a few years of retirement when the sequence of returns risk window has hopefully past.

retirement asset allocation strategy

Conventional Strategy: add bonds and keep that allocation until death.

This would be common advice. The rationale is that we need to know that our money will be there when we need it. Since it is assumed that we can’t earn more income when we are old, we need predictable income from our investments. Bonds are a lower risk for loss of capital and they spit out regular income. Thinking of that regular income as different from simply selling periodically as needed to generate cash is mental accounting. However, that predictable and automated income generation is psychologically soothing and helps us to behave.

Unfortunately, the trade-off for the predictability of fixed income is that it is generally lower-risk and has a lower expected return. It is also intentionally taxed more than most other investment income. If we start to draw more than the income that our portfolio returns, then our capital will erode over time.

How do the lower sequencing risk and lower expected returns from adding bonds balance out?

Using the above model, the investors switch from an all-equity portfolio to a 60:40 split 5 years before retirement. They keep that until death 30 years later. If they are lucky, they run out of money a few years before dying. If they have an unlucky sequence of returns, then they are hitting the Fancy Feast for seven years before death.

bonds reduce risk
click to enlarge

There is a trade-off between decreasing expected returns and decreasing the sequence of returns risk from adding lower risk and less volatile investments. Once outside the window of the highest sequencing risk, the cause of running out of money can shift back to not having high enough returns over time. Most people need to invest to retire. If the portfolio size is small relative to the drawdown or the length of retirement is long – they need to invest aggressively enough to get sufficient returns to beat inflation and meet their cash flow needs.

Rising Equity Strategy: add bonds for the “sequencing risk window” only and then add equity back.

What if they invest more aggressively again as they pass the early stages of retirement when the sequence of returns risk lessens?

In the model below, our investors change from all equity to a 60:40 portfolio for a 10-year period (5yrs before until 5yrs after retirement). They then go back to the 100% equity portfolio. That reduces the return during that decade from 4.5%/yr to 3.5%/yr, but also cuts the volatility during that time in half (std dev 16.9% to 9.4%).

bonds reduce sequencing risk
click to enlarge
There are two important take-home messages from the above model.

First, neither investor ran out of money this time. However, this was still not without a trade-off.

The lucky investor ended up with $1.25M when they croaked. That still translates into lucky beneficiaries. However, if they had stayed with an all-equity portfolio for the entire time period, the would have had $1.75M.

Like the rest of investing, decreasing the sequence of return risk (if unlucky) also decreased the potential reward (if lucky). Since we don’t know the future, this comes down to the subjective decision of which risk is more important to you. Avoiding Fancy Feast while alive vs. leaving behind a smaller estate. My taste buds may fade with age, but I know what I would prefer.

Putting This Into Context

The strategy of increasing bonds when nearing the financial destination is pretty standard advice. However, ramping our equity allocation back up as we move further past that is not. Why is that?

Sequence of returns risk is a secondary consideration

The primary risk from volatility for most people is still likely to be behavioral risk. Only those with really high investing intestinal fortitude can tolerate the higher equity allocations where sequencing risk becomes a greater threat. Optimizing mathematical models and risks are meaningless if the emotional investor beast is in charge.

asset allocation to reduce SORR

Running out of money becomes more frightening when we are retired and may not be able to simply earn more or spend less. Fear feeds the beast. On the other hand, if we make it past the “risk window” and it becomes obvious that we are likely to have more money than we need, that should alleviate fear. That would be logical, but emotions are not logical. The tipping point between these fears is definitely subjective and personal.

Strategy 3: Ignore Sequence of Return Risk

With behavioral risk being the primary consideration for most people, there is also a good argument for simply choosing the asset allocation that suits your emotional risk profile. Then, sticking with it throughout your lifespan. This is probably the most reasonable choice for most high-income professionals who will either have a risk tolerance requiring bonds anyway, buffer in their portfolio, and/or some flexibility with discretionary spending.

Sequencing risk has received increased attention recently because of the very early FIRE movement. Sequence risk is a major threat in that setting since the planning is often dependent on the high returns of equity and a low spending level that leaves little wiggle room over an extra-long retirement duration.

The above model was simple and extreme to illustrate the concept.

The above model may have scared some people. A 60:40 balanced portfolio is generally considered “safe”. Yet, in the above models, it ran out of money. That was not because of the portfolio per se. The portfolio returns were actually quite good. However, a mix of variables determines portfolio survivability.

retirement sequence returns

In the above models, the ~$2M portfolios did not survive the strain put upon them if bad luck intervened. The portfolios failed to survive because the mix of the above variables aligned in the wrong combination.

In this model, the size of the portfolio was small compared to the drawdown rate. Putting away $25K/yr for 30 years for someone making $250K/yr is a 10% savings rate and enables after-tax spending of ~$140K/yr. Reducing spending slightly in retirement to $125K/yr is also seems reasonable. However, taking $125K/yr for 30 years from a $2M portfolio is a 6.25%/yr withdrawal rate. That is extreme.

Someone, starting to save later in life, like many professionals do, likely need to be more aggressive at saving (like a 20% savings rate) or plan on a more frugal retirement.

To get a more realistic sense of the range of possibilities, one must run thousands of simulations with different assumptions about the above variables. That approach (Monte Carlo simulation) generally yields a safe withdrawal rate in the 3-4%/yr range for historical return rates. It is probably even lower for longer retirements – like if you retire extremely early or live way past your best-before-date.

Portfolio volatility control is only half of the sequencing risk equation

In this post, we looked at mitigating the sequence of return risk by trying to lower volatility through adding bonds to a portfolio. That comes with the downside of decreasing expected returns which can also lead to portfolio failure. However, volatility is only part of the equation. Sequencing risk is caused when we have a combination of volatility and cash flows. In the next post, we’ll look at how to mitigate sequencing risk from the cash flow side of the equation.


  1. Awesome post! I’m so glad you’re investigating the drawdown period as this is difficult to clarify in terms of approach. There are so many variables to consider and map, it’s like LEGO for big kids:)

    I’ve realized that the question of allocation has been simplified in our case as potentially having pensions cover up to half of our withdrawals. Having the stable income really increases my comfort with volatility but I’m not sure if I’d be comfortable with 100% equity in the portfolio portion after ceasing work (if that ever happens:).

    I know that this is a controversial question, but what are your thoughts on including pension income as part of the fixed income component? (Work, cpp, oas) I remember Fred vittesse making some great arguments that pensionizing 30% of a total portfolio can actually increase the total amount withdrawn over a lifetime too a swr of 5 or 6%.

    1. Hey Phil. I definitely count pensions and entitlements as part of my fixed income allocation. Otherwise, it is artificially dividing up my resources (mental accounting). That should allow a higher equity allocation in the remainder of my portfolio. However, key to that is attaching some kind of value to the pension and being able to easily see that. It needs to be obvious for our emotional-selves to see that during a market drawdown and realize that while our investment accounts are down 30%, or financial capital is only down say 15% when our pensions are included.

  2. Another great thought-provoking post! Decumulation strategies are like a black box (or the dark side…hidden and concealed) to me, thanks for shedding some light on it.

    I remember reading an article illustrating very early FIRE people and the concept of applying a yield shield during the sequencing risk window. I think the couple who retired early maintained a 60:40 portfolio during their early retirement, but also garnered up some cash/GICs equal to a 3-4 year period for any bear markets that happen to coincide with their retirement. Do you think there’s any merits to this approach? For high income professionals, would this be a beneficial add-on to an otherwise constant risk portfolio throughout their lifespan?

    Looking forward to the cash flow side of the equation!

    1. Thanks Mark. I think for the very early FIRE crowd, something like that to attenuate their sequence risk is wise. I don’t know that it is mathematically necessary for most high income professionals who likely have buffer from a larger portfolio and more discretionary spending to trim in a pinch. However, I would never underestimate the importance of the psychology of knowing you have enough money in a very straightforward set-up.

      1. Ed Rempel argues against the need to keep a cash/GIC ladder. If you were doing a 60/40 split, you could always draw down the bond ETF, which should be flat-ish or possibly benefit during a bear market event.

        Will that work?

        Cheers, TM

        1. I think so. To have a separate stash of cash or GICs is just mental accounting. It is all part of a fixed income allocation. Most people will be holding enough fixed income for behavioural reasons that they can draw on that. It is the folks with little to no fixed income allocation and/or a borderline sized portfolio for their basic needs that are vulnerable.

    2. Mark S, The Millennial Revolution couple came up with the “yield shield” approach but in this analysis (part 29-31), part of this very extensive series of safe withdrawal strategies, Big Ern shows it doesn’t work. Reaching for yield just creates a less diversified and risker portfolio that doesn’t survive the big down turns. There is no free lunch.

      1. I agree. All companies that make profit then choose how to use it. Some is dividends, some is share buy-back (equity gain for existing shareholders), and some is re-investing to grow the business. Focusing on companies that do one of those is less diversified. Each approach has pros/cons and works at different times. No free lunch.

  3. This is a great series of posts LD! Very interesting and helpful. Thanks for putting out very solid information in an illustrative and thought provoking way. Looking forward to the next post!

  4. Great analysis LD. The rising equity once you are out of your sorr window looks like a decent option but I am sure it is hard to implement in practice. When you no longer have income from a job to ride the lows of the market it would make it much harder to stomach drops in the market when that is your sole source of income.

  5. Thanks Loonie, this is a great, timely post! I’m about 3 years out from FIRE and currently holding 75% of my net worth in cash or in a HISA (oops not the most tax efficient!) Mostly because I have this (speculative) fear that a bear market is snarling right around the corner, so I’m deciding on how to structure the ‘final’ asset locations/allocations.

    The other consideration is that I estimate a <10% likelihood of actually sitting on my bum and retiring (ie. watching Star Trek in chronological order, starting with Jonathan Archer). So if I'm probably not going to retire, am I just playing a different game of mental accounting? If so, then why not go 100% equities now, and presume that we will all actually retire at a 'normal' age. I could try to retire in 10 years, by then I would have finished watching Picard.

    Are we selling our portfolio 'short' with believing that we will actually stop being income producing when the time comes, by having elaborate glide paths?

    Cheers, Doc TM

    1. Hey Tooth Mechanic. Asset allocation for sequence risk is only a secondary consideration. I would pick an asset allocation that suits your emotional risk tolerance and run with it. It is also only one of the levers to control sequence risk. The other is cash flow. If you intend to keep working (even in just a small enough amount to cover your basic costs) that gives you enough wiggle room to largely ignore sequencing risk. If a bad year, you just work a bit more or spend a bit less and don’t need to touch your portfolio. There is always a fear of loss when markets are hitting all-time highs. It is an emotion twice as powerful as regular fear. However, statistically all-time highs are followed by more highs most of the time (the market moves up >70% of the time). Trying to time the downs and ups requires you to be right on when to sell and right on when to buy with precision. It is emotionally attractive (I have fallen into it too in my investing lifetime. Repeatedly.), but it is practically impossible. Picking the right allocation and remembering that you are investing for the long-term and don’t care about the short-term (especially if still working) is best.

  6. Hi LD,

    While not directly related to your post, a related question did come up in the discussion.

    Would you consider a) mortgage payments (on a corporately held rental property), and b) Whole Life policy premiums part of your fixed income allocation as well? If so, that would dramatically increase our equity allocation in the liquid investment accounts (TFSA, RRSP, corp taxable). However, this would also limit our ability to use liquid bond funds as a rebalancing tool to buy stocks, and would force any equity positions to be gained with fresh cash (also not terrible given we have many working years ahead).

    Currently we consider our 70eq 30fi to apply only to our liquid investment portfolio, with real estate and WL considered altogether seperately. Reading your comments, however, have made me wonder if this is again a case of Mental Accounting.

    1. Hi Dan,

      I would (and do) consider my whole life cash value as part of my fixed income allocation. Same with my CPP entitlement. I’d count rental income except as an “alternative investment” since it is complicated, but could be fixed income-like if it is very secure. You can’t liquidate your whole life to rebalance – but you could borrow against it. The need to do that for rebalancing seems very unlikely though. If counting bonds and whole life as fixed income, it would just mean selling even more bonds (since they are the liquid part) to rebalance. To outstrip that source of cash could happen if a really low bond allocation or a really huge diversion between bonds and equity. I would think that whole life would (or should) only be a small part of an overall portfolio. Fresh cash being added makes it even less likely during the accumulation years. Great comment! Mental accounting is insidious and I keep catching myself doing it as I learn and think more about this stuff.

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