Two people can retire with the same total balance, the same asset mix, the same withdrawal rate, and even the same average annual return over the following thirty years, yet one runs out of money before the end while the other finishes with more than they started with.
The only difference between them is the order the returns showed up in. It’s one of the best documented patterns in retirement research, and the fix is rebalancing.
Two Jobs, One Portfolio
During the saving years, a portfolio has one job, growing the money as efficiently as possible given how much risk someone can tolerate and how many years they have before they need it.
In retirement, the job splits in two. A retirement portfolio has to fund the life someone is living right now, this month’s expenses and next year’s, without depending on the market cooperating on cue, while also continuing to grow, because a retirement can easily run thirty years or more. Managing both inside the same pool of money is what makes retirement investing harder than it looks.
How Portfolios Drift
Portfolios drift out of balance constantly, without anyone doing anything wrong. Stocks generally grow faster than bonds over long stretches (past performance does not guarantee future results), so a 60/40 mix can drift to 70/30 over a few strong years, purely through ordinary market growth.
Picture a $1,000,000 portfolio split 60/40, $600,000 in stocks and $400,000 in bonds. Assume, for illustration only, that stocks compound at 10% a year and bonds at 4% a year over five years (not a projection, and past performance does not guarantee future results). After five years, the stock piece grows to roughly $966,000, and the bond piece grows to roughly $487,000. The total portfolio is worth about $1,453,000, and stocks now make up around 66% of it instead of 60%, without anyone deciding anything or making a single trade.
That added risk shows up right at the point in life when a downturn does the most damage.
Two Ways to Rebalance
There are two common approaches, and either one beats doing nothing. A calendar-based approach picks a schedule, once a year is common, and brings the portfolio back to target on that date regardless of what happened in between. A threshold-based approach sets a tolerance, say five percentage points, and rebalances whenever an asset class drifts that far. It responds faster to big market moves, but takes more attention.
There’s also a tax difference. Inside a 401(k) or IRA, rebalancing doesn’t create a taxable event, so there’s freedom to adjust without a tax consequence. Inside a taxable brokerage account, selling an appreciated position to rebalance can trigger capital gains, so it often makes sense to do the heavy rebalancing inside tax-deferred accounts first, and use new contributions or planned withdrawals in the taxable account to nudge things back gradually. (Tax treatment depends on individual circumstances. Consult a tax professional before making decisions based on this.)
The War Chest
We build something into every retirement allocation for exactly this reason. We call it the War Chest. It means setting aside three to five years of anticipated spending, the dollars someone expects to draw from their portfolio each year on top of Social Security or pension income, and holding it in cash, short-term bonds, and inflation-protected securities (TIPS). That money isn’t invested for growth. Its job is to sit there, stable and available, so someone is never forced to sell stocks during a downturn just to cover this month’s bills.
A widely cited Morningstar analysis of simulated retirement outcomes found that nearly 70% of the portfolios that eventually ran out of money had already lost value within the first five years of retirement, not at some point over thirty years, but early, while withdrawals were still happening. A War Chest exists specifically to interrupt that pattern.
These inflation-protected securities are government bonds where the principal adjusts with inflation, measured by the Consumer Price Index, so money waiting to be spent isn’t losing purchasing power the way plain cash sometimes can.
A Real Example
In the spring of 2025, the S&P 500 fell close to 19% from its earlier high before recovering and finishing the year up nearly 18% overall. Someone who retired near that low point and had to sell stocks to cover spending locked in losses at the worst possible moment. Someone with three to five years of spending already sitting in a War Chest didn’t have to sell anything. They drew from cash while the growth portion of the portfolio recovered on its own timeline, which happened within the same calendar year.
The market was identical for both of them. The outcome depended entirely on whether a War Chest existed before the drop, not after.
Sequence of Return Risk and the Red Zone
This is what researchers call sequence of return risk: the risk that poor returns early in retirement, combined with ongoing withdrawals, do far more damage than the same poor returns would later on. Two people can retire with identical portfolios and identical thirty-year average returns and land in different places, purely because of when the bad years happened to hit.
How this affects a given household depends on two things. One is retirement age. Someone retiring at 55 is exposed to a longer stretch before Social Security or other guaranteed income arrives to ease the pressure than someone retiring at 68. The other is funding level. A retiree whose portfolio comfortably exceeds what they need has more room to absorb a bad sequence, while a retiree whose plan is tightly funded needs the War Chest and rebalancing discipline even more.
Keeping Speculative Money Separate
Speculative investments, an individual stock, cryptocurrency, a position with a much wider range of outcomes than the rest of the portfolio, aren’t automatically a mistake. They belong in a different category from retirement assets, though, and should be treated that way on purpose, not by accident.
A useful test is to pick an amount small enough that losing every dollar of it wouldn’t change the retirement plan at all. For a lot of households, that lands somewhere in the low single digits of the total portfolio, though the right number depends on how well funded the rest of the plan already is. Keep that money separate from the War Chest and the core growth portfolio, mentally and often literally in its own account, so its performance never gets confused with the plan funding retirement.
Coordinating Withdrawals With Taxes
In a down market year, pull spending money from the War Chest first, cash and short-term bonds that haven’t lost value, and leave the growth portfolio alone to recover. In a strong market year, that’s the time to refill the War Chest, ideally from accounts and positions where the tax impact is smallest. (Tax outcomes vary by individual circumstances and current tax law. Consult a tax professional.)
Retirees with guaranteed income, Social Security, a pension, sometimes have room to skip an inflation adjustment on spending during a rough market year rather than drawing the same dollar amount regardless of what the market just did. A plan that can bend a little when conditions call for it tends to hold up better than a rigid one, especially once real markets and real life get involved.
Building Your Own Three Buckets
Sort a retirement portfolio, or the one being built toward, into three buckets with numbers attached to each:
- A contingency fund, true emergency money sized for unexpected costs like a roof repair, a car, or a medical bill
- An income reserve, the War Chest itself, three to five years of anticipated spending held in cash, short-term bonds, and inflation-protected securities
- A long-term growth portfolio, the piece allowed to ride out volatility because it isn’t needed for years, sized to keep growing across a retirement that could run three decades or longer
Write down what percentage, or dollar amount, belongs in each one. That’s the starting point of a retirement allocation built on purpose, instead of one that drifts wherever the market happens to take it, one strong year and one weak year at a time.
Source: Morningstar, “The Biggest Risk for New Retirees” — https://www.morningstar.com/retirement/biggest-risk-new-retirees
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