Sequence-of-Returns Risk
Two people can retire the same year with the same money, earn the identical average return, and end up in different places. The difference is the order the returns arrived in, and it only matters once money is coming out.
While you are saving, the order of returns does not change where you end up. Gains and losses in any sequence produce the same balance, because nothing is leaving the account. Start withdrawing and that stops being true. Selling shares to fund a withdrawal in a year prices are down removes shares permanently, and those shares are not there for the recovery.
The same average returns, in a different order
Two hypothetical retirees. Same starting balance, same withdrawals, same yearly returns, in opposite order. One meets the poor years first; the other meets them last.
Why withdrawals change the math
A portfolio falling 20% needs a 25% gain to get back to even. A portfolio falling 20% while also paying out a year of spending needs more than that, and the gap compounds.
The damage is not the decline. Markets decline and recover. The damage is that the decline and the withdrawal happen at the same time, so the portfolio funds the spending by selling more shares than it would have at a higher price. When prices recover, they recover on a smaller base. A retiree who meets a bad market in year two has fewer shares participating in every year after it. A retiree who meets the same market in year twenty has already had twenty years of compounding on a full base.
The risk has a window. It concentrates in roughly the first decade of withdrawals and fades after that, once the portfolio has either grown enough to absorb a decline or reached a point where a long recovery is no longer needed.
What actually drives it
Three inputs decide how exposed a given retirement is, and two of them are controllable.
| Input | Why it matters | Controllable |
|---|---|---|
| Withdrawal rate | The share of the portfolio sold each year. The higher it is, the more shares a down year costs | Yes, within limits |
| How much sits in stocks | Sets how far the portfolio can fall while withdrawals continue | Yes |
| What markets do in the first decade | Decides whether any of this is a live problem | No |
| Flexibility of spending | Can withdrawals shrink for a year or two without real hardship | Usually yes, and it matters more than people expect |
| Income that does not come from the portfolio | Social Security, a pension, rent, or part-time work reduce what has to be sold | Partly, and decisions here are permanent |
The last row does the heaviest lifting and gets the least attention. A retiree covering most of their spending from Social Security and a pension has a portfolio that is mostly a reserve, and sequence risk barely reaches them. A retiree funding everything from investments carries the full exposure.
What can be done about it
None of these removes the risk. Each trades something for a reduction in it.
| Approach | What it does | What it costs |
|---|---|---|
| Cash and short-term reserve | Spending comes from assets that did not fall, so stocks are not sold into a decline | A drag on long-run return for the years it sits unused |
| Bond ladder | Matches specific maturities to specific spending years, so the money is there regardless of markets | Locks in current yields, with less upside than stocks over long periods |
| Flexible spending rules | Reduces withdrawals after a bad year and raises them after good ones, by formula rather than mood | Income varies, which some households can absorb and others cannot |
| Rising equity glidepath | Starts retirement with less in stocks and increases it over time, putting the least exposure in the riskiest window | Gives up some growth early, and runs against the instinct to get more conservative with age |
| Guaranteed income | Converts part of the portfolio into payments that do not depend on markets | Irreversible, gives up liquidity and any legacy on that portion, and depends on the insurer |
| Delaying Social Security | Raises lifetime inflation-adjusted income that does not come from the portfolio | Requires funding the gap years from the portfolio, which uses assets early |
| Working longer or part-time | Shortens the withdrawal period and shrinks the early withdrawals | It is a life decision before it is a financial one |
Most plans use several. A common shape is a reserve covering a couple of years of spending, a bond allocation covering several more, a spending rule that flexes inside a band, and a Social Security claiming decision made deliberately rather than by default.
The part nobody can plan around
Sequence risk is the reason a retirement plan should be tested against bad starting years, not average ones.
An average return assumption produces an answer that is true on average and useless in the case that matters. A useful plan asks what happens if the first three years are poor, how much the household could cut for a year without hardship, and how long the safer assets would last before stocks had to be touched. Those answers are more useful than any single projected number, and they are available before anything goes wrong.
The behavioral half is real too. A retiree who understands why the reserve exists is less likely to sell everything in a bad year, and that decision does more damage than any sequence of returns. What to do in a falling market is worth writing down while markets are calm.
Where this lands
The order of returns does nothing while you are saving and a great deal once you are spending, because withdrawals in a down market remove shares that never come back. The exposure is concentrated in the first decade of retirement. What reduces it is having money to spend that did not come from selling stocks, spending that can flex, and income from outside the portfolio. Each of those costs something, so the mix gets built around one household rather than borrowed from another.
- While you are saving, the order of returns does not change the outcome. Once you are withdrawing, it does.
- Selling shares in a down market removes them permanently, and they are not there for the recovery.
- The risk is concentrated in roughly the first ten years of withdrawals.
- A higher withdrawal rate and a higher stock allocation both increase exposure to it.
- Income from outside the portfolio, including Social Security and pensions, reduces it more than any investment decision.
- Cash reserves and bond ladders let spending come from something that did not fall, at the cost of long-run return.
- Spending that can flex by a few percent after a bad year is one of the most effective tools available, and the most commonly overlooked.
- Test a plan against poor early years rather than average ones.
- The largest single risk is still selling everything in a bad market, which is a decision rather than a return.
Income designed for the years it has to survive.
Building a retirement income plan, and deciding what it holds, is central work here.
How we work →Educational content only. This article is for informational and educational purposes and does not constitute personalized investment, tax, or legal advice, and does not create an advisory relationship. It does not recommend any withdrawal rate, allocation, product, or strategy. The approaches described carry different risks and costs, and whether any of them suits a household depends on individual circumstances. No return, outcome, projection, or performance is shown or implied anywhere in this article, and the figure illustrates a concept rather than any portfolio or result. All investing involves risk, including possible loss of principal. Past performance does not indicate future results. The firm and its related persons may or may not hold any security, fund, or asset class mentioned, and any such position may change at any time.
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Written by Schad TenBroeck, CFP®, Principal. CFP Board owns the marks CFP® and CERTIFIED FINANCIAL PLANNER® in the United States.