While you're saving and not withdrawing, the order in which returns arrive doesn't change your ending balance much. Once you start withdrawing in retirement, it matters enormously. This is sequence-of-returns risk, and it's one of the main reasons retirement planners are cautious about withdrawal rates.
Same returns, very different outcomes
Take two retirees who each start with $1,000,000 and withdraw $50,000 at the start of every year for 28 years. Both experience exactly the same set of annual returns, averaging about 7.3%, just in reverse order.
- Retiree A hits the bad years first: −20%, −10% and +5% in years one to three, then steady 8% years, with strong years at the end.
- Retiree B gets the strong years first and the bad years at the end.
| Retiree | Balance after 28 years |
|---|---|
| A: bad years first | $391,771 |
| B: bad years last | $3,442,768 |
Hypothetical illustration: 3 negative or weak years, 22 years at 8%, and 3 strong years, with the order reversed. Withdrawals aren't inflation-adjusted.
Same average return, same withdrawals, and a $3 million difference in the result. The reason: when losses come early, you're selling investments at depressed prices to fund withdrawals. Those shares are gone and can't participate in the recovery.
Why it matters most around retirement
The years just before and just after retirement are when your balance is typically largest and when withdrawals begin. A deep decline in this window does the most lasting damage. Morningstar's retirement income research found that retirees who hit poor returns in the first five years of retirement were much more likely to run out of money unless they cut spending.
Ways to reduce the risk
- Hold a cash or bond buffer. Keeping one to three years of planned withdrawals in cash or short-term bonds means you don't have to sell stocks during a downturn.
- Be flexible with spending. Trimming discretionary spending after a bad year, even modestly, significantly improves the odds your money lasts. This is why separating essential from discretionary expenses is so useful.
- Use a conservative starting withdrawal rate. A lower rate leaves more margin for a bad sequence. See how much you need to retire.
- Increase guaranteed income. Delaying Social Security increases your benefit, and annuities can cover essential expenses, which reduces how much you depend on the portfolio.
- Adjust your allocation near retirement. Many people reduce stock exposure in the years around their retirement date, then rebalance gradually.
- Keep working part-time through the first few years if a downturn hits early.
A note on calculators
Most calculators, including our Compound Interest and Retirement Number calculators, assume a steady return every year. That's useful for setting targets, but it can't show sequence risk. Treat a plan that only works at a steady average return as optimistic, and build in a margin.
Frequently asked questions
Does sequence risk matter while I'm still saving?
Much less. While you're contributing, a downturn lets you buy at lower prices. The risk is concentrated around the time withdrawals begin.
Is sequence risk the same as market risk?
It's a specific form of it. Market risk is about returns being volatile. Sequence risk is about how that volatility interacts with withdrawals.