Understanding Sequence of Returns Risk in Retirement

The quiet problem most investors miss

During your working years, market volatility averages out. Good years and bad years come and go, and your overall return over decades is what matters.

But in retirement, the rules change. When you're withdrawing from your portfolio, the order of returns matters enormously. Two retirees with identical average returns can have vastly different outcomes based solely on when the good and bad years occurred.

This is sequence of returns risk, and it's one of the least understood threats to retirement security.

How this actually works

Consider two retirees who both:

Start with $1,000,000
Withdraw $50,000 per year
Experience average returns of 7% over 20 years

Retiree A gets good returns early (years 1-10) and poor returns later (years 11-20).

Retiree B gets poor returns early (years 1-10) and good returns later (years 11-20).

Despite identical average returns:

Retiree A ends with $1,200,000+
Retiree B runs out of money in year 18

Same average return. Completely different outcomes. The difference is sequence.

Here's why: When you withdraw during down markets, you sell more shares to fund the same spending. Those shares are gone and can't participate in later recoveries. Early losses combined with withdrawals create a death spiral that better later returns can't reverse.

Where people get this wrong

Using accumulation-phase thinking. "Don't worry about short-term volatility" works when you're adding money. When you're withdrawing money, short-term volatility in the wrong direction is devastating.

Ignoring the first decade of retirement. Research shows the first 5-10 years of retirement are the danger zone. Poor returns early create damage that's nearly impossible to recover from.

Using fixed withdrawal rates blindly. The famous "4% rule" assumes average historical returns. It doesn't account for the possibility of a bad early sequence.

Having the same asset allocation at 65 as at 55. The retirement transition requires rethinking risk. Sequence risk means aggressive portfolios carry dangers they didn't have a decade earlier.

What to focus on instead

Build flexibility into your withdrawal strategy. If markets drop significantly, reduce withdrawals temporarily. Rigid spending rules amplify sequence risk.
Consider a bond/cash buffer. Keeping 2-3 years of spending in stable assets allows you to avoid selling stocks during downturns.
Think about a "rising equity glidepath." Some research suggests starting retirement more conservatively and increasing stock allocation over time may reduce sequence risk.
Plan for multiple scenarios. Don't assume average returns. Model what happens if you retire into a prolonged bear market. Have a plan.

How this connects to long-term outcomes

Sequence of returns risk is the reason some retirees run out of money while others with identical savings and average returns end up wealthy. It's largely luck—you can't control which sequence you get.

But you can control your preparation. Flexible spending, cash reserves, and appropriate asset allocation create resilience against bad sequences. Rigid spending plans and aggressive portfolios amplify the danger.

The retirement phase of investing requires different thinking than the accumulation phase. The same volatility that's merely uncomfortable for a 40-year-old can be catastrophic for a 65-year-old. Understanding this distinction is essential for protecting the wealth you've spent decades building.

Averages are reassuring. Sequences are real.