What is Sequence of Returns Risk?

Sequence of returns risk is one of the most important yet often overlooked risks in retirement planning. While many investors focus primarily on average annual returns, the order in which those returns occur can significantly affect long-term outcomes—especially during retirement. Two portfolios with the exact same average return may produce dramatically different results depending on when market gains and losses occur relative to withdrawals.

The infographic highlights this concept by comparing two hypothetical investors who both experience an average annual return of 5% over a ten-year period. Although the long-term average return is identical, the timing of market declines creates very different financial outcomes. Investor A experiences negative returns early in retirement, while Investor B experiences those same negative returns later. Despite identical averages, one portfolio becomes severely depleted while the other remains relatively healthy.

For Investor A, poor market performance occurs during the early retirement years while withdrawals are simultaneously being taken from the portfolio. This combination creates a particularly dangerous scenario because the investor is forced to withdraw money from investments that have already declined in value. As assets are sold to fund retirement spending, fewer dollars remain invested to participate in any future market recovery. Over time, this can permanently impair the portfolio’s ability to recover and grow.

Investor B experiences the opposite sequence. Strong returns occur during the early retirement years, allowing the portfolio to grow and build a larger cushion before later market declines occur. Even though negative returns eventually arrive, the portfolio has already accumulated additional gains, making it more resilient to downturns and ongoing withdrawals. This demonstrates why the sequence of returns can matter more than average returns alone during retirement.

The infographic also introduces the concept of the “retirement red zone,” which refers to the five years before and after retirement. This period is often considered the most critical stage for sequence risk because investors are transitioning from accumulating assets to drawing income from them. Large market declines during this window can significantly reduce retirement sustainability, especially if withdrawal rates remain fixed regardless of market conditions.

One reason sequence risk becomes so dangerous is the interaction between withdrawals and market losses. During accumulation years, market downturns may eventually recover because the investor is not actively spending from the portfolio. In retirement, however, ongoing withdrawals can lock in losses and reduce future recovery potential. Even if markets eventually rebound, the portfolio may no longer have enough capital remaining to fully benefit from that recovery.

To help manage sequence risk, many retirees use strategies designed to create greater flexibility and stability during market volatility. One common approach is the bucket strategy, which separates assets into different time horizons. Short-term expenses may be held in cash or cash equivalents, intermediate-term needs in bonds or income-focused investments, and long-term growth assets in equities. This structure can help reduce the need to sell stocks during market downturns.

Another mitigation strategy involves dynamic withdrawal rates. Rather than withdrawing the exact same amount every year regardless of market performance, retirees may adjust spending based on portfolio conditions. Spending slightly less during down markets and allowing greater flexibility during stronger periods can improve portfolio longevity and reduce pressure on investments during difficult years. Maintaining cash reserves can also provide an additional buffer that helps retirees avoid selling investments at unfavorable times.

Ultimately, sequence of returns risk highlights the importance of retirement planning beyond simple average return assumptions. Retirement success is influenced not only by how much a portfolio earns, but also by when returns occur and how withdrawals are managed throughout the process. While no one can predict market performance with certainty, thoughtful planning, diversification, disciplined spending strategies, and proper risk management can help retirees navigate uncertainty more effectively and improve the long-term sustainability of their financial plan.