Sequence of Returns Risk: The Enemy of the Soon-to-Retire
Sequence of returns risk is when the ORDER of good and bad years dramatically changes your outcome once you start withdrawing. We explain why it matters at retirement and how to reduce it.
Same average return, wildly different outcome
Two retirees hold portfolios with the same average return over 20 years, yet one runs out of money while the other lives comfortably. The difference? The order in which the good and bad years arrived. This is sequence of returns risk β a little-known risk that becomes critical the moment you start withdrawing.
Why order matters
While you are accumulating (only paying in, not withdrawing), the order of gains and losses barely affects the final result β only the average return matters.
But when you are withdrawing steadily (as in retirement), order becomes decisive:
- A sharp drop RIGHT AT THE START of withdrawals: you are selling assets at low prices to cover spending while the portfolio is also shrinking β principal erodes fast and struggles to recover even if markets rebound later.
- Strong gains early on: principal grows first, providing a better "cushion" for the bad years that follow.
The same series of returns reversed in order can produce a completely different outcome β someone who retires at the start of a bear market carries the greatest risk.
Link to drawdown and withdrawal rules
This risk amplifies the damage of maximum drawdown: withdrawing while the portfolio is deep in a drawdown is the worst possible combination. It is also why the 4% rule is designed conservatively β to survive a bad-sequence scenario.
How to reduce it
- Cut portfolio risk as you approach withdrawals: shift gradually toward safer weightings following age-based asset allocation β reducing dependence on any single bad market year.
- Keep a "cash cushion": enough cash or safe assets to cover several years of spending, so you never have to sell risky assets at low prices.
- Stay flexible on withdrawals: spending less during bad market years protects your principal.
- Accumulate a surplus first: a larger principal gives a wider safety margin against sequence risk.
The lesson for those still accumulating
If you are young and accumulating steadily (DCA), sequence risk has little impact β down years are even good because you buy more. It only becomes a major danger when you switch from "paying in" to "taking out." Understanding it early lets you plan ahead.
Conclusion
Sequence of returns risk is when the order of good and bad years dramatically changes your outcome while withdrawing β a sharp drop right at the start of retirement is the most dangerous scenario. Reduce it by lowering portfolio risk near withdrawal, keeping a cash cushion, staying flexible on spending, and accumulating a surplus first. For those still accumulating, this risk is a minor concern.
Next step
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