Learn Sequence-of-Returns Risk | Risk You Can't See

Swipe to show menu

Two investors each retire with $1,000,000. Both experience the same average annual return of 7% over 20 years. Both withdraw $60,000 per year. One runs out of money at year 17. The other still has $1,200,000 at year 20.

Same average return. Same withdrawals. Completely different outcomes.

This is sequence-of-returns risk – the risk that the timing of investment losses, not just their magnitude, determines whether a retirement portfolio survives. It matters only when you are withdrawing from a portfolio. During the accumulation phase, sequence of returns is irrelevant – bad years early actually become buying opportunities.

The numbers average out the same way. The sequence doesn't.

Why Withdrawals Make It Lethal

The mechanism is straightforward. When you withdraw from a portfolio that has just dropped 30%, you are selling more shares to raise the same dollar amount. Those shares are gone – they can't participate in the recovery. The more you withdraw during a down period, the fewer shares remain to benefit when prices rise again.

This creates a permanent drag that average return calculations completely hide:

During accumulation: bad early years are irrelevant – you keep buying at lower prices;
During withdrawal: bad early years are catastrophic – you sell at lower prices and reduce the base that recovers;
The danger zone: roughly the five years before and five years after retirement – when the portfolio is largest and withdrawals begin.

Definition

The risk that the order in which investment returns occur significantly affects the long-term outcome of a portfolio during the withdrawal phase. Two portfolios with identical average returns can produce dramatically different final balances depending on whether losses occur early or late in retirement.

Note

Sequence-of-returns risk is why the 4% rule has caveats. The rule was derived from historical data, but it implicitly assumes a range of sequence outcomes. Retiring into a major bear market – as someone who retired in 2000 or 2008 discovered – tests the 4% rule far harder than retiring at the start of a bull market does.

1. Two investors retire with identical portfolios and withdraw the same amount annually. Investor A experiences strong returns in the first five years. Investor B experiences large losses in the first five years. Both achieve the same average return over 20 years. What is the most likely outcome?

2. A 35-year-old investor experiences three consecutive years of −20% returns early in their career. They continue contributing throughout. How does this compare to a retiree experiencing the same three-year sequence?

Two investors retire with identical portfolios and withdraw the same amount annually. Investor A experiences strong returns in the first five years. Investor B experiences large losses in the first five years. Both achieve the same average return over 20 years. What is the most likely outcome?

Select the correct answer

Both investors end with roughly the same portfolio balance because average returns determine outcomes.

Investor B likely depletes their portfolio earlier because losses in the withdrawal phase force selling more shares at lower prices, permanently reducing the recovery base.

Investor A runs out of money sooner because strong early returns create overconfidence and higher spending.

Sequence of returns only matters during the accumulation phase, not during retirement withdrawals.

Everything was clear?

Thanks for your feedback!

Section 4. Chapter 2

Ask AI

Ask anything or try one of the suggested questions to begin our chat

Section 4. Chapter 2