Sequence of returns risk is one of the most consequential threats to a retirement plan, and most people have never heard the term until it’s too late to do much about it.
The concept is straightforward: when your returns happen matters as much as what those returns actually are. Two retirees can have identical average returns over 20 years and end up in completely different financial situations depending on which years the bad markets happened to fall. One runs out of money. The other leaves a healthy estate.
You’ve probably spent years watching your portfolio’s average annual return. A good year, a bad year, back and forth. Over time, you figure it averages out and you’ll be fine. That logic works when you’re still accumulating. Once you start withdrawing, it doesn’t.
Why Sequence of Returns Risk Hits Hardest at the Start of Retirement
When you’re still working and contributing to a portfolio, a down year is actually somewhat helpful. You’re buying more shares at lower prices, and you have time for the market to recover before you need the money.
In retirement you’re no longer buying, you’re selling. Every withdrawal you take in a down market locks in losses and permanently removes shares from your portfolio that can never recover. The portfolio that remains is smaller, which means future growth compounds on a smaller base, which means you’re further behind than the raw return numbers suggest.
This is the part most people miss. It’s not just that a bad market hurts your balance. It’s that taking withdrawals during a bad market creates a hole that’s mathematically very difficult to climb out of, even if the market recovers strongly in later years.
A Tale of Two Retirements
Here are two retirees. Call them Mark and Linda. Both retire with $1,000,000. Both withdraw $50,000 per year, adjusted for inflation. Both experience the exact same annual returns over 20 years, just in reverse order.
Mark retires in a bad sequence. His first several years deliver negative or weak returns while he’s pulling $50,000 out every year.
Linda retires in a good sequence. Her first several years are strong, which builds a larger base before the down years arrive.
By year 10, both portfolios have experienced the same returns on paper. Their average annual return is identical. But their balances look nothing alike.
Mark’s portfolio might be approaching exhaustion by his late 70s. Linda’s portfolio is still comfortably funded well into her 90s.
The money, the withdrawals, and the average return are all identical. The only difference is the order. The outcome couldn’t be more different.
This is essentially what happened to people who retired in 2000 versus 1995, or in 2008 versus 2003. The timing of when you retired relative to market conditions had an enormous effect on how retirement actually played out, independent of how disciplined or diversified the investor was.
The Early Years Are What Define the Outcome
Most people don’t realize how much the first five to ten years of retirement shape everything that follows.
If your portfolio takes a serious hit in years one through five while you’re withdrawing regularly, the damage tends to be permanent. You’ve sold assets at depressed prices, your remaining balance is smaller than it should be, and future recoveries have less to work with.
Conversely, if your first decade goes reasonably well and your portfolio grows while you withdraw, you build a cushion that can absorb later downturns without threatening the plan. A bad market in year fifteen of retirement is a problem. A bad market in year two can be a catastrophe.
This is why retirement date matters in ways that have nothing to do with your investment choices. Someone who retired in March 2009, right at the bottom, had a much smoother path than someone who retired in January 2007 with an identical portfolio and identical strategy.
Why Average Return Is the Wrong Number to Focus On
Investment marketing loves to show long-term average returns. The S&P 500 has returned roughly 10% annually over long periods. A balanced portfolio might show 7%. These numbers are real, but they’re built from a sequence of individual years that varies widely, and they’re often calculated assuming no withdrawals.
Once you add withdrawals, the math changes. The technical term for this is the difference between arithmetic average return and geometric return, but you don’t need the math. What you need to understand is that variability itself is costly when you’re withdrawing, even if the average looks fine.
A portfolio that returns 20% one year and negative 10% the next has an arithmetic average of 5%. But if you withdrew money during the down year, your actual experience looks nothing like a steady 5% annual gain. The withdrawal during the down year removed shares at their worst price. That loss doesn’t average away.
What Retirees Can Actually Do About It
Sequence of returns risk can’t be eliminated, but it can be managed. A thoughtful retirement income plan addresses it directly. Here’s how:
Keep enough cash or short-term reserves to avoid forced selling. One of the most practical defenses is maintaining one to three years of living expenses in cash or stable, liquid assets. When markets drop sharply, you draw from reserves rather than selling equities at depressed prices. This buys time for the portfolio to recover before you need to touch it again.
Build a bucketed withdrawal strategy. Rather than treating a portfolio as one undifferentiated pool, some retirees benefit from organizing assets into short, medium, and long-term buckets. Near-term spending needs sit in stable assets. Longer-term money stays invested in growth assets. This creates a psychological and practical buffer against panic selling in volatile markets.
Be flexible with spending early in retirement. Retirees who can reduce discretionary withdrawals during a significant down market, even temporarily, meaningfully reduce the damage a bad sequence can cause. This isn’t always easy, but it’s one of the most effective adjustments available.
Don’t ignore the income floor. Guaranteed income sources like Social Security and pensions matter more in this context than most people realize. If your essential expenses are covered by guaranteed income, you can leave your portfolio invested through downturns without being forced to sell. This is one reason delaying Social Security to maximize your benefit is worth serious consideration.
Consider your asset allocation in light of withdrawal timing. A 60/40 portfolio that made sense at 55 may not be the right allocation on the day you retire. The sequence risk you face in the first decade of retirement might warrant a more conservative tilt early, with the flexibility to shift back as the most vulnerable window passes.
None of these are one-size-fits-all. What makes sense depends on your spending needs, your other income sources, your portfolio size, and your tolerance for adjusting if markets don’t cooperate early in retirement.
This Is Why Retirement Planning Isn’t Just Investment Management
Most wealth management conversations are about building a portfolio. Returns, allocation, fund selection. That work matters, but it only gets you so far.
What determines whether a retirement plan actually holds up is how the portfolio is structured for withdrawals, how income sources are coordinated, how spending is sequenced across account types, and how the plan handles a rough stretch in the early years.
Those are the questions a fee-only retirement advisor in Colorado works through with you well before you retire.
At Inclinevest, we work with pre-retirees and retirees across the Denver metro area who want a plan that holds up when markets don’t cooperate. Sequence of returns risk is a core part of what we plan around, alongside tax efficiency, Social Security coordination, and long-term withdrawal strategy.
If you’re within five to ten years of retirement and haven’t stress-tested your plan against a bad early sequence, that’s a conversation worth having before you need it. You can schedule a call here.
Key Takeaways
- Sequence of returns risk is the danger that poor market returns early in retirement, combined with ongoing withdrawals, can permanently impair a portfolio even if long-term average returns look fine.
- Two portfolios with identical average returns over 20 years can produce dramatically different outcomes depending solely on which years the bad returns occurred.
- The first five to ten years of retirement carry the most weight. A rough start is much harder to recover from than a rough stretch later.
- Cash reserves, flexible spending, guaranteed income sources, and a coordinated withdrawal strategy are the main tools for managing this risk.
- Retirement income planning is not the same as accumulation planning. The strategy that built your portfolio may not be the right one for protecting it.
About the Author
Gabriel Motta, CFP®, MBA, is the founder and principal of Inclinevest LLC, a fee-only fiduciary financial planning firm based in Greenwood Village, Colorado. He works with pre-retirees and retirees across the south Denver metro, including Highlands Ranch, Centennial, Lone Tree, Parker, Castle Rock, and Littleton, helping them navigate retirement income planning, Social Security strategy, tax-efficient withdrawals, and equity compensation. Gabriel is a NAPFA and XY Planning Network member. Learn more at inclinevest.com or schedule a conversation.
Sources
- William Bernstein, “The Retirement Calculator from Hell,” Efficient Frontier, efficientfrontier.com
- Michael Kitces, “Understanding Sequence of Return Risk,” Kitces.com — kitces.com/blog/understanding-sequence-of-returns-risk-safe-withdrawal-rates-bear-market-crashes-at-retirement/
- Wade Pfau, “Sequence of Returns Risk,” Retirement Researcher — retirementresearcher.com
- Vanguard Research, “Spending in Retirement” — institutional.vanguard.com
- Social Security Administration, “Retirement Benefits” — ssa.gov/benefits/retirement/
This article is for general informational and educational purposes only. It isn’t personalized investment, tax, or legal advice, and it shouldn’t be relied on as a substitute for guidance specific to your situation. Inclinevest LLC is a registered investment adviser. Please consult a qualified professional before making decisions about your own financial circumstances.
