Sequence-of-Returns Risk Explained
Sequence-of-returns risk is the danger that poor returns arrive early in retirement, while you are withdrawing money. In our worked example, two retirees with identical returns in reverse order, each withdrawing $50,000 a year from $1,000,000, end ten years apart by about $296,433. Order doesn’t matter for untouched money; it matters a lot once money is flowing out.
At a glance
- Definition
- Risk from the order of returns while withdrawing (or adding) money
- Example gap
- ≈ $296,433 after 10 years on $1M
- Highest risk
- Years around the retirement date
- Key lever
- Withdrawal rate and flexibility
What is sequence-of-returns risk?
Sequence-of-returns risk is the risk that bad investment years arrive at the wrong time: early in retirement, while you are withdrawing money. Two retirees with the same average return can end up with very different balances purely because of the order in which the good and bad years happen.
The Society of Actuaries defines it as “the risk that the timing of withdrawals from a retirement account will require a larger portion of the account to be liquidated and have a negative impact on the overall rate of return available to the investor.” In plain terms: when you sell investments to fund spending after prices have fallen, you sell more units to raise the same cash, and those units are not there to benefit when markets recover.
This is why the order of returns doesn’t matter at all for a lump sum you leave untouched, but matters a great deal once money is flowing in or out.
Order doesn’t matter with no cash flows
Take ten annual returns: −20%, −10%, +5%, +8%, +12%, +10%, +7%, +15%, +9% and +11%. Their simple average is 4.7% and their compound annual growth rate (CAGR) is 4.12%. (The gap between those two numbers is explained in CAGR vs average annual return.)
Put $1,000,000 in and never touch it, and you finish with about $1,497,571 whichever order the years arrive in. Multiplication doesn’t care about order: 0.8 × 0.9 × … × 1.11 gives the same product forwards or backwards.
Worked example: the same returns, reversed, with withdrawals
Now assume a retiree starts with $1,000,000 and withdraws $50,000 at the start of every year (5% of the starting balance, held flat for simplicity). Retiree A gets the returns in the order above, with the losses first. Retiree B gets exactly the same ten returns in reverse, with the losses at the end.
| Year | A: return | A: end balance | B: return | B: end balance |
|---|---|---|---|---|
| 1 | −20% | $760,000 | +11% | $1,054,500 |
| 2 | −10% | $639,000 | +9% | $1,094,905 |
| 3 | +5% | $618,450 | +15% | $1,201,641 |
| 4 | +8% | $613,926 | +7% | $1,232,256 |
| 5 | +12% | $631,597 | +10% | $1,300,481 |
| 6 | +10% | $639,757 | +12% | $1,400,539 |
| 7 | +7% | $631,040 | +8% | $1,458,582 |
| 8 | +15% | $668,196 | +5% | $1,479,011 |
| 9 | +9% | $673,833 | −10% | $1,286,110 |
| 10 | +11% | $692,455 | −20% | $988,888 |
Same returns, same average, same CAGR, same withdrawals. After ten years Retiree A has about $692,455 and Retiree B about $988,888: a difference of roughly $296,433, created entirely by the order of returns.
Look at year one. Retiree A withdraws $50,000, leaving $950,000, which then falls 20% to $760,000. Retiree B withdraws the same $50,000 from the same starting balance, but the remaining $950,000 grows 11% to $1,054,500. Every later withdrawal takes a bigger bite out of A’s smaller portfolio, and the recovery years compound on a smaller base. By the time B hits the same losses in years nine and ten, B’s balance has grown large enough to absorb them.
The effect grows with the withdrawal rate. Raise the withdrawal to $60,000 a year and the ten-year balances become about $531,432 for A and $887,151 for B.
All calculations assume withdrawals at the start of each year, no fees or taxes, and returns applied to the balance after the withdrawal. The returns are illustrative, not a forecast or a historical series.
It works in reverse while you are saving
Sequence risk isn’t only a retirement problem; it flips direction when you are adding money. If someone invests $20,000 at the start of each year into the same two sequences, the saver who gets the losses early ends with about $322,046, while the saver who gets them at the end finishes with about $203,473. Early losses hurt the retiree but help the saver, who buys more units cheaply before the good years. Late losses hurt the saver most, because they hit the portfolio when it is largest.
That is why the riskiest window is often described as the years just before and just after retirement: the portfolio is near its peak size and is about to switch from receiving contributions to paying out income. A large loss in that window affects the most money, with the least time to recover.
Why your average return can mislead you
Most retirement projections quote a single average return. That hides sequence risk completely, because an average contains no information about order. It is the same reason a fund’s reported performance can differ from what an investor who added and withdrew money actually earned. Fund performance is usually reported as a time-weighted return, which ignores cash flows; your personal experience is closer to a money-weighted return, which is sensitive to when money went in and out.
When you test a retirement plan, a fixed average return is a starting point, not a stress test. At minimum, rerun the plan with a bad first few years and see whether the result is still acceptable.
Ways people manage sequence risk
None of these removes the risk, and each has costs. They are commonly discussed approaches, not recommendations for your situation.
- Start withdrawals conservatively. FINRA notes that while expert opinion on sustainable withdrawal rates tends to cluster in the 3 to 5 percent range, most retirement specialists agree you should start withdrawing as conservatively as possible, to give a portfolio a chance to recover if markets fall early.
- Flexible spending. Cutting withdrawals, or skipping an inflation increase, after a bad year reduces the number of units sold at low prices. FINRA also suggests being prepared to adjust your withdrawal rate if returns disappoint or expenses rise.
- A cash or short-term bond reserve. Holding one to a few years of spending outside equities lets you avoid selling shares immediately after a fall. The cost is lower expected growth on that reserve.
- Lower risk around the retirement date. Reducing equity exposure in the years either side of retirement shrinks the potential size of an early loss, at the cost of lower expected returns.
- Guaranteed income for essential costs. Pensions, government retirement benefits or annuities that cover fixed expenses reduce how much must be drawn from investments in a bad year.
How to test your own plan
- Work out your planned withdrawal as a percentage of your starting portfolio. Our FIRE number guide explains how withdrawal rates relate to the portfolio you need.
- Run your projection with your expected average return, then again with two or three poor years at the start, keeping the long-run average the same.
- Compare the two outcomes at 10, 20 and 30 years. If the early-loss version runs out of money, or forces cuts you couldn’t live with, the plan depends on luck in the order of returns.
- Decide in advance what you would change after a bad year, so the decision isn’t made in a panic.
A simple spreadsheet with one row per year, like the table above, is enough to see the effect. The portfolio growth calculator is useful for the savings phase.
Frequently asked questions
What is sequence-of-returns risk in simple terms?
It is the risk that poor investment returns happen early in retirement, while you are withdrawing money. Selling investments after a fall locks in losses, so two people with the same average return can end up with very different balances depending on the order of good and bad years.
Does sequence risk matter if I am not withdrawing money?
Not for a lump sum left untouched: the final value is the same whatever the order of returns. It matters whenever money is added or withdrawn. For savers adding money, late losses tend to hurt more; for retirees withdrawing, early losses hurt more.
When is sequence-of-returns risk highest?
Usually in the years just before and just after retirement, when the portfolio is near its largest and withdrawals are about to start or have just started.
Does a lower withdrawal rate reduce sequence risk?
It reduces the damage. In our example, the gap between early and late losses was about $296,433 with $50,000 annual withdrawals and about $355,720 with $60,000. FINRA notes that most retirement specialists recommend starting withdrawals as conservatively as possible.
Sources
- Society of Actuaries: Managing Post-Retirement Risks (Retirement Risk Chart) — definition of sequence of returns risk and why timing of losses matters for retirees
- FINRA: Managing Your Retirement Portfolio — withdrawal rates, starting conservatively and adjusting withdrawals