What Is Sequence of Returns Risk?
Two retirees can earn the exact same average return over thirty years and end up in very different places, simply because of when the good and bad years happened to land.
The short answer
Sequence of returns risk is the danger that the order in which investment returns occur, not just their average, can affect how long a portfolio lasts, especially once someone is withdrawing money from it regularly. A downturn early in retirement, while withdrawals are already happening, tends to do more damage than the same downturn occurring later, even if the long-term average return ends up identical either way. This risk is most relevant during the years right before and after someone stops working and starts drawing down savings rather than adding to them.
Why timing changes the math
While someone is still contributing to an account, a market downturn can actually work in their favor over time, since new contributions buy in at lower prices, a dynamic related to dollar-cost averaging. Once withdrawals begin, that dynamic flips. Selling investments to fund withdrawals during a downturn locks in losses on the shares sold and leaves fewer shares remaining to benefit when the market eventually recovers. The portfolio has less time and less money working for it during the recovery, which can permanently shrink how long the remaining balance lasts, even if the market fully bounces back later.
An illustration, not a prediction
Consider two hypothetical portfolios that both average the same annual return over a stretch of years, but one experiences a sharp decline in its first two years while the other experiences that same decline in its last two years. The portfolio that took the hit early, while withdrawals were already being taken, can end up depleted well before the other one, purely because of when the losses landed. This is a simplified illustration meant to show the mechanism, not a forecast of what any specific portfolio will do.
How people think about managing it
- Diversifying holdings. Spreading investments across different types of assets, discussed further under what diversification actually means, doesn’t eliminate this risk but can smooth out how sharply a portfolio might swing in a bad stretch.
- Adjusting withdrawals in down years. Some retirees plan to reduce spending temporarily after a market decline rather than withdrawing a fixed amount regardless of performance.
- Keeping some cash or stable assets on hand. Having a buffer that doesn’t need to be sold at a loss during a downturn can reduce how much a bad sequence affects the rest of the portfolio.
- Reviewing risk tolerance before retirement. Understanding how much investment ups and downs someone can comfortably handle matters even more in the years surrounding a withdrawal phase than during the accumulation years before it.
Why this matters most around the transition
Sequence of returns risk is generally less concerning for someone many years from retirement, since they have time to recover from a downturn before they need the money. It becomes more relevant in the years immediately before and after leaving work, when withdrawals are beginning and there’s less time to wait out a bad stretch. That narrower window is part of why some people shift how their portfolio is structured as they approach that transition, rather than keeping the exact same setup they used decades earlier.
A practical habit
Sequence of returns risk is a reminder that averages can hide a lot of important detail. Two retirements with identical average returns can turn out very differently depending on when the ups and downs happened to occur, which is a good reason to think about withdrawal flexibility and portfolio structure together, rather than focusing on long-term average returns alone.