What Does Sequence of Returns Risk Mean for Someone Nearing Retirement?
The term keeps popping up in retirement articles and forum threads, usually with a warning tone attached, but rarely with an actual plain explanation. It sounds technical enough to skim past, except it’s describing something that genuinely affects how far retirement savings actually stretch.
The quick answer
Sequence of returns risk describes the danger that the order in which investment returns happen, not just their average over time, can significantly affect how long a retirement portfolio lasts, particularly for someone who is withdrawing money from it rather than only contributing. Two portfolios with the identical average annual return over a period can end up with very different outcomes depending on whether the losing years happened early or late in that stretch, especially once withdrawals are involved.
Why order matters once withdrawals begin
While someone is still working and contributing to accounts, the order of good and bad market years matters less, because there’s no need to sell investments at a particular point in time; a downturn is just a period to ride out. Once withdrawals start, though, selling investments during a down market to cover living expenses locks in losses and leaves less money in the account to benefit from a later recovery. This is the core mechanic behind why sequence of returns risk gets discussed alongside decisions about when to stop working: the timing of a downturn relative to the start of withdrawals can matter more than the downturn’s size alone.
A simplified illustration
Imagine two hypothetical retirees who both average the same annual return over 20 years, but one experiences a market decline in the first few years of retirement while the other experiences a similar decline in the last few years. The retiree who hits the downturn early is withdrawing from a shrinking balance during the worst years, which can permanently reduce how long the money lasts. The retiree who hits the same downturn late has already drawn down less of the account by that point and has less exposure to the loss. The average return across both scenarios is identical; the outcome for each retiree is not.
Approaches some people consider
- Holding a cash or short-term reserve. Some retirees keep a portion of savings in more stable, liquid assets, such as a high-yield savings account, specifically to cover near-term expenses without needing to sell investments during a downturn.
- Adjusting withdrawal amounts flexibly. Reducing withdrawals during a down market, rather than sticking to a fixed dollar amount, is one way some retirement plans try to reduce the impact of poor early timing.
- Diversifying across asset types. A portfolio spread across different kinds of investments doesn’t eliminate this risk, but it can reduce how sharply a single market event affects the whole balance at once, which is part of why some people also weigh consolidating scattered old retirement accounts into a clearer overall picture.
- Reviewing an emergency-style buffer separately. Similar to how an emergency fund protects someone during working years, a separate buffer in retirement can serve a comparable purpose against needing to sell at the wrong moment.
Why this concept gets more attention near retirement
Sequence of returns risk is most relevant in the years right before and right after someone stops working, sometimes referred to as a retirement red zone, because that’s when a downturn has the least time to be offset by future contributions and the most direct interaction with ongoing withdrawals. It’s less of a concern decades before retirement, when there’s ample time for markets to recover before withdrawals begin.
What to weigh
Sequence of returns risk is a reminder that averages can be misleading in retirement planning; the same average return can produce very different real-world outcomes depending on when the good and bad years occur relative to when withdrawals start. Understanding the concept doesn’t eliminate the underlying market uncertainty, but it does explain why the timing of a downturn, not just its existence, is something retirement planning conversations tend to focus on.