Understanding Sequence-of-Returns Risk

When you are still saving for retirement, the order of your yearly returns barely matters. Over decades, what matters is the average. Once you start withdrawing income, that changes — sometimes dramatically. The sequence in which returns arrive can matter as much as the returns themselves.

This is called sequence-of-returns risk, and it is one of the most important — and least understood — risks in retirement.

What is sequence-of-returns risk?

Sequence-of-returns risk is the danger that market declines occur early in retirement, while you are withdrawing income. Because withdrawals lock in losses, a downturn in the first few years can permanently reduce how long a portfolio lasts — even if the average return over the full period is healthy.

During accumulation, a decline is a buying opportunity. During distribution, a decline forces you to sell more shares to generate the same dollar of income, leaving fewer shares to recover when markets rebound.

Why the same average return can produce different outcomes

Two retirees can experience the exact same returns in the exact same years — just in a different order — and end up with very different results.

Why the early years matter most

The first several years of retirement are sometimes called the "fragile decade." A significant decline during this window, combined with withdrawals, can create a hole that is difficult to recover from — because there are fewer dollars left to compound when markets eventually return.

This is why retirement income planning often focuses on reducing the impact of early declines rather than simply maximizing long-term returns.

Strategies that may help manage sequence risk

No strategy eliminates risk, but several approaches can help reduce the damage an early decline can do:

• Cash reserves. Holding a cash or short-term reserve can let you avoid selling depressed assets during a downturn, giving the portfolio time to recover.
• Diversified income sources. Relying on guaranteed income — Social Security, pensions, or insurance-based income — for essential expenses reduces the amount of income that depends on favorable markets.
• Flexible withdrawals. Adjusting spending or withdrawal amounts during market declines can help preserve the portfolio.
• Avoiding panic selling. Selling at the bottom locks in losses and removes the ability to participate in a recovery.

Some retirees use a combination: guaranteed income for essentials, a cash reserve for near-term needs, and growth assets for the long run. The goal is not to avoid markets entirely — it is to avoid being forced to sell at the worst time.

The takeaway

Sequence-of-returns risk is a reminder that retirement is not just about how much you have — it is about the order in which returns arrive and how your income strategy responds. A plan built around dependable income, reserves, and flexibility can help a portfolio weather the years that matter most.

For more, see creating a retirement paycheck and our retirement income planning page.