Sequence of Returns Risk: Why Timing Can Matter as Much as Returns

A market downturn is never pleasant. But when it happens during the first few years of retirement, it can have consequences that last for decades. That’s the essence of sequence of returns risk, and it’s one of the least understood threats to a retirement plan, not because the math is complicated, but because it runs against a lifetime of assumptions about how investing works.

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During the accumulation years, the order in which good and bad years arrive doesn't matter much. A portfolio that averages 7% a year ends up in roughly the same place whether the gains came early or late, because there's still a paycheck coming in and no need to sell anything. Retirement changes that arithmetic entirely.

What Sequence of Returns Risk Actually Means

Sequence of returns risk describes what happens when withdrawals and market declines occur at the same time. Once someone begins drawing income from a portfolio, they’re no longer just riding out volatility, they're selling investments, often at a loss, to cover living expenses. Selling into a down market locks in losses that a portfolio never gets the chance to recover from, even if the market eventually rebounds.

It’s a timing problem more than a performance problem. Two people can retire with identical portfolios, identical average returns over a 25-year retirement, and identical withdrawal rates, and still end up in very different places, purely because of which years were up and which were down.

Why the Early Years Carry Outsized Weight

The first five to ten years of retirement tend to matter disproportionately because that’s when the portfolio is at its largest and withdrawals are being layered directly on top of whatever the market is doing. A decline early on shrinks the base that future withdrawals (and future growth) are calculated from. A decline that happens fifteen or twenty years into retirement, by contrast, is landing on a portfolio that has already had years to compound and, in many cases, has a shorter remaining time horizon to fund.

This is part of why retirement income planning increasingly focuses less on average long-term return assumptions and more on what happens if the first few years go badly. It's a different question, and it deserves a different kind of planning.

Two Retirees, Same Average Return, Different Outcomes

Consider two hypothetical retirees who each start with the same portfolio balance and withdraw the same percentage every year. One experiences a market decline in year one and year two of retirement, followed by strong recovery years. The other experiences the exact same returns, just in reverse order, strong years first, decline years later. Even though both portfolios experience an identical average annual return over the full period, the retiree who faced the early downturn typically ends up with meaningfully less money later in retirement, and a higher risk of running out of assets altogether.

That's the counterintuitive part. The market's long-term average return is often treated as the headline number that matters most. In retirement, the order those returns arrive in can matter just as much.

Building a Retirement Income Plan That Can Absorb a Bad Start

None of this means retirees should abandon growth-oriented investments or retreat entirely to cash, that trade-off carries its own long-term risks, particularly around inflation. Instead, it usually means building in ways to avoid selling depressed assets during a downturn.

A cash reserve or short-term bond allocation covering one to three years of living expenses can give a portfolio room to recover before withdrawals resume from it. A flexible withdrawal approach — one that can trim spending modestly during a bad market year rather than withdrawing a fixed amount regardless of conditions — can meaningfully reduce the damage. Some retirees also find it useful to establish guardrails in advance: predetermined thresholds that signal when a spending adjustment may be worth considering, so the decision doesn't have to be made emotionally in the middle of a downturn.

Why This Is Different from Ordinary Market Risk

It's worth separating sequence of returns risk from the more general idea of market risk, because the two get treated as interchangeable when they're not. Market risk is the possibility that investments lose value. Sequence of returns risk is about the interaction between losing value and simultaneously withdrawing from that same pool of money. A retiree who never touches the portfolio during a downturn experiences market risk without the compounding damage of sequence risk. Add withdrawals into the mix, and the same decline becomes considerably more costly to recover from, because there's less capital left to participate in the eventual rebound.

This distinction matters because it changes what the solution looks like. Simply choosing a more conservative portfolio doesn’t fully address sequence of returns risk,; it may reduce volatility, but it can also reduce the growth needed to sustain a multi-decade retirement, and it does little to solve the core problem of being forced to sell into a decline. The more effective response tends to be structural: reducing the need to sell depressed assets in the first place, rather than trying to avoid volatility altogether.

A Downturn Doesn't Have to Mean a Change in Plans

The goal of planning for sequence of returns risk isn’t to predict when the next downturn will happen, that's not a knowable thing. It's to build a plan sturdy enough that a bad first few years doesn't force a permanent change in retirement lifestyle. A retirement plan that only works if markets cooperate isn't much of a plan at all.

For anyone approaching retirement in the next few years, it may be worth asking not just what the expected long-term return might be, but what would happen to the plan if the market declined during the very first year of retirement. That second question is often the more useful one, and addressing sequence of returns risk before it becomes a live issue tends to be far easier than reacting to it after the fact.

By Andrew Rosen, Contributor