When planning for retirement, most people focus on how much money to save or which investments to choose. But one overlooked concept can drastically change your financial future: Sequence of Returns Risk.
This hidden risk can make the difference between a retirement full of freedom and one where you run out of money too soon — even if your average returns match someone else's.
Let’s break it down in simple terms.
What Is Sequence of Returns Risk?
Sequence of returns risk refers to the danger of experiencing poor investment returns early in retirement when you're starting to withdraw money from your portfolio. The timing of these returns — not just the average return — can significantly impact how long your money lasts.
While market fluctuations are normal, if a market downturn hits early, when your retirement withdrawals begin, your portfolio may shrink faster than you planned.
Why Timing Matters More Than You Think
Let’s say you and your neighbor both average a 5% annual return over 20 years. But you experience losses in the first 3 years, while your neighbor faces them at the end of their retirement. Even with identical investments, you might run out of money much sooner.
This is because withdrawals amplify losses early on. You're pulling money from a portfolio that’s already down — making it harder to recover.
Example: Comparing Two Retirement Outcomes
Here’s a simplified table showing how the order of returns affects outcomes:
| Year | Scenario A (Bad Early Returns) | Scenario B (Bad Late Returns) | Annual Withdrawal |
|---|---|---|---|
| 1 | -15% | +10% | $50,000 |
| 2 | -10% | +8% | $50,000 |
| 3 | +7% | +6% | $50,000 |
| 4–20 | +6% avg | Declines in years 18–20 | $50,000/year |
| Portfolio at Year 20 | Depleted | Still Growing |
Even with the same average return over time, the sequence in which you experience gains and losses — especially in the early years — can either preserve your nest egg or drain it prematurely.
How to Reduce Sequence of Returns Risk
You can’t control the market, but you can take steps to minimize this risk:
1. Use a Bucket Strategy
Divide your retirement funds into:
-
Cash reserves (1–2 years of expenses)
-
Bonds and stable income assets
-
Stocks for long-term growth
Withdraw first from safer buckets while letting stocks recover from downturns.
2. Delay Withdrawals If Possible
If you're able to work part-time or reduce expenses early in retirement, this gives your portfolio time to recover from any early market dips.
3. Consider Annuities or Guaranteed Income
Products like annuities can provide steady, guaranteed income, reducing your need to sell investments in a down market.
4. Rebalance Annually
Rebalancing your portfolio ensures you're not overexposed to risky assets after big market swings.
5. Withdraw Conservatively
Start with a safe withdrawal rate, like the 4% rule, and adjust based on market performance.
Why This Risk Matters More Than Ever
With increased life expectancy and more retirees managing their own savings, understanding sequence of returns risk is crucial. The transition from saving to spending is a sensitive phase — and poorly timed market losses can have lifelong effects.
Planning your retirement isn’t just about how much you’ve saved — it’s about how you spend it and when.
If you're worried about protecting your legacy and helping your loved ones thrive in the future, this idea is central to the lessons found in Smart Financial Grandparenting. It’s a powerful read for anyone preparing to guide the next generation through smart decisions.
Internal Resources That Can Help
You’ll also find guidance and tools on SmartFinancialLifestyle.com to help you take control of your money and plan confidently.
FAQs About Sequence of Returns Risk
What does "sequence of returns" mean?
It’s the order in which your investment gains and losses occur. The average return doesn’t tell the full story — timing matters when you're making withdrawals.
Is sequence of returns only a risk in retirement?
Primarily, yes. It affects retirees most, especially during the early years when they rely on withdrawals. It’s less relevant during accumulation years (when you’re saving).
Can diversification protect against this risk?
It helps reduce volatility but doesn’t eliminate the risk. Diversification + withdrawal strategy is your best defense.
How can annuities help?
Annuities can provide guaranteed monthly income, helping to cover essentials so you’re less reliant on selling investments when markets dip.
Final Thoughts
The sequence of returns risk is a silent threat — often missed in traditional retirement calculators. But by building a strategy that’s resilient to market timing, you can safeguard your future.
Start by planning smartly, withdrawing wisely, and protecting your portfolio from early shocks. Whether you're decades away from retirement or just a few years out, understanding this concept could be the key to lasting financial peace.