Most investors focus on average annual returns when evaluating a portfolio. But for those in or near retirement, the order in which returns occur matters just as much — sometimes more — than the average itself.
What Is Sequence of Returns Risk?
Sequence of returns risk refers to the danger that poor investment returns early in retirement can permanently impair a portfolio, even if long-term average returns are strong. When withdrawals are taken from a declining portfolio, fewer shares remain to participate in any subsequent recovery.
A Simple Illustration
Consider two retirees, each starting with $1,000,000 and withdrawing $50,000 per year. Both experience the same average return of 6% over 20 years — but in reverse order. The retiree who experiences losses early runs out of money years before the one who experiences gains first.
This asymmetry is not a market anomaly. It is a structural feature of the withdrawal phase that every retirement plan must account for.
How to Manage It
There is no single solution, but several strategies can reduce exposure:
- Bucket strategy: Segment assets into short-, medium-, and long-term pools so near-term withdrawals are not drawn from volatile holdings.
- Flexible withdrawal rates: Reducing withdrawals modestly during down markets can significantly extend portfolio longevity.
- Bond laddering: Holding a ladder of individual bonds maturing in sequence provides predictable income without forcing equity sales at depressed prices.
- Delay Social Security: Deferring Social Security to age 70 increases guaranteed income, reducing reliance on portfolio withdrawals in early retirement years.
The Broader Point
Retirement income planning is fundamentally different from accumulation planning. The tools, metrics, and frameworks that work well during the saving phase often fail to capture the risks that matter most during the distribution phase. A fiduciary advisor can help model these scenarios and build a withdrawal strategy designed to withstand a range of market environments.