Two portfolios can have identical average annual returns over 20 years and produce completely different retirement outcomes — depending solely on the order in which those returns occurred. This is sequence-of-returns risk, and it is the single most underappreciated risk in retirement planning.
During the accumulation phase — when you are adding money to your portfolio — the order of returns does not affect your final outcome. If you invest $1,000 per year for 30 years, it does not matter whether the good years come first or last. The average return is what determines the outcome.
During the withdrawal phase — when you are taking money out of your portfolio — the order of returns matters enormously. If you retire and immediately experience a 30% market decline, you are selling depreciated assets to fund living expenses. This depletes your portfolio faster, leaves less capital to participate in the eventual recovery, and can cause the portfolio to run out of money years earlier than the average return would suggest.
Consider two investors, each retiring with $500,000 and withdrawing $25,000 per year (a 5% withdrawal rate). Investor A experiences strong returns in early retirement and poor returns later. Investor B experiences the reverse: poor returns first, strong returns later. Both have an identical 7% average annual return over 20 years.
Investor A, who gets the good years first, ends with approximately $850,000 after 20 years. Investor B, who gets the bad years first, exhausts the portfolio completely by year 17 — three years before Investor A’s portfolio is still growing. Same average return. Radically different outcomes. The only difference is the sequence.
Sequence risk is most acute in the five years before and the five to ten years after retirement — what some planners call the “retirement red zone.” During this window, the portfolio is at or near its peak size (maximum exposure to a percentage decline in dollar terms) and withdrawals are beginning (no ability to wait out a recovery by simply holding and not selling).
A severe market decline 10 years into retirement, when the portfolio has already grown through withdrawals being funded by returns, is far less damaging than the same decline in year one. The portfolio has less exposure in dollar terms, and there is a shorter remaining withdrawal period over which the damage compounds.
Shifting to a more conservative allocation in the 5 years before retirement reduces the magnitude of the decline you would experience in a bad-sequence scenario. A portfolio that falls 15% is less damaging than one that falls 35%, even if both recover to the same long-run average. The cost is some forgone growth in good years — a trade-off worth making as the retirement date approaches.
Maintain 1–2 years of living expenses in cash, 3–5 years in short-duration bonds, and the remainder in equities. During market downturns, draw from cash and bonds rather than selling equities. This gives the equity bucket time to recover without forcing selling at the bottom. Refill the cash and bond buckets during market recoveries.
A fixed 4% withdrawal rate regardless of portfolio performance is a common planning assumption but an impractical real-world rule. Reducing withdrawals by 10–15% in a down market year — by cutting discretionary spending — meaningfully reduces sequence damage while preserving capital for recovery. Retirees who can flex their spending have substantially better long-run outcomes than those locked into a fixed withdrawal.
Every additional year of work reduces sequence risk on two dimensions: it adds contributions rather than withdrawals, and it shortens the withdrawal period that sequence effects have to compound across. Even partial retirement — reducing work hours while maintaining some income — significantly reduces sequence exposure compared to full retirement.
Annuities, defined benefit pensions, and delayed social security or government pension claims all provide income that does not depend on portfolio performance. The more of your essential expenses are covered by guaranteed income sources, the less your investment portfolio needs to perform perfectly in year one of retirement, and the lower your sequence risk exposure.
Your current risk score is a useful proxy for sequence risk exposure. The higher your score as you approach or enter retirement, the more vulnerable your portfolio is to a bad-sequence scenario. Our rebalancing panel shows the specific allocation shifts needed to move toward a more conservative position aligned with a retirement or capital preservation goal.
Check how your current allocation handles a pre-retirement risk assessment.
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