The Sequence of Returns Risk: Why When You Lose Matters More Than How Much

Imagine two investors, both with $1 million portfolios, both withdrawing $50,000 annually for living expenses. Over 30 years, both experience the exact same market returns—just in different order. Investor A faces losses early, then gains. Investor B enjoys gains first, losses later. Same average return, same withdrawal rate. Yet one runs out of money while the other thrives. Welcome to sequence of returns risk, the silent wealth destroyer that makes timing everything.

Sequence of returns risk is the danger that the order of your investment returns will work against you, particularly when you're withdrawing money from a portfolio. It doesn't matter during accumulation—if you're 30 and adding money monthly, a market crash is actually beneficial (you buy low). But once you start withdrawals, typically in retirement, the math changes dramatically. A bear market in your first few years of retirement can be catastrophic, even if the market eventually recovers.

Here's why: when your portfolio drops 20% and you withdraw $50,000, you're selling shares at depressed prices. Those shares can never recover because they're gone. If the market then rebounds 30%, you have fewer shares participating in the growth. This creates a mathematical hole that becomes increasingly difficult to escape. Conversely, if you experience gains early and build your portfolio cushion before losses hit, you have more shares working for you and can weather the storm.

The concept emerged from retirement planning research in the 1990s, notably work by financial planner William Bengen, who studied sustainable withdrawal rates. His research revealed that identical average returns produced vastly different outcomes based purely on sequence. A retiree experiencing the 1970s sequence (stagflation and poor returns early) would face portfolio depletion, while someone with the 1980s-90s sequence (strong early returns) would die wealthy—despite mathematically equivalent long-term performance.

Consider a real example: Someone retiring January 1, 2000 with $1 million, taking 5% annual withdrawals ($50,000 increasing with inflation), would have been devastated by the dot-com crash and 2008 financial crisis hitting early. By 2010, their portfolio might be worth just $600,000 despite a decade passing. Someone retiring January 1, 2010 with the same withdrawal rate would have ridden the longest bull market in history and potentially doubled their wealth.

Key Takeaways

Three insights make you conversant with sequence risk:

The decade before and after retirement is critical: Financial advisors call this the "retirement red zone." Poor returns during these years devastate portfolios far more than poor returns at any other life stage.
You can't control sequence, but you can manage exposure: Strategies include reducing equity allocation as retirement approaches, maintaining larger cash reserves (2-3 years of expenses), or using flexible withdrawal strategies that decrease spending during bear markets.
Average returns lie during distribution phase: A portfolio averaging 7% annually can succeed brilliantly or fail completely based solely on return sequence. This is why retirement calculators using average returns can be dangerously misleading.

Next time someone tells you they're planning retirement around "average market returns," you can gently explain why the sequence might matter more than the average—and potentially save them from a very expensive mistake.

References

Bengen, William P. "Determining Withdrawal Rates Using Historical Data" (Journal of Financial Planning, 1994)
Pfau, Wade D. "The Retirement Income Showdown: Comparing Strategies" (Forbes, 2018)
Kitces, Michael. "Understanding Sequence Of Returns Risk" (Kitces.com, 2015)

Shallow Dives

The Sequence of Returns Risk: Why When You Lose Matters More Than How Much