Most people think retirement success depends on earning a decent average return over time. But once you start taking withdrawals, the order of returns can matter just as much—or more—than the long-term average. That’s the heart of sequence-of-returns risk: when poor returns happen early in retirement, withdrawals can permanently damage the portfolio’s ability to recover.
What Sequence-of-Returns Risk Is (in plain English)
Sequence-of-returns risk is the risk that you experience market declines at the worst possible time—right when you begin drawing income from your investments. “Sequence” refers to the timing and order of returns, not merely how good or bad they are on average.
During retirement, your portfolio isn’t just sitting there compounding—it’s also being tapped for spending. Ideally, growth replenishes some of what you withdraw. But a sharp drop early on can disrupt that balance.
Why a Down Market Early in Retirement Is So Dangerous
A major decline in the early years can create a double hit:
- Your portfolio value falls, and
- You still need cash to live, so you may have to sell more shares than you otherwise would to raise the same withdrawal amount.
That can drain your savings faster and leaves you with fewer assets to participate in a later recovery.
If a similar decline happens later in retirement, the damage is often less severe because your portfolio may not need to last as long, and you may already be closer to the finish line.
A Simple Illustration: Same Return Pattern, Very Different Outcome
One example compares two retirees who both start with $1 million, withdraw $50,000 in the first year, then increase withdrawals by 2% annually for inflation. Both experience a 15% decline—but at different times. The retiree who gets hit in the first two years runs out of money far sooner than the retiree who faces the drop much later.
The point isn’t that “15% is fatal.” The point is that withdrawals during early declines can create lasting damage that later average returns may not fully repair.
Two Practical Ways to Reduce the Impact
1) Keep a short-term reserve (so you don’t have to sell stocks at a bad time)
One approach is to maintain a near-term pool of lower-risk, liquid assets to fund spending while you avoid tapping stocks during market declines.
A suggested framework is:
- About one year of expenses (after other income sources like Social Security, if applicable) in cash investments, plus
- Another two to four years of expenses in high-quality short-term bonds or short-term bond funds.
With that cushion in place, you may feel more comfortable keeping a meaningful stock allocation for longer-term growth potential.
2) Be willing to temporarily spend less after early losses
If you haven’t built a reserve (or haven’t otherwise prepared), another lever is reducing withdrawals—at least temporarily—after a downturn. Ideas include:
- scaling back spending,
- skipping or reducing inflation increases for a period, or
- postponing large discretionary expenses.
The core goal is the same: avoid selling a lot of investments when the market is down.
Why “Just Wait for the Market to Bounce Back” Isn’t Always Enough
Even if markets rebound, ongoing withdrawals can act like a headwind. In the example discussion, a retiree withdrawing less after early declines can recover much sooner than one withdrawing more—even with identical market returns afterward.
The Bottom Line
Sequence-of-returns risk is a retirement-specific problem: bad returns early + withdrawals can shorten portfolio longevity in a way that “average returns” don’t capture. The most practical defenses are:
- keeping a cash/short-term bond reserve to avoid selling stocks in downturns, and/or
- having spending flexibility so you can reduce withdrawals after a market drop.
If you tell me roughly (1) how many years until retirement, (2) whether you expect Social Security or other income, and (3) what withdrawal rate you’re aiming for, I can sketch a simple “reserve + withdrawal flexibility” plan you can adapt.