Sequence of Return Risk

The sequence of return risk refers to the order in which investment returns occur over time and how that order affects outcomes during retirement. While average returns matter during saving years, the sequence of those returns becomes far more important once withdrawals begin.

This risk is not about poor investing decisions or extreme market events alone. It is about timing. Two retirees can earn the same long term average return and still experience very different results depending on when market losses occur.

Understanding sequence of return risk is essential for anyone transitioning from accumulation to retirement income. It explains why some plans fail early while others remain resilient even in volatile markets.

What Sequence of Return Risk Means

Sequence of return risk occurs when negative investment returns happen early in retirement while regular withdrawals are being taken from a portfolio. Losses combined with withdrawals reduce the portfolio balance, leaving less capital to recover when markets improve.

The key point is that the order of returns matters more than the average return during retirement. A poor sequence early on can permanently impair a plan even if markets perform well later.

This risk is unique to the distribution phase of life. It does not meaningfully affect investors who are still contributing and have time to recover from downturns.

Why It Matters More in Retirement Than During Accumulation

During working years, market declines can be uncomfortable but often beneficial. Regular contributions buy more shares at lower prices, and time allows for recovery.

In retirement, the situation reverses. Withdrawals lock in losses. Selling assets after a decline reduces future earning power, and time is limited.

Once withdrawals begin, the portfolio must do two jobs at the same time. It must support spending today and sustain growth for future decades. Early losses disrupt that balance.

A Simple Illustration

Consider two retirees who each retire with the same portfolio value and withdraw the same amount each year. Over thirty years, both experience the same average annual return.

One retiree experiences strong returns early and weaker returns later. The other experiences losses in the first few years and stronger returns later.

Despite identical averages, the retiree who experiences early losses may run out of money years earlier. The retiree with early gains often maintains flexibility and resilience throughout retirement.

The difference is not skill or luck alone. It is the sequence.

Why Early Losses Are So Damaging

Early losses reduce the base from which all future growth occurs. When withdrawals continue during downturns, more shares must be sold to generate the same income. This accelerates depletion.

Later market recoveries may not be enough to restore the portfolio because the capital that would have benefited from growth is no longer there.

This creates a compounding problem in reverse. Losses plus withdrawals reduce future opportunity.

Common Misunderstandings

Sequence of return risk is often confused with market timing or short term volatility. It is neither.

It does not require extreme market crashes to matter. Modest declines combined with consistent withdrawals can be enough to cause long term damage.

It is also not solved by simply earning higher average returns. A plan can fail despite strong long term performance if early years are unfavorable.

How Retirement Planning Addresses This Risk

Effective retirement planning acknowledges that risk changes over time. The years just before and after retirement are the most fragile.

Strategies often focus on managing cash flow and flexibility rather than maximizing returns alone. The goal is to reduce forced selling during market declines.

This may involve structuring income sources so that not all spending depends on market performance in any single year. It may also involve adjusting withdrawal behavior when conditions change.

The emphasis shifts from chasing performance to preserving optionality.

Why This Risk Is Often Overlooked

Many projections rely on average returns and smooth assumptions. While useful for long range modeling, averages hide the impact of timing.

Sequence of return risk is less intuitive because it challenges the idea that long term investing always smooths outcomes. In retirement, time works differently.

As longevity increases and retirements span multiple decades, the consequences of early decisions become more pronounced.

The Wealthspan Perspective

From a wealthspan perspective, the objective is not simply to make money last. It is to sustain freedom, flexibility, and choice over time.

Sequence of return risk directly affects that outcome. A plan that survives early stress preserves agency. A plan that is damaged early often forces permanent tradeoffs later.

Understanding this risk helps reframe retirement planning away from static rules and toward adaptive design that respects both markets and life.

Conclusion

Sequence of return risk is one of the most important and least understood challenges in retirement planning. It explains why identical portfolios can produce very different outcomes once withdrawals begin.

The risk is not about predicting markets. It is about recognizing that timing matters when income depends on investments.

By understanding how early returns shape long term results, retirees and planners can design strategies that are better aligned with real world uncertainty and longer lives.

Sources:

Journal of Financial Planning
Blanchett, Finke, Pfau research on sequence of returns risk - https://www.onefpa.org/journal/Pages/Managing-Sequence-of-Returns-Risk.aspx

Journal of Financial Planning
Pfau, Wade D. Safe Savings Rates and sequence of returns research - https://www.onefpa.org/journal/Pages/FPJ-June2011-Pfau.aspx

Vanguard Investment Strategy Group
Understanding sequence of returns risk - https://investor.vanguard.com/investor-resources-education/article/understanding-sequence-of-returns-risk

Pension Research Council University of Pennsylvania
Blanchett, Finke, Pfau retirement income and return sequencing research - https://pensionresearchcouncil.wharton.upenn.edu/publications/working-papers/