Retirement-planning discussions frequently center on how much you need to save and the average annual return your investments could potentially generate. While these factors certainly matter, they’re not the only things determining whether your retirement savings will last. The order in which investment returns or losses occur can also play a critical role, particularly once withdrawals begin. This phenomenon is known as “sequence of returns” (or “sequence”) risk.

What is sequence of returns risk?

Sequence of returns risk refers to the possibility that negative market returns early on in retirement can significantly reduce the lifespan of your retirement savings. When investors begin withdrawing funds from investments to cover living expenses, these—combined with early losses—can permanently reduce the portfolio’s value.

With less money invested, the portfolio may have a difficult time recovering even if markets rebound later on; two retirees with an identical starting balance and average annual returns can thus end up with dramatically different financial outcomes, depending on the timing of gains and losses. Understanding sequence of returns risk is an important part of retirement planning, highlighting why simply focusing only on average returns is perhaps not enough to ensure long-term financial security.

Why the timing of returns matters

Market volatility affects all investors, but consequences vary depending on whether you’re still saving or otherwise drawing income from your investments. During the accumulation phase—when you regularly contribute to retirement accounts—market downturns may actually provide opportunities to purchase investments at lower prices. These additional shares may benefit from market recoveries and long-term growth over time, but the situation changes once retirement begins and withdrawals replace contributions. At this stage, you may need to sell investments to generate income regardless of market conditions (e.g., perhaps you need a new roof or have unexpected medical bills on your hands). If those sales occur during periods of declining market values, it can be difficult to reverse the impact.

Sequence of returns risk: example

To truly understand the significance of this risk, consider an example featuring two retirees—Retiree A and Retiree B. Both begin retirement with identical $1 million portfolios, withdrawing $50,000 annually to fund their lifestyles and achieving the same average annual return of 6% over 20 years. You might expect their final outcomes to look nearly identical at first glance, yet you’ll see how the order in which they receive those returns leads to dramatically different results.

Retiree A: early positive market returns

Retiree A benefits from strong market performance in the early years of retirement, earning returns of +15%, +12%, and +10% in the first 3 years and seeing portfolio growth of approximately $1.2 million by the end of the third year even after withdrawing $50,000 annually. This early momentum and larger asset base help cushion losses that occur later on when markets weaken and some years deliver negative returns.

Retiree B: early market downturns

Retiree B, on the other hand, encounters poor market conditions at the outset with negative returns of -10%, -5%, and -6% in the first 3 years. These—combined with $50,000 withdrawn annually—results in a portfolio decline of ~$720,000 by the end of the third year. While markets eventually recover and produce strong returns later on, these gains are applied to a much smaller asset base that in turn limits their impact.

Why sequence of returns risk can make or break retirement

Twenty years post-retirement, both retirees have experienced the same 6% average return. Yet, Retiree A retains several hundred thousand dollars while Retiree B’s portfolio is nearly depleted. The difference? Retiree B was forced to withdraw funds during market downturns, locking in losses and reducing the capital available to benefit from subsequent growth. This example underscores why sequence of returns risk is so critical in retirement: when making withdrawals, the order of returns is often just as important—if not more so—than the average return itself.

When sequence risk is highest

Sequence of returns risk can impact retirees at any stage but is most pronounced during the initial 5 to 10 years following retirement: often referred to as the “danger zone” for retirement portfolios, when they’re usually at their highest value following years of saving and investment growth and with the larger sum exposed to market movements (both gains and losses). While strong investment returns early on in retirement can create a cushion to absorb future market volatility, substantial losses combined with ongoing withdrawals can severely hinder the portfolio’s ability to recover—this vulnerability causing many retirement-planning strategies to emphasize portfolio protection in the early years of retirement.

Financial tools and strategies to help mitigate sequence of returns risk

Although investors cannot control financial markets, they can enlist the help of several strategies to help reduce sequence of returns risk impacts. These include…

A cash reserve or spending buffer

Maintaining a dedicated cash reserve or short-term spending buffer is a common and effective tactic. In keeping a portion of assets in cash or low-volatility investments, retirees can cover living expenses without the need to sell stocks during market downturns: giving the equity portion of the portfolio time to recover before there’s a need to sell any assets, reducing the risk of locked-in losses.

A bucket approach to retirement investing

A related strategy is a bucket approach dividing retirement assets into different segments based on time horizon and risk tolerance. Typically, the short-term bucket holds cash or conservative investments for immediate spending needs, the intermediate bucket contains bonds or balanced funds for the next 5 to 10 years, and the long-term bucket is invested in equities for future growth. This segmented structure can help ensure funds needed in the near term aren’t exposed to the same level of market volatility as long-term investments.

Flexible withdrawal strategies

Flexible withdrawals mean adjusting annual spending based on market conditions rather than sticking to a fixed withdrawal rate. By reducing withdrawals in years when markets are down—especially early on in retirement—retirees can significantly extend the longevity of their savings and avoid selling assets at depressed values. Even modest reductions during difficult periods can make a substantial difference over time.

Diversification

Diversification is another important risk-management tool. In spreading investments across a variety of asset classes (e.g., stocks, bonds, and other investments), you can reduce portfolio volatility and limit the severity of market declines. While no strategy can eliminate risk entirely, diversification helps smooth investment returns and provides greater financial stability over time.

Guaranteed income sources

Incorporating guaranteed income—such as Social Security, pensions, or some annuities—can provide retirees with a stable stream of payments not directly impacted by market fluctuations. Covering essential expenses with predictable income sources ultimately helps retirees reduce their reliance on portfolio withdrawals (especially during volatile periods) to further safeguard long-term financial security.

Pre-retirement sequence risk planning

Effectively managing sequence of returns risk often starts in the years leading up to retirement. As retirement nears, investors typically transition their asset allocation in order to balance the need for continued growth with the desire for more stability: a gradual shift to help cushion portfolios from the market downturns that can jeopardize retirement security. Building multiple sources of retirement income can also help reduce reliance on a single investment portfolio (e.g., delaying Social Security benefits may boost future monthly payments, providing a larger guaranteed income stream later in retirement). Some new retirees may also choose to work part-time, reducing the need for portfolio withdrawals.

Financial-planning tools can also help investors evaluate how different market conditions might affect their retirement plans. By modeling various scenarios (including periods of market decline), investors can better understand the resilience of their retirement strategy and identify potential tweaks for the sake of better long-term sustainability.

Other retirement risks

Sequence of returns risk is one of several challenges retirees must consider when planning for long-term financial security. Other things to keep in mind are longevity risk (the possibility of outliving one’s savings), market volatility, and inflation: all of which often interact with one another. For example, inflation can force you to withdraw a higher annual amount to maintain your standard of living.

Market volatility, meanwhile, can cause fluctuations in your portfolio value. If these factors occur simultaneously—particularly early on in retirement—the combined impact can place additional strain on retirement savings. The interconnected nature of these risks means effective retirement planning must carefully balance investment growth, income stability, and spending flexibility to help safeguard long-term financial well-being.

The bottom line

Sequence of returns risk highlights an important but often-overlooked aspect of retirement investing: the timing of investment returns can have a major impact on financial outcomes. While long-term average returns are of course important, poor market performance early on in retirement can significantly reduce portfolio lifespan when withdrawals are underway.

Although no strategy can eliminate market uncertainty entirely, thoughtful planning can indeed help reduce potential sequence risk impacts—maintaining cash reserves, diversifying investments, adopting flexible withdrawal strategies, and incorporating stable income sources all helping retirees manage this risk more effectively. In understanding how sequence of returns risk works and taking steps to prepare for it, investors can help ensure their retirement savings lasts.

Have questions about your sequence of returns risk or retirement income planning? Schedule a FREE discovery call with one of our CFP® professionals to get them answered.

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The content in this post was developed by our team of writers and reviewed by our team of CFP® professionals here at Vision Retirement.

Retirement Planning | Advice | Investment Management

Sequence of Returns Risk: How This Can Ruin Retirement Dreams