Sequence of Returns Risk

Posted November 11, 2025, By Cole Ferrier

Key Takeaways:

• Sequence of Returns Risk is the danger of experiencing poor investment returns in the first few years of retirement, which can cause irreversible damage to your portfolio's longevity.

• The order in which you receive your investment returns matters more than the long-term average return once you start making withdrawals.

• This risk is most dangerous when combined with a high withdrawal rate, as it forces you to sell more shares at low prices, permanently depleting your capital.

• The most effective solutions involve creating a buffer to avoid selling stocks in a down market, such as a cash reserve (bucket strategy) or implementing a flexible spending strategy that reduces withdrawals during market downturns.

In this series, we've debugged some of the most formidable risks to your retirement plan. We've built a vessel designed for a long journey (Longevity Risk), fortified it against the corrosion of Inflation Risk, and learned to manage the engine's inherent volatility (Market Risk). Now we arrive at the risk that combines these forces in the most dangerous way possible, especially for a new retiree: Sequence of Returns Risk.

This risk is often called the retiree's worst nightmare, and for good reason. It dictates that when you earn your investment returns is far more important than what your average return is over 30 years. A string of bad returns after you've been retired for two decades is a bump in the road. The very same string of bad returns in the first five years of retirement can be a catastrophic, plan-ending event.

From my engineering perspective, this is a "critical launch failure." It's a bug that occurs in the first few moments of operation that corrupts the entire system, making full recovery impossible. No matter how well the system is designed to run in the long term, a catastrophic failure at ignition can be fatal. This is why managing the "retirement risk zone"—the five to ten years immediately before and after you stop working—is the most critical task in building a durable financial blueprint.

By the Numbers

• 50.6%: The probability of portfolio failure for a retiree who experienced a significant market shock at the point of retirement, compared to only 33.5% for a retiree who experienced the same shock 15 years later. This quantifies the disproportionate impact of bad timing. (Source: "Retirement Risk Zone," Drew and Walk, 2014)

• -37%: The total return of the S&P 500 in 2008. A retiree who started taking withdrawals in that environment faced a devastating sequence of returns. (Source: S&P Dow Jones Indices)

• 4% to 10%: The massive range of actual maximum sustainable withdrawal rates over different 30-year historical periods, demonstrating that the "safe" withdrawal rate is entirely dependent on the market sequence you happen to retire into. The median, or 'typical' lucky retiree, could have sustainably withdrawn closer to 6.5%." (Source: Kitces.com, "The Ratcheting Safe Withdrawal Rate – A More Dominant Version Of The 4% Rule?")

From the Case Files

Let's illustrate this with the classic example. Imagine two retirees, Lucky Larry and Unlucky Lucy. Both retire with a $1 million portfolio and withdraw $50,000, increased by 3% inflation each year. Over the first ten years of their retirement, both portfolios earn the exact same average annual return of 7%. The only difference is the order of those returns.

• Lucky Larry retires into a bull market. He enjoys strong gains in his early years, and his portfolio grows to over $1.5 million before a market downturn hits in his eighth year.

• Unlucky Lucy gets the exact same returns, but in the reverse order. She retires directly into a bear market, and her portfolio is hit with immediate, significant losses.

The result? After ten years, Lucky Larry's portfolio is healthy and worth nearly $1.2 million. Unlucky Lucy, despite having the same average return, is on the brink of failure with a balance of only $535,000. Her portfolio was crippled by the bad returns at the beginning and never had a chance to recover. It wasn't the average return that mattered; it was the sequence.

Understanding the Risk: The Math of Withdrawals

When you are saving for retirement, a dollar-cost averaging strategy makes market downturns your friend. When you are taking withdrawals, the math flips. This is called reverse dollar-cost averaging.

When the market falls, you have to sell more shares to generate the same amount of cash for your living expenses. For example, if you need $4,000 a month and your mutual fund is priced at $50 per share, you need to sell 80 shares. If the market drops and your fund is now worth $40 per share, you must sell 100 shares to get the same $4,000. Those 20 extra shares are now gone forever, unable to participate in the eventual recovery. This is the mechanism that makes a bad sequence so destructive.

The Impact on Your Plan: A Crippling Start

A poor sequence of returns is the catalyst that causes several other risks to trigger a full-blown system failure.

• Interaction with Excess Withdrawal Risk: A bad sequence turns a moderately aggressive withdrawal rate into a highly destructive one. A 5% withdrawal from a $1 million portfolio is $50,000. If the market drops 25%, that same $50,000 withdrawal is now 6.7% of your remaining $750,000, dramatically accelerating the drain on your capital.

• Interaction with Longevity Risk: For someone facing a 50-year FIRE retirement, a bad sequence in the first few years is an almost insurmountable obstacle. You simply don't have enough time relative to your total retirement horizon for even stellar average returns to make up for the initial damage. The longer the race, the more devastating a crippling injury at the starting line becomes.

• Psychological Impact: Beyond the math, a bad sequence can be emotionally devastating. It can cause retirees to panic and abandon their strategy (like selling everything and going to cash), which locks in the losses and makes recovery truly impossible.

Solutions & Your Risk Mitigation Toolkit

You cannot control the market sequence you retire into, but you can build a plan that is resilient to a bad one. The goal is to create a system that insulates your portfolio from the need to sell assets at the worst possible times.

• Tool #1: The Cash Reserve / Bucket Strategy. This is the primary defense. By holding 1-3 years of living expenses in a dedicated "safe" bucket of cash and short-term bonds, you create a buffer. When the market is in a downturn, you draw your income from this cash bucket, leaving your stock portfolio untouched. This gives your growth assets the time they need to recover without being depleted by withdrawals.

• Tool #2: Dynamic Spending Rules. A rigid withdrawal strategy is fragile. As discussed in the Excess Withdrawal Risk article, a dynamic or "guardrail" strategy builds in rules to reduce withdrawals during market downturns. Forgoing an inflation adjustment or even taking a small 5-10% spending cut after a severe market drop can dramatically reduce the damage from a poor sequence and increase your plan's long-term success rate.

• Tool #3: Partial Annuitization or a Bond Ladder. Creating a secure floor of income from sources that are not correlated to the stock market—like Social Security, a pension, or an income annuity—directly reduces the pressure on your portfolio. If your essential expenses are covered by these guaranteed sources, you have much more flexibility to reduce or postpone withdrawals from your investment portfolio during a downturn.

• Tool #4: A Rising Equity Glidepath (Advanced). This is a more technical and counter-intuitive strategy. It involves starting retirement with a more conservative stock allocation (e.g., 40% stocks) and then gradually increasing that allocation over time. The logic is to have the least amount of market exposure when the portfolio is at its largest and most vulnerable (at the start of retirement) and then to increase exposure to capture growth later on when sequence risk is less of a threat.

A Resilient Framework for the 'Retirement Risk Zone'

Strategically, sequence of returns risk is the danger of poor investment returns early in retirement causing irreversible damage to your plan's longevity. This "critical launch failure" occurs when a market downturn collides with portfolio withdrawals, forcing you to sell more assets at low prices and permanently depleting the capital base needed for a multi-decade retirement.

A resilient plan is engineered to survive a bad start. The primary defense is to create a buffer, such as a cash reserve or "bucket strategy," which insulates the first few years of spending from market volatility, ensuring you are never a forced seller in a down market. This is complemented by a flexible spending strategy, like a "guardrail" system, which provides disciplined rules for reducing withdrawals during market downturns to preserve capital for the eventual recovery.

Conclusion: The Great Balancing Act

The fundamental trade-off in managing sequence risk is between holding non-productive assets and protecting your portfolio. Every dollar you hold in a cash reserve is a dollar that isn't participating in a potential market recovery. This can feel like a drag on your returns during good years. The "great balancing act" is recognizing that this cash isn't just sitting there; it's buying you insurance. It's the premium you pay for the peace of mind that comes from knowing you will never be a forced seller in a panic, and that your long-term plan can survive a bad start.

Create Your Financial Compass with Us

Are you prepared for the retirement risk zone? We specialize in building dynamic, resilient retirement income plans that are designed to withstand a poor sequence of returns. We can stress-test your current strategy and help you implement the buffers and rules you need for a confident retirement. Contact us today.

Resources:

• The American College of Financial Services - Retirement Income Center: Publishes research and articles on retirement risks, including sequence risk. (retirement.theamericancollege.edu)

• Journal of Financial Planning: A source for practitioner-focused research on topics like safe withdrawal rates and dynamic spending rules. (www.financialplanningassociation.org/learning/publications/journal)

• Kitces.com: Michael Kitces's blog is an exhaustive resource for deep dives into advanced financial planning topics, including detailed analyses of sequence risk. (www.kitces.com)