Two retirees can have the exact same average investment returns over a 30-year retirement, save at the exact same rate, and end up with dramatically different outcomes — one running out of money, the other leaving a substantial legacy. The difference isn’t skill or luck in the usual sense. It’s the order in which returns occur, especially in the years right around retirement.
This is called sequence of returns risk, and it’s one of the most underappreciated risks in retirement planning.
Why order matters when you’re withdrawing money
While you’re still working and contributing to your portfolio, the order of good and bad market years doesn’t matter much. You’re adding money throughout, so it averages out over time.
Once you start withdrawing money, though, the math changes. If a market downturn hits early in retirement, you’re forced to sell investments at depressed prices to fund your living expenses. That leaves fewer shares left to participate in the eventual recovery, permanently impairing your portfolio’s ability to recover, even if average returns over the full retirement turn out fine.
A worked example
Consider two retirees, both starting with $1,000,000 and withdrawing $50,000 annually, adjusted for inflation, over a 25-year retirement. Both experience the exact same set of annual returns — just in reverse order of each other.
- Retiree A experiences strong returns in years 1 through 5, followed by a rough stretch later
- Retiree B experiences a rough stretch in years 1 through 5, followed by strong returns later
Even though both retirees experience the identical average return over the full 25 years, Retiree B — the one who hit bad returns early — often ends up with a meaningfully smaller ending balance, or in severe cases, runs out of money entirely. Retiree A, who got the same bad years but later in retirement, is often in a much stronger position, since the portfolio had already grown before the downturn hit.
This example illustrates why “average return” alone is a misleading way to evaluate whether a retirement plan will actually hold up. We charted this exact effect with a full set of year-by-year numbers in Three Things to Watch Out For When Preparing for Retirement, if you want to see the two paths side by side.
Why this risk is highest in the first few years
The years immediately before and after retirement, sometimes called the “retirement red zone,” are when sequence of returns risk matters most. This is simply because your portfolio balance is at its highest relative to your remaining working years and future contributions, so a downturn during this window has the most dollars exposed to it, with the least time to recover before withdrawals begin.
Strategies to manage sequence risk
| Strategy | How it helps |
|---|---|
| Maintain a cash or bond reserve of one to three years of expenses | Lets you avoid selling stocks at depressed prices during a downturn |
| Flexible withdrawal strategy | Reducing withdrawals in down years, drawing from discretionary spending first, reduces the amount of portfolio sold at a loss |
| Bucket strategy | Segmenting assets by time horizon, with near-term needs in stable assets and long-term needs in growth assets, reduces forced selling of volatile assets |
| Delaying retirement or phasing in slowly | Even a short delay can meaningfully reduce exposure if markets are down right before your planned retirement date |
| Reducing equity exposure gradually approaching retirement | Lowers volatility exposure specifically during the highest-risk years, without abandoning growth assets entirely |
The second strategy in that list connects to something worth thinking through ahead of time: which parts of your spending are genuinely essential, and which could flex in a bad year. We walk through that distinction in How much do you actually need to retire?
Frequently asked questions
Does sequence of returns risk mean I should avoid stocks in retirement?
Not necessarily. Stocks remain important for long-term growth, especially since retirements can last 25 to 30 years or more. The goal isn’t to eliminate stock exposure, but to structure withdrawals so you’re not forced to sell them at the worst possible time.
How much cash reserve is enough?
This varies by individual comfort level and spending flexibility, but many planners discuss a range of one to three years of essential expenses in stable, accessible assets as a starting point for discussion.
Can annuities help with this risk?
Some annuity products are specifically designed to provide guaranteed income regardless of market performance, which can reduce reliance on portfolio withdrawals during vulnerable years, though they come with their own tradeoffs worth evaluating carefully.
Is this risk the same for everyone?
No. The size of the risk depends on how much of your income relies on portfolio withdrawals versus guaranteed sources like Social Security or pensions. Retirees with a larger guaranteed income floor generally have more flexibility to ride out a downturn.
The takeaway
Average returns tell you very little about whether your specific retirement plan will succeed. The sequence in which those returns occur, especially in the years surrounding retirement, can matter just as much. Building in flexibility, a cash reserve, and a plan for how to respond to an early downturn is often more valuable than chasing a higher average return.
This article is for general informational purposes only and does not constitute personalized financial, investment, or tax advice. Please consult with a qualified financial advisor to discuss your individual circumstances.
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