What is Sequence-of-returns risk?

Sequence-of-returns risk is the danger that the order in which investment returns arrive, and not only their average, decides how long a pot of savings lasts. It matters once money is being taken out, typically in retirement. If nothing is withdrawn, a bad year followed by a good year ends in the same place as a good year followed by a bad one. Once regular withdrawals start, losses early on force the investor to sell more shares at low prices, and those shares are no longer there to benefit when markets recover.

Say a retiree has a hypothetical $1,000,000 and takes out $50,000 at the start of each year. In the first version, year one returns −20% and year two returns +20%. After the first withdrawal, $950,000 falls 20% to $760,000. The next withdrawal leaves $710,000, which grows 20% to $852,000. In the second version the same two returns come in reverse order. $950,000 grows 20% to $1,140,000. The second withdrawal leaves $1,090,000, which falls 20% to $872,000. Same returns, same withdrawals, yet the order alone creates a $20,000 gap. Without withdrawals, both versions would end at exactly $960,000.

A common misunderstanding is that the average return tells the whole story. Two retirees can share the same compound annual growth rate (the steady yearly rate that turns a starting value into an ending value) and still end up in very different positions, because averages ignore timing. The risk is also concentrated: the years just before and after retirement carry the most weight, when the balance is largest and withdrawals are beginning. The order of future returns cannot be known in advance, so the risk cannot be measured ahead of time, only planned around. Historical studies of the 4% rule show this clearly: for a 60/40 portfolio using US data from 1872 to 2025, over 30-year retirements, the money lasted in 124 of 125 start years, and the one failure started in 1966.

For a private investor building a long-term portfolio, this risk shapes the shift from saving to spending. During the saving years, early declines are less harmful and new contributions buy at lower prices. Near and in retirement, a deep drawdown (a fall from a previous peak) does more damage, because the loss arithmetic is harsh even before withdrawals: a 50% loss needs a 100% gain to recover. Investors commonly respond with diversification across asset classes, a cash or bond reserve to draw on during sell-offs, and flexible withdrawals that shrink after poor years.

By Dr. Harry Hamann

What is sequence-of-returns risk in plain words?
It is the risk that bad market years arriving early in retirement, while money is being withdrawn, shrink savings permanently. The same returns in a different order could leave a much larger balance, even though the average return is identical.

Does sequence-of-returns risk affect people who are not withdrawing money?
Not in the same way. Without withdrawals or contributions, the order of returns does not change the ending value. For savers adding money regularly, early declines can even help, because contributions buy more shares at lower prices.

How do retirees reduce sequence-of-returns risk?
Common approaches include holding a mix of stocks and bonds, keeping a cash reserve to avoid selling shares after a fall, reducing withdrawals after poor years, and limiting the size of potential drawdowns around the retirement date.