What is sequence of returns risk?
Sequence of returns risk is the danger that poor investment returns early in retirement, while withdrawals are being made and can permanently damage a portfolio, even if long-term average returns are strong.
Why Average Returns Can Be Misleading?
Many retirees assume that if their portfolio earns a respectable average return, their retirement is safe.
Unfortunately, that assumption can be dangerously wrong.
Two retirees can earn the same average return, withdraw the same income, and yet one runs out of money decades earlier. The difference is caused by something most investors never plan for:
Sequence of Returns Risk
It is one of the most underestimated threats to retirement income and one of the biggest reasons retirees panic-sell during market downturns.
Sequence of returns risk refers to when investment returns occur, not just how much return you earn overall.
It becomes critical only during retirement, when:
- You are making regular withdrawals
- Your portfolio no longer has time to recover from early losses
Why It matters more during market crashes
Market crashes are temporary.
Withdrawals during crashes are permanent.
Once money is withdrawn, it can’t participate in future recoveries.
A Simple Example: Same Returns, Very Different Outcomes
Let’s look at two retirees:
Assumptions
- Starting portfolio: $1,000,000
- Annual withdrawal: $40,000 (4%)
- Retirement length: 30 years
- Same average return over time
Retiree A: Bad Early Returns
- Year 1–3: Market drops 20%, 10%, 5%
- Withdrawals continue
- Portfolio shrinks rapidly
- Recovery later, but from a much smaller base
Retiree B: Good Early Returns
- Year 1–3: Market gains 15%, 12%, 10%
- Portfolio grows despite withdrawals
- Later downturns are survivable
📌 Result:
Both retirees experience the same long-term average return, but Retiree A may run out of money 10+ years earlier.
Why Sequence Risk Is Most Dangerous in Early Retirement
Sequence risk is highest during:
- The first 5–10 years of retirement
- Periods of high inflation
- Large early withdrawals
This is why many retirees who retired in 2000–2002, 2008–2009 and 2020 felt intense financial stress—even if markets later recovered.
Why Traditional 4% Rule Can Fail
The 4% rule assumes:
- Historical averages
- No flexibility
- No behavioral mistakes
But it does not account for:
- Market crashes at the wrong time
- Panic selling
- Forced withdrawals during downturns
This is where smarter strategies become essential.
How to Protect Yourself From Sequence of Returns Risk
1️⃣ Use a Bucket Strategy (Most Effective)
The bucket strategy isolates short-term income from long term growth.
How it helps:
- Withdraw from cash and bonds during downturns
- Avoid selling stocks when markets are down
- Give growth assets time to recover
👉 Read more: The Automatic Paycheck: Can a SWP Make Your Retirement More Comfortable?
2️⃣ Keep 2–3 Years of Expenses in safe assets
This “income buffer” acts as shock protection.
Examples:
- Treasury bills
- Money market funds
- Short-term bond ETFs
3️⃣ Use Dynamic Withdrawals (Not Fixed)
Instead of rigid withdrawals:
- Pause increases after bad years
- Increase income after strong market years
- Adjust withdrawals within safe guardrails
This dramatically improves success rates.
4️⃣ Avoid Selling Growth Assets in Bear Markets
Selling equities during downturns locks in losses.
If you must sell:
- Sell bonds or cash
- Rebalance only during strong markets
How the Bucket Strategy Solves Sequence Risk (Visually)
| Market Condition | What You Sell |
| Market crash | Bucket 1 (cash) |
| Flat markets | Bucket 2 (income) |
| Bull markets | Bucket 3 (growth) |
This simple rule removes emotion from decisions.
Disclaimer: This article is for educational and informational purposes only and does not constitute professional financial, investment, tax or legal advice. Every financial situation is unique. Always consult with a certified financial planner or tax professional before making significant investment decisions.