Average return does not tell the whole story.
Sequence-of-returns risk is the risk that the timing and order of investment returns—especially losses—can materially affect a portfolio when money is being withdrawn. Two portfolios can experience the same set of annual returns but produce different retirement outcomes if those returns occur in a different order.
Before withdrawals begin, the order of returns can matter less than it does after distributions start. Once money is leaving the portfolio, a market decline can reduce the account while withdrawals remove additional assets, leaving fewer dollars available to participate in a later recovery.
Sequence risk is about the interaction between returns and cash flows. It does not mean a particular market decline will cause a portfolio to fail.
Why do withdrawals make the order of returns more important?
When someone is still accumulating assets and making contributions, a decline may occur while money is continuing to enter the portfolio. During retirement, the direction of cash flow often reverses: money is being withdrawn to support spending.
Regular contributions can purchase investments at different market levels, and no retirement withdrawals may be required from the portfolio yet.
If withdrawals occur during a market decline, shares or other assets may need to be sold while values are lower, reducing the amount left to recover.
A simple hypothetical example
Consider two retirees who begin with the same amount, withdraw the same dollar amount each year, and experience the same annual returns—but in reverse order.
This is a conceptual illustration, not a projection. Actual outcomes depend on the size and timing of returns and withdrawals, fees, taxes, asset allocation, inflation and other factors.
When can sequence risk matter most?
Sequence risk can be especially important around the transition from saving to withdrawing—often the years immediately before and after retirement—because early losses can affect a portfolio that may need to support many future years of spending.
A portfolio reduced early may have less capital available for later growth while still needing to fund ongoing distributions.
Market declines still matter, but the portfolio may have already funded years of spending and the remaining planning horizon may be different.
There is no universal “safe” year. Market returns cannot be known in advance. Sequence-risk planning is about preparing for uncertainty rather than predicting when a decline will occur.
Does sequence risk only matter if the market crashes?
No. A dramatic decline can make the concept easy to see, but sequence risk can also result from several years of weak or uneven returns combined with withdrawals. The size of withdrawals, inflation adjustments, portfolio allocation, fees and the length of retirement all influence the effect.
How can a retirement-income plan respond to sequence risk?
There is no single strategy that eliminates sequence risk without introducing other tradeoffs. Planning approaches generally focus on reducing the need to sell volatile assets at unfavorable times, preserving flexibility, or coordinating other income sources with portfolio withdrawals.
Why not simply move everything out of the market?
Avoiding market volatility entirely can reduce one source of uncertainty, but retirement can last for decades. Assets may also need to address inflation and long-term purchasing power. Moving too much into low-growth or illiquid resources can create different problems.
Can guaranteed or dependable income reduce sequence risk?
Income that does not depend directly on current portfolio market values can reduce the amount that must be withdrawn from invested assets for recurring spending. Social Security and pensions may provide part of that foundation. Certain annuity contracts can also provide contractual income features.
That does not make an annuity universally appropriate or remove all retirement risk. Annuities can involve liquidity restrictions, surrender provisions, fees or other contract limitations. Guarantees are subject to the terms of the contract and the claims-paying ability of the issuing insurer.
How does sequence risk connect to longevity?
Sequence risk and longevity risk can compound one another. A poor early return sequence can reduce portfolio value, while a long retirement increases the number of years those remaining resources may need to support spending.
This is one reason retirement-income planning often considers market exposure, withdrawal flexibility, dependable income and longevity together rather than treating each as an isolated issue.
Common misconceptions
Questions worth asking about sequence risk
- How much of my expected retirement spending must come from investment withdrawals?
- Which recurring expenses are already covered by Social Security, pensions or other dependable income?
- How much liquid reserve do I want available during a prolonged market decline?
- Could I reduce discretionary spending temporarily after poor market performance?
- How would my withdrawal strategy respond if markets declined early in retirement?
- Does my asset allocation still make sense once I begin taking distributions?
- How might inflation affect both my spending and the amount I need to withdraw?
- What happens if retirement lasts longer than I expect?
- Would an insurance-based income feature address a specific need, and what liquidity or cost tradeoffs would come with it?
The bottom line
Sequence-of-returns risk explains why retirement planning cannot rely on an average investment return alone. When withdrawals begin, the order of market gains and losses can influence how much of the portfolio remains available for future years.
A useful retirement-income structure considers how much spending depends on market-based withdrawals, how much flexibility is available during difficult markets, and how other income sources fit into the plan.