Sequence-of-Returns Risk: Why the First Years of Retirement Matter Most
Two retirements with identical average returns can end very differently depending on the order those returns arrive. Here is why, and what to do about it.
Key Financial Group
The short version: If a market decline arrives early in retirement while you are withdrawing money, the damage is far greater than the same decline arriving later. The order of returns matters, not only the average. Covering near term spending with money that cannot fall is the main defence.
The idea, stated simply
Imagine two people who retire with the same savings and experience the same average return across thirty years.
One has good years first and a poor stretch later. The other has the poor stretch first and good years afterwards.
The averages are identical. The outcomes are not, and they can differ dramatically. The second person can run short while the first is comfortable, on the same average return.
Why the order matters when you are withdrawing
The mechanism is straightforward once you see it.
When you withdraw during a decline, you are converting holdings at reduced values. Those holdings are gone. They are not there to participate when conditions improve.
So a decline early in retirement does two things at once: it reduces the balance, and it means your withdrawals consume a larger share of what remains. The recovery, when it comes, operates on a smaller base.
Late in retirement the same decline matters less, because the remaining balance is smaller and the remaining period is shorter.
The asymmetry with the accumulation years
This is why advice that served you well for thirty years may not serve you well now.
While you were working and contributing, a decline was arguably helpful. Your regular contributions bought more, and the recovery lifted everything you had accumulated at lower prices.
The moment you stop adding and start withdrawing, that reverses completely. The same event that once worked in your favour now works against you.
Recognising that reversal is one of the more important shifts in thinking that retirement requires. We look at the wider version in preservation of principal after 60.
What actually reduces the risk
Do not sell at a bad moment
Almost everything else is a version of this.
The most direct approach is to hold several years of spending in things that do not fall in value: savings and money market accounts for the nearest portion, and certificates of deposit beyond that.
If the next several years are covered, a poor market stretch does not force you to convert anything. You wait. We set out how to build that in building a safe money bucket for the next five years.
Cover essential expenses with guaranteed income
If the bills are met by income that arrives regardless, market conditions stop determining whether you can pay them.
Social Security does much of this for most households. Where a gap remains, a fixed annuity is the usual tool. We work through sizing it in how much guaranteed income do you need.
Keep flexibility in discretionary spending
Households able to postpone a large discretionary expense in a poor year have a genuine advantage. It is not a product, it is an attitude, and it works.
Structure the whole thing by timing
The bucket approach exists largely to address this risk. See the three-bucket retirement strategy.
Why this is not an argument against growth
It would be easy to read all this as saying that anything capable of falling has no place in a retirement plan. That is not the conclusion.
A retirement can last a long time, and money with a genuinely distant purpose has the one thing that makes a decline survivable: time to wait. The problem is never that a holding can fall. The problem is being forced to sell it while it has.
So the useful distinction is not between safe and risky holdings. It is between money you will need soon and money you will not. Once near term spending is covered by things that cannot fall, the rest of the plan has room to breathe, and a poor year becomes an inconvenience rather than an emergency.
That is why the bucket structure and this risk are really the same subject approached from two directions.
What does not reduce it
Predicting the market. If anyone could reliably identify poor stretches in advance, this risk would not exist. Treat confident forecasts accordingly.
Averages. Long run average returns are the wrong tool for someone withdrawing money, because the average conceals the order, and the order is the whole problem.
Hoping. Retiring with no plan for a poor first few years is a bet that they will not happen. Sometimes it pays off. It is still a bet.
The good news
This risk is unusually responsive to preparation, which is not true of every risk in retirement.
You cannot control what markets do in your first years. You can control whether those years require you to sell anything, and that is the part that determines how much damage is done.
Which means the defence is entirely within reach: know your spending, cover the near years with things that cannot fall, and cover essentials with income that arrives regardless.
A note on timing your retirement date
People sometimes ask whether they should delay retiring because conditions look poor.
That is a personal decision and there is no general answer. What we would say is that the question itself reveals the anxiety this risk creates, and that the structural answers above address it more reliably than trying to pick a good moment.
If you are approaching retirement and would like to work out whether your first years are adequately covered, schedule a free consultation. It is a straightforward review and there is no obligation.
This article is for general education and is not financial, tax, or legal advice. Please speak with a licensed professional about your situation.
