What Is Sequence-of-Returns Risk?

Before withdrawals, the order matters less

Here's a simplified way to understand the concept.

Suppose an account experiences three annual returns:

+10%

+5%

−15%

Now reverse their order:

−15%

+5%

+10%

If no money is added or removed along the way, the ending result is essentially the same.

The account experienced the same three returns.

They simply arrived in a different sequence.

But retirement introduces something that can change the outcome:

withdrawals.

Withdrawals change the equation

Once an account is helping fund your retirement, money may be coming out every month or every year.

Now imagine a significant market decline occurs early in retirement.

The account falls in value.

But you still need income.

If you withdraw money from the account while its value is down, there are fewer dollars remaining to participate in a future recovery.

That's what makes the sequence important.

It's not simply:

Did the market eventually recover?

It's also:

How much money was still invested when it did?

Same returns. Different order. Different experience.

Consider two hypothetical retirees.

We'll call them Retiree A and Retiree B.

Both begin retirement with the same savings.

Both need regular withdrawals to help fund their lifestyle.

Over several years, both experience the same collection of positive and negative market returns.

But Retiree A experiences the stronger years earlier.

Retiree B experiences the market declines earlier.

Even if their average returns eventually look similar, Retiree B may have had to make withdrawals from a smaller account during those difficult early years.

That can leave less money available when better markets eventually arrive.

Same returns. Different sequence. Potentially different result.

Early retirement can be an especially important period

A market decline at age 45 and a market decline shortly after retirement aren't necessarily the same financial event.

At 45, you may still have:

• years of employment ahead,
• continued retirement contributions,
• a paycheck funding your lifestyle,
• and substantial time before withdrawals begin.

Shortly after retirement, the situation may be different.

Your paycheck may have stopped.

Contributions may have stopped.

And withdrawals may have begun.

A difficult market during those early retirement years can therefore affect both:

the value of the account

and

the amount that must continue supporting future withdrawals.

The problem isn't simply that markets decline

Markets have always moved up and down.

Sequence-of-returns risk doesn't mean a retiree must somehow avoid every market decline.

That's unrealistic.

The issue is the combination of two things happening at once:

Market values fall

while

retirement withdrawals continue.

That combination can make an early decline more consequential than the same decline occurring when withdrawals aren't being taken.

Average return doesn't tell the whole story

People naturally focus on average investment returns.

That's understandable.

Average return is useful information.

But averages can hide the path taken to get there.

Imagine being told that a retirement account averaged a certain return over 20 years.

That tells you something about performance.

It doesn't tell you:

• when the difficult years occurred,
• when withdrawals were taken,
• how much was withdrawn,
• or how much remained invested after those withdrawals.

For someone accumulating money, that distinction may be less important.

For someone spending from the account, it can become much more important.

This connects directly to your retirement paycheck

Sequence risk becomes easier to understand when we stop thinking only about investment balances and start thinking about income.

Suppose your retirement lifestyle requires:

$7,000 per month

And dependable sources such as Social Security provide:

$4,500 per month

That leaves a:

$2,500 monthly income gap

If that $2,500 must consistently come from accounts exposed to market fluctuations, withdrawals may continue whether the market is rising or falling.

Now the question isn't simply:

“What return might my investments earn?”

It also becomes:

“What happens to my retirement paycheck if a difficult market arrives early?”

That's a retirement-income question.

Different dollars can help handle different jobs

As we've discussed throughout Blackburn's retirement education, not every retirement dollar has to perform the same job.

Some resources may be intended to provide growth potential.

Some may provide liquidity.

Some may help create dependable income.

Some may provide guarantees or protection for particular retirement needs.

The purpose of understanding sequence risk isn't to prescribe exactly where each dollar should go.

It's to recognize that depending on one fluctuating pool of money for every retirement need can expose your income to the timing of market returns.

Understanding that tradeoff can help you ask better questions about how your retirement resources are organized.

Sequence risk doesn't tell you what the market will do

There's another important distinction.

Understanding sequence-of-returns risk doesn't help anyone predict the next market decline.

That's not the point.

No one knows exactly when the strongest or weakest market years will occur.

Sequence risk is about preparing for that uncertainty rather than predicting it.

Useful questions include:

• How much of our regular retirement spending depends on market withdrawals?
• Which expenses must be paid regardless of market conditions?
• What dependable income do we already have?
• How much flexibility do we have in our withdrawals?
• What resources are available if markets decline?
• Which parts of our savings need growth, liquidity, income or protection?

Those questions focus on what you can plan for rather than what you can't predict.