Sequence of Returns Risk: The Timing of Investment Returns Matters

Written by John Macy, Financial Coach, MBA, Retirement Income Certified Professional® (RICP)

Part 1a of the Retirement Risk Management Series

Executive Summary  

• The Core Definition:  Sequence of Returns Risk (SoRR) is the danger that a market downturn occurs in the initial years of retirement.  

• The Impact:  When paired with portfolio withdrawals, early negative returns can permanently hollow out a portfolio, even if long-term historical averages eventually recover.  

• The Limitation: Traditional static withdrawal strategies assume retirees continue taking inflation-adjusted withdrawals regardless of market conditions, offering little flexibility when severe market declines occur early in retirement.

For decades, the standard blueprint for financial independence was remarkably simple: divide your projected annual retirement expenses by 4% to determine the needed size of the retirement nest egg, save regularly to build that nest egg, and invest in a balanced mix of stocks and bonds. This foundational "4% Rule" provided millions with a clear target number.

However, when you transition from accumulating wealth to spending it, the rules of mathematics change completely. In the accumulation phase, a market crash is often an opportunity to buy assets at a discount. In the decumulation phase, that same market crash can be catastrophic, depending on when it occurs. The primary culprit behind this shift is Sequence of Returns Risk.

This is Part 1 of a 2-part series on Sequence of Returns Risk. In Part 2 of this series we will discuss ways to shield your portfolio and retirement income from SoRR.

In his landmark 1994 paper, Determining Withdrawal Rates Using Historical Data, financial planner Bill Bengen demonstrated why the timing of market returns — not just the average return — is critical to retirement success. A lucky or unlucky timing of market returns can determine whether a retirement portfolio lasts 30 years or runs out of money prematurely. Understanding how this risk functions is the first step toward building a retirement strategy that actually lasts.

A retiree doesn't have to experience poor lifetime investment returns to run into trouble. Even an excellent long-term average return can fail if the worst losses occur during the first few years of retirement.

Sequence of Returns Risk is one of the most important concepts in retirement income planning, yet many investors don't encounter it until they are close to retirement.

What is Sequence of Returns Risk?

Sequence of Returns Risk is the danger that market declines occur precisely as you begin drawing down your assets early in retirement. When your portfolio drops in value and you simultaneously withdraw cash for living expenses, you are forced to liquidate a higher percentage of your remaining shares to fund that fixed income. This permanently reduces the number of shares remaining to participate in the eventual recovery.  

Mathematically, if you are simply buying and holding a portfolio without adding or removing any money, the order of your annual returns does not matter. Whether you get great market returns in year one and a crash in year ten, or a crash in year one and great returns in year ten, your final balance will be exactly the same because investment returns compound over time, and without deposits or withdrawals, the order of those returns does not affect the ending balance.

But the moment you begin taking regular withdrawals, the order of those returns dictates everything.  This is what makes retirement investing fundamentally different from wealth accumulation. Once withdrawals begin, managing risk becomes just as important as pursuing returns.

Many retirees focus on average annual returns for their portfolios. Unfortunately, retirement success often depends less on the average return and more on when those returns occur.

A Tale of Two Retirees: The Math of Decumulation

The following illustration uses actual annual market returns observed between 1995 and 2025 but rearranges their order to isolate the impact of return sequencing. Although the returns have been resequenced, both retirees experience the same average annual return over the 30-year period. Retiree A experiences the best decade first and the worst decade last. Retiree B experiences the worst decade first and the best decade last.

Despite earning the same average annual return, Retiree A finished with nearly 8.5 times as much wealth as Retiree B. The only variable that changed was the order of annual returns which produced dramatically different retirement outcomes for the two retirees over the same 30-year period. Everything else — including average return, withdrawals, inflation adjustments, and starting portfolio value — remained identical.

The "luck of your retirement date": Researchers have found that retirees who began in years like 1966, 1968, 1973, and 2000 faced some of the most challenging historical market sequences. By contrast, retirees beginning in years like 1982 or 2009 benefited from much more favorable early market conditions.

It's Not Just About the Sequence of Investment Returns

While SoRR receives most of the attention, retirees face another important and similar challenge: the timing and persistence of inflation.

Persistently high inflation early in retirement can magnify the damage caused by poor market returns. As the cost of living rises, retirees following a traditional 4% withdrawal strategy typically increase their withdrawals each year to maintain their purchasing power. Those larger withdrawals may coincide with a declining portfolio, forcing even more shares to be sold at depressed prices. In other words, inflation doesn't just increase your grocery bill — it can also accelerate the depletion of your investment portfolio when markets are already under pressure.

This is precisely what made retirements beginning in the late 1960s so difficult. Investors weren't battling weak stock and bond markets alone — they were also coping with some of the highest inflation rates in modern U.S. history. The combination of falling portfolio values and rapidly increasing withdrawals created a powerful "double squeeze" that challenged even well-diversified retirement portfolios.

The lesson is clear: a successful retirement income strategy must account for both the sequence of market returns and the timing and persistence of inflation. Protecting purchasing power while managing withdrawals during difficult market environments is one of the keys to building a retirement plan that can endure decades of uncertainty.

Why the Retirement Risk Zone Can Break the 4% Rule

Researchers call the five years immediately preceding retirement and the first five years of retirement the Retirement Risk Zone. This ten-year window is the most fragile period for your wealth.  Losses during this period have less time to recover (and fewer shares of stock to grow) because share sales and withdrawals begin just as the portfolio is attempting to rebuild.

The traditional 4% rule was designed to survive even difficult historical market sequences, but it assumes retirees continue taking inflation-adjusted withdrawals regardless of market conditions. Today's research suggests that greater spending flexibility may improve outcomes, including increasing possible withdrawal rates.

When equity valuations are stretched and bond yields fluctuate, relying on a rigid, unyielding percentage can quickly expose your plan to failure.  Morningstar's forward-looking research estimates that a retiree beginning today might consider an initial withdrawal rate around 3.9% under a traditional static spending approach, although the appropriate rate depends on portfolio composition, flexibility, and individual circumstances.

The problem isn't that you cannot spend 4% or more from your retirement assets; the problem is that static rules lack the defense mechanisms required to protect your principal during a sharp and prolonged market drop.  Fortunately, sequence risk can be managed. Simple planning strategies — including flexible withdrawals, maintaining dedicated cash reserves, and diversifying beyond traditional stock-and-bond portfolios — can significantly reduce its impact.

In retirement, average returns tell only half the story. The sequence of those returns — and the inflation that accompanies them — often determines how the story ends.

The lesson is clear: retirement success depends not only on the sequence of market returns, but also on the path of inflation and how withdrawals are managed along the way.

Next in the Retirement Risk Management Series: How to navigate sequence of returns risk and reduce the risk to your retirement.

Author:  John Macy, MBA, RICP®

John Macy is a professional financial coach and the founder of FlourishingPath Financial Coaching. With over six years of experience as a financial coach, John helps pre-retirees and retirees design resilient portfolios and income streams for their next act. Read his full story here.