Why the order of returns matters once withdrawals start
While you are working and saving, a bad year is mostly a paper loss. You keep contributing, you buy shares at lower prices, and the account has time to come back.
Retirement flips that. You are selling shares every month to pay the bills. When the market is down, each withdrawal sells more shares to raise the same dollars, and those shares are not there when the recovery comes. The loss becomes permanent even after prices bounce back.
A worked example
Two people retire with $1,000,000 and take out $50,000 at the start of every year. Over ten years they get exactly the same ten annual returns, averaging 4.9 percent. The only difference is the order. One gets the two down years first. The other gets them last.
| Same returns, different order | Balance after 10 years |
|---|---|
| Down years first (-18%, -10%, then gains) | $739,941 |
| Down years last (gains, then -10%, -18%) | $1,006,858 |
| Difference | $266,917 |
Hypothetical illustration. Returns used: -18, -10, 6, 12, 9, 10, 7, 14, 11 and 8 percent, reversed for the second retiree. Not the performance of any real investment.
Same average, same withdrawals, and one of them has about a quarter of a million dollars less to live on for the next twenty years.
When the risk is highest
The danger is concentrated in a window of roughly five years before your retirement date and ten years after it. That is when the balance is at its largest and the withdrawals are just starting. A 30 percent drop at 80 hurts. A 30 percent drop at 63, right after you stopped working, can set the tone for the rest of the plan.
Five ways to reduce sequence risk
1. Keep a reserve for the next one to three years of withdrawals
Holding cash or short-term bonds for the withdrawals you will need soon means you are not forced to sell stocks in a down year. You spend the reserve, and refill it after the market recovers.
2. Cover essential expenses with income that does not depend on the market
If Social Security, a pension and possibly an annuity pay for housing, food, utilities and insurance, a bad market affects your travel budget, not your groceries. There is more on this in how much of your retirement income should be guaranteed.
3. Use a flexible withdrawal rule
Skipping the inflation raise after a down year, or trimming withdrawals by 5 to 10 percent until the portfolio recovers, lowers the number of shares sold at bad prices. Small changes in the first few years have an outsized effect.
4. Protect part of the principal
Some people move a portion of their savings into vehicles where the principal is not exposed to market losses, such as fixed or fixed index annuities, CDs or Treasury bonds held to maturity. Each comes with trade-offs in liquidity, growth and fees, so the real question is how much to protect.
5. Plan the timing of Social Security and part-time work
A year or two of part-time income, or delaying Social Security while drawing from a reserve, can keep you from leaning on the portfolio during the most fragile stretch. See when to claim Social Security.
What I look at with clients
I run the plan through a bad first five years on purpose, because that is the version that ends retirements early. Then we decide which of the tools above you need and how much of each. Most people end up using two or three of them together.
Questions people ask
Does sequence of returns risk matter if I am not withdrawing yet?
For a lump sum you leave alone, the order of returns does not change the ending balance. It starts to matter once money is going in or coming out, and it matters most once withdrawals begin.
How big should a cash reserve be in retirement?
A common range is one to three years of the withdrawals that your guaranteed income does not cover. A larger reserve gives more protection in a long downturn but earns less in the meantime.
Is sequence of returns risk the same as market risk?
It is a specific form of market risk. Market risk is the chance your investments lose value. Sequence risk is the extra damage that happens when those losses arrive while you are withdrawing.
Pete Alexander plans retirement income, asset protection and insurance for families in Fremont and the East Bay, and co-wrote Crash Proof Wealth with Brett Kitchen. More about Pete.
This guide is general information. It is not tax, legal or investment advice or a recommendation to buy any product. Figures and rules were checked on October 25, 2026 and can change. Talk with a qualified professional about your own situation.