Sequence of Returns Risk: Why the Order of Market Returns Can Make or Break Retirement
October 21, 2026
When you are saving, the order of investment returns barely matters: if you contribute steadily and hold on, a 20% drop in year 2 or year 20 leads to similar averages in the end. When you are withdrawing, order matters enormously. A market decline early in retirement forces you to sell more shares at low prices to fund your spending, leaving fewer shares to recover when the market rebounds. This is known as sequence of returns risk, and it is one of the main reasons retirement planning is harder than saving.
To see it, take a $1,000,000 portfolio from which a retiree withdraws $50,000 in the first year, rising 3% a year for inflation. Use the same twenty annual returns in two different orders.
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The twenty returns are: −20%, −10%, −5%, +8%, +12%, +15%, +18%, +10%, +8%, +7%, +9%, +10%, +8%, +7%, +6%, +9%, +10%, +11%, +8%, +7%. The arithmetic average is 6.4% and the annualized (geometric) return is about 6.0%. In Scenario A, the retiree experiences these in the order listed, with the bad years first. In Scenario B, the same numbers occur in reverse order, with the bad years last.
Each year, the retiree withdraws the planned amount at the start of the year and the remainder earns that year's return.
| Scenario | Order of returns | Result after 20 years |
|---|---|---|
| A: crash first | -20%, -10%, -5%, then gains | Portfolio exhausted in year 20 |
| B: crash last | Same returns, reversed | $1,188,000 remaining |
Why Order Matters With Withdrawals
In Scenario A, the portfolio falls to about $555,000 after three years even though the retiree has only taken out about $154,500. The next withdrawal of $54,600 then represents nearly 10% of the portfolio, and the strong later returns apply to a much smaller base. In Scenario B, good returns compound on a large balance for years, so when the poor years arrive at the end, the portfolio has a big cushion and withdrawals are a smaller share.
Mathematically, the withdrawal rate relative to the current portfolio value rises when markets fall, creating a feedback loop. The first five to ten years of retirement are the most critical period, which planners call the retirement risk zone.
Strategies to Reduce the Risk
Flexible spending: cut withdrawals by 10% in down years. Studies show this can substantially improve the survival of a portfolio. A cash or short-term bond reserve of one to three years of spending lets you avoid selling stocks during a downturn. A bond tent or rising equity glide path starts retirement with a lower stock allocation (for example 40% to 50%) and increases it gradually as the risk window passes. Delaying retirement by a year or two, working part-time, or delaying Social Security to increase guaranteed income lowers the pressure on the portfolio. Annuities can cover essential expenses with guaranteed income, at the cost of liquidity.
A lower initial withdrawal rate, such as 3.5% instead of 4%, provides more safety margin.
Using Simulations
Because one set of returns is only a single scenario, planners use Monte Carlo simulations and historical backtests to estimate the probability that a plan survives. A 90% success rate means that in 90 out of 100 simulated futures the money lasts, but the failures tend to be those with early bad returns. Test your plan against bad sequences, such as retiring just before a major bear market, and decide what adjustments you would make.
Takeaways
Average returns are not enough to evaluate a retirement plan. Build in flexibility, hold adequate safe assets for near-term spending, and revisit your withdrawal rate annually. If you are far from retirement, this risk should not stop you from investing in stocks, but it should shape how you transition to retirement.
Frequently Asked Questions
What is sequence of returns risk?
The risk that poor market returns early in retirement, while withdrawing, permanently damage a portfolio's ability to last.
Does the order of returns matter during the saving years?
Much less, because contributions buy more shares when prices are low.
How can I reduce sequence risk?
Use flexible spending, hold a cash reserve, lower initial withdrawals, or use a rising equity glide path.
What is a bond tent?
A strategy of holding more bonds around retirement and increasing stocks later.
Why do planners use Monte Carlo simulations?
To test many possible return sequences and estimate the chance a plan succeeds.