Two people can retire the same year, with the same savings, and earn the same average return over time. One runs low on money. The other is fine. The difference often comes down to one thing: the order in which the good and bad years arrive. That is sequence of returns risk, and it deserves a plain explanation.
What is sequence of returns risk?
Sequence of returns risk is the danger that a stretch of poor investment returns early in retirement will do lasting damage to your savings, even if your average return over the years turns out fine.
Here is the short version. When you are still working and adding money, a market drop can actually help you, because you buy investments at lower prices. When you are retired and pulling money out, a drop early on does the opposite. You are selling investments at low prices to pay your bills, and there is less left to recover when the market comes back.
The word “sequence” is the key. It means order. The same returns in a different order can leave you with very different amounts of money.
Why does the order of returns matter if the average is the same?
Because you are taking money out along the way. Withdrawals turn the order of returns into something that matters a great deal.
Let me show you with two retirees.
Say Linda and Robert each retire this year at age 65. Each starts with $500,000. Each takes out $30,000 at the start of every year to live on. And here is the important part: over the next ten years, they earn the exact same set of yearly returns. The only difference is the order.
Linda gets several solid years first, then some losses later. Robert gets the same numbers, but his good years and bad years are flipped around, so a rough patch lands earlier in his retirement.
At the end of ten years, their average return is identical: about 4.5 percent a year for both. But their balances are not close.
- Linda has about $397,000 left.
- Robert has about $321,000 left.
That is a gap of roughly $76,000 on a $500,000 starting balance. Same savings. Same withdrawals. Same average return. The only thing that changed was the order of the good and bad years. That gap is sequence of returns risk in action.
Why is the danger worse right after you retire?
The first few years of retirement carry the most weight. A loss in year one or year two is much harder to undo than the same loss ten years later.
Think about why. When you retire, your savings are usually at their largest. Every dollar is invested and working for you. If the market falls hard right then, the drop applies to your biggest balance. On top of that, you are still taking withdrawals to pay your bills, so you are removing money from an account that just got smaller. A bear market in early retirement is a textbook example of sequence risk: the loss hits your largest balance at the exact moment you are also drawing income from it.
Here is a simple picture. Say you retire with $500,000 and take your first $30,000 for the year. That leaves $470,000 invested. Now the market falls 20 percent. Your balance drops to $376,000.
To climb back to $470,000, you do not need a 20 percent gain. You need about 25 percent, just to get back to where you were before the drop. And you will keep taking withdrawals while you wait for that recovery. That is why a bad start digs a hole that is deep and slow to climb out of.
The same 20 percent drop in year fifteen, when you may have already spent down part of your savings and lived through some good years, does far less long-term harm.
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How is this different from a normal bad market?
The market has always had good years and bad years. What changes in retirement is your relationship to those bad years.
While you are working and saving, time is on your side. You are not selling. You have years, sometimes decades, for prices to recover. A downturn can even be a chance to buy more at lower prices through your regular contributions.
In retirement, you flip from adding money to spending it. Now a downturn forces you to sell some of your investments at low prices to cover your withdrawals. Those sold shares are gone, so they cannot rebound when the market recovers. This is sometimes called the difference between the accumulation phase, when you build savings, and the withdrawal phase, when you draw on them.
The math of building wealth and the math of spending it down are not the same. Sequence risk is one of the biggest reasons why.
How can you protect your retirement income from sequence risk?
You cannot control when a downturn arrives. You can control how exposed you are to it. Several steps, used together, lower the risk that a bad start does lasting harm.
Keep a cash cushion for the early years
One common approach is to hold a portion of near-term spending needs in cash or other very safe savings vehicles. If the market falls right after you retire, you can spend from that cushion instead of selling investments at a low point. This gives your portfolio room to recover before you have to touch it. Some people call this a “bucket” approach, because you separate your money into a near-term bucket and a long-term bucket.
Be willing to adjust your spending
A withdrawal plan does not have to be locked in stone. If your first couple of years bring losses, trimming your spending a little, or skipping an inflation raise for a year, can take real pressure off your savings. Small, temporary cuts early on protect the base that everything else depends on. Flexible spending is one of the most powerful tools most retirees already have.
Watch your withdrawal rate, especially at the start
Your withdrawal rate is the share of your savings you take out each year. A widely used starting point is around 4 percent of your balance in the first year, adjusted for inflation after that. This is often called the safe withdrawal rate, though it is a guideline, not a promise. Starting on the lower side, or staying flexible about that rate in the early years, leaves more of a margin if the market does not cooperate.
Match your investment mix to when you will spend the money
The money you need in the next few years should not be sitting in the most volatile investments. Some retirement researchers have suggested maintaining a slightly more conservative allocation early in retirement, while others favor different approaches. The appropriate mix depends on your goals, risk tolerance, and income sources, so it is worth thinking through carefully rather than guessing.
What role does Social Security play in sequence risk?
Social Security gives you income that does not rise and fall with the stock market. That steady payment is a real defense against sequence risk.
Here is the connection. Every dollar of your monthly Social Security benefit is a dollar you do not have to pull from your investments. The more of your basic expenses that guaranteed income covers, the less you are forced to sell in a down market. In effect, Social Security acts as an income floor beneath your retirement.
This is also why the timing of your benefit matters. Waiting to claim, when you can afford to, raises your monthly benefit for life. For many retirees, that larger guaranteed benefit can reduce the amount that must come from investments each month. The trade-off is that you have to bridge the gap in the years before you claim, often by spending from savings, so the decision is not automatic.
One note on wording: Social Security sends monthly payments, or benefits. It is your guaranteed income, and it keeps coming no matter what the market does that year.
How do you know if your retirement plan can survive a bad start?
You test it. Guessing is not enough with something this important, and the good news is that you do not have to guess.
The core question is simple to ask and hard to answer in your head: if the market falls sharply in my first two or three years of retirement, and I keep spending the way I plan to, does my money last? Answering it well means looking at your specific savings, your specific spending, your Social Security, your taxes, and how they all interact over 25 or 30 years.
This is exactly the kind of problem that good retirement planning tools are built to handle. A solid plan can model different orders of returns, including a rough early stretch, and show you whether your income holds up or runs thin. It can test how much a cash cushion helps, what happens if you trim spending in a down year, and how claiming Social Security earlier or later changes the picture. Seeing those trade-offs on paper, before you are living them, is what turns a hopeful guess into a plan you can trust.
Many people find that a short session with an independent professional, or time spent with planning software that runs these scenarios, is what finally lets them feel confident about their income. The point is not to predict the future. The point is to know your plan can handle a bad start if one arrives.
The one thing to remember
Averages hide the risk. Over a long retirement, your average return matters less than when the good and bad years show up. A rough start, in your first few years of withdrawals, can do damage that a rough finish never could.
You cannot schedule the market. But you can build a plan that does not fall apart if the early years disappoint: keep a cushion for the near term, stay flexible on spending, mind your withdrawal rate, lean on guaranteed income like Social Security, and test your plan against a bad start before you need to. Do that, and the order of returns becomes something you have prepared for, rather than something that catches you off guard.
This article is for educational purposes only and is not personalized financial, tax, or investment advice. Your situation is unique. Before making decisions about withdrawals, investments, or when to claim Social Security, confirm the details with a qualified professional or the relevant agency (for Social Security, that is SSA.gov).
Note Boldin is an affiliate relationship of Holy Schmidt!. This means if you purchase a product or use their service, we earn a small commission. This does not increase your cost.
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