Why the Order of Returns Matters in Retirement
Two retirees can earn the same average return over 30 years and end up in very different places. The difference is timing. One hits a bad market early, while withdrawals are already underway. The other hits it late.
This matters most for pre-retirees within 5-10 years of leaving work and for retirees who pay living expenses from their portfolios. In 2019, 28.7% of adults 65 and older received IRA withdrawals as household income.
This article covers how sequence risk affects retirement, practical ways to reduce exposure, flexible income planning, and the role of tax-aware advice.
Key Takeaways
- Sequence risk is the damage that poor early returns do when you're also taking withdrawals.
- Early losses hurt more because fewer assets remain to recover.
- Reserves, diversification, flexible spending, and guaranteed income can reduce exposure, not erase it.
- Taxes, income sources, insurance, and legacy goals belong in the same plan.
What Is Sequence of Returns Risk?
Sequence of returns risk is the effect the order of good and bad returns has on a portfolio once contributions stop and withdrawals begin.
During accumulation, a market drop is often an opportunity: workers keep contributing and buy at lower prices. In distribution, retirees may have to sell during the drop to fund expenses. Those sales lock in losses and leave fewer assets to recover.
When Is Sequence Risk Greatest?
Morningstar calls the years just before and after retirement a retirement risk zone. Returns right before retirement set the base your income comes from. Vulnerability rises with:
- A long retirement horizon (a 65-year-old can expect about 19.5 more years on average, and many will live longer)
- High withdrawal rates
- Inflation-adjusted spending
- Little guaranteed income
Sequence risk isn't one bad year. It differs from general market risk, inflation risk, longevity risk, and average annual return, though it interacts with all of them.
It also can't be predicted or fully eliminated. The goal is to lower the odds that a downturn forces harmful decisions.
How Sequence of Returns Risk Affects Retirement
A Hypothetical Comparison
Morningstar's hypothetical shows how much order matters. Two retirees each start with $1 million, withdraw $40,000 in year one, and raise that 2% annually. Both earn the same 5.89% annualized return over 30 years.
One gets 12% returns in the first decade, 6% in the second, and 0% in the third. The other gets the reverse.
By year 11, the first portfolio has grown to about $2.2 million, a 2.2% withdrawal rate. The reverse-order portfolio has shrunk to about $562,000, an 8.7% withdrawal rate. This is an illustration, not a forecast.
The Mechanics
- Withdrawals during a decline force you to sell more shares for the same dollars.
- Fewer shares remain when markets recover.
- Ongoing withdrawals keep the portfolio from fully benefiting from later gains.
Practical Consequences
Retirees hit by early losses may need to:
- Delay retirement
- Cut discretionary spending
- Lower their withdrawal rate
- Return to work
- Leave less to heirs
What Makes It Worse
- Inflation-adjusted spending that raises the dollars you must withdraw each year (CPI-U rose 3.7% in the 12 months ending September 2026)
- Taxes on distributions and required minimum distributions, which begin at 73 or 75 depending on birth year
- Healthcare costs that compete with other withdrawals: Fidelity's planning benchmark for a 65-year-old retiring in 2026 is $185,500
- Concentrated holdings, which FINRA says can amplify losses
- A longer-than-average life that stretches the withdrawal period
Early Versus Late Declines
A similar drop later in retirement usually does less damage, since the horizon is shorter and more withdrawals have already been taken. It still matters. The real impact depends on spending, allocation, income sources, and years remaining.
How to Protect Against Sequence of Returns Risk
Liquidity Reserves and Buckets
A reserve holds near-term essential spending in cash so you don't sell growth assets at a low.
A Morningstar study of 150 hypothetical retirements, chosen for terrible starting markets, found reserve and bucket strategies beat systematic withdrawals when the modeled investor overreacted. The same study reported opportunity-cost trade-offs and didn't crown a universal winner.
There's no universal reserve size. It depends on your spending, other income, and risk tolerance.
Diversification and Rebalancing
Spread money across stocks, bonds, cash, and other appropriate investments, and rebalance by a set rule. The SEC is clear that diversification cannot guarantee against loss in a declining market, and asset allocation doesn't guarantee a profit either.
Flexible Withdrawals
- Variable percentage: apply a set percentage to the current balance, so dollars rise and fall with the portfolio.
- Guardrails: the Guyton-Klinger rules cut withdrawals 10% when the withdrawal rate drifts more than 20% above its starting level.
- Spending changes: postpone optional purchases or temporarily trim withdrawals after poor returns.
The tradeoff is real: more flexibility improves sustainability but makes income less predictable.
Guaranteed Income
Social Security, pensions, and properly evaluated annuities can cover essential expenses and reduce reliance on market withdrawals. Social Security grows if you delay claiming up to age 70, and the 2026 COLA is 2.8%.
Before buying an annuity, review:
- Guarantees depend on the insurer's ability to pay; check financial-strength ratings
- Fixed immediate annuity payments can lose purchasing power to inflation
- Surrender charges, holding periods, and variable-annuity fees
- Liquidity and contract terms
- State guaranty association coverage, which is limited by state law
Tax-Aware Income Planning
Vanguard describes drawing from taxable accounts first, tax-deferred next, and Roth last as a pattern that may lower lifetime taxes for many retirees. Morningstar cautions there's no cookie-cutter order, and mixing account types can make sense.
Traditional IRA distributions are generally ordinary income, and long-term capital gains face 0%, 15%, or 20% rates. Plan around after-tax spending, not portfolio value alone.
Build a Sequence-Aware Retirement Plan
Before Retirement
Stress-test before you leave work. Vary retirement dates, withdrawal levels, market sequences, inflation, and income sources.
Monte Carlo tools, such as the 1,000-scenario simulations Schwab describes, report the share of scenarios that meet your goals. An 85% result means failure in 15% of modeled cases.
Weak results may call for:
- More savings
- A later retirement date
- Lower planned spending
- More guaranteed income
During Retirement
Write your downturn rules down while markets are calm:
- Name which expenses can be cut and by how much.
- Define when reserves can be tapped.
- Set how and when you'll rebalance.
- Schedule a plan review, so changes come from analysis rather than panic.
Coordinated Planning
Sequence risk touches taxes, investments, income, estate plans, and insurance at once. Zebulon Tax & Wealth Advisory's Zebulon Method is one example of coordinating those pieces rather than leaning on a single product. It covers:
- Tax strategy
- Investment management
- Retirement income
- Estate and legacy planning
- Insurance design
Zebulon's retirement work includes Roth conversion planning, withdrawal strategy, Social Security timing, and pension decisions. The firm coordinates with tax and legal professionals but doesn't prepare taxes or give legal advice.
Common Mistakes to Avoid
- Treating the average as a promise. A long-term average never arrives as a smooth yearly pattern.
- Locking in a rigid withdrawal. Automatic inflation raises and untouchable discretionary spending add pressure during an early downturn.
- Reacting emotionally. Morningstar's Mind the Gap study found 10-year investor returns of 13.2% versus 13.7% for US equity ETFs, though it cautions the gap doesn't prove bad behavior.
- Hiding in one "safe" asset. Concentration brings its own risk.
- Buying income products without review. Check taxes, liquidity, inflation exposure, fees, guarantees, and legacy goals first.
Frequently Asked Questions
What is sequencing risk?
It's the effect the order and timing of returns has on a portfolio while withdrawals are being taken. Losses early in retirement do the most harm because fewer assets remain to recover.
How do you protect against sequence of returns risk?
Combine a cash reserve or buckets, diversified investments, flexible withdrawals, guaranteed income, and tax-aware planning. None removes all risk.
What is variable percentage withdrawal?
You withdraw a chosen percentage of the current portfolio value each year, so the dollar amount moves with the balance. The tradeoff is less predictable income in exchange for better sustainability.
What is the biggest mistake most people make regarding retirement?
There is no single agreed-upon biggest mistake, but a common one is relying on a single average return or fixed withdrawal without stress-testing timing, taxes, inflation, longevity, and spending.
Does sequence of returns risk only affect people who are already retired?
No. It can start in the 5-10 years before retirement, when a major decline shrinks the assets available to generate future income.
Can sequence of returns risk be eliminated?
No. An integrated plan can reduce exposure through liquidity, diversification, spending flexibility, guaranteed income, and regular reviews.
