Retirement Risk: Understanding Sequence of Returns

Most people believe that if they save a million dollars by retirement and earn a solid average market return, they are set for life. The truth is far more complicated. A hidden danger called sequence of returns risk can disrupt even the most disciplined retirement plan. It affects how long your savings last and how quickly withdrawals drain your account.

Accumulation and distribution are two very different phases. Consider the Mount Everest comparison. The climb is important, but most fatalities happen on the way down. Retirement is the same. Savings is only half the battle. Navigating withdrawals safely is the part that matters most.

This article breaks down what sequence of returns risk is, why it matters and how retirees can build a strategy that protects them when markets move in the wrong direction at the wrong time.

Why Sequence of Returns Risk Is So Dangerous

To understand this risk, you first have to understand the timeline of a typical retirement. Consider a married couple that starts saving at age 45. They aim for a $1 million nest egg by age 65. Based on current actuarial data, there is a greater than 50% chance that at least one spouse will live to age 92.

That means the couple needs their savings to last roughly 27 years.

Planners often use withdrawal rates to calculate longevity. A 5% withdrawal rate means a $1 million account produces $50,000 of income in year one. The withdrawal amount increases each year to keep up with inflation, assuming a modest 3% inflation assumption.

Everything looks straightforward on paper. But the stock market does not produce the same return every year. Some years deliver gains, some bring losses. The order of those gains and losses determines whether your account survives or collapses.

That order is the sequence of returns.

What Happens During Accumulation

When you’re saving and not withdrawing, sequence does not matter. If the average return over twenty years is 7%, you end with the same balance whether the good years come early or late. This leads to the first major misconception. People assume that if the average return looks strong, the outcome will always be positive. That’s only true while you’re saving.

What Happens During Distribution

Once you begin withdrawals, sequence becomes everything. Early losses hurt far more because you’re pulling money out while the account is already falling. Even if the long-term average still looks good, the math can break down and the account empties years before life expectancy.

A Real World Example Using Actual Market Returns

The early 2000s were brutal for the market, with negative or low returns in the first three years. When retirees begin withdrawals during weak periods like this, the damage compounds quickly.

Here is what happens:

1. Start with $1 million at retirement.

2. Withdraw $50,000 in year one.

3. Increase each year by 3% for inflation.

4. Use actual historical returns from the S&P 500.

5. Watch how long the account lasts.

With the real sequence from the early 2000s, the account runs out by age 80. That’s only 15 years into retirement, far short of the target age 92.

Now shuffle the returns so the good years come first. The same average return produces a very different outcome. In some shuffled scenarios, the couple makes it to age 86. In the few cases where strong gains hit immediately, the account lasts the full 27 years.

The Core Lesson

You cannot control market order. You cannot predict whether your retirement begins during a bull market or a downturn. You can do all the right things and still be exposed to a risk that has nothing to do with average returns.

This is why retirees need guard rails.

Withdrawal Rates and How They Impact Longevity

Retirement outcomes are extremely sensitive to early losses. Even a small change creates massive differences in longevity.

●      5% withdrawal: Often leads to portfolio depletion unless early returns are strong

●      4% withdrawal: Still fails in many scenarios unless market conditions are favorable

●      6% withdrawal: Accelerates depletion even faster

This is why experts argue about sustainable withdrawal rates. The truth is that no fixed number works for everyone because sequence risk can disrupt even the most careful plan.

Sequence risk is the reason the old rule of thumb withdrawal formulas can no longer be trusted.

Inflation Adds Pressure That Many Retirees Ignore

Inflation escalates the challenge. Looking at recent data, we can see how unpredictable inflation can be:

●      Two-year average inflation in 2022 and 2023 was 6%.

●      The prior two years were nearly 3%.

●      Earlier decades saw periods around 4%.

If inflation climbs during retirement, withdrawal needs rise faster. That forces larger withdrawals during downturns and increases the risk of running out of money.

What makes inflation especially dangerous?

●      It reduces purchasing power.

●      It forces larger withdrawals.

●      It compounds every year.

●      It creates stress in the budget.

Sequence risk and inflation together create a powerful threat many retirees underestimate.

Managing Sequence Risk Requires Strategy, Not Guesswork

Most retirees focus on investment products. They ask about funds or bonds or dividends. Like in golf, it’s not the club that determines performance; it’s the swing. A great swing can make a mediocre club work. A poor swing will fail no matter how expensive the club is.

Retirement planning works the same way. The strategy is far more important than the product. A few important principles show why.

●      You need a structured withdrawal plan.

●      You need financial vehicles that create stability.

●      You need income sources not tied directly to market volatility.

●      You need a safety net to prevent early sequence losses.

●      You need liquidity for unexpected needs.

These guard rails give retirees protection from the unpredictable nature of market cycles.

Why Every Retiree Needs a Plan Before Distributions Begin

Sequence of returns risk is unpredictable and unavoidable, which makes it dangerously powerful. It’s the reason two retirees with identical savings and identical average returns can experience completely different outcomes. One enjoys security for 30 years. The other runs out of money before reaching 80.

No one can choose the order of market returns, but every retiree can choose a strategy that limits exposure to the worst-case scenarios.