Sequence of Returns Risk

So, what is Sequence of Returns Risk? It is the danger retirees face of receiving lower or negative returns early in retirement when withdrawals are made from their underlying investment accounts. Savvy investors planning their retirement have to understand that there is risk in the order in which investment returns occur for those that are nearing, or in, retirement.

All Retirements are Not the Same

Two retirees with identical wealth can have entirely different financial outcomes, depending on when they start retirement. A retiree starting out at the bottom of a bear market will have better investing success in retirement than another starting out at a market peak, even if the long-term averages are the same.Sequence of Returns Risk

In short, it has to be understood that it is not just the average returns on your investments in retirement, but the timing of those returns which is important. When you begin withdrawing money from your retirement accounts, the returns during the first few years can have a major impact on ensuring you do not run out of money and any money you plan to pass along as an inheritance.

This phenomenon can be viewed and understood in a couple of different ways. The first article [John Hancock] illustrates different potential outcomes when two retirees retire ten years apart when all else (e.g. portfolio value, rate of return, etc.) is equal. The second article [BlueCreek Investment Partners] illustrates a possibility when all factors are the same, except in this case the rates of return are identical, just flipped over a 15-year period. So, what does it mean now that you are aware of this phenomenon and you ponder your own retirement?

Investors Beware

I believe there are two actions a savvy investor can take to avoid an unpleasant surprise halfway through retirement. First, have a well thought out withdrawal plan that considers the order of withdrawals from various types of accounts (e.g. taxable, tax-deferred or tax-exempt) and the tax implications of each. Second, be keenly aware of the rates of return during the first  five years in retirement.

As both examples illustrate, low (or negative) returns during the early years of retirement can wreak havoc. This is where continually tracking and adjusting your retirement portfolio is a must. It isn’t enough to manage and track during the years leading into retirement. If, during the first few years in retirement, you see that the rate of return on your investments cannot support your spending rate over another 20 – 25 more years, you need to be ready to make the necessary adjustments, namely reducing spending and consider modifying your asset allocation.

Blogger-in-Chief here at RetirementSavvy and author of Sin City Greed, Cream City Hustle and RENDEZVOUS WITH RETIREMENT: A Guide to Getting Fiscally Fit.


  1. Hey, James. This is the one financial topic that really scares me. We’re at a market top and Mrs. Groovy and I are retiring this October. At some point in the near future we’re going to have a correction. How big it will be is anyone’s guess. We’ll head into retirement with a 50/50 split between stocks and bonds/cash. We have 4-5 years of expenses in cash, so we think we got things covered.

    Michael Kitces thinks going into retirement with a 30/70 split is a better strategy for handling the sequence of return risk. I like this approach. But Mrs. Groovy doesn’t want to be that conservative with stocks. She’s very happy with our 50/50 split. Maybe I can talk her into a 40/60 split? We’ll see. Thanks for addressing a very important topic, James. Damn, I wish personal finance wasn’t so hard!

    • I believe this is a risk that most people have not given sufficient thought to and of course, have not prepared for. You guys are ahead of most people in that you are aware of the danger and have settled (more or less) on an approach. As I often note on this blog, a lot of people are focused on the accumulation phase but have not put a lot of thought into the decumulation – or withdrawal- phase. What makes the decumulation task more daunting is the fact that you really have to get it right the first time. You really don’t want to be in a situation where you realize your plan was flawed – fatally flawed? – 6-7 years into retirement and you find yourself in a situation where you need to return to the workforce, which discriminates against older workers, to avoid financial ruin.

      Nice share by the way. Interesting article. Thanks for stopping by, my friend and sharing your thoughts.

  2. A Google+ reader notes …

    “Interesting point as it is not a straight forward issue. Simply reaching retirement, thinking all will be well because you only withdraw x%, and forgetting about the underlying investments could be financial suicide.

    By coincidence I wrote an article on pension withdrawals (link at bottom of the note) recently. Relating to this post I found that any drops in fund value have larger impacts when they occur close to retirement.

    One can argue that it is best to retire at the bottom of a bear market (if it is affordable to retire then it will be at any time), at the top of a bull market (you will have more wealth than at the bottom of a bear market) or any stage in between. Ultimately, it all depends on how the wealth & the person’s expectations are managed that will make the difference.”

    Liberty Wealth [Pension Withdrawal Guide]

  3. I Am one of the folks Karen is speaking of, my focus has been to get “money in the bank.” … Going to revisit Develop Your Withdrawal Plan

    Good information.

    • In the 20s, 30s, and early 40s, most investors would be well served to focus like a laser on accumulation. However, by the time an investor reaches 45 or so – particularly if they plan to retire in the 55 – 65 age range, accumulation should be on auto-pilot and in a lot of respects, attention should be turned to a detailed withdrawal plan that considers the types of retirement accounts, their respective tax implications and sequence of returns.

      With respect to the 4% rule, which I touch on in the Withdrawal Plan post, another “rule” or method gaining favor lately is an adoption of the Required Minimum Distributions (RMDs) for setting the withdrawal rate. Look for a post in the near future on this method.

  4. These are the things a lot of people wouldn’t think of. They think once you have the money in the bank you are good to go. As shown here that is not the case. It’s a very interesting article SavvyJames, thank you.

    • It is an interesting topic as it is a risk many do not consider. Thanks for stopping by and kicking off the conversation.

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