Sequence of Returns Risk

Sequence of returns risk is the danger that the timing of investment returns can permanently damage a retirement portfolio, even if the long-term average return is acceptable. Specifically, experiencing poor returns in the early years of retirement — while simultaneously making withdrawals — can deplete a portfolio much faster than poor returns later in retirement.

The reason: early withdrawals during a market downturn remove shares from your portfolio that cannot benefit from subsequent recoveries. This is sometimes called the 'reverse dollar-cost averaging' problem.

For example, two retirees both averaging 7% annual returns over 20 years, but one experiences a market crash in years 1-3 while the other experiences the crash in years 17-20. The first retiree often runs out of money; the second survives comfortably. Managing sequence risk through cash buffers, flexible withdrawal strategies, or part-time income is critical for early retirees.