Why Two Retirees With Identical Average Returns Diverge
The order in which investment returns arrive does not matter while you are saving. Once you are withdrawing, it matters enormously, and a bad start can ruin a retirement that the averages said was fine.
When Order Suddenly Matters
While saving for retirement, the order in which returns arrive does not affect the final result. A good year followed by a bad year produces the same ending balance as a bad year followed by a good one, since no money is being added or removed based on the balance. Only the average matters.
In retirement, this reverses completely. Once money is being withdrawn, the order of returns matters enormously. Two retirees earning the identical average return over their retirement can have wildly different outcomes, one running out of money and the other leaving a fortune, purely because of the sequence in which those returns arrived. This is sequence of returns risk.
While saving, only the average return matters. While spending, the order matters more than the average, and a bad start can be fatal.
Why Withdrawals Change Everything
The reason is the interaction between withdrawals and a falling portfolio. When a retiree withdraws money from a portfolio that has dropped, they are selling assets at low prices to fund the withdrawal, locking in the loss and leaving less invested to recover when markets rebound.
If the poor returns come early, the portfolio is depleted by withdrawals at exactly the wrong time, and it may never recover even when good returns eventually arrive, because too much was sold off cheaply. If the poor returns come late, the portfolio has already grown through good early years and can absorb them.
| Timing of poor returns | Effect |
|---|---|
| Early in retirement | Portfolio depleted by withdrawals, may not recover |
| Late in retirement | Portfolio already grew, can absorb the losses |
The Cruel Arithmetic
The danger is that a retiree can do everything right, save enough, plan a reasonable withdrawal rate based on a sound average return assumption, and still fail simply because they retired just before a bad stretch.
Someone who retires and immediately faces a market downturn while withdrawing income can deplete their portfolio to a level from which the eventual recovery cannot save it, even though the long run average return over their whole retirement was perfectly adequate. The averages said they were fine; the sequence ruined them. This is what makes the risk so insidious, since it is invisible in the planning based on averages and reveals itself only in the actual path of returns.
How to Defend Against It
Because the danger is concentrated in the early retirement years, defences focus on that period.
Hold a cash buffer. Keeping a few years of spending in cash or safe assets means that in a downturn, the retiree can spend from the buffer rather than selling depressed investments, giving the portfolio time to recover. This directly addresses the mechanism of the risk.
Reduce spending in bad years. Cutting withdrawals when the portfolio has fallen reduces the selling at low prices, preserving assets for the recovery. Flexibility in spending is one of the strongest defences.
Adjust the allocation approach. Some strategies reduce risk in the years just before and after retirement, when sequence risk is highest, then allow risk to rise again later, since the vulnerable window is concentrated around the retirement date.
Why It Is Underappreciated
Sequence risk is underappreciated because standard retirement planning often uses average returns, which hides it entirely. A plan built on an average return looks safe, and the same plan can fail badly if the returns arrive in an unfavourable order, which the average conceals.
Understanding it changes how a retirement should be planned: not around a single average return, but around the possibility of a bad early stretch, with defences in place for exactly that scenario. The retiree cannot control the sequence they will face, but they can prepare so that a poor start is survivable rather than fatal.
The Bottom Line
Sequence of returns risk is the danger that the order of investment returns, irrelevant while saving, becomes decisive while withdrawing. Poor returns early in retirement force selling into a falling market and can deplete a portfolio beyond recovery, even when the long run average return was adequate. The defences, a cash buffer, flexible spending, and reduced risk around the retirement date, all address the vulnerable early years. It is a risk that averages hide and that a sound retirement plan must confront directly.