Sequence of Returns Risk

Sequence of returns risk is the danger that negative returns early in retirement permanently impair a portfolio's ability to sustain spending, even if average returns across the period are fine. Two retirees with identical average returns over 30 years can have drastically different outcomes based on order. A bear market in years 1-3 (while withdrawing from a shrinking portfolio) creates a 'withdrawal crater' that subsequent gains can't fill. A bear market in years 27-30 barely matters. This is why the 4% rule fails ~5% of the time in historical simulations—failures cluster around poor early returns.

When to use it

When planning retirement within the next 5-10 years. When designing a portfolio withdrawal strategy. When evaluating retirement plan robustness against downturns. When advising clients whose retirement coincides with a market decline.

How it can help

For anyone within 5 years of retirement, this is critical. Practical implications: hold 2-3 years of expenses in cash or bonds as a buffer against selling stocks during downturns; consider a 'bond tent' (temporarily increasing bonds around retirement, then reducing); maintain spending flexibility (10-20% reduction during bear markets dramatically improves survival). For advisors, this explains why average return projections mislead—the sequence matters as much as the average for retirees.