Retirement · Explainer
Sequence risk: why the order of returns decides your retirement
Two portfolios can average the same return over twenty years and leave one retiree solvent and the other not.
The short answer
- Withdrawals during a downturn lock in losses that later gains cannot undo.
- The years immediately before and after retirement carry the most sequence risk.
- Cash buffers and flexible spending reduce it more reliably than asset selection.
While a portfolio is accumulating, only the average return matters — contributions during a fall buy more units. Once withdrawals begin, that symmetry breaks. Selling assets after a fall permanently removes units that would have participated in the recovery.
Why the order matters
Take two retirees with identical average returns over their retirement. The one who experiences poor returns in the first few years, while withdrawal rates relative to the shrunken pot are highest, can run out of money. The one who gets the same bad years at the end may finish with a surplus.
Practical mitigations
- Hold one to three years of planned withdrawals in cash or short bonds, so the portfolio is not sold into a fall.
- Make spending flexible: reducing discretionary withdrawals in bad years has a large effect.
- Reduce risk gradually into the retirement date rather than at a single point.
- Cover essential spending with guaranteed income — state pension, annuity or defined benefit — so market falls only touch discretionary spending.
The years that matter most
Roughly the decade spanning retirement — five years either side — carries the concentrated risk. Planning attention and de-risking effort are best spent there rather than spread evenly across a working life.
Sources
- Retirement planning basics — U.S. SEC (Investor.gov)
- Pensions guidance — MoneyHelper
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