Sequence of Returns Risk: Why Order Can Break Retirement

Here is a result that breaks most people's intuition: two retirees can earn the exact same average return, withdraw the exact same amount each year, and end up in completely different places — one comfortable, one running out of money. The difference is not luck with the average. It is sequence of returns risk: the order in which good and bad years arrive. When you are drawing an income from a portfolio, order stops being a footnote and becomes the whole story.

This post shows you exactly why that happens, with the arithmetic laid out step by step, why the risk barely touches you while you are still saving, and the three practical levers that blunt it. If you are within ten years of living off your investments — in the US, the UK or Europe — this is the risk that deserves most of your planning attention. If you would rather turn it into a repeatable plan than a worry, a structured ETF and index-investing course walks through building and drawing down a portfolio step by step.

What is sequence of returns risk?

Sequence of returns risk is the danger that the order of your returns — not just their average — decides whether your money lasts once you are withdrawing an income. A run of losses early in retirement forces you to sell more units for the same withdrawal, leaving fewer to recover when markets rebound.

Here is the counterintuitive part: your average return over three decades can look perfectly healthy and you can still run out of money. Notice the condition — once you are taking money out. That is what trips people up, and it is where most explanations stop short. Hold the thought, because it is the key to both the danger and the defence.

Why the order of returns doesn't matter while you're still saving

During the accumulation phase — the decades when you are adding money, not withdrawing it — the order of returns is mathematically irrelevant to your final balance. Multiplication is commutative: a 20% gain followed by a 10% loss leaves you in exactly the same place as a 10% loss followed by a 20% gain.

Take a simple case. Put $100,000 to work and let it earn three annual returns of –30%, +10% and +20%, in that order. You finish with $100,000 × 0.70 × 1.10 × 1.20 = $92,400. Now reverse the order to +20%, +10%, –30%. You finish with $100,000 × 1.20 × 1.10 × 0.70 = $92,400. Identical. The order changed; the destination did not.

This is why a 25-year-old drip-feeding a workplace pension or an index fund should mostly ignore sequence risk. In fact, a crash early in a saver's life is a gift: it buys more units cheaply, exactly the logic behind building a retirement fund with global ETFs through steady contributions. The problem is what happens when the arrows reverse and money starts flowing out.

How the same average return can leave you broke

Add withdrawals and the symmetry collapses. Watch the same three returns — –30%, +10%, +20% — do very different things to two retirees who each start with $1,000,000 and withdraw $50,000 at the end of every year. Both face an arithmetic average return of 0%. The only difference is the order.

Retiree A — the bad sequence (the crash lands first):

• Year 1: $1,000,000 × 0.70 = $700,000, minus $50,000 = $650,000
• Year 2: $650,000 × 1.10 = $715,000, minus $50,000 = $665,000
• Year 3: $665,000 × 1.20 = $798,000, minus $50,000 = $748,000

Retiree B — the good sequence (the crash lands last):

• Year 1: $1,000,000 × 1.20 = $1,200,000, minus $50,000 = $1,150,000
• Year 2: $1,150,000 × 1.10 = $1,265,000, minus $50,000 = $1,215,000
• Year 3: $1,215,000 × 0.70 = $850,500, minus $50,000 = $800,500

Same average, same withdrawals, same three numbers — and after just three years the two portfolios sit $52,500 apart. Remember, with no withdrawals both paths land on exactly $924,000. Every dollar of that gap was manufactured by order alone.

What should you take from this chart? Not that a 0% average is realistic over a lifetime — it isn't. The point is the mechanics. Stretch this over a 30-year retirement, with a real crash of 40% or 50% instead of 30%, and the gap between the lucky and unlucky retiree becomes the difference between leaving an inheritance and asking your children for help. You cannot choose your sequence. You can only build a plan that survives a bad one.

The danger zone: the first years of withdrawals

If order is the engine, timing is the amplifier. Sequence risk concentrates almost entirely in the first five to ten years after you start drawing an income. In that window your portfolio is at its largest, so a percentage fall removes the most capital, and every withdrawal during the slump sells units you can never buy back at that price.

Put a number on it. A 30% fall on a $1,000,000 starting pot erases $300,000; the same 30% fall after the pot has already shrunk to $400,000 erases only $120,000. Early losses are larger in absolute terms, and they compound with the withdrawals you are still taking — which is why the opening decade carries most of the lifetime risk even when later years turn out to be far more turbulent.

The historical record makes this vivid. The canonical worst case is the retiree who stopped work in 1966 and ran straight into a decade of bear markets and high inflation.

Source: William Bengen, "Determining Withdrawal Rates Using Historical Data," Journal of Financial Planning, 1994. Recovery figure is an arithmetic identity.

Bengen's work — the origin of the famous 4% rule — found that the safe withdrawal rate swung wildly depending on the year you retired, from roughly 4.15% for the 1966 cohort to well over 10% for those who retired into the early-1980s bull market. Same portfolio, same discipline, same 30-year horizon; the start date did the damage. (A note on accuracy: the 1966 retiree is often said to have "gone broke," but Bengen's data shows the portfolio barely survived at around 4%. The lesson stands either way.)

Morningstar's retirement simulations point the same direction: the probability of depleting a portfolio rises sharply when poor returns cluster in the first five years rather than later. The order of the bad years, not their existence, is what ruins plans.

What is pound cost ravaging?

Pound cost ravaging is the retirement mirror image of pound cost averaging, and it is simply the UK name for sequence risk in action. When you drip money in during a falling market, each contribution buys more units — averaging works for you. When you pull a fixed income out during a falling market, each withdrawal sells more units to raise the same cash — averaging works against you, "ravaging" the pot.

The recovery arithmetic is unforgiving. A portfolio that falls 50% needs a 100% gain merely to get back to where it started, as we explain in detail in why a 50% loss needs a 100% gain to recover. For a saver, time usually delivers that recovery. For a retiree selling units every month through the slump, there is permanently less capital left to enjoy the bounce — so even a full market recovery may not rescue the plan.

How do you protect against sequence of returns risk?

You cannot dictate the order of returns, but you can stop a bad early run from forcing you to sell into weakness. Three levers do most of the work, and they stack:

1. Hold a cash buffer of two to three years of spending. Kept outside the portfolio and spent only after a serious fall, it lets you pause withdrawals from your investments while prices are depressed. Research by Early Retirement Now (Karsten Jeske, 2018) frames this as relatively inexpensive insurance against sequence risk.
2. Make your withdrawals flexible. "Guardrail" rules — most associated with Jonathan Guyton and William Klinger (2004–2006) — trim spending when markets fall and restore it when they recover. Giving up a holiday in a bad year can save the whole plan.
3. Get the asset mix right as you approach drawdown. Shifting toward bonds and cash in the years just before and after you retire shrinks the size of an early shock. A single diversified holding such as a single multi-asset fund can do this automatically through a glide path.

None of these promises a bigger average return. That is the point. They are about surviving the worst-case order so that your average return actually has time to show up in your account — which, in decumulation, is the only kind of return that pays your bills.

Treat the three levers as one system rather than a menu. The cash buffer buys time, flexible withdrawals buy breathing room, and the right asset mix shrinks the shock in the first place; used together they let a retiree ride out a bad opening decade without crystallising losses at the worst moment. The investor who plans for a poor sequence and never meets one simply retires with a surplus. The one who assumes a good sequence and meets a bad one may not get a second chance.

Frequently asked questions

Investing carries risk, including the loss of capital, and past performance does not predict future results. This article is educational content, not investment advice.