Sequence of Returns Risk: Why When You Retire Matters More Than How Much

Sequence of Returns Risk: Why When You Retire Matters More Than How Much

Most people spend decades obsessing over a single number — the magic portfolio size that will let them retire comfortably. Hit that number, and you’re done. Safe. Free. But there’s a problem with this framing that financial textbooks often gloss over, and it has derailed more retirement plans than any market crash or savings shortfall ever could. It’s called sequence of returns risk, and once you understand it, you’ll never look at your retirement date the same way again.

I was surprised by some of these findings when I first dug into the research.

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Here’s the brutal truth: two people can retire with identical portfolio sizes, experience identical average market returns over their retirement, and end up in completely different financial situations — one running out of money in their seventies, the other dying with a surplus. The only difference? When the bad years hit relative to when they stopped working.

What Sequence of Returns Risk Actually Means

Let’s strip away the jargon. Sequence of returns risk refers to the danger that the timing of investment losses — not just their magnitude — can permanently damage your retirement portfolio. This risk is almost nonexistent during your accumulation years, when you’re still working and contributing to your investments. But the moment you flip into withdrawal mode, everything changes.

During accumulation, a market crash in year three of your career is actually a gift. You’re buying more shares at lower prices, and you have decades for the market to recover. But if that same crash happens in year three of your retirement, when you’re selling shares to fund your living expenses? You’re locking in losses at the worst possible time. You’re selling more shares than you would have at higher prices, which means fewer shares left to benefit from the eventual recovery.

This is what mathematicians call a “path-dependent” outcome. The sequence, the order, the specific path of returns matters enormously — not just the average. Kitces and Pfau (2015) demonstrated that retirees who experience poor returns in the first decade of retirement face dramatically higher portfolio failure rates compared to those who experience the same average returns but with strong early years, even when the math would suggest identical long-term outcomes.

A Tale of Two Retirees

Let me make this concrete, because abstract risk is easy to dismiss. Imagine two people, both retiring at 65 with $1,000,000, both withdrawing $50,000 per year, and both experiencing average annual returns of 7% over a 30-year retirement. Sounds identical, right?

Now change one thing: the first person retires in 1969, right before a brutal bear market and inflationary period. The second retires in 1982, right at the beginning of one of the greatest bull markets in history. Same average returns. Completely different sequence. The first retiree runs out of money before turning 85. The second ends up with more money at 95 than they started with.

This isn’t a hypothetical constructed to scare you. It’s based on historical data. Bengen (1994), whose research gave us the famous “4% rule,” identified that the sequence of early retirement returns was the single most important variable in determining whether a portfolio survived 30 years. It wasn’t the average return. It wasn’t the withdrawal rate alone. It was the order in which those returns arrived.

Why Knowledge Workers Are Particularly Vulnerable

If you’re a knowledge worker between 25 and 45, you might be thinking this is a problem for people much older than you. And you’d be partially right — the acute danger zone is roughly the five years before and ten years after retirement, what some researchers call the “retirement red zone.” But understanding this risk now matters for reasons that are very specific to your situation.

First, knowledge workers tend to have high human capital concentrated in a specific industry. A software engineer, a lawyer, a data analyst — your income is valuable, but it’s not diversified. If a sector-wide downturn hits your industry at the same time a market crash occurs, you might face involuntary early retirement (layoffs, burnout, health issues) right when markets are at their lowest. This is exactly the worst-case scenario for sequence risk.

Second, many knowledge workers in their 30s and 40s are now engaging seriously with FIRE (Financial Independence, Retire Early) planning. The shorter your planned retirement horizon, the more compressed your withdrawal period, and the more catastrophic a bad early sequence becomes. Someone planning to retire at 45 has potentially 50 years of withdrawals ahead of them. That’s a very long time for sequence risk to express itself.

Third, your portfolio is likely heavily weighted toward equities — which is entirely appropriate at your age — but it means you’re building up exposure to the very asset class that creates sequence risk in the first place. Knowing this now lets you build a transition strategy rather than improvising one at 58.

The Mathematics Nobody Talks About

Standard retirement planning uses something called the Monte Carlo simulation — thousands of randomized return sequences run against your portfolio to calculate a probability of success. This is genuinely useful. But here’s what gets lost in the presentation: when a Monte Carlo simulation tells you that you have an 85% probability of success, it’s also telling you that 15% of possible sequences would leave you broke. And those failure scenarios are not randomly distributed throughout the retirement period. They cluster in the early years.

The reason is mathematical and unforgiving. When you withdraw money from a declining portfolio, you’re not just losing paper value — you’re reducing the base that future gains will be calculated on. A 50% loss requires a 100% gain to recover. But if you’ve also withdrawn 5% of your portfolio during that down period, the math becomes even more brutal. Your remaining portfolio needs even larger gains to compensate, and you have fewer assets to benefit from those gains.

Pfau (2012) formalized this through what he calls “withdrawal rate efficiency,” showing that the sequence of returns has an asymmetric impact: a bad early sequence is far more damaging than a late bad sequence is helpful. In other words, you can’t average your way out of this problem. A terrible first decade followed by excellent years is categorically different from excellent years followed by a terrible last decade, even with identical averages.

Practical Strategies That Actually Work

Build a Cash Buffer Before You Retire

One of the most evidence-supported strategies is maintaining one to three years of living expenses in cash or short-term bonds before you retire. This creates a buffer that allows you to avoid selling equities during a market downturn. Instead of liquidating shares at depressed prices, you draw from the cash buffer and wait for recovery. It costs you some return during accumulation, but it can be the difference between a failed retirement and a successful one.

This approach, sometimes called a “bucket strategy,” has been studied extensively. The psychological benefits are also real — knowing you have two years of expenses in cash makes it dramatically easier to hold equities during a crash rather than panic-selling at the bottom.

Consider a Flexible Withdrawal Rate

The 4% rule is a starting point, not a gospel. It was derived from historical U.S. market data over specific periods, and Bengen (1994) himself noted it as a conservative floor rather than a rigid prescription. A more resilient approach involves building flexibility into your withdrawal rate — reducing withdrawals by 10-15% during down market years and allowing yourself to spend slightly more during strong years.

This sounds simple, but it requires something psychologically difficult: accepting that your retirement income will fluctuate. For people accustomed to a salary, this can feel deeply uncomfortable. But the alternative — rigid withdrawals regardless of market conditions — is precisely the behavior that turns a temporary market downturn into a permanent portfolio impairment.

Think Carefully About When You Retire, Not Just Whether You Can

This is the most underappreciated lever you have. If you hit your “number” during a period of elevated market valuations, you face a higher risk of sequence problems because a reversion to mean is statistically more likely in the near term. Conversely, retiring after a significant market correction — when valuations are depressed — gives you a better starting sequence even if your portfolio is temporarily smaller.

Shiller’s cyclically adjusted price-to-earnings ratio (CAPE) has been used by researchers including Pfau (2012) as a predictor of retirement success rates. High CAPE values at retirement correlate with higher sequence risk, not because the long-run average return necessarily differs, but because the timing of drawdowns tends to shift earlier in the retirement period when starting valuations are elevated.

This doesn’t mean you should time the market or wait for a crash to retire. But it does mean that having flexibility around your retirement date — even a one or two year window — can meaningfully improve your outcomes.

The Role of Part-Time Work in the Early Retirement Years

One of the most powerful and underused tools against sequence risk is continuing some form of income in the first five to ten years of retirement, even at a fraction of your previous salary. Scott, Watson, and Hu (2011) showed that even modest supplemental income during the early retirement years can dramatically reduce sequence risk by lowering the withdrawal rate during the most vulnerable period.

For knowledge workers, this is particularly realistic. Consulting, part-time work in your field, teaching, or even a low-stress side project can generate $20,000–$40,000 annually — enough to reduce or eliminate equity withdrawals in bad years. This one strategy can functionally eliminate most catastrophic sequence risk scenarios while maintaining a sense of purpose and connection to your professional identity.

What This Means for Your Planning Right Now

If you’re in your 30s or early 40s, sequence of returns risk might feel like a distant problem. But the decisions you make now about portfolio construction, target retirement date flexibility, and income diversification will determine your exposure to this risk when it becomes acute. The knowledge that timing matters — not just magnitude — should shift how you think about several things.

Stop anchoring purely to a portfolio number. A $2 million portfolio is not equally safe at all times and under all conditions. Its safety depends on market valuations at the moment you retire, your withdrawal rate, and your ability to be flexible in those early years. A smaller portfolio retired into a depressed market with flexible spending can outperform a larger one retired at a market peak with rigid spending.

Build optionality into your retirement plan. This means having skills that allow for part-time work, maintaining lower fixed expenses so withdrawal rates stay manageable, and thinking about your retirement date as a range rather than a specific target. Knowledge workers have a natural advantage here — your skills remain valuable for longer, and the knowledge economy offers more opportunities for flexible, high-value work than most sectors.

Understand the difference between average returns and experienced returns. When a financial model shows you a projected 7% annual return, that number is an average. Your actual experience will be a specific sequence that deviates from that average in ways that matter enormously depending on when you’re withdrawing. Don’t let smooth projected lines in a retirement calculator give you false confidence about the texture of what you’ll actually live through.

The Honest Reality

Sequence of returns risk is one of those concepts that feels academic until it isn’t. Until you watch your portfolio drop 35% in the first two years of retirement and realize that every withdrawal you’re making is locking in losses and shrinking the base that needs to recover. At that point, it stops being a theoretical concern and becomes a very practical problem with very real consequences.

The people who work through retirement successfully aren’t necessarily the ones who saved the most or picked the best funds. They’re often the ones who understood that timing — the sequence, the path, the order of events — shapes outcomes in ways that the averages can’t reveal. They built buffers, maintained flexibility, kept some income flowing in the early years, and didn’t let a fixed number or a fixed date substitute for genuine financial resilience.

You have time to build that resilience. The fact that you’re thinking about sequence risk now, decades before it becomes your immediate reality, puts you in a genuinely advantageous position. Use that time not just to accumulate more, but to build the structural flexibility that will let the when of your retirement work in your favor rather than against you.

Last updated: 2026-03-31

Sources

Bengen, W. P. (1994). Determining withdrawal rates using historical data. Journal of Financial Planning, 7(4), 171–180.

Kitces, M., & Pfau, W. D. (2015). Retirement risk, rising equity glidepaths, and valuation-based asset allocation. Journal of Financial Planning, 28(3), 38–48.

Pfau, W. D. (2012). Capital market expectations, asset allocation, and safe withdrawal rates. Journal of Financial Planning, 25(1), 36–43.

Scott, J. S., Watson, J. G., & Hu, W. Y. (2011). What makes a better annuity? Journal of Risk and Insurance, 78(1), 213–244.

I believe this deserves more attention than it gets.

Ever noticed this pattern in your own life?

References

• Capital Group (2026). Is sequence-of-returns risk really sequence-of-withdrawals risk? Link
• Retirement Researcher. Why Sequence of Return Risk Matters for Your Retirement Income. Link
• Charles Schwab (n.d.). What Is Sequence-of-Returns Risk? Link
• J.P. Morgan Asset Management (n.d.). How to avoid dollar-cost ravaging in retirement. Link
• Lucia Capital Group (n.d.). Sequence-of-Returns Risk: Will You Retire at the Wrong Time? Link
• Gainbridge (n.d.). Sequence of Returns Risk: How To Manage It for Retirement. Link

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