Sequence-of-returns risk
Also called sequence risk
The danger that poor investment returns early in retirement, while withdrawals are being taken, permanently shrink how long savings last.
What it means
Sequence-of-returns risk is the risk that the order of investment returns, not just their average, determines how a portfolio holds up once money is being withdrawn. During the saving years, the order of returns does not change the ending balance of a lump sum. Once withdrawals begin, losses in the early years force the sale of more shares at low prices, leaving less invested to benefit from any later recovery.
The risk is greatest in the years just before and after retirement, when balances are largest and withdrawals are starting. Common ways to manage it include holding a cash or bond reserve to draw on during downturns, reducing withdrawals after a bad year, delaying retirement or using guaranteed income to cover basic expenses.
Example
Suppose two retirees each start with $1,000,000, withdraw $50,000 at the start of every year and earn the same ten annual returns averaging 5%: losses of 15% and 10%, a 5% gain, then seven years of 10%. One gets the losses first and ends with about $771,000; the other gets the same returns in reverse order, losses last, and ends with about $1,025,000.
How it’s used
- Planning the years around a retirement date
- Deciding how much cash or bonds to keep as a buffer
- Understanding why average returns can mislead retirees
Good to know
- Retirement projections that show a range of outcomes, not a single average return, reveal this risk more clearly.
Related terms
Educational information only, not financial, tax or legal advice. Rules, limits and rates change; check the IRS, your lender or plan, or a qualified professional before acting.