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Ever heard the term "sequence of returns"? It might sound complex, but it's really just a way to describe the ups and downs in an investment portfolio's yearly returns. The big question, though, is how these fluctuations affect your portfolio's final value over time. And if you're planning for retirement, this is something you'll definitely want to understand.
Why Does the Sequence of Returns Matter?
Let's walk through a few different scenarios to illustrate how market swings can impact your investments—whether you're still building up your retirement savings or already withdrawing funds.
During the Accumulation Phase
If you're in the stage of life where you're saving and growing your investments, the sequence of returns tends to be less worrisome. A study by BlackRock looked at three investors who each started with $1 million in their portfolios. Over 25 years, each portfolio earned an average annual return of 7%.
Here's the catch: the returns for two of those portfolios fluctuated wildly, ranging from -7% to +22% each year. The third portfolio had a flat 7% return every year. Despite these differences, all three portfolios ended up with the same value—$5,434,372—after 25 years. Why? Because the average return was 7% across the board.
All three portfolios: $1,000,000 starting value → $5,434,372 after 25 years, no withdrawals taken.
The takeaway? During the accumulation phase, as long as you're in it for the long haul, the ups and downs can balance out. It's when you begin to take withdrawals that things get a little more complicated. However, working with a Cedar Rapids financial advisor can help ensure your portfolio aligns with your personal risk tolerance and goals.
What Happens When You Start Taking Withdrawals?
Here's where the story shifts, especially for those planning for retirement. Once you start pulling money out of your portfolio, the sequence of returns can have a much bigger impact. If the market takes a dip early on, it could throw off your entire retirement strategy.
When you're adding money to a portfolio, a down year just means you buy in at a lower price. But when you're taking money out, a down year means you're selling shares at a lower price to generate the same dollar amount — permanently reducing the number of shares left to recover when the market rebounds.
An Illustrative Example
Consider two hypothetical retirees, each starting retirement with $1,000,000 and withdrawing $50,000 per year, adjusted for inflation. Both portfolios average the exact same 7% annual return over 20 years. The only difference is the order the returns arrive in.
| Retiree | First 5 Years | Remaining 15 Years | Portfolio After 20 Years |
|---|---|---|---|
| Retiree A | Down years first (-10% avg) | Strong recovery (+14% avg) | Portfolio depleted early |
| Retiree B | Strong years first (+14% avg) | Down years later (-10% avg) | Substantial balance remains |
Simplified, hypothetical illustration for educational purposes only. Actual results depend on market performance, withdrawal amounts, fees, and taxes.
Same average return. Same withdrawal amount. Two very different outcomes — purely because of when the down years happened. That's the sequence of returns risk in action.
What's the Lesson Here?
Even if two portfolios have the same average return, early losses can make a huge difference if you're in the withdrawal phase. That's why understanding the sequence of returns can be crucial as you plan for retirement. Consulting with a financial professional can help you craft a distribution strategy that minimizes risk, especially during those early retirement years when the market may be volatile.
Ways to Help Protect Against Sequence of Returns Risk
- Keep a cash reserve of 1–2 years of expenses so you're not forced to sell investments during a downturn
- Use a bucket strategy that separates near-term income needs from long-term growth assets
- Reduce withdrawal amounts temporarily during down years if your plan allows for flexibility
- Layer in guaranteed income sources so market performance doesn't determine 100% of your spending
- Revisit your withdrawal strategy regularly rather than setting it once and leaving it unchanged
This risk is central to what happens if the market drops right as you retire — we cover it in more detail, including how to stress-test your own plan, in What Happens If the Market Drops Right When You Retire?
So if you're preparing for retirement in Cedar Rapids, consider working with a trusted financial professional at Iowa Retirement Benefits & Solutions who can help you navigate these challenges and keep your investment strategy on track.
Frequently Asked Questions
What exactly is "sequence of returns risk"?
It's the risk that the order in which your investment returns occur — not just their average — determines how long your portfolio lasts. Two portfolios can have identical average returns over 20 or 25 years, but if one experiences its worst years early in retirement while you're withdrawing money, it can run out far sooner than a portfolio that saw the same losses later on.
Why doesn't sequence of returns matter as much while I'm still working and saving?
During the accumulation phase, you're adding money rather than withdrawing it, so a down year simply means you're buying shares at a lower price — which can actually help your long-term average. There's no withdrawal locking in a loss. The risk shows up specifically once you start pulling income from the portfolio.
How many years of retirement are the riskiest for sequence of returns?
Generally, the first 5 to 10 years of retirement carry the most risk. This is often referred to as the "retirement red zone" — the window where a market downturn combined with ongoing withdrawals can do outsized, sometimes permanent, damage to a portfolio's longevity.
Can I eliminate sequence of returns risk entirely?
Not entirely — market timing isn't predictable, and no strategy removes risk completely. But the impact can be meaningfully reduced through steps like keeping a cash reserve for down years, using a bucket strategy, staying flexible with withdrawal amounts, and layering in guaranteed income sources so your spending isn't 100% dependent on portfolio performance.
Does sequence of returns risk affect Social Security or pension income too?
No. Guaranteed income sources like Social Security and traditional pensions aren't subject to market sequencing — they pay a set (or COLA-adjusted) amount regardless of what the market does. That's exactly why many retirement income strategies lean on guaranteed income to cover essential expenses, reserving market-based withdrawals for discretionary spending.
Protect Your Portfolio From Bad Timing
Let's build a withdrawal strategy that holds up whether the market's first few years of your retirement are kind — or not.
Schedule a Free Retirement Review →Investment advisory services are offered through Fusion Capital Management, an SEC registered investment advisor. The firm only transacts business in states where it is properly registered or is excluded or exempted from registration requirements. SEC registration is not an endorsement of the firm by the commission and does not mean that the advisor has attained a specific level of skill or ability. All investment strategies have the potential for profit or loss.
