Understanding Sequence-of-Returns Risk in Early Retirement

Imagine two retirees with identical portfolios, identical withdrawal rates, and identical average returns over 25 years. Yet one runs out of money while the other dies wealthy. The difference? The order in which those returns occurred. This is sequence-of-returns risk, and it’s the most dangerous and least understood threat to retirement portfolios.

During your accumulation years, the sequence of returns doesn’t matter — only the average matters. A 10% loss followed by a 10% gain produces the same result as the reverse. But once you’re withdrawing from your portfolio, the math changes dramatically. Early losses compound with withdrawals to permanently reduce your portfolio’s recovery potential.

Consider a simple example: a $1 million portfolio with 5% annual withdrawals ($50,000/year). If the market drops 20% in year one, the portfolio falls to $750,000 after the withdrawal. Now it needs a 33% gain just to get back to the starting point — while you continue withdrawing. Three bad years at the start of retirement can create a deficit that 20 subsequent good years can’t overcome.

The “risk zone” is typically the five years before and five years after retirement. During this period, your portfolio is at its largest and most vulnerable to sequence risk. A severe downturn here has maximum impact because there’s the most money at stake and the longest withdrawal period ahead.

Mitigation strategies include maintaining a cash reserve covering 1-2 years of expenses (so you can avoid selling during downturns), reducing equity exposure as you approach retirement, and using a dynamic withdrawal strategy that adjusts spending based on portfolio performance. The bucket strategy, which segments assets by time horizon, is another effective approach.

Some retirees use annuities to guarantee a baseline income floor, removing the need to sell portfolio assets during market stress. Others employ a “rising equity glide path” — starting retirement with a lower equity allocation and gradually increasing it, which research suggests can actually outperform the traditional approach of reducing equity over time.

At Authentikos Advisory, sequence-of-returns risk is a central concern in our Risk & Returns pillar. We stress-test every retirement plan against historical worst-case scenarios, including the 2000-2002 dot-com crash, the 2008 financial crisis, and the 2020 pandemic selloff. The goal is to build a plan that sustains your lifestyle even if the worst happens in your first years of retirement.