What Is Sequence of Returns Risk?
Sequence of returns risk is the danger that the order of investment returns, particularly poor returns early in retirement, can permanently damage portfolio longevity even if average returns are acceptable over time.
Key Characteristics
- Order of returns matters when withdrawing from portfolios
- Early losses are more damaging than later losses
- Cannot be diversified away
- Highest risk in years around retirement
- Requires strategic planning to mitigate
Key Takeaways: Sequence of Returns Risk
- 1.Order of returns matters when withdrawing from portfolios
- 2.Early losses are more damaging than later losses
- 3.Cannot be diversified away
- 4.Highest risk in years around retirement
- 5.Consult a fiduciary financial advisor to understand how sequence of returns risk applies to your specific financial plan.
Detailed Explanation
Sequence of returns risk is one of the most significant risks facing retirees. While working and accumulating wealth, the order of returns doesn't matter, only the average. But when you're withdrawing money, early losses combined with withdrawals can deplete a portfolio to a point where it never recovers, even if markets subsequently perform well.
This risk is highest in the years immediately before and after retirement, often called the "retirement red zone." A 30% market decline at the start of retirement is far more damaging than the same decline 15 years into retirement.
Strategies to mitigate this risk include maintaining a cash buffer, using a bucket strategy, employing dynamic withdrawal strategies, and potentially delaying retirement during market downturns.
Sequence of Returns Risk: Quick Reference
| Aspect | Detail |
|---|---|
| Definition | Sequence of returns risk is the danger that the order of investment returns, particularly poor returns early in retirement, can permanently damage portfolio longevity even if average returns are acceptable over time. |
| Category | Retirement |
| Key Feature 1 | Order of returns matters when withdrawing from portfolios |
| Key Feature 2 | Early losses are more damaging than later losses |
| Key Feature 3 | Cannot be diversified away |
| Related Service | Professional Guidance Available |
Source: SWE90 Fiduciary Advisory Team, SEC, IRS, CFP Board
Example Scenario
Two retirees both average 7% returns over 30 years but in opposite order. One experiences poor returns early (while withdrawing), the other late. Despite identical average returns, the first retiree runs out of money while the second has a large surplus.
Why It Matters
Sequence risk can mean the difference between a comfortable retirement and running out of money. Understanding this risk helps you plan appropriately and avoid the devastating impact of early retirement losses.
"Understanding sequence of returns risk is one of the building blocks of financial literacy. I advise all my clients to learn this concept thoroughly; it directly impacts how you build, protect, and transfer wealth."
Brett R. Henderson, CIMA, CPFA, CRPS
Fiduciary Financial Advisor, SWE90
786+
Pages of financial education
Source: SWE90
150+
Financial terms defined
Source: SWE90 Knowledgebase
3%+
Potential "Advisor Alpha" value attributed to behavioral coaching, tax-efficient withdrawals, asset location, and rebalancing in a third-party industry study (hypothetical industry-wide estimate; not a SWE90 performance result, expected return, or guarantee)
Source: Vanguard, Putting a value on your value: Quantifying Vanguard Advisor's Alpha (Kinniry et al.), latest update
The Bottom Line
Understanding sequence of returns risk is essential for making informed financial decisions. Sequence of returns risk is the danger that the order of investment returns, particularly poor returns early in retirement, can permanently damage portfolio longevity even if average returns are acceptable over time. A fiduciary financial advisor can help you evaluate how this concept applies to your specific situation and integrate it into a comprehensive financial plan.
Brett R. Henderson, CIMA, CPFA, CRPS, Fiduciary Financial Advisor, SWE90
Frequently Asked Questions
How can I protect against sequence of returns risk?
Strategies include maintaining 2-3 years of expenses in cash/bonds, using dynamic withdrawal strategies, delaying Social Security, and potentially working part-time early in retirement.
Does asset allocation help with sequence risk?
Partially. A more conservative allocation reduces volatility but may not provide enough growth. The bucket strategy attempts to address both needs.
Should I delay retirement if markets are down?
If possible, even a 1-2 year delay can significantly improve outcomes by avoiding early withdrawals during a downturn and allowing time for recovery.
Need Help Understanding Sequence of Returns Risk?
Our fiduciary advisors can help you understand how this concept applies to your specific financial situation.