Sequence of Returns Risk: The Hidden Threat to Your Retirement Income
What Is Sequence of Returns Risk?
Knowledgeable investors know that investing in the capital markets comes with a number of risks — interest rate risk, company risk, and market risk among them. Risk is simply the price of admission for long-term growth, and some of these risks can be reduced through diversification.¹
But there’s another, lesser-known risk that the market doesn’t compensate you for, and that diversification alone can’t solve. It may be one of the biggest threats to the sustainability of your retirement income.
This is sequence of returns risk.
Sequence of returns risk refers to the uncertainty around the order in which an investor receives returns over an extended period of time. As Milton Friedman once put it, you should “never try to walk across a river just because it has an average depth of four feet.”²
How Sequence of Returns Risk Works
Friedman’s point was that averages can hide dangerous possibilities — and this is especially true in the stock market.
You may feel confident the market will deliver its historical average return over the long run. But you can never know when you’ll receive the positive years and the negative years that make up that average. The order in which those returns arrive can make a significant difference to your outcome.
Here’s a simple way to think about it:
- A hypothetical 30% market decline isn’t unusual over a long investing timeline.
- Would you rather experience that decline early on, when your retirement savings are relatively small — or right as you’re about to retire, when your savings are likely at their highest value?
Most people would clearly prefer the first scenario. Unfortunately, the timing of a major decline is completely out of your control.
Why Sequence Risk Is Especially Dangerous in Retirement
Sequence of returns risk in retirement is particularly problematic because of one added factor: withdrawals.
During retirement, you’re no longer just riding out market ups and downs — you’re also withdrawing money from your portfolio to cover living expenses. When a down market year combines with ongoing withdrawals, it can seriously damage your portfolio’s ability to recover, even after the broader market fully rebounds.
In other words, investment sequence risk doesn’t just affect your portfolio’s returns — it can permanently reduce how long your money lasts.
Managing Retirement Sequence Risk
If you’re nearing retirement or already retired, it’s worth taking sequence risk in retirement seriously and asking questions about how to better manage your portfolio around it — including how your withdrawal strategy, asset allocation, and timing of retirement can all play a role.
If you’re planning for retirement in Fort Myers, Florida or elsewhere, working with a fee-only fiduciary advisor can help you build a withdrawal and investment strategy designed with sequence of returns risk in mind, rather than relying on long-term averages alone.
Frequently Asked Questions
What is sequence of returns risk?
Sequence of returns risk is the risk that the order in which you receive investment returns — rather than just the average return itself — negatively affects your retirement savings, especially when withdrawals are involved.
Why is sequence of returns risk important in retirement?
During retirement, portfolio withdrawals combined with a down market can significantly damage your savings’ ability to recover, even if the market later rebounds. This makes timing far more important in retirement than during the accumulation years.
Can diversification protect against sequence of returns risk?
Diversification can help manage certain investment risks, but it does not eliminate the risk of loss, and it does not specifically protect against sequence of returns risk, since that risk is tied to the timing of returns rather than the types of investments held.
How does sequence risk affect someone still saving for retirement?
Investors still in the accumulation phase generally have more time to recover from a market downturn, since they aren’t yet withdrawing from their portfolio. This is why a decline earlier in your investing timeline is generally preferable to one right as you retire.
What can retirees do to help manage sequence of returns risk?
Retirees and near-retirees should discuss their withdrawal strategy and portfolio structure with a financial professional, since factors like withdrawal rate, asset allocation, and timing of retirement can all influence how sequence risk affects their savings.
- Diversification is an approach to help manage investment risk. It does not eliminate the risk of loss if security prices decline.
- Quotefancy.com, 2021
This material is developed from sources believed to be providing accurate information. It is not intended as tax or legal advice and may not be used to avoid federal tax penalties. Please consult a legal or tax professional regarding your individual situation. The opinions expressed are for general information only and should not be considered a solicitation for the purchase or sale of any security.
