Sequence of Returns Risk -- The Retirement Danger Nobody Talks About

Let me tell you about two people. Both of them retired at 65 with $500,000 in savings. Both of them withdrew $30,000 a year to cover their expenses. And over 20 years, both of their investments averaged 7% annual returns.

Same starting point. Same withdrawal amount. Same average return. But one of them ran out of money at age 81. The other still had over $600,000 left at 85.

How is that possible?

The answer is something called sequence of returns risk. And it's one of the biggest threats to your retirement that almost nobody talks about.

It's Not About Average Returns

Here's the thing most people get wrong about investing in retirement: they focus on the average. "My advisor says I can expect 7% average returns." Great. But that average can play out in very different ways.

Let me use a simple example. Say you get these returns over five years: +20%, +15%, -10%, +5%, +5%. That averages out to 7% per year. Not bad.

Now flip the order: +5%, +5%, -10%, +15%, +20%. Same five numbers. Same 7% average. But the outcome for someone withdrawing money is dramatically different.

Why? Because when you're taking money out of your account every year, the order matters. A lot.

Why the Early Years Matter Most

When you're saving for retirement -- what the industry calls the "accumulation phase" -- a bad year early on isn't a big deal. You have decades to recover. Your portfolio is small, the loss is small in dollar terms, and you're still adding money every paycheck.

But once you retire and start withdrawing money, the math changes completely.

Let's say you retire with $500,000 and the market drops 30% in your first year. Your account falls to $350,000. Now you withdraw $30,000 for living expenses. You're down to $320,000. That's a 36% reduction from where you started -- in one year.

Now your portfolio needs to grow about 56% just to get back to $500,000. And you're still pulling $30,000 a year out while you wait for that recovery. You can see how fast this spiral gets ugly.

On the other hand, if you get good returns in those first few years of retirement and the bad years come later, your portfolio has had time to grow. The base is bigger, so the losses are more manageable. Same average return, completely different outcome.

A Tale of Two Retirees

Let me paint this picture more clearly.

Retiree A retires in a year where the market happens to crash. In the first three years, their returns are -15%, -10%, and +5%. They're withdrawing $30,000 a year the whole time. By the end of year 3, their $500,000 has dropped to around $340,000 -- even though year 3 was positive. The hole is already deep.

Now the market recovers and they get great returns for the next several years. But it doesn't matter enough. They started withdrawing from a shrinking base, and they never fully recover. By their early 80s, the money is gone.

Retiree B retires in a strong market. Their first three years are +15%, +10%, and +5%. They're also withdrawing $30,000 a year. By the end of year 3, they're sitting on around $580,000. When the bad years come later, they have a much bigger cushion to absorb the losses.

Same average returns over 20 years. Same withdrawal amount. Completely different retirement. One person is fine. The other is broke.

That's sequence of returns risk in a nutshell.

Why This Is Scarier Than a Market Crash

A market crash by itself isn't the end of the world -- if you're not pulling money out. During the 2008 financial crisis, people who stayed invested and didn't touch their accounts eventually recovered. Many of them came out ahead within a few years.

But the people who were already retired and withdrawing from those accounts? They got hit twice. Once by the market drop, and again by their own withdrawals chipping away at the reduced balance. That double hit is what makes sequence risk so dangerous.

And here's the kicker: you can't predict it. Nobody can tell you whether the market will crash in your first year of retirement or your fifteenth. It's pure luck. And building your entire retirement plan around luck is not a plan at all.

What You Can Do About It

The good news is that you're not powerless here. There are real strategies to protect yourself. Let me walk through a few.

Build a Guaranteed Income Floor

This is the approach I focus on with most of my clients. The idea is simple: make sure your basic expenses are covered by income sources that don't depend on the market. Social Security is one piece. A pension if you have one. And an annuity with a guaranteed income rider can fill the gap.

If your monthly bills are covered no matter what the market does, you don't have to sell investments at the worst possible time. That's the whole point.

Use a Bucket Strategy

The bucket approach splits your money into three groups based on when you need it:

• Bucket 1 (1-3 years): Cash, CDs, money market. This covers your near-term expenses no matter what the market does.
• Bucket 2 (4-7 years): Conservative investments. Fixed annuities, bonds, things that are stable but grow a little.
• Bucket 3 (8+ years): Growth investments. This money has time to ride out downturns because you won't need it for years.

When the market drops, you pull from Bucket 1 and leave Bucket 3 alone to recover. You're not forced to sell at a loss.

Be Flexible With Withdrawals

If you can reduce your withdrawals during a down market -- even temporarily -- it makes a huge difference. Taking out $25,000 instead of $30,000 for a couple of years while the market recovers can add years to the life of your portfolio.

This only works if you have flexibility, though. Which goes back to having guaranteed income covering your essentials, so the market-dependent money is truly optional.

Consider Delaying Retirement (If You Can)

I know this isn't what anyone wants to hear. But if the market just tanked and you're on the edge of retiring, waiting even one or two years can make a significant difference. It gives your portfolio time to recover without the drag of withdrawals, and it means one or two more years of contributions and growth.

This Is Why I Focus on Guarantees

I'm not anti-market. I think equities have a place in most people's long-term plans. But when it comes to the money you need to live on in retirement, I believe in guarantees. Not because the market is bad, but because you can't control when the bad years show up.

Sequence of returns risk is real. It has ruined real retirements for real people. And the solution isn't hoping it doesn't happen to you -- it's building a plan that works regardless of what the market does in your first few years.

You can't control the market. But you can control how much of your retirement depends on it.