Sequence of Returns Risk: What Retirees Must Know

By Brent Meyer — SafeMoney.com Founder & Editor Reviewed by Licensed Financial Professionals  |  SafeMoney.com — Trusted Since 2011  |  Updated Regularly Quick Answer: Sequence of returns risk can devastate a retirement portfolio even when long-term returns are positive. Learn what it is and how to protect your income from it. Quick Answer Sequence of returns risk is the danger that poor investment returns early in retirement permanently damage your portfolio — even if long-term average returns look fine. A retiree taking $4,000/month in withdrawals who experiences a 25% loss in year 1 depletes their portfolio far faster than one who experiences the same loss in year 10. The only guaranteed protection is income that doesn't require selling assets. Most people would be thrilled at the prospect of 10% average annual returns or higher in retirement. But now that folks are living longer , they face more challenges than just adequate returns. With decades of retired living on the horizon, people must ensure their portfolios last as long as they might need them. Sequence of returns risk can affect your long-term income the most in your early-retirement years. That is the timespan just before and right after you retire. You may have heard of that period called the “retirement red zone,” or generally the 10-year spread prior to and after retirement. It’s true that average returns (including dividends) for the S&P 500 from 1928 to 2021 have exceeded 10%. But averages can be deceiving for long-term income planning. What matters just as much is the order of returns, or the actual timing of when a portfolio grows or loses value. As we will see, losses in those early years could make or break your income goals, setting up the risk of running out of retirement money. This potential hazard is called sequence of returns risk, or just sequence risk. To illustrate it, we will talk about it in two formats: by analogy and then through two hypothetical portfolio scenarios. What is Sequence Risk? Imagine that you have two gardens. You plant identical vegetable seeds in each so that you can grow your own food. Early in the growing stage, Garden 1 experiences blight. Not all the vegetables make it. You still have a small crop, but each time you pull a vegetable to eat, you are leaving less and less behind to continue growing. By contrast, Garden 2 progresses and gives you a great first crop and seeds for your next planting. You keep planting, can