Sequence of Returns Risk
Why the ORDER of Your Returns Matters More Than the Average
Two investors can have the exact same average return but end up with vastly different outcomes. Learn why timing matters and how to protect yourself from this hidden retirement risk.
The Hidden Danger in Retirement
Experiencing negative returns early in retirement can devastate your portfolio—
even if your average return looks great on paper!
The Tale of Two Retirees
Meet Sarah and Michael. Both retire at 65 with $1,000,000. Both withdraw $50,000 per year. Both experience the exact same returns—just in different order. Watch what happens...
Sarah: Good Returns First
Started retirement during a bull market
$1,000,000 starting portfolio
How to read: Each year shows the return earned, balance after growth, annual withdrawal, and final balance after withdrawal.
| YEAR | RETURN | BALANCE AFTER GROWTH |
WITHDRAWAL | ENDING BALANCE |
|---|---|---|---|---|
| Start | — | — | — | $1,000,000 |
| 1 | +20% | $1,200,000 | $50,000 | $1,150,000 |
| 2 | +15% | $1,322,500 | $50,000 | $1,272,500 |
| 3 | +10% | $1,399,750 | $50,000 | $1,349,750 |
| 4 | +5% | $1,417,238 | $50,000 | $1,367,238 |
| 5 | 0% | $1,367,238 | $50,000 | $1,317,238 |
| 6 | -10% | $1,185,514 | $50,000 | $1,135,514 |
| 7 | -15% | $965,187 | $50,000 | $915,187 |
| 8 | -20% | $732,150 | $50,000 | $682,150 |
| End | Avg: +1.9% | — | $400,000 | $682,150 |
Result: Despite market downturns later, Sarah's portfolio still has $682,150 after 8 years of withdrawals because strong early returns gave her portfolio room to breathe.
Michael: Bad Returns First
Started retirement during a bear market
$1,000,000 starting portfolio
How to read: Each year shows the return earned, balance after growth, annual withdrawal, and final balance after withdrawal.
| YEAR | RETURN | BALANCE AFTER GROWTH |
WITHDRAWAL | ENDING BALANCE |
|---|---|---|---|---|
| Start | — | — | — | $1,000,000 |
| 1 | -20% | $800,000 | $50,000 | $750,000 |
| 2 | -15% | $637,500 | $50,000 | $587,500 |
| 3 | -10% | $528,750 | $50,000 | $478,750 |
| 4 | 0% | $478,750 | $50,000 | $428,750 |
| 5 | +5% | $450,188 | $50,000 | $400,188 |
| 6 | +10% | $440,206 | $50,000 | $390,206 |
| 7 | +15% | $448,737 | $50,000 | $398,737 |
| 8 | +20% | $478,484 | $50,000 | $428,484 |
| End | Avg: +1.9% | — | $400,000 | $428,484 |
Result: Michael's portfolio has only $428,484 after 8 years—despite having the exact same returns as Sarah! Early losses forced him to sell more shares when prices were low.
The Shocking Difference
This is sequence of returns risk: The order of returns matters more than the average when you're taking withdrawals from your portfolio.
A 20-Year Real-World Scenario
Meet Bob and Ted. Both start with $500,000 and experience the exact same 121% return over 20 years. But Ted retires early and faces a brutal market crash in his first three years. The timing of those early losses changes everything...
Bob: Favorable Sequence
44% gain in first 3 years
$25,000 annual withdrawals
How to read: Each year shows the return earned, balance after growth, annual withdrawal, and final balance after withdrawal.
| YR | RETURN | BALANCE AFTER GROWTH |
WITHDRAWAL | ENDING BALANCE |
|---|---|---|---|---|
| 0 | — | — | — | $500,000 |
| 1 | +29% | $645,000 | $25,000 | $620,000 |
| 2 | -6% | $582,800 | $25,000 | $557,800 |
| 3 | +19% | $663,782 | $25,000 | $638,782 |
| 4 | +10% | $702,660 | $25,000 | $677,660 |
| 5 | -1% | $670,883 | $25,000 | $645,883 |
| 6 | +11% | $716,930 | $25,000 | $691,930 |
| 7 | +30% | $899,509 | $25,000 | $874,509 |
| 8 | +13% | $988,195 | $25,000 | $963,195 |
| 9 | 0% | $963,195 | $25,000 | $938,195 |
| 10 | +13% | $1,060,160 | $25,000 | $1,035,160 |
| 11 | +23% | $1,273,247 | $25,000 | $1,248,247 |
| 12 | -38% | $773,913 | $25,000 | $748,913 |
| 13 | +4% | $778,869 | $25,000 | $753,869 |
| 14 | +14% | $859,410 | $25,000 | $834,410 |
| 15 | +3% | $859,442 | $25,000 | $834,442 |
| 16 | +9% | $909,542 | $25,000 | $884,542 |
| 17 | +26% | $1,114,523 | $25,000 | $1,089,523 |
| 18 | -23% | $838,933 | $25,000 | $813,933 |
| 19 | -13% | $708,122 | $25,000 | $683,122 |
| 20 | -10% | $614,810 | $25,000 | $589,810 |
| End | 121% | — | $500,000 | $589,810 |
Result: Bob ends with $589,810 after withdrawing $500,000 over 20 years. Early gains gave him breathing room for later volatility.
Ted: Unfavorable Sequence
40% loss in first 3 years
$25,000 annual withdrawals
How to read: Each year shows the return earned, balance after growth, annual withdrawal, and final balance after withdrawal.
| YR | RETURN | BALANCE AFTER GROWTH |
WITHDRAWAL | ENDING BALANCE |
|---|---|---|---|---|
| 0 | — | — | — | $500,000 |
| 1 | -10% | $450,000 | $25,000 | $425,000 |
| 2 | -13% | $369,750 | $25,000 | $344,750 |
| 3 | -23% | $265,458 | $25,000 | $240,458 |
| 4 | +26% | $302,977 | $25,000 | $277,977 |
| 5 | +9% | $302,995 | $25,000 | $277,995 |
| 6 | +3% | $286,335 | $25,000 | $261,335 |
| 7 | +14% | $297,922 | $25,000 | $272,922 |
| 8 | +4% | $283,839 | $25,000 | $258,839 |
| 9 | -38% | $160,480 | $25,000 | $135,480 |
| 10 | +23% | $166,640 | $25,000 | $141,640 |
| 11 | +13% | $160,053 | $25,000 | $135,053 |
| 12 | 0% | $135,053 | $25,000 | $110,053 |
| 13 | +13% | $124,360 | $25,000 | $99,360 |
| 14 | +30% | $129,168 | $25,000 | $104,168 |
| 15 | +11% | $115,626 | $25,000 | $90,626 |
| 16 | -1% | $89,720 | $25,000 | $64,720 |
| 17 | +10% | $71,192 | $25,000 | $46,192 |
| 18 | +19% | $54,968 | $25,000 | $29,968 |
| 19 | -6% | $28,170 | $28,170 | $0 |
| 20 | +29% | $0 | $0 | $0 |
| End | 121% | — | $478,170 | $0 |
Disaster: Ted runs completely out of money in year 19! Early losses devastated his portfolio beyond recovery—despite having the same 121% total return as Bob.
The Catastrophic Reality
This is the TRUE danger of sequence of returns risk: Early market crashes combined with withdrawals can completely destroy a retirement portfolio—even if the market eventually recovers with excellent long-term returns!
Why Does This Happen?
Dollar-Cost Averaging in Reverse
When you withdraw money during market downturns, you're forced to sell more shares at depressed prices. This is the opposite of dollar-cost averaging—and it permanently removes those shares from your portfolio, so they can't recover when the market rebounds.
Compound Losses Hurt More
A 20% loss on a $1 million portfolio leaves you with $800,000. Now you need a 25% gain just to get back to even. But if you're also withdrawing $50,000 for living expenses, you need even higher returns—which may never come soon enough.
Smaller Base = Less Recovery
When Michael's portfolio dropped to $478,750 in year 3, subsequent gains were applied to a much smaller base. Even a 20% gain in year 8 only added about $57,000. Meanwhile, Sarah's portfolio was much larger, so her losses were absorbed more easily.
When Are You Most Vulnerable?
The Retirement Red Zone
The 5 years before and 10 years after retirement are the most critical. A market crash during this window can permanently damage your retirement plans.
- • Ages 60-75 are highest risk
- • Portfolio is at its largest size
- • Beginning to take withdrawals
- • Less time to recover from losses
During Accumulation Phase
Interestingly, sequence risk works in your favor when you're saving money. Market downturns early in your career can actually help you!
- • Buy more shares at lower prices
- • Dollar-cost averaging works for you
- • More time for recovery
- • Strong later returns boost final value
How to Protect Yourself from Sequence Risk
The best defense against sequence of returns risk is using financial vehicles that provide downside protection while still allowing participation in market growth. Learn more about down market protection strategies.
Fixed Indexed Annuities
For Retirement Income Protection
Zero Floor Protection: Your principal is protected from market losses—you can never lose money due to market downturns.
Index-Linked Growth: Participate in market gains (typically with caps or participation rates) without the downside risk.
Guaranteed Lifetime Income: Convert your accumulation into a pension-like income stream that you can't outlive.
Lock in Gains: Many FIAs reset annually—locking in your gains and raising your floor each year.
Perfect for: Pre-retirees and retirees who need predictable income and can't afford to lose principal to early market crashes during the retirement red zone.
Indexed Universal Life
For Accumulation & Tax-Free Income
Downside Protection: Cash value never decreases due to market losses—0% floor protection keeps your money safe.
Tax-Free Growth: Cash value grows tax-deferred, and you can access it tax-free through policy loans in retirement.
Flexible Income: Take withdrawals when you need them without forced distributions—perfect for managing sequence risk.
Death Benefit Protection: Guarantees your family receives a benefit even if markets crash early in retirement.
Perfect for: Pre-retirees building wealth who want market participation without sequence risk during accumulation years.
Complementary Strategies
Cash Reserve Bucket
Keep 2-3 years of expenses in safe, liquid accounts to avoid selling during downturns.
Dynamic Withdrawals
Adjust spending based on portfolio performance—reduce withdrawals during market declines.
Glide Path Strategy
Gradually de-risk your portfolio as you approach the retirement red zone (ages 60-75).
Why IUL and FIA Are Ideal for Sequence Risk Protection
Remember Ted from our example? He lost everything because early market losses forced him to sell shares at depressed prices. With FIA or IUL, Ted's story would have ended very differently:
- No forced selling: When markets crash, your floor protection means you never realize losses.
- Gains are locked in: Good years permanently raise your account value—bad years can't erase them.
- Predictable income: You can plan retirement spending without fear of running out due to market timing.
Key Takeaways
Average returns don't tell the whole story. Two portfolios with identical average returns can have dramatically different outcomes based on the order of returns.
Withdrawals amplify sequence risk. When you're taking money out of your portfolio, bad returns early on can be devastating—even if good returns come later.
The retirement red zone is critical. The 5 years before and 10 years after retirement are when you're most vulnerable to sequence risk.
Protection is possible with the right strategies. Fixed Indexed Annuities and Indexed Universal Life insurance provide floor protection that prevents losses during market downturns—eliminating the forced selling that destroyed Ted's portfolio. These products lock in gains while protecting against sequence risk.
Planning matters more than ever. Working with a financial professional to create a comprehensive retirement income strategy is essential for managing this risk.
Don't Let Sequence Risk Derail Your Retirement
Understanding sequence of returns risk is just the first step. Let's work together to build a retirement income strategy that protects you from market timing risk while ensuring you can maintain your lifestyle throughout retirement.
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