Sequence-of-returns risk

Sequence-of-returns risk is the risk that poor market returns arrive at an especially damaging time. It matters most when money is being withdrawn from a portfolio.

Same average, different result

Imagine two retirements with the same returns in a different order. One begins with several strong years and later has a downturn. The other suffers the downturn first.

Without withdrawals, both sequences can finish in the same place. With withdrawals, the early downturn can be much harder. Spending requires selling more of a depressed portfolio, leaving fewer assets to participate in the recovery.

Why retirement is sensitive

Contributions during working years can soften a downturn because new money buys assets at lower prices. Retirement often reverses that pattern: withdrawals continue while the portfolio is falling.

This is why a plan based only on an average return can look safer than it is. Simulations test many different orders of returns so the plan experiences both favorable and unfavorable beginnings.

Ways a plan can respond

There is no single cure, but a plan may become more resilient through:

• flexible discretionary spending;
• cash or lower-volatility assets for near-term needs;
• a retirement date that can move if markets are unusually weak;
• an allocation and glide path appropriate for the household’s risk capacity; or
• reliable income that reduces the amount the portfolio must provide.

The point is not to predict the next downturn. It is to understand whether the plan has room to adapt if poor returns arrive at the wrong time.