Sequence of returns risk

Sequence of returns risk is the mathematical asymmetry that bad returns early in retirement damage long-term outcomes far more than bad returns late. Two retirees with the same portfolio and the same average return over 30 years can have radically different outcomes if one experiences the downturn in year one and the other in year 25. Withdrawals during a downturn lock in losses and reduce the base that compounds through the recovery. The effect is concentrated in the first 5 to 10 years of retirement.

Example: a retiree starts at $3 million with $120,000 annual withdrawal and 7% average returns. With losing years 1-3 (down 20% each), the portfolio falls to $1.4 million by year 4 and never recovers fully, running out in year 24. With identical returns reordered (losing years 28-30), the portfolio ends year 30 at $2.1 million.

Common mistake: holding a fully stock portfolio at retirement. A bond allocation or cash bucket of 2-3 years of spending creates a reserve to draw from during drawdowns, avoiding sales at depressed prices.

Sequence risk matters at every retirement transition, at large early retirement planning, and at Roth conversion ladder timing in down markets.