Sequence of Returns Matter

With the school year coming to an end, my girls have been cramming for exams and scrambling to make sure all their assignments have been turned in. Those of you with kids in school probably know just what I mean as you watch them (or nudge them to) check all the boxes before summer slacking begins. It’s for this very reason that I found myself on the phone with Maeve, who’s finishing another year at Quinnipiac University, trying to help her through a particularly challenging math assignment. We were reviewing a problem related to the concept of sequency of numbers – or “an ordered set of numbers or other mathematical entities in one-to-one correspondence with the integers 1 to n.” Phew – I really had to dust off my mathematical brain for that discussion. Luckily, we talked through the problem and she got off the phone prepared to tackle the assignment. 

But the conversation got me thinking. Not only that math really IS something that we will use throughout our lives, no matter how much you might hate the subject – but also how important the concept of sequencing is, too. Not only in the classroom or in textbooks, but in retirement planning as well.  There’s a term for it, too – it’s called Sequence of Return Risk. You already know that you face plenty of risks when investing for retirement. The markets crash, inflation can eat into your returns, you might even worry about outliving your savings. But in my experience, sequence of return risk doesn’t get the attention it deserves.

So just what is sequence of returns risk? Well, this is the risk that comes from the order in which your investment returns occur. To put it another way, sequence of return risk is the risk that market declines in the early years of retirement, paired with ongoing withdrawals, could significantly reduce the longevity of a portfolio. This typically comes into play as you begin taking withdrawals from your retirement accounts and the possibility that the timing of your retirement withdrawals may negatively impact your overall rate of return. Timing is everything, and in retirement early market declines, particularly if they are paired with rising inflation, can have a huge effect on how long a nest egg can last.

To break this down, let’s consider a fairly common concept: the average rate of return. The fact is, averages don’t matter, but real returns do. It’s not necessarily what you get for a return that matters as much as when you get it. The order in which you experience returns is one of the single greatest determinant of retirement success from risk-based accounts. It doesn’t matter solely what your portfolio averages, but rather in what order it experiences good and bad years. In short, a negative run at the beginning of your retirement can have a significant effect.

Some of you might be confused by this – you’ve seen the market go down before, but it always comes back, right? So why hasn’t sequence of returns risk been an issue? The key here is the withdrawals. If the market crashed during your income-producing years, your patience is rewarded when the market bounces back. But when you’re retired, you can’t afford to be patient. You need that money. And taking withdrawals into a declining market, in some cases, can make recovery a mathematical impossibility.

To understand how sequence risk works, it’s helpful to have an example. Now, suppose we have two investors, Mr. Jones and Mr. Smith, who both retired at age 66 with a retirement account balance of $1,000,000 and planned to withdraw $40,000 from their portfolio every year until their passing at age 90. Their situations are identical except they experienced their annual returns in an inverse order from each other. They earned the same average annual rate of return, but in this example the order of returns was reversed. Mr. Jones experienced positive returns early in retirement, while Mr. Smith experienced negative returns early in retirement. At age 90, Mr. Jones ends up with $2,720,982 while Mr. Smith has only $256,813 remaining. Mr. Smith experienced the same returns as Mr. Jones but his portfolio experienced losses in the first few years after he began taking withdrawals. Mr. Jones had positive returns initially in retirement, so he got off on the right foot and was able to extend his portfolio throughout his retirement and beyond, leaving a greater legacy to his heirs₁.

This example illustrates just how important timing can be when planning for retirement. While both investors began with the same initial nest egg, they were affected differently by the timing of the market cycle. Unfortunately, it’s not possible to predict whether the market will be up or down when you’re ready to retire. And while it may not be possible to entirely avoid sequence risk when preparing for retirement, it is possible to plan ahead for sequence risk and potentially minimize the impact it may have on your retirement.

There are a number of potential strategies to employ for this purpose. For example, diversifying your portfolio can also offer some protection against sequence of returns risk. Investing in fixed income securities, such as bonds, alongside stocks, exchange-traded funds or mutual funds can help you create a portfolio that’s well-rounded. You may also want to consider an annuity to produce guaranteed income in retirement to help to offset negative returns if the market dips. An annuity can also help with paying for long-term care costs, which could take a sizable bite out of your retirement income. 

Folks, sequence of return risk is just another risk to consider when building out a sound retirement system.  Another risk that reinforces the need to build and deploy a downside risk mitigation program using quantitative data to help give your portfolio the greatest chance of financial success. 

So, tell your kids to pay attention in math, because some of the concepts they’re leaning now will be a crucial component to understand when they’re ready to plan their own retirement!

And as always – be vigilant and stay alert, because you deserve more!

Have a great week.

Jeff Cutter, CPA/PFS is President of Cutter Financial Group, LLC, an SEC Registered Investment Advisor with offices in Falmouth, Duxbury, Mansfield. Jeff can be reached at

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