Sequence of Returns Risk

The demonstration

Consider two retirees, each with $1,000,000 starting and withdrawing $50,000/year. Both experience the same average return of 5% per year over 20 years, but the order differs:

Retiree A experiences:

• Year 1: −15% (bad early year)
• Year 2: −10%
• Year 3 onward: +8% every year

Retiree B experiences:

• Years 1–18: +8% every year
• Year 19: −10%
• Year 20: −15%

Both have the same arithmetic average return. Both withdraw $50,000/year (inflation-ignored for simplicity).

Retiree A's portfolio:

• Start: $1,000,000
• After year 1 (-15%): $850,000, withdraw $50k = $800,000
• After year 2 (-10%): $720,000, withdraw $50k = $670,000
• Now growing at 8% with $50k annual withdrawal from a damaged base.
• Portfolio at year 20: roughly $300,000 (or potentially exhausted, depending on exact figures).

Retiree B's portfolio:

• Enjoys 18 years of growth with $50k withdrawal on a mostly-rising balance.
• By year 18, portfolio is around $1.6M.
• Year 19 drop to $1.44M still leaves plenty.
• Portfolio at year 20: roughly $1.2M.

Same average returns, wildly different outcomes. The difference is almost entirely about the interaction between withdrawals and returns in the early years.

Why it matters for retirement specifically

During accumulation (working years), bad returns are actually somewhat helpful — you buy shares at lower prices with ongoing contributions. The average-of-final-outcomes doesn't depend much on order, because you always have more years of compounding ahead.

During decumulation (retirement), the portfolio is diminished by withdrawals every year. A bad year early permanently reduces the base from which future years compound. There's no "make it up" period.

This is why the years immediately before and after retirement are the highest-risk period in a lifetime of investing. A 2008-style crash in year 2 of retirement can turn a secure plan into a difficult one.

How to mitigate

Glide path. Reduce equity allocation in the years approaching retirement. A 50/50 portfolio entering retirement has much lower sequence risk than a 90/10 portfolio. The trade-off is lower expected return.

Cash bucket. Maintain 2–5 years of spending in short-term assets (money market, short bonds). When markets are down, spend from the cash bucket rather than selling stocks at a loss. Refill the cash bucket during up markets.

Guaranteed income floor. Social Security, pension, and annuity income all reduce the portfolio's burden. If essentials are covered by guaranteed income, the portfolio's job is discretionary spending, which has more flexibility.

Flexible spending. Plans that can cut discretionary spending in bad markets (travel, dining out, major purchases) survive sequence shocks better. Dynamic withdrawal strategies formalize this.

Part-time income. Some retirees work part-time in early retirement specifically to avoid large withdrawals during the sequence-risk window.

Delay retirement. If a crash happens near your planned retirement date, working another 2–3 years can dramatically improve the outcome by avoiding the early withdrawal phase.

The "no-withdrawal early years" trick

If you can avoid withdrawing from the portfolio for the first 2–3 years of retirement, sequence risk drops substantially. Approaches:

• Bucket strategy with 2–3 years of cash available.
• Bridge job / consulting income covering spending.
• Roth ladder already in place, with 5-year-aged conversions providing tax-free cash.
• Sell part of the taxable account before retirement to build a cash reserve.

Each of these essentially pre-funds the sequence-risk window.

The retirement date fear

People approaching retirement often feel acute anxiety during major market drops near their target date. This is appropriate — sequence risk is real — but the response should usually not be panic selling. Options:

• Delay retirement 1–2 years until the market recovers.
• Enter retirement with extra cash cushion, delaying portfolio withdrawals.
• Reduce early-retirement spending, preserving the portfolio for later.

Selling all equity at the bottom of a crash locks in the damage with no upside if recovery happens.

How Horizons uses this

The Horizons Monte Carlo engine explicitly models sequence risk by simulating correlated return paths across all years of your forecast. A trial that happens to draw bad returns early contributes to the low-percentile outcomes and risk-of-ruin measures. The Retirement Readiness score's Risk Resilience component captures your plan's sensitivity to sequence risk.