Sequence-of-returns risk is the danger that bad market years arrive early while you are taking money out of savings.
What it means
Average return does not tell the whole story after withdrawals begin. A loss early in retirement can force you to sell more shares to pay the same bill.
Those sold shares are no longer in the account for a later recovery. That is why two people with the same starting balance and the same average return can end in different places.
A simple example
Two retirees each begin with $1 million and take $50,000 a year for living costs. They receive the same set of market returns, but in a different order. One suffers the worst losses during the first few years. The other gets those losses much later.
The first retiree must sell more shares after prices fall to produce the same $50,000. Those shares are gone when the market recovers. The second retiree has more time for the account to grow before the losses arrive. The average return can be the same while the retirement results are very different.
What people often miss
This is not a reason to predict the next crash. It is a reason to make a plan for spending and withdrawals when markets fall.
Cash, flexible spending, work, steady income, and a different withdrawal choice can all be parts of that plan.
Three questions worth asking
- What will pay the bills after a large market drop?
- Which spending could pause?
- How many years of withdrawals have we tested?
Checked against primary sources
This explanation was checked against the sources below. Rules and limits can change, so check the source before making a decision.
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