Why sequence-of-returns risk matters for early retirement
Sequence-of-returns risk describes how the timing of investment returns — not just the average return — affects the longevity of a retirement portfolio. Two retirees can earn the same average return over 30 years, yet the one who experiences large losses in the first decade and continues to withdraw income can run out of money while the other does not. This timing effect becomes critical for early retirees (age 50–60) because their portfolios are expected to support many more withdrawal years than traditional retirees. (See Vanguard on sequence risk for additional background: https://investor.vanguard.com/investing/financial-literacy/sequence-of-returns-risk.)
A practical way to think about it: withdrawals during a down market force sales of investments at depressed prices, locking in losses and reducing the base that can grow when markets recover. The impact is sometimes called a “double whammy” — withdrawing while the account is declining.
How sequence-of-returns risk works — a simple numeric example
Assume two retirees each start retirement with $1,000,000 and plan to withdraw $40,000 the first year (4% initial withdrawal) and then increase withdrawals for inflation. One retiree experiences poor returns early; the other sees strong returns early. Over time they can end up with very different outcomes even if their long-term average returns are identical.
Year-by-year simplified example (withdrawals taken at year start):
| Year | Early Negative Returns | Portfolio after return (early loss case) | Withdrawal | End of year balance |
|---|---|---|---|---|
| 0 | $1,000,000 | — | $40,000 | $960,000 |
| 1 | -20% | $768,000 | $40,000 | $728,000 |
| 2 | +10% | $800,800 | $40,000 | $760,800 |
| 3 | +15% | $875,920 | $40,000 | $835,920 |
Compared to a case with positive early returns, the starting base for compounding is much lower in the early-loss case, and each year’s withdrawal represents a larger share of the remaining portfolio. Over long periods this can materially reduce the probability that assets last through retirement — a primary concern for early retirees.
Empirical research and retirement simulation studies (for example, the Trinity Study and later refinements) show withdrawal success rates fall when long retirements begin with poor return sequences. The 4% rule, developed by Bill Bengen and supported by the Trinity Study, assumes a retirement length around 30 years; early retirees who need 35–40+ years should treat the rule as a starting point, not a guarantee (Bengen; Trinity Study summaries published widely by financial educators and practitioners).
Who is most affected
- Early retirees (50s–early 60s) who will rely on portfolio withdrawals for multiple decades.
- People with high equity exposure and insufficient cash or guaranteed-income buffers.
- Households lacking alternative income sources (part-time work, pensions, rental, Social Security deferral plans).
Practical strategies to reduce sequence-of-returns risk
Below are well-tested approaches used by financial planners to reduce the exposure and improve portfolio resiliency. These steps are additive and often work best when combined.
1) Build a cash and short-term bond reserve (the “bucket” approach)
- Keep 2–5 years of expected spending in cash, ultra-short bond funds, or a high-quality short-term ladder. This allows you to meet withdrawals without selling equities during deep market drops.
- Use a multi-bucket strategy: near-term bucket (cash/short bonds), intermediate bucket (short/intermediate bonds or conservative balanced funds), and growth bucket (equities). When markets fall, draw from the near-term bucket while letting equities recover.
2) Reduce initial withdrawal rate and use a dynamic withdrawal policy
- Instead of a fixed percentage forever, consider a lower initial withdrawal (for example, 3–3.5% for very early retirees) or a dynamic strategy that cuts withdrawals after major market declines. Research and practice show flexible withdrawals materially increase the odds of portfolio survival. (See evidence and withdrawal design guidance summarized by financial planners and academic studies.)
- Tools: spending rules tied to portfolio value (e.g., guardrails that trigger a 10–20% spending reduction if real portfolio value falls by a preset amount).
3) Use guaranteed income to replace part of fixed spending
- Lifetime annuities, pension options, and qualified longevity annuity contracts (QLACs) convert savings into guaranteed income and remove some longevity/sequence risk exposure. QLACs allow deferred lifetime payouts that start later in life and are designed to preserve RMD compliance for qualified accounts. Evaluate costs, fees, and counterparty risk before purchasing. (See general annuity explanations: https://finhelp.io/glossary/annuity/ and QLAC descriptions.)
4) Ladder bonds and certificates of deposit (CDs)
- A ladder of bonds/CDs timed to the expected spending horizon provides predictable income and rolling liquidity. Ladders reduce the need to sell equity in downturns and lock in yields when rates are attractive.
5) Maintain a diversified portfolio with an appropriate glidepath
- Diversification across stocks, bonds, and alternative income sources reduces volatility. As retirement approaches, many planners shift allocations gradually (a glidepath) to moderate downside exposure without sacrificing all growth potential. Avoid over-concentration in single stocks or single-sector funds.
6) Use partial Roth conversions and tax-aware sequencing
- Strategically converting taxable retirement assets to Roth accounts in low-income years can create a tax-free bucket to draw on during bad market years without increasing required taxable income. Tax-aware withdrawal sequencing can reduce overall tax drag and provide more flexibility during downturns. Consult a tax advisor before implementing conversions.
7) Create optional income buffers
- Retaining or planning for part-time work, contract income, or phased retirement reduces withdrawal pressure and can be an effective hedge against sequence risk. Many planners recommend a conservative plan assuming no part-time work, then treating earned income as a bonus that increases financial flexibility.
Implementation checklist (practical first 12 months)
- Calculate your safe starting withdrawal rate given your time horizon and risk tolerance; consider running Monte Carlo or historical-sequence simulations.
- Establish a 2–5 year cash/short-bond bucket sized to cover near-term spending.
- Create an asset allocation glidepath and rebalancing schedule.
- Evaluate annuity options (including QLACs) and pension choices for guaranteed income components.
- Plan a tax-aware withdrawal sequence; discuss Roth conversion windows with a tax professional.
- Set written spending guardrails (trigger points for spending reductions or reallocation).
Common mistakes to avoid
- Relying solely on a static rule (like 4%) without considering time horizon, sequence risk, or flexibility.
- Cashing out equity holdings at the bottom of the market because you lack a liquid reserve.
- Ignoring fees and surrender charges on annuities and structured products that can erode the benefit of guaranteed income.
- Neglecting tax consequences of withdrawals and conversions.
Example scenarios and outcomes
Financial-planning software and Monte Carlo simulations let you test outcomes across thousands of return sequences. In advisory practice, I’ve seen two practical examples:
- Client A (age 55) built a four-year cash bucket, lowered initial withdrawals to 3.25%, and purchased a modest deferred-income annuity for lifetime income at age 75. During a severe early-10-year bear market, Client A drew from cash and lower-yield bonds, avoided selling equities, and preserved long-term growth — extending their portfolio life by several years versus a static 4% strategy.
- Client B (age 58) followed a static 4% rule with no cash reserve and experienced a large early drawdown; forced equity sales during the downturn reduced their terminal wealth and required them to take a 20% reduction in lifestyle ten years later.
Authoritative sources and further reading
- Vanguard: Sequence of Returns Risk (investor education) — https://investor.vanguard.com/investing/financial-literacy/sequence-of-returns-risk
- William Bengen’s research on safe withdrawal rates and the 4% rule (foundational work often cited by retirement planners)
- Trinity Study (historical withdrawal success-rate research)
- Morningstar and industry white papers on withdrawal strategies and sequence-of-returns risk (search recent analyses for updated guidance).
For more practical guides on withdrawal policy design and mid-retirement adjustments, see our pages on “Designing a Safe Withdrawal Rate for Variable Market Conditions” (https://finhelp.io/glossary/designing-a-safe-withdrawal-rate-for-variable-market-conditions/) and “Adjusting Withdrawal Strategy During Market Recoveries” (https://finhelp.io/glossary/adjusting-withdrawal-strategy-during-market-recoveries/). For guaranteed-income options, read our annuity overview: https://finhelp.io/glossary/annuity/.
Final notes and professional disclaimer
Sequence-of-returns risk is a mechanical effect of timing and withdrawals that you can plan for. Combining cash buffers, flexible withdrawals, partial guaranteed income, tax-aware sequencing, and realistic spending assumptions materially improves the odds that your assets will support a long early retirement. This article is educational and not personalized financial advice. For guidance tailored to your situation, consult a qualified financial planner or tax advisor licensed to practice in your jurisdiction.
Published guidance referenced above includes academic and industry research current through 2025. Always verify product details and current tax rules before acting.
