Sequence of Returns Risk: What It Is and How to Protect Your Retirement
By Rick at ModelBuddies · 2026-10-02 · 6 min read
Sequence of returns risk is the danger that the order of your investment returns, not just their average, determines how long your retirement savings last. A big loss early in retirement, while you are also withdrawing money, can do damage that later gains never fully repair.
If you are within ten years of retiring, or already there, this is probably the single most important investing idea to understand. Here is how it works, what it looked like in real markets, and what you can do about it.
What sequence of returns risk means, in plain English
While you are working and adding money to your accounts, a market drop can even help you: you buy shares cheaper. Once you start taking money out, the same drop works against you. You have to sell shares at low prices to pay your bills, and those shares are no longer there when the market recovers.
That is the whole idea. Two retirees can earn the exact same average return over 20 years and end up in very different places, because one hit the bad years first.
One detail worth knowing: if you never add or withdraw money, the order of returns does not change your ending balance. The risk only exists when money moves in or out, which is why it matters most in the years around retirement.
A simple example: same returns, opposite order
Take the same five yearly returns and use them twice. Each retiree starts with $500,000 and withdraws $25,000 a year.
| Yr 1 | Yr 2 | Yr 3 | Yr 4 | Yr 5 | Balance after year 5 | |
|---|---|---|---|---|---|---|
| Bad years first | −25% | −12% | +8% | +18% | +25% | $357,694 |
| Bad years last | +25% | +18% | +8% | −12% | −25% | $426,592 |
The returns are identical. The only difference is the order. The retiree who met the losses first ends about $69,000 lower, and at the low point had a balance near half of what they started with.
What it looked like in real markets
Hypotheticals are one thing. Here is what actually happened to a retiree who put $500,000 in an S&P 500 index fund and withdrew 4% of the starting balance each year ($1,667 a month), starting in three different periods:
| Retired in | After 5 years | After 10 years | Lowest balance along the way | S&P 500 average return over those 10 years |
|---|---|---|---|---|
| January 2000 | $330,059 | $238,455 | $167,113 | −1.0% a year |
| October 2007 | $394,481 | $625,699 | $231,078 | 7.3% a year |
| January 2010 | $867,733 | $1,358,273 | $457,876 | 13.4% a year |
Same fund, same withdrawals, same amount saved. A retiree who started in January 2000 had less than half their money left after a decade. One who started in January 2010 had nearly tripled theirs.
The first two periods began just before major declines. Measured at month-end with dividends included, the S&P 500 fell about 39% between January 2000 and September 2002, and about 51% between October 2007 and February 2009. The retirees who started then were withdrawing money through the worst of it.
Not an exact sequence-of-returns comparison: these decades also had very different average returns, which is part of the point. You cannot choose when you retire, and the market does not care.
Who is most exposed: the "retirement red zone"
Planners often call the five or so years before and after your retirement date the red zone. Two things make it dangerous:
- Your balance is at its peak. There is the most money to lose, in dollars.
- You have little time to recover. There are few earning years left to rebuild, and you are about to start withdrawals.
A retiree who sees their portfolio fall 30% in year one has not just lost 30%. They have also started selling shares at the bottom, and the withdrawals compound the damage.
Isn't the 4% rule supposed to handle this?
The well-known "4% rule," popularized by financial planner William Bengen in the 1990s, was built by testing withdrawals against historical worst cases, including bad starting years. It is a reasonable starting guideline, not a guarantee. It assumes you keep withdrawing steadily whatever the market does, and it was designed around a specific historical record that the future may not repeat. The 2000 row above is a reminder that it can be uncomfortably close to the line.
Five ways to reduce sequence of returns risk
None of these removes the risk. Each one trades something away.
- Hold a cash or short-term bond reserve. Keep one to three years of spending in cash or short-term bonds, so you are not forced to sell stocks after a drop. Trade-off: that money earns less in good years.
- Be flexible with withdrawals. Cutting spending by even 10% in a down year can meaningfully slow the damage. Trade-off: it requires a budget you can actually trim.
- Lower your stock exposure as you near retirement. Many investors reduce risk gradually in the red zone, sometimes called a "glide path" or "bond tent." Trade-off: a lower return if markets keep rising. And in 2022, stocks and bonds fell together: a standard 60/40 mix lost about 16% that year.
- Delay retirement or earn some income early on. Even part-time income in the first few years means smaller withdrawals when prices are low. Trade-off: it is a lifestyle choice, not an investment one.
- Use rules that cut risk when markets weaken. This is where tactical strategies fit: a written, rules-based approach that shifts between growth and defensive holdings based on market conditions, so the decision is made in advance instead of in a panic. Trade-off: rules can be wrong, can lag a recovery, and any backtest is hindsight. They reduce risk; they do not eliminate it.
It is not either-or. Many people combine several of these.
Frequently asked questions
Is sequence of returns risk only a problem in retirement? Mostly, yes. It matters whenever you are taking money out regularly, which for most people means retirement. During the years you are saving, the order of returns matters much less.
What is the "worst case" for sequence of returns risk? A large loss in the first few years of retirement, especially while you are withdrawing a fixed amount. The January 2000 example above is a real case.
Can you eliminate sequence of returns risk? No. You can reduce it with a cash reserve, flexible spending, a lower stock allocation or rules that cut risk when markets weaken, but each approach has costs.
How much does the order of returns matter if I don't withdraw anything? Not at all for the ending balance. The order matters only when money is added or withdrawn along the way.
Go deeper
We put together a free report that walks through two more real stress tests, the 2022 retiree and the March 2020 crash, and is upfront about what its data does not show: The Retirement Sequence-of-Returns Risk Report. It is free, and you can unsubscribe any time.
If you want to see how a rules-based approach is built, the strategies behind our tactical asset allocation service are published, with their backtests, at ModelBuddies Tactical Asset Allocation. You can also check current market conditions on our free market risk dashboard.
For informational purposes only. Not investment advice. The examples use an S&P 500 index fund (SPY, total return, month-end prices), assume a fixed withdrawal of 4% of the starting balance per year, and ignore taxes and fees; they are historical illustrations, not predictions. Past performance does not guarantee future results, and all investing involves risk, including loss of principal.