Sequence of Returns Risk can ruin your retirement

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Sequence of Returns Risk can ruin your retirement

If you follow any blog about Financial Independence, you probably have heard about Sequence of Returns Risk. Even on this blog, I talked about this concept. But do you know exactly what it is?

A sequence of Returns Risk, or simply Sequence Risk, affects people that regularly invest or regularly withdraw from their portfolio. When you invest, they should average out. But this is more important when you withdraw. The main idea is that negative returns in the early years are much worse than in the later years.

It is a bit difficult to explain with words. But it is straightforward to understand with examples. I will show the difference that sequence of returns risks can make to different scenarios.

So let’s delve into Sequences of Returns Risk and what to do about it.

Sequence of Returns Risk (SRR)

A Sequence of Returns Risk (SRR), or a Sequence Risk, is the danger that some timings of withdrawals or investments are reducing the overall returns. Withdrawing during a bull market is not equal to withdrawing during a bear market.

Sequence risks affect every kind of investment. However, some investment instruments are stable enough that it will not matter as much. For instance, treasury bonds and cash are affected, but not that significantly. However, for volatile investments, it is very significant. If you hold stocks, bonds, or gold, you need to be aware of this.

For investments, we can almost ignore the sequences of returns risk. Because investing is a long-term effort, it will average out. Moreover, when you invest during a bear market, you can buy more shares for the same amount of money. During the accumulation phase, sequence of returns risks can accelerate your net worth growth.

However, this is not the case for withdrawals. In retirement, sequence of returns risks can put you at risk of running out of money. So, it is essential to understand that and to try to protect yourself from this risk.

Let’s run a few examples to get to understand these risks better.

Negative years vs positive years

I want to start with a simple example and a question. Let’s say you start with 1000 USD. How much do you have after one year with -10% and one year with +10%?

You probably answered 1000 USD. But this is wrong! You will end up with 990 USD! It is a widespread mistake. After the first year, you are at 900 USD. Then, you will get 10% out of 900, which is 90 USD. So you will end up with 990 USD and not 1000 USD!

This fact is incredibly important to understand. To recover from a year with -10%, you need a year with 11.11% returns, not 10%! And the more down it is, the more significant the difference is! You will need 25% returns to recover from a 20% down year! And in the extreme, you will need 100% returns to recover from a -50% year!

Here is the value of your money after two years at -20% and two years at +20%:

Positive years vs Negative Years
Positive years vs Negative Years

As you can see, you are not back where you started!

Now, this is not directly a sequence of returns risk. But this effect will be increased when you start withdrawing from your portfolio. To recover from a 4% withdrawal, you will need a 4.166% return.

Example without withdrawals

Let’s start with a scenario with the given returns per year. Here is scenario A:

  1. 10%
  2. 10%
  3. 10%
  4. -10%
  5. -10%

And here is scenario B:

  1. -10%
  2. -10%
  3. 10%
  4. 10%
  5. 10%

And here is a graph of both scenarios when starting with 1000 USD:

Return Timings without withdrawals, no sequence of returns risk
Return Timings without withdrawals, no sequence of returns risk

As you can see, you end up precisely in the same position. The difference is that the first scenario goes up faster and then goes down quicker.

If you do not do any withdrawals or investments, there is no sequence of returns risk.

Example with withdrawals

Finally, we can start an example with a sequence of returns risk. You will see that everything is tied together.

Let’s run the same simulation, but imagine that you are in retirement. Let’s say you follow the 4% rule. So, you will withdraw 40 USD out of the total money at the end of every year.

If we keep the same two scenarios and we add the withdrawals, this gives us the following results:

Return Timings with withdrawals, Sequence of Returns Risk
Return Timings with withdrawals, Sequence of Returns Risk

This time, the results are different. With Scenario A, you end up with about 894 USD. In Scenario B, you end up with only 844 USD. Timings of the stock market just made you lose 50 CHF. You may think this is not significant, but this is 5% of your initial portfolio. This loss is more than what you spend in a year! You have effectively lost one year of expenses.

Effective Withdrawal Rates

This difference is very significant for your retirement. Where does that difference come from?

The difference comes from the fact that your withdrawals are higher in the second scenario. In the second scenario, every year, you withdraw more than 4%! In the first scenario, only in the last year will you withdraw more than 4%.

It is because the 4% withdrawal is based on the initial portfolio, not on the actual portfolio.

Therefore, it is necessary to consider your effective withdrawal rate. Your effective withdrawal rate is the current withdrawal amount divided by the current amount of money you have. Let’s look at the effective withdrawal rates during this scenario:

Effective Withdrawal Rates - Sequence of Returns Risk
Effective Withdrawal Rates – Sequence of Returns Risk

As you can see, the effective withdrawal rates in the second scenario are always higher than in the first. And most importantly, they are always higher than what you planned for!

When your portfolio value goes up, your effective withdrawal rate goes down. But when your portfolio goes down, your effective withdrawal rate goes up!

As we saw before, you need more than 4% returns to recover from a 4% withdrawal. So, if your effective withdrawal rate is higher than 4%, you will need even more profits to recover from it! That is also why higher withdrawal rates are dangerous.

Realistic scenario

At this point, you may be wondering if these scenarios are realistic.

So, let’s try with a more realistic scenario. We are going to take the S&P 500 Index starting during The Great Recession.

Here are the returns of the S&P 500 from 2008 to 2018:

2008 -38.49%
2009 23.45%
2010 12.78%
2011 0.00%
2012 13.41%
2013 29.60%
2014 11.39%
2015 -0.73%
2016 9.54%
2017 19.42%
2018 -6.24%

These returns are very typical of a bear market, followed by a bull market. It is a regular stock market cycle. For decades, the stock market has behaved like this: each bull market followed by a bear market.

So, let’s imagine two scenarios again. In the first scenario (A), we have precisely the returns of the S&P 500 Index. In the second scenario (B), the bear market appears at the end. In this case, we switch the returns of 2008 with the returns of 2018.

Let’s see what happens with the 4% rule in these two scenarios:

Bear market Vs Bull Market Retirement - Sequence of Returns Risk
Bear market vs Bull Market Retirement – Sequence of Returns Risk

The difference is very significant between these two scenarios! In the first scenario, you have 1002 USD in the end, while you have 2301 USD in the second scenario!

This difference represents more than eight years of expense. This difference is not something you can ignore.

You may think that it is not too bad in the first scenario since you still have the same amount as when you started. However, if you follow the typical lifecycle, the next thing that will happen in the first scenario is another bad year. The second scenario just went through a bear market and yet has more value!

Moreover, the Great Recession is not the worst example of recessions. The cumulated negative years of the Dotcom Bubble (2000-2002) are significantly worse than -38.49%. And I am not talking about The Great Depression that would have destroyed almost any hope of retiring.

So, this goes to show that there is a massive difference between retiring at the top of a bull market or the beginning of a bull market!

Of course, this is still a strong example since our first scenario starts in the worst year in these ten years. But you also have the same effect, to a smaller extent, if you retire two years before a bear market against two years after.

Negative years at the beginning of your retirement will negatively influence your chances of success!

Protecting yourself from Sequence of Returns Risks

So, now that we know that sequence of returns risks can ruin a retirement, what can we do about it?

The first obvious solution is to not retire just before a bear market! However, this is easier said than done. If you are ready for retirement and a bear market just started, you should continue working until the end of it. But if you are currently in a bull market, it is impossible to predict the next bear market.

Sequence of returns risks are especially dangerous during the first years of retirement. These first years are where they will do the most damage.

1. Be careful with average returns

When you plan for your retirement, you should not plan for huge returns. If you plan for 10% returns per year, after inflation, you may be surprised in the case of a bear market. I account for an average of 5% returns per year, after inflation. Considering lower returns is much safer. If my portfolio can survive this, I should be fine.

The reason you should account for lower returns is that they are just an average. Half of the time, the profits will be lower than the average. And you need to account for this. It is the reason why simple retirement calculators are generally inaccurate.

2. Withdraw Less Money

Since Sequence of Returns Risks are reducing your chances of success, you can increase your chances of success by withdrawing less money.

If a sequence of returns can ruin your retirement with a 4% withdrawal rate, you could use a 3.5% withdrawal rate instead. Using a lower withdrawal rate would significantly increase your chances of success.

But, this would not entirely protect you against the risks. And, this would significantly increase the amount of money that you have to accumulate.

Reducing risks is excellent, of course. But if you are too conservative, you may well end up never retiring. Or you will end up with a ton of money. It is always a matter of balance.

3. Be Flexible

The best course of action against Sequence of Returns Risks is to be able to be flexible.

If you see that your effective rate is higher than the planned withdrawal rate, you could reduce your expenses. The idea is to plan for some reductions that you can do when the market is not doing well.

For instance, you could consider your vacations optional and only go on holidays when your effective withdrawal rate is lower than a certain threshold.

Another way to be flexible is to be able to generate some income when necessary. For instance, you could pick a side hustle when the economy is not excellent. Or you could do some part-time jobs during that time.

Some extra income will significantly help to reduce the risks of running out of money.

You can also be flexible in the other direction. If the stock market is doing well, your effective withdrawal rate may be very low. In that case, you may also withdraw some extra money.

Of course, there are limits to flexibility. Some people think they can be incredibly flexible. But in practice, people are often not as flexible as they believe. Many expenses simply cannot be cut.

You need to be realistic about your flexibility. If you plan for 50% flexibility and a 6% withdrawal rate and you can only achieve 20% flexibility, you may well be on for a big surprise!

4. Use a separate reserve of cash

We said that a bear market happening during the first years of your retirement could be quite harmful to your chances of success.

So, you could use a second cash cushion that you would only use during the years where the stock market is down at least 20%. That way, you are not going to withdraw from your principal when your effective withdrawal rate would be too high. You can use other conditions to decide when to use it, of course.

This cash cushion should hold at least one year of expenses. You could even go higher and accumulate two years of expenses to be on the safe side. After the bad years, you will want to refill it by selling some good investments.

This second cash cushion is not your emergency fund. And it is not your cash account for your expenses. And it is not even part of your primary portfolio. It should be kept separate and only used in this case. Otherwise, it will lose its advantage.

Of course, this is not without disadvantage. It means that you need to accumulate more money than if you were simply following the 4% rule. Moreover, this has a substantial opportunity cost. This money will be almost dormant and generate no returns.

I would probably use this strategy if I were ready to retire in a situation where we would already be many years into a bull market.

5. Use a bond ladder

Another solution that many people recommend is to use a bond ladder.

The idea is to buy several sets of bonds. Each set of bonds would mature in a different year. For instance, you could have five sets of bonds, one maturing in the first year, one in the second year, and so on until the fifth year.

That way, you will have some guaranteed income during the first years of your retirement. You will receive the interests and also the principal once it matures. The advantage is that you will significantly reduce the risks of running out of money in the early years.

You can do this for five years or even ten years. Some people do it for even longer. But there is no point in doing it for longer.

Of course, as with every other technique, there are some disadvantages. There is still an opportunity cost. A bond ladder does not have the same returns as stocks. But the most significant drawback is that this is a bit complex for most investors to set up. You will need to hold many different bonds yourself.

I would not use this technique myself. But this is an interesting solution. A bond ladder could solve issues during the first years of retirement.


What is a Sequence of Returns Risk?

A Sequence of Returns Risk (SSR), or simply Sequence Risk (SR) is the risk that some timings in the stock market are worse than others. For instance, negative years in the early withdrawal years could be awful.

What is the biggest Sequence of Returns Risk for your retirement?

The biggest issue that can happen during your retirement is if a bear market starts at the beginning of your retirement. Your withdrawals will be larger than expected and you will lower your chances of success.


By now, you should know that you should not ignore Sequence of Returns Risks.

They have the potential to reduce your chances of a successful retirement significantly. Retiring just before a bear market or just after a bear market can make a huge difference in your results!

They are several solutions to improve this situation. But there is no way to avoid it entirely. I believe that the most effective strategy against sequence of returns risks is awareness.

Once you know about it, you will plan a better and safer strategy. Some people should be less cocky about their retirement strategy. Several people are taking a lot of risks and do not even realize it!

Now that you know about these risks, make sure that you are planning your retirement with that in mind!

Since Sequence of Returns Risks are highly related to recessions, you should read more information about recessions.

If you want even more information about Sequence of Returns Risks, you should read this great article by big ERN.

What do you think about Sequence of Returns Risk? How do you plan to protect yourself from this?

Mr. The Poor Swiss

Mr. The Poor Swiss is the author behind In 2017, he realized that he was falling into the trap of lifestyle inflation. He decided to cut on his expenses and increase his income. This blog is relating his story and findings. In 2019, he is saving more than 50% of his income. He made it a goal to reach Financial Independence. You can send Mr. The Poor Swiss a message here.