Sequence-of-Returns Risk
AdvancedSequence-of-returns risk is the risk that poor investment returns early in retirement, while withdrawals are being made, permanently reduce how long savings will last, even if average returns over the whole period are acceptable.
When someone is saving and not withdrawing, the order of good and bad years does not affect the final result. Once regular withdrawals begin, it does. Selling investments after a fall to pay living costs locks in losses, leaving less money to benefit from any recovery.
For example, two retirees each start with 1,000,000 and withdraw 50,000 at the start of each year. One gets returns of −20%, then +10% and +10%. The other gets the same returns in reverse order. After three years, the first has about 804,100 and the second about 835,600, even though their returns were identical, just in a different order.
The risk is greatest in the years just before and after retirement, when the portfolio is largest and withdrawals are starting.
Ways to manage it include keeping a cash or bond buffer to avoid selling shares after a fall, reducing withdrawals in bad years, reducing risk gradually as retirement approaches and using guaranteed income such as annuities for part of spending.
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