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The order of your returns matters more than the average
Two retirees can earn exactly the same average return over ten years and end up more than two hundred thousand dollars apart. The only difference is which years were the bad ones.
Ask most people how their retirement savings are doing and they will tell you an average. Seven percent a year, say. It is a reasonable way to think about money while you are still working, because while you are contributing rather than withdrawing, the order the returns arrive in genuinely does not matter. Good year first or bad year first, you land in the same place.
The moment you begin taking income out, that stops being true. And nobody tells you it stops being true.
The same average, two very different outcomes
Here are two people. Both retire with $500,000. Both withdraw $30,000 at the end of each year. Both earn an average of 6.2 percent over ten years. The only difference between them is the order the returns arrive: one gets the poor years at the beginning, the other gets them at the end. The individual yearly returns are identical, just reversed.
| Return | Retiree A | Return | Retiree B | |
|---|---|---|---|---|
| Year 1 | -20% | $370,000 | +12% | $530,000 |
| Year 2 | -12% | $295,600 | +14% | $574,200 |
| Year 3 | +5% | $280,380 | +10% | $601,620 |
| Year 4 | +12% | $284,026 | +8% | $619,750 |
| Year 5 | +15% | $296,629 | +18% | $701,305 |
| Year 6 | +18% | $320,023 | +15% | $776,500 |
| Year 7 | +8% | $315,625 | +12% | $839,680 |
| Year 8 | +10% | $317,187 | +5% | $851,664 |
| Year 9 | +14% | $331,593 | -12% | $719,465 |
| Year 10 | +12% | $341,384 | -20% | $545,572 |
| After 10 years | 6.2% avg | $341,384 | 6.2% avg | $545,572 |
Same average. Same ten returns. A gap of $204,187.
And here is the part that makes the point properly: if neither person had withdrawn a dollar, both accounts would have finished at exactly $852,058. Identical, to the dollar. The order of returns creates no difference at all until you start taking money out.
Withdrawals turn a temporary decline into a permanent loss, because the shares you sell in a down year are never there to recover.
Why it happens
When Retiree A takes $30,000 out of an account that has just fallen twenty percent, that money comes out at the worst possible price. Those dollars are gone. They do not participate in the recovery that follows, and neither does the growth they would have produced. Retiree A spends the rest of the decade with a permanently smaller base to grow from.
Retiree B withdrew the same $30,000, but did it from an account that had just gained twelve percent. Same withdrawal, much less damage.
This is what people mean by sequence-of-returns risk. It is not about whether the market goes up over time. It is about when it goes down relative to when you need the money.
The first five years carry most of the risk
The danger is concentrated at the beginning of retirement, and it fades as you go. A bad year in your first year of retirement compounds against you for the entire rest of your life. The same bad year at eighty-five, when the balance has already done most of its work and the remaining time horizon is short, is a far smaller problem.
Which produces an uncomfortable fact: two people can do everything the same, retire eighteen months apart, and have materially different retirements. Not because one planned better. Because of when they happened to stop working.
You cannot control that. What you can control is how much of your income depends on it.
What actually reduces the risk
There are three honest approaches, and they are not mutually exclusive.
Be willing to spend less in bad years
The most effective and least popular option. If you can cut withdrawals by ten or fifteen percent in a year the market falls, you avoid most of the damage. It works. It requires that your budget has genuine flexibility in it, and many do not.
Hold enough cash to avoid selling low
Keeping one to three years of expenses in something stable lets you spend from that instead of selling investments during a decline. The cost is that money sitting in cash earns very little, which is a real drag if the downturn never comes.
Cover your essential expenses with income that does not depend on the market
Social Security already does part of this. A pension, if you have one, does more. Beyond that, some retirees choose to convert a portion of savings into contractual lifetime income so that the mortgage, the utilities, the groceries and the insurance premiums are covered no matter what any given year does. What remains invested can then absorb a bad year without threatening the household budget.
That last approach is part of what I do, so treat me as an interested party and weigh it accordingly. It also has real costs: money committed to an income contract is not fully liquid, and the terms need to be understood in detail before anyone signs anything. It is a legitimate tool for this specific problem, not a solution to every problem.
The short version
- While you are saving, the order of returns does not matter. Once you are withdrawing, it matters enormously.
- The first five years of retirement carry the most risk, and you do not get to choose what the market does in them.
- The question worth answering is not "what return do I need," it is "how much of my monthly income would be at risk if the next five years go badly."
- If the answer is "all of it," that is worth addressing before you retire rather than after.
If you would like to see this run against your actual balance, your actual spending and your actual timeline rather than a hypothetical, that is essentially what the first meeting is.
This article is general education and is not tax, legal, or investment advice, nor a recommendation to buy any product. The table is a hypothetical illustration created to demonstrate a concept. It is not a projection, does not represent any actual investment or product, and does not reflect fees, taxes or trading costs. Actual results will differ.
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