Sequence of returns risk is the danger that a market decline in retirement’s early years shrinks a portfolio for good, even if the average return over the full retirement looks fine.
Why this matters two to eight years from retirement
The years right around retirement are the ones where sequence risk does the most damage, because that is when the portfolio is at its largest and withdrawals are just starting. A market decline the year after you retire forces you to sell more shares to generate the same income, leaving fewer shares to participate when the market recovers. The same decline hitting fifteen years into retirement, after a decade of growth, does far less harm. Timing your retirement date and structuring your withdrawals for the years right after it matters more than the return average over thirty years.
What this looks like for one retiree
A retiree draws $80,000 a year from a $2M portfolio. In one version, the market falls 25% in year one; to generate $80,000, she now sells a larger share of a smaller portfolio, and those shares are gone when the market recovers. In another version, the same 25% decline happens in year fifteen, after years of growth had already built a cushion. The ending balance in each version can differ by hundreds of thousands of dollars, from the same average return, only reordered. A larger Social Security check works against this the same way a cash buffer does. Benefits grow about 8% a year for every year you delay past full retirement age, up to 70, according to the Social Security Administration, and that bigger guaranteed floor needs less help from the portfolio in a bad year. These figures are illustrative, built to show the mechanism.
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