Sequence of Returns Risk: Why a Crash at 65 Hurts More Than One at 45
Two retirees can earn the same average return for 30 years. One dies with money. The other runs out in year 27. The difference is not the average — it is the order the returns arrived in.
When order does not matter
You are working. You are not selling. A −20 percent year and a +20 percent year, in either order, leave the account in about the same place after both years. Compounding cares about the product of the returns, not the lineup. Early crashes in accumulation can even help: you buy cheap shares with years of deposits still ahead of you.
When order matters
You are retired and taking money out every year. A drop plus a withdrawal means you sell more shares at the low to raise the same dollars. Those shares never come back for the recovery. A late crash is annoying. An early crash can be fatal — the portfolio never gets the chance to compound back.
The same average, two endings
Take a tiny three-year sketch: start with $500,000, withdraw $20,000 at each year-end. Same three returns, same withdrawals — but run the bad year first versus last, and the leftover is different.
Now the longer pair that researchers actually test: both start at $1 million, both take 4 percent the first year and raise it with inflation, both live through the same 30 years of returns averaging about 6 percent. Losses first — often empty before year 30. Losses later — often a large leftover. Same average. Different sequence.
Why early losses lock in
Think in shares, not dollars. Your withdrawal is a fixed dollar amount, but after a crash each dollar costs more shares — so you sell more shares to raise the same spending money. Those shares are gone; they cannot participate in the recovery. Then the next withdrawal takes more shares from an even smaller base. This is the compounding that kills: not returns compounding upward, but withdrawals compounding downward against a shrinking base.
What shrinks the risk
- Guaranteed income. Every dollar of Social Security or pension is a dollar you do not have to sell in a crash. This is the deepest reason the Planner subtracts guaranteed income before sizing the nest egg.
- Flexible spending. A fixed inflation-adjusted withdrawal is the most fragile kind. The Planner's guardrails are one flexible version: if your withdrawal rate climbs above 1.2 times its starting level, cut spending 10 percent; if it falls below 0.8 times, raise it 10 percent. Small, rule-based cuts early beat panicked cuts late.
Sequence risk is also the engine inside most 4-percent-rule failures — the withdrawal-rate article walks through where that number came from and why the bad early years are what break it.
What this means for your plan
When the Planner says your plan is “on track,” it means on track if returns are reasonably even. When it says you are short, it means short even in the smooth case — and sequence risk would make it worse. A small surplus can still fail if the first five years are ugly. The defense is not a cleverer return assumption. It is guaranteed income, flexible spending, and a withdrawal rate with slack in it.