Sequence Of Returns Risk And How It Affects Your Retirement

Wow! Even Tom Brady is going back to work after experiencing sequence of returns risk after retiring. Playing for 23 years in the NFL is a lot. At age 44, I hope he doesn't injure himself. I'm on a retirement kick, so let's keep the subject going.

Sequence of returns risk refers to the risk of receiving lower or negative returns early in a period when withdrawals are made from an investment portfolio. Withdrawals are made from an investment portfolio usually during times of financial duress or more traditionally, during retirement.

If you happen to retire before a bear market hits, you face sequence of returns risk. Therefore, it's generally better to retire near the bottom of a bear market rather than near the top of a bull market.

If you retire near the bottom of a bear market, your finances have already been battle-tested. Chances are higher good times will return while you're still unemployed.

What Is Sequence of Returns Risk?

If you are planning on eventually retiring, you must be aware of sequence of returns risk.

Also called sequence risk, this is the risk that comes from the order in which your investment returns occur. Sequence of returns risk is the risk that the market declines in the early years of retirement, paired with ongoing withdrawals.

If your retirement portfolio declines by 10-20% and you withdraw at a 4% or higher rate, this combination could significantly reduce the longevity of your portfolio. Due to sequence of returns risk, it is important to have a more conservative portfolio as you get closer to retirement. Once you do retire, capital preservation becomes even more important.

The people who had most of their net worth in stocks in 2007 and 2008 got a rude awakening. Many likely had to delay their retirement for years. Or, they simply couldn't spend and do as much in retirement.

Here is my recommended proper asset allocation of stocks and bonds by age. You'll notice how the stock allocation declines with age and the bond allocation increases with age. Bonds are defensive investments that tend to outperform stocks when stocks decline. However, will low rates, bond’s effectiveness at being defensive has declined.

If you also invest in real estate and alternative investments, please take a look at my recommended net worth allocation by age. This article will provide a more complete picture to help counteract sequence of returns risk.

Personally, I’ve allocated more of my defensive capital toward real estate instead of traditionally toward bonds. Real estate provides shelter, generates income, benefits from inflation, and does well when interest rates decline. Owning physical rental properties and investing in private real estate funds is my favorite way to build passive income.

How To Mitigate Sequence Of Returns Risk

The easiest way to mitigate sequence of returns risk is to lower your safe withdrawal rate during down years. In fact, for the first two or three years of retirement, try living off the FS safe withdrawal rate, even if times are good. This will help train you to live on less when the next downturn inevitably arrives.

The concept is similar to paying yourself first by automatically contributing the maximum you can to your 401(k) or IRA with each paycheck. You will learn to live on less.

Lowering your withdrawal rate in retirement is something you can control. You can also alter your asset allocation to be more conservative before a down market arrives. However, once a bear market hits, changing your asset allocation may already be too late.

An alternative solution to combatting sequence of returns risk is to generate supplemental retirement income. For example, you could start working a minimum wage job, consulting, giving piano lessons, or making money online. Or, you can do what one Financial Samurai reader did and ask for his old job back, but in a part-time capacity.

Finally, you can simply set aside two-to-three years of living expenses to prevent you from selling your investments on the low. Although, holding that much cash may be tough in a high inflation environment.

Even if your investment returns start declining after you retire, you have the ability to offset the negative effects of losing money. Any supplemental retirement income you generate will help reduce your withdrawal rate. Further, it may also help you buy more investments on the cheap.

Eventually, the good times will return again. Your goal is to last as a retiree until that time comes. In the meantime, do whatever you can to survive.

Sequence of Returns Risk Examples

Here are two examples of sequence of returns risk.

Sequence Of Returns Risk Examples

In both scenarios, the S&P 500 returns are identical, except they are in reverse order. As a result, the Compound Annual Growth Rate (CAGR) of each scenario is the same.

Scenario A is what most retirees prefer. Good returns for three years followed by two years of bad years. By lowering your safe withdrawal rate for the first three years, you'll be able to better withstand negative returns in years 4 and 5. Further, as you grow older and wealthier, your asset allocation should become more conservative, which will help you lose less money.

Scenario B is the nightmare scenario for new retirees. As soon as you hang up your boots, your retirement portfolios start getting pounded. It's already stressful enough to retire from a job after so many years. But to then experience a bear market may really freak you out. You're less likely to go more aggressive in your investment portfolios in year three and beyond to make up for your losses.

The key to surviving the Painful Scenario is to lower your withdrawal rate and generate supplemental income so you aren't forced to sell your investments after a big decline. Ideally, you'll also be able to generate enough passive income to invest more during the downturn.

The 4% Rule Is Too Aggressive Due To Sequence of Returns Risk

The 4% Rule was devised in 1994 by Bill Bengen. He found that an initial withdrawal rate of 4% of a portfolio, with distributions adjusted for inflation each year thereafter, provided at least 30 years of income. The 4% rule worked even for individuals who retired just before significant bear markets.

However, we no longer live in the 1990s when the 10-year bond yield was between 5% – 7%. Interest rates are much lower, which means dividends, rental income, and other income streams are also lower. Further, investment returns expectations over the next 10 years have all declined. As a result, we will need to accumulate more capital to generate a similar amount of income.

Sequence risk increases with lower investment return forecast for stocks and bonds by Vanguard

I recommend not withdrawing at a 4% rate when the 10-year bond yield is at 2% and we've gone through a prolonged bull market since 2009. Further, elevated inflation is also hurting the purchasing power of retirees.

Even Bill Bengen mentioned in a comment on this site that he is steadily earning supplemental retirement income through consulting. Generating extra income once you no longer have a day job is key to surviving sequence of returns risk.

In my case, I'm generating supplemental retirement income online through advertising revenue on this website. I love to write and talk about personal finance on my podcast.

As a result, I've found my ideal combination of doing what I love and getting paid for it in fake retirement. I just have to be careful not to spend more than 20 hours a week online. Otherwise, it'll start feeling like work.

Sequence of Returns Risk And Stagflation (2022+)

The worst-case scenario for retirees is experiencing negative retirement portfolio returns and high inflation. Stagflation refers to slower economic input and high inflation. The combination of high inflation hurting a retiree's purchasing power and negative portfolio returns is one of the worst scenarios for retirees.

2022 is shaping up to be a year of potential stagflation. If stagflation doesn't come in 2022, it may come in 2023. As a result, it is vital for retirees today to be more cautious about their withdrawal rates. The last thing you want to do is lose a bunch of money and have to go back to work.

Other risky times from the past include the years 1929, 1933, and 1966. Study history so you can minimize experiencing a similar bad fate.

Sequence Of Returns Risk Could Crush Your Retirement Dreams

Since I fake retired in 2012, some readers have commented I'm too conservative with my investments and my investment outlook. Well, obviously, because I thought I had accumulated enough to be happy. However, things changed as my aspirations for a family grew. Since I left, the majority of my net worth has been invested in risk assets to varying degrees.

However, as someone who was in Asia during the 1997 Asian financial crisis, went through the 2000 Dotcom bubble, and had significant assets during the 2008 -2009 global financial crisis, I have some experience. And the good thing about having gone through a lot of pain is that subsequent painful events tend to hurt less.

Once you've made enough money to never have to work again, you need to protect your capital. You've already won the game, so stop running so hard. You might sprain your ankle or worse!

Final Sequence Of Returns Risk Example

To help bring you back down to earth, here is a final example of sequence of returns risk from the website Retire One. It shows how a retiree at the beginning of a down market ends up with 65% less after 15 years. The down market returns of between negative 5% and negative 15% aren't even that bad!

The problem is the consistently high withdrawal rate of 5.55% starting in year one all the way up to a 14% withdrawal rate in year 15. Hopefully, none of us are so robotic as to keep on withdrawing at a higher and higher rate while the markets decline.

The other problem is five consecutive down years in the market right after you retire. That is straight up misery right there. Thankfully, this is unlikely to occur based on historical returns. Three consecutive down years is the worst we should really expect.

More Sequence Of Returns Risk Examples

The upshot is that after 15 years in retirement, the retiree still has 35% of their original retirement portfolio left. Not bad if you retired at 65. You don't want to die with too much money. Otherwise, you will have wasted all that time working to accumulate that money.

But if you had retired earlier, let's say at age 50, you're still only 65 years old. Therefore, it's up to you to figure out the proper way to best decumulate your assets, invest, and spend your money. I've actually got a post on decumulation coming up.

The best way to counteract sequence of returns risk is to start with a low withdrawal rate and slowly work your way up. The goal is to bank any investment overages to help you weather downturns. Of course, if you retire right before a big bear market, you can always try to get your old day job back like Tom Brady until the good times return.

Reader Questions

Readers, how are you prepared for sequence of returns risk? Is stagflation the worst-case scenario for new retirees? Are you worried about sequence risk at all given bear markets seem to last shorter than the average two years nowadays?

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About The Author

37 thoughts on “Sequence Of Returns Risk And How It Affects Your Retirement”

  1. I’m wondering if I’m misunderstanding your comments about dividend stocks. You mention 1-3% and I’m investing in ones with a 10-15% dividend yield.

    One of my problems that I just realized with fundrise is that the only portion of your return that is compounding is the dividend portion. So despite Fundrise claiming I made a gain of 24% last year, I calculated the dividend to be about 3%. Am I wrong in this idea?

    I’ve started to pivot towards stocks with 10%+ dividend yields, as I’d like to harness the power of compounding and I’m unsure if Fundrise will be able to do that easily.

  2. In 2013, our traditional investments were returning about 1% in our early 50’s. Decided we didn’t understand those well enough to depend on them for retirement. Not to mention 1% wouldn’t work. So we pulled back and invested 100% of our retirement savings (from 401K’s) in long term single family rental property. Almost all mortgage free. That returns 7-10%, plus appreciation, which is way more than anticipated.

    We fully retired about 2019. But is there a risk to this one horse retirement strategy? We are diversified in that we own enough property, one or two won’t take us down. We also have kept our expenses to a minimum. Our small 2/1 home is fully paid for, and the 1/1 cottage rental in the backyard basically pays taxes and insurance.

    Why post? I think this strategy might impact the safe withdrawal rate. Although, I’m not sure. No children, so no reason to leave a large legacy. Maybe we can afford a bigger place in retirement?

    1. With no kids, no debt, and strong cash flow, it sounds like your strategy works absolutely fine.

      The only negative may be a time and stress bent managing many physical properties.

  3. Ms. Conviviality

    Stagflation was on my mind this morning and I was wishing that the blog would address it. I knew I could count on FS for timely articles!

    I was planning on buying the stock market dips but was holding off to make sure it was the right move since I am “retiring” at the end of this year. If anything, it’s more like a sabbatical. If things don’t work out I would have no problem getting a job again with my organization.

    My stock market investments make up less than 10% of net worth so I had plans to build it up but with stagflation, not really motivated to do so. The new plan is to have cash reserves for two years. It will be nice to have a financial runway while I build my online business. Worst case scenario is that I go back to work for 8 years before taking pension benefits at age 52.

  4. “You’ll notice how the stock allocation declines with age and the bond allocation increases with age. Bonds are defensive investments that tend to outperform stocks when stocks decline.”

    Tricky time for bonds. Even with all this recent angst in 2022, SPY down 12.5% and BND still down 8.5%. Not like BND offering incredible protection. But more damning for Bonds is since August 2020 SPY, even in this bear market, still up 28% and BND down 9.7%. Think about that for a minute. BND is down almost 10% since aug 2020. and yield on BND about the same on SPY. BND price is same as 2014. SPY up 150% with almost 2% yield OUCH!!

    So with the premise of the article lets say you retired beginning of 2020 before the pandemic bear market and to protect your principal (seemingly), you shifted to more bonds. Your are now much worse off than leaving it in stocks. I understand it is an allocation and you aren’t recommending moving to all bonds, but in general for those who don’t want to spend their life monitoring financial markets, I think odds favor leaving vast majority in broad stock index vehicles. Have enough in cash to last for a year or two, maximum length of bear markets.

    The argument for bonds is very poor when vehicles like BND or not yielding substantially more than SPY. YOu would have to chase high-yield bonds to have any case, and well, then you are taking on more risk anyway.

    1. Bonds are more difficult to invest in at these compressed rates.

      March – May 2020 was the quickest bear market rebound in history.

      If you measure how bonds did during those months, they outperformed stocks and dampened volatility.

      And it’s good to differentiate between a bond ETF and holding individual bonds. Bond ETFs may be more volatile.

      Personally, I’ve allocated more of my defensive capital toward real estate instead of traditionally toward bonds. Real estate provides shelter, generates income, benefits from inflation, and does well when interest rates decline.

      Owning physical rental properties and investing in private real estate funds is my favorite way to build passive income.

      1. I’m 57 so not as applicable to me, but I don’t see much value in holding any bonds. I hold cash, real estate, and stocks. Cash allows me to let the stocks grow through good and bad times – no selling at lows cause of panic. A 250k HELOC on my paid-off $800k house is a true emergency fund and/or opportunity if I see another real estate investment opp similar to the opportunities in 2010-2012. I have a feeling the recession and inflation will pinch housing and open up some good opps next year. Looking for a lakehouse.

      2. Thank you Sam for sharing your opinions. I am a recent follower who saw your blog in summer 2020 for the first time due to interest in asset allocation topic. My husband and I are in our early 40s and we have two kids age 8 and 5. Our net worth is about $5M with $3M in real estate (one primary residence and two rental properties in San Diego) and $2M in equity investment.

        From the asset allocation chart you shared, we were at roughly 90/10 split for stocks/cash and this year after mid late Jan I have adjusted our split to 80/20. I want to ask you if it remains a good diversification to have a larger asset allocation to real estate as people get older.

        Real estate so far has offered a great diversification as it hedges against inflation and it produces passive rental income. I am hoping to work for another 15 years so we can both retire by 56/57 of age. I am wondering if it’s better to count on rental income for retirement so we worry less about stock market volatility.

        In addition, I think your advice on holding mostly Index ETF instead of individual tech stocks is a great advice, especially as people get close to retirement. The volatility from individual stocks has been so huge since Q4 last year and it probably isn’t something retirees can deal with when they enter the years of capital preservation.

        1. I’m a big fan of real estate. However, as I get older and usually wealthier, my tolerance for dealing with tenants and maintenance issues declines.

          Therefore, I recommended fining your physical rental property limit. Mine is three and one vacation property 100% managed by a property manager. Once you fill that limit, diversify through real estate ETFs, real estate stocks, and private real estate funds.

          I’ve mostly diversified through private real estate funds due to diversification into the heartland, passive income, and no visible volatility. Investing in real estate ETFs and property stocks can often be as volatile as stocks or more, which defeats a big purpose of holding real estate.

          Related post: How Real Estate Gets Impacted By A Decline In Stock Prices

  5. Excellent article and illustration!

    My takeaway is that the idea of retirement and *any* “safe withdrawal rate” (SFR) fundamentally relies on an unspoken assumption of having one’s portfolio benefit from the sheer mathematical power of compounding, i.e., SFR is only applicable with the understanding that the portfolio has grown sufficiently/will continue to grow. I would therefore argue that SFR for your “painful scenario” is therefore not applicable at all in the 5 year timeframe because no portfolio growth has been realized (and will only kick in *after* year 5 when the initial principal has grown a little bit).

    What should one do if they are close to retirement within that 5 year period, and not have the luxury to wait till the 5 year period is over?
    #1) The returns assumptions are highly volatile.. if your retirement portfolio is at risk of experiencing those fluctuations, it’s a good sign that you need to migrate towards a less volatile portfolio mix, being prepared to sacrifice returns to do so (think more real estate, less public equities; or within public equities, more dividend stocks, less growth stocks)
    #2) Be realistic. If your portfolio still has that kind of volatility then, very simply, you will not have *any* SFR. However else you might be able to live (social security, other investments, dividends, rents), do not count on SFR income

  6. “how are you prepared for sequence of returns risk?”

    By only using returns instead of capital.

    1. How do you use returns if returns are negative? That’s the whole point of sequence of returns risk, you face the rest that your returns go negative when it’s time for you to withdraw.

    1. I am adding to my positions in stocks and real estate. Back in 2018, when the S&P 500 close down about 5%, Fundrise client portfolios went up about 9%.

      Yes SP 500 down up to around 15% has provided for the biggest outperformance of real estate over stocks I have observed.

  7. A lot of people don’t know this, but Tom Brady stayed home recently and his wife asked him to take out the garbage and his kids asked him to help with math homework. That’s all it took.

    I’m looking at $1.5 trillion annual deficits, and 8% annual inflation, and wondering if grasshopper tacos are in my future!

    1. And just think of the collector who paid $518K for “Tom Brady’s final touchdown pass ball” hours before he decided to unretire.

      1. The good thing is the collector probably is worth at least $50 million, if not waaaaay more. I’m sure he’s doing fine!

        Buy buying Tom’s TD football is definitely a sequence of returns risk example too.

      2. Philly! Would it surprise any of us if it turned out to be Charlie Sheen, trying to get out from under that Bill Buckner ‘baseball investment’? NGMI!

  8. Simple Money Man

    Those are some eye-opening charts. How can rebalancing 3-5 years before retirement reduce this risk? I’m about 25 years away from 65 so am wondering when to start migrating from growth to balanced to income based investments in my portfolio that accounts for sequence of returns (I’m sure you have a chart from a past post). :-)

    1. Chuck Sarahan II

      You still have enough time to consider dropping on your knees and praying for a market meltdown. That way, you can buy assets cheap. It is what I tell all the young people coming into the stock market and to me 40 is young. BTW, I am 50 something.

      This article points to an interesting generational conflict when investing in the market. When you are young, you want it to drop to buy assets cheap. When you are old, just the opposite.

  9. What about a bucket strategy? Where you set aside a portion of assets to fund 5 years of required income and allowing the remainder to recover from downturns or replenish your conservative bucket w/ds in good times.

    1. Yes, definitely a good strategy to prevent you from having to sell after a correction. Although, holding that much cash may be tough in a high inflation environment.

      I don’t think future bear markets will last beyond three years. Two years max in my opinion. So two years cash would be the max I’d hold.

  10. Manuel Campbell

    I like this article. Better be more careful than not enough ! Our life is not like a video game we can reset if we don’t like the outcome.

    My goal is to get under 3% SWR. That would be much more secure than my current 4%. That would imply a ~33% portfolio increase. It’s not impossible. But it will take some time. Probably around 3-5 years.

    My ultimate worst-case scenario would be a bout of hyperinflation in the US/Canada. I think very few people could stay retired if that were to happen, including “traditional retirees” who receive a regular pension.

    To protect against this, I added some gold to my portfolio since 2020. I am now at 7.5% allocation. With the most recent events, I can say I am very happy with this change. But I don’t know if it will be a drag my portfolio returns in the long term. Maybe just investing in the best companies in the world would be a better idea. I am still considering what is best for the future.

      1. Manuel Campbell

        2020 – 18.8%
        2021 – 25.8%

        Surprinsingly, it was pretty close to the S&P500 for both years, although I have years of +/- 10% to 15% differences. Over time, I match the S&P500 performance. I would like to do better, but it’s very hard (almost impossible ?) to do.

    1. I decided to add some gold a few years ago as a diversification strategy (it tends to be uncorrelated with other asset classes). Just FYI- Over time, it does keep up with inflation but it sometimes takes years to catch up. As an example look at the 1 year return of the IAU ETF…it’s down slightly despite inflation running at 7+%

  11. Lost in the woods

    I am in my early 50s and have been preparing for 6+ years by doing the following:

    1.) Putting new investment dollars into higher dividend yielding companies (or those with growing dividends) rather than high growth stocks with no dividends as I had invested in in the past.

    2.) Increasing my exposure to real estate, primarily through REITs and one physical property.

    3.) I haven’t shifted to bonds in any meaningful way since they generate a negative real after tax return.

    One of my challenges has been what to do with stocks (including that of a former employer) which have heavily appreciated over the years. I didn’t sell much to re-balance my portfolio due to the tax implications, and now I am paying for that as the price declines (and now am hesitant to sell at the lower price).

    Despite a portfolio that is too heavily weighted to growth stocks, I am slowly increasing the income my portfolio generates. My goal is to use that income to fund most of my retirement expenses, requiring only modest asset sales to supplement.

    In hindsight, I should have begun the slow rebalancing a few years earlier, and been more willing to pay capital gains taxes on the sale of overweighted positions.

    I am now considering my next moves. Still hoping to get there soon.

    1. “1.) Putting new investment dollars into higher dividend yielding companies (or those with growing dividends) rather than high growth stocks with no dividends as I had invested in in the past.

      2.) Increasing my exposure to real estate, primarily through REITs and one physical property.”

      I like these moves. And obviously, having the ideal allocation in these two moves at the start of 2022 would have been better.

      But you preparing for 6+years already surely means you’ve done a lot to change your asset allocation to be more defensive before you retire right? When do you plan to call it quits?

      1. Lost in the woods

        Yes, I think the moves over the last 6+ years have been in the right direction, and maybe I was 80% there at the beginning of 2022 from a portfolio allocation perspective (with the exception of former company stock). I am now thinking ~2 more years. By then I hope my passive income will require only modest assets sales to supplement. But inflation is causing me to re-evaluate my spending needs. This part of the equation (drawdown rates, sequence of return risk, long term inflation predictions, etc.) is much more complicated than the first part (earn, save, invest).

  12. Thanks for the thorough explanations! This terminology is all new to me. Makes sense and definitely important to take into consideration. I’m somewhat worried but you make a good point on the shrinking duration of bear markets. That is a positive if the trend continues. But I don’t expect any guaranteed patterns. The markets and world events are so unpredictable!

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