Sequence-of-returns risk

Explanation

If you invest a lump sum and never add or withdraw, the order of returns does not matter: 1.10 × 0.80 gives the same result as 0.80 × 1.10. Once you add withdrawals, it matters a lot. Money you withdraw after a crash is taken from a shrunken portfolio, so each dollar of spending uses up more of your shares. Those shares are gone before the recovery arrives.

This is why two retirees with the same average return can have very different outcomes, and why many historical failures of the 4% rule trace back to bad markets (or high inflation) in the first five to ten years of retirement. The same logic works in reverse while you are saving: poor returns early, when your balance is small, matter less than poor returns near retirement, when your balance is largest.

Ways people manage it:

• Lower or flexible withdrawal rates (such as guardrails)
• A cash or bond buffer to avoid selling stocks after a crash
• A “bond tent”: holding more bonds around the retirement date and shifting back toward stocks later
• Part-time income or delaying retirement after a bad start
• Guaranteed income (Social Security, pensions, annuities) covering essential expenses

In scenarios, deterministic projections with a steady average return hide this risk. Monte Carlo mode exposes it by testing thousands of different return orders, and you can also run a “bad start” stress test.

Example

Two retirees each start with $1,000,000 and withdraw $50,000 at the start of each year. Both experience the same five annual returns, −20%, −10%, +10%, +15% and +25% (an average of 4%), but in opposite order.

Year	Retiree A return	A balance	Retiree B return	B balance
1	−20%	$760,000	+25%	$1,187,500
2	−10%	$639,000	+15%	$1,308,125
3	+10%	$647,900	+10%	$1,383,938
4	+15%	$687,585	−10%	$1,200,544
5	+25%	$796,981	−20%	$920,435

Same returns, same withdrawals, but Retiree A ends with $123,454 less because the losses came first. Without withdrawals, both would end with exactly $1,138,500.