Sequence of Returns Risk: Why Your First 5 Years of Retirement Matter Most

Imagine two retirees who each start with $1 million, spend the same amount, and invest in the same funds. Over 25 years, they experience the exact same yearly market returns, but in a different order.

Despite having the same average return over the period, one retiree's portfolio continues to grow, while the other's runs completely dry.

This scenario is caused by sequence of returns risk. It's a critical concept in retirement planning, and it highlights why relying on a single "average" return rate can lead to inaccurate projections.

What Is Sequence of Returns Risk?

In plain English: bad years hurt more when they come early.

While you're working and saving, the order of returns barely matters. A crash when you're 35 is almost a gift. You keep buying stocks on sale and you have decades to recover.

Retirement flips that around. Now you're selling every year to pay for groceries. If the market drops 30% in your first year, you're forced to sell more shares at low prices to get the same cash. Those shares are gone. They aren't there for the recovery.

Think of it like a leaky bucket. A small leak in a full bucket is fine. The same leak in a half-empty bucket drains it fast.

The Same Returns, Two Very Different Retirements

Let's make the riddle concrete. We ran two retirees through our simulator. Both:

• Retire at 65 with $1,000,000 in a 60/40 stock and bond portfolio
• Spend $50,000 a year, rising with 3% inflation
• Get $24,000 a year of Social Security starting at 67

Both get the actual S&P 500 returns from 2000 to 2024. The only difference is the order.

Retiree A walked straight into the dot-com crash and then 2008. They lost nearly 30% of their nest egg in the first five years, while still withdrawing $50,000 or more every year. The great years came later, but by then there wasn't enough money left to ride them back up.

Retiree B got the boom years first. Their portfolio grew big enough that the crashes later on were survivable dents instead of fatal wounds.

Same returns. Same average. Completely different lives.

Why Averages Lie

This is why we built the simulator around Monte Carlo simulations instead of a single average return.

A simple calculator assumes you earn the average every single year. In that world, sequence risk doesn't exist, and every plan looks safer than it really is.

Monte Carlo replays history thousands of times in random orders. Some runs start with a crash, some start with a boom. Your success rate is simply the share of those runs where your money lasts. That number has sequence risk baked right in.

The Danger Zone: Five Years Before and After You Retire

Researchers call it the "retirement red zone." Roughly the five years on either side of your retirement date are when your portfolio is biggest and your ability to recover is smallest.

A 30% drop at 40 is a temporary setback. A 30% drop at 66, while you're withdrawing, can permanently lower what you can safely spend.

How to Protect Yourself

You can't control the order of returns. You can control how exposed you are to them.

1. Stay flexible with spending. This is the big one. If you trim spending by 10% after a bad year, you sell fewer shares at the bottom. Our guide to safe withdrawal rates explains the "guardrails" approach.
2. Keep a cash or bond buffer. One to three years of spending in safer assets means you don't have to sell stocks in a crash. You spend the buffer and give stocks time to recover. (More on balancing this in asset allocation for retirement.)
3. Delay Social Security, if you can. A bigger guaranteed check later means you lean less on your portfolio for life. See when to claim Social Security.
4. Work a little longer, or a little part-time. Even modest income in the first few years of retirement reduces how much you have to sell when prices are low.
5. Start with a slightly lower withdrawal rate. Starting at 3.5% instead of 4% gives you a lot more margin if the early years are rough.

See It for Yourself

You don't have to take my word for it. The simulator has a Historic Cycle mode that replays actual market history starting from any year you pick.

Open the scenario below. It starts the retirement in 2000. Then change the Start Year to 1982 and run it again. Same person, same plan, different luck. It's a little unsettling, and that's the point.