Skip to content
Log in
← Glossary

sequence risk

Also called: sequence of returns risk

The risk that bad returns arrive right when you start withdrawing, which hurts far more than the same returns later.

Sequence risk, or sequence-of-returns risk, is the risk that bad returns arrive right when you start taking money out. If you neither add nor withdraw, the order of good and bad years doesn't change where you end up. Regular withdrawals change that: a fall in the first years forces you to sell more units at low prices, and those units aren't there to benefit from the recovery.

That's why two people with the same average return over 20 years can finish with very different amounts, depending only on when the bad years came. The risk is highest in the few years just before and after withdrawals start, when the pot is at its largest and there's the least time to recover.

Common ways to reduce it: keep the money for the first few years of withdrawals in safer assets such as short bonds or cash, so you don't have to sell stocks in a fall; be ready to take a little less in bad years; and shift the mix gradually as the date approaches. Each of these is a trade-off, not a rule.

Example

An illustrative case Grace builds for Zapas's withdrawal preview, with simple made-up numbers. A user starts with $100,000 and takes $10,000 at the end of each of three years. Two of the years return +10%; one is a crash of −30%.

Crash in the first year: $100,000 × 0.70 = $70,000, minus $10,000 = $60,000; × 1.10 = $66,000, minus $10,000 = $56,000; × 1.10 = $61,600, minus $10,000 = $51,600. Crash in the last year: $100,000 × 1.10 = $110,000, minus $10,000 = $100,000; the second year repeats that; then × 0.70 = $70,000, minus $10,000 = $60,000. The early crash leaves $8,400 less. Without withdrawals both cases end at $100,000 × 1.10 × 1.10 × 0.70 = $84,700. Illustrative numbers, not market data.

Common mistakes

  • Judging a withdrawal plan only by its average return.
  • Keeping all the money for the first withdrawal years in stocks.
  • Treating a fixed withdrawal rate as a safe rule rather than a trade-off.
  • Forgetting that sequence risk also hits a big planned withdrawal, such as a down payment, not only retirement.

Learn it in the course