Order of Returns Risk: Why the Sequence of Market Returns Matters More Than the Average

Here’s a financial concept that doesn’t get nearly enough attention — and it could be the single biggest threat to your retirement portfolio that your 401(k) statement never tells you about.

It’s called sequence of returns risk (or “order of returns risk”), and it explains why two people with identical average investment returns over 30 years can have completely different retirement outcomes — one running out of money and one leaving a substantial estate.

The difference isn’t luck. It’s when the bad years happened.

The Average Return Lie

Let’s start with a common misconception.

Most financial illustrations show you an “average annual return” — say, 7% per year over 30 years. It looks great on paper. But here’s what the illustration doesn’t show: the order in which those returns occur matters enormously when you’re withdrawing money.

During your accumulation years (while you’re working and saving), order of returns doesn’t matter much. Up years and down years average out over time, and you’re not pulling money out — you’re adding to it.

During your distribution years (when you’re drawing income from your portfolio), it matters tremendously. A bad sequence of returns early in retirement can permanently and catastrophically damage your portfolio — even if the average return over your full retirement looks fine on paper.

The Two Retirees: A Tale of Two Sequences

Meet Robert and Patricia. Both retire at age 65 with $500,000 in their investment portfolios. Both plan to withdraw $30,000 per year (6% withdrawal rate). Both experience the exact same set of annual returns over 25 years — just in reverse order.

Robert’s sequence: Starts with a terrible market (years 1–5: -15%, -10%, -8%, +3%, +5%), then recovers beautifully in later years.

Patricia’s sequence: Starts with an excellent bull market (years 1–5: +18%, +22%, +15%, +12%, +10%), then hits the same downturns in years 20–25.

The result:

Robert runs out of money by age 82 — despite the same average return
Patricia’s portfolio has nearly $800,000 remaining at age 90

Same starting balance. Same withdrawal rate. Same average return. Completely different outcomes — because of sequence.

Why This Happens

When you’re taking withdrawals and the market drops, you’re forced to sell more shares to generate the same dollar amount of income. Those shares are gone permanently. They can’t participate in the recovery.

Early losses + ongoing withdrawals = a death spiral your portfolio may never escape.

Here’s the math in simple terms:

Portfolio drops 30% in Year 1: $500,000 → $350,000
You withdraw $30,000: down to $320,000
Market recovers 30% in Year 2: $320,000 → $416,000
You withdraw $30,000: down to $386,000
You’re already $114,000 behind where you started, and you’ve only withdrawn $60,000

The portfolio may never catch back up. Every subsequent withdrawal is taken from a permanently reduced base.

The 4% Rule and Why It May Not Protect You

The widely cited “4% rule” — withdraw 4% of your portfolio per year and you won’t run out of money — was developed in the 1990s based on historical market data. It assumed a 30-year retirement horizon and a balanced portfolio.

There are two problems with relying on it today:

Problem 1: Today’s retirees often live 30–35 years in retirement. A 65-year-old couple has more than a 50% chance that at least one of them will live past 90. The 4% rule wasn’t designed for a 35-year horizon.

Problem 2: It doesn’t protect against sequence of returns risk. The rule works beautifully if your early years are strong. But if you retire into a down market — like 2000 or 2008 — the math breaks down, and your portfolio may fail even at 4%.

Three Ways to Reduce Sequence of Returns Risk

1. Build a Guaranteed Income Floor

The single most effective defense against sequence of returns risk is not needing to sell investments in a down market.

If your essential living expenses are covered by guaranteed income — Social Security, a pension, or an annuity with a lifetime income rider — you don’t have to touch your investment portfolio when the market drops. You wait for the recovery. Your shares stay intact.

This is why financial economists consistently show that annuities reduce sequence of returns risk more effectively than any portfolio allocation strategy. You’re not eliminating market risk — you’re eliminating the forced selling that turns temporary losses into permanent ones.

2. Bucket Strategy

Divide your retirement assets into time-segmented “buckets”:

Bucket 1 (0–3 years): Cash and short-term bonds for near-term withdrawals — never touch the growth assets for current expenses
Bucket 2 (4–10 years): Conservative growth assets; intermediate bonds, dividend stocks
Bucket 3 (10+ years): Long-term growth assets — equities, real estate

When the market drops, you draw from Bucket 1 and give Bucket 3 time to recover. But this strategy requires discipline and active management — and doesn’t eliminate the risk, just manages it.

3. Dynamic Withdrawal Strategy

Reduce withdrawals in down years — spend a bit less when the market is underperforming. This preserves shares and allows recovery. The challenge: this requires flexibility in your lifestyle spending, which not everyone has (or wants).

The Best Strategy: Combine Guaranteed Income and Flexibility

Most effective retirement income strategies combine elements of all three approaches:

Guaranteed income (annuities + optimized Social Security): Covers fixed living expenses — removes the need to sell in down markets
Bucket strategy: Stages the remaining assets for growth
Dynamic flexibility: Gives you discretionary spending that can flex up or down based on portfolio performance

The guaranteed income layer is the anchor. Everything else gets to grow.

Is Your Retirement Plan Protected Against Sequence of Returns Risk?

If your retirement income plan relies entirely on portfolio withdrawals — with no guaranteed income floor — you’re exposed to sequence of returns risk. One bad bear market in your first five years of retirement could permanently alter your financial trajectory.

The time to address this is before you retire. The closer you are to retirement, the more important it becomes to evaluate your exposure.

At Legacy Wealth Services, we help pre-retirees and retirees build income strategies that specifically address sequence of returns risk — using a combination of optimized Social Security timing, guaranteed income annuities, and strategic asset allocation.

Request a complimentary Retirement Income Risk Assessment to see how your current plan stacks up.

📞 Call or text: 503-832-8555 🌐 LegacyWealthServices.com

Rodney Cummings, Licensed Insurance Agent | OR License #18847712 | Licensed in 22 States