July 28, 2026
Two investors who’ve invested the same principal can earn the same average return over 30 years, yet experience entirely different financial outcomes in retirement. Sequence of returns risk is often the reason why, and it is a commonly overlooked concept in retirement planning.
During the accumulation years, the order of returns barely matters. A bad year early or a bad year late produces roughly the same ending balance if no money is moving in or out. The math changes the moment withdrawals begin.
Why Return Order Matters Once Withdrawals Start
When a portfolio is used to fund living expenses or cash flow needs, every withdrawal during a portfolio downturn locks in losses. Once shares have been sold, they no longer participate in any subsequent recovery. According to Investopedia, this is why the timing of withdrawals relative to market declines can meaningfully affect how long a portfolio lasts, even when long-term average returns are identical.
A portfolio downturn in the first three to five years of retirement has the most meaningful consequences. This is typically when portfolios are at their largest, withdrawals are just beginning, and there is increasingly less time to recover.
A Simple Illustration
Consider two hypothetical retirees, each starting with $2,000,000 and withdrawing $100,000 per year. Both earn the same average return over 25 years. Retiree A experiences a 20% decline in years one and two. Retiree B experiences the identical decline in years 24 and 25.
Retiree A is withdrawing from a portfolio that has fallen to roughly $1,400,000 within two years, so each withdrawal represents a much larger percentage of what remains. Retiree B spent two decades compounding first. Same average return, dramatically different ending balances, and in severe cases, one portfolio depleted years earlier than the other.
Reaching a net worth target is not the finish line. How the drawdown is structured can matter as much as the number itself.
How Adequate Planning Can Mitigate Sequence of Returns Risk
Managing sequence of returns risk is less about predicting markets and more about building a plan that can absorb bad timing. A financial plan that’s built to withstand include market fluctuations is one that may include:
- Cash reserves covering one to three years of expenses, so withdrawals can pause during declines
- Allocation shifts in the years approaching retirement to reduce early drawdown exposure
- Coordinating equity compensation and retirement timing so vesting income can offset early portfolio withdrawals
- Managing cash flow volatility so spending is not forced onto the portfolio at the wrong moment
Because withdrawal sequencing also carries tax consequences, coordinating with your Certified Public Accountant (CPA) can help align the drawdown order across taxable, tax-deferred, and tax-free accounts.
If you would like to discuss how your retirement plan accounts for sequence of returns risk, feel free to Contact Spectrum Asset Management to learn more.
Disclaimer: This material is for informational and educational purposes only and should not be construed as personalized investment, legal, or tax advice, or as a recommendation of any specific security or strategy. All investing involves risk, including the potential loss of principal. Hypothetical examples are for illustrative purposes only and do not represent actual client results. Consult your financial, legal, and tax professionals regarding your personal circumstances. Spectrum Asset Management, Inc. (SAM) is an SEC-registered investment adviser headquartered in Newport Beach, California. SAM is not affiliated with any other firm using a similar name.
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Sequence of returns risk is the danger that the order of investment returns, not the average, determines how long a portfolio lasts once withdrawals begin. The risk only exists when money is being withdrawn; during accumulation, return order has almost no effect on the ending balance.
The first three to five years of retirement carry the greatest exposure. Portfolios are typically at their largest, withdrawals have just started, and there is the least time remaining to recover from a decline. A downturn in year 24 of a 25-year retirement affects a portfolio that has already compounded for two decades, while the same downturn in year one forces every withdrawal to consume a larger percentage of what remains.
A common approach is holding cash reserves covering one to three years of expenses, which allows portfolio withdrawals to pause during a decline rather than locking in losses. The right amount depends on fixed spending, other income sources such as deferred compensation distributions or final RSU vesting tranches, and overall portfolio size. Individual situations vary, so the reserve target should be set within a broader withdrawal plan.
It matters less than in retirement, as long as no money is leaving the portfolio. If nothing is moving in or out, a bad year early and a bad year late produce roughly the same ending balance. The math changes the moment withdrawals begin, which is why the years immediately before and after a retirement date deserve the most planning attention.
They can, if timed deliberately. Final Restricted Stock Unit (RSU) vesting tranches or Nonqualified Deferred Compensation (NQDC) distributions scheduled for the first years of retirement can fund living expenses and reduce or delay portfolio withdrawals during the highest-risk window. Coordinating vesting schedules, distribution elections, and a retirement date is one of the more direct ways an executive can blunt early-drawdown exposure.
Yes, because withdrawal sequencing determines both the tax cost of each dollar spent and which assets are sold during a decline. Drawing from taxable accounts or cash first can leave tax-deferred assets compounding longer, while poorly timed withdrawals can push income into higher brackets. Coordinating the drawdown order with your Certified Public Accountant (CPA) helps align tax outcomes with the withdrawal plan.
