Sequence-of-returns risk is the danger that poor market returns arrive in the first years of retirement, while you are withdrawing. Two retirees with identical average returns can end up decades apart in outcome depending purely on the order those returns came in.
Average return is the number everyone quotes and, for someone taking money out, one of the least useful. What determines whether a retirement plan survives is not the average — it is the order.
This is sequence-of-returns risk, and it is arguably the single largest threat to an otherwise sound retirement plan.
Why the same average produces different outcomes
Take two retirees with the same starting balance, the same withdrawals, and the same average annual return over thirty years. Give one of them their worst years at the beginning and the other their worst years at the end.
The second finishes comfortably. The first can run out of money years or decades earlier. Nothing differed except the order, and no amount of investment skill in year twenty compensates for what happened in year two.
The mechanism: selling shares that never come back
While accumulating, a downturn is close to good news — you keep buying at lower prices. The mechanism reverses the moment withdrawals start.
Selling to fund living expenses during a decline permanently removes shares from the portfolio. Those shares are not there for the recovery. The portfolio is smaller when the rebound arrives, so the rebound is worth less, and the effect compounds against you for the rest of the plan.
Why average return is a misleading planning input
A projection that applies a smooth assumed return every year describes a path that has never occurred and cannot occur. It systematically understates the risk faced by anyone withdrawing.
This is why we care about the range of outcomes rather than a single line, and why the question worth asking about any plan is not what it does in an average decade but what it does if the first three years are poor.
What actually mitigates it
Flexibility, mostly. A bucket approach — holding several years of spending in stable, short-duration assets — means a decline is funded from the reserve rather than by selling depressed holdings.
Spending guardrails do the other half: a defined rule that adjusts withdrawals when the portfolio moves outside set boundaries, decided in advance rather than under stress. Together they address the specific mechanism rather than trying to predict the market.
This risk is concentrated in a window — roughly the five years either side of your retirement date — and it is largely manageable if the plan anticipates it. What it is not is something to discover after the fact. If your plan has no defined answer for a poor first three years, that is the gap worth closing before you need it.