If you've ever worried about market timing (not in the day-trading sense, but in the "what if I retire right before a crash?" sense), you've already encountered sequence risk. You just might not have known it had a name.
Sequence risk is one of those investing concepts that sounds abstract until it happens to you. Then it becomes painfully real. The good news? Once you understand it, you can actually do something about it. And you won't need a PhD in mathematics or a lucky rabbit's foot.
What Is Sequence Risk?
Sequence risk, also called sequence-of-returns risk, is the danger that poor investment returns early in your withdrawal period will permanently damage your financial outcome, even if long-term returns are fine.
Here's the key insight: when you're taking money out of a portfolio, the order of returns matters as much as the average return. It's like how the order of ingredients matters when baking a cake. You can't just throw everything in at once and hope for the best.
Let's make this concrete with two investors:
Investor A retires in 2000, right before the dot-com crash and the 2008 financial crisis. They experience terrible returns in their first decade of retirement. (Tough luck, Investor A. We feel for you.)
Investor B retires in 2009, right after the crash, and enjoys the spectacular bull market of the 2010s. (Nice timing, Investor B. Buy a lottery ticket while you're at it.)
Both investors had the same portfolio, the same withdrawal rate, and experienced the exact same returns, just in reverse order. But Investor A runs out of money years before Investor B does.
That's sequence risk. Same ingredients, different order, wildly different outcomes.
Why Does This Happen?
When you're withdrawing money from a declining portfolio, you're locking in losses. You sell more shares to meet your cash needs, leaving fewer shares to participate in the eventual recovery.
It's the reverse of dollar-cost averaging. Instead of buying more shares when prices are low (the good kind of shopping), you're forced to sell more shares when prices are low (the "I need to pay my mortgage" kind of shopping). And those shares are gone forever. They're not coming back. They've moved on to someone else's portfolio.
Think of it this way: losing 50% in year one and gaining 50% in year two sounds like you'd break even, right? Math class taught us that, didn't it?
Wrong.
If you started with $100,000 and withdrew $5,000 after the first year's 50% loss, you'd have $45,000 left. A 50% gain on $45,000 only gets you back to $67,500, not the $95,000 you'd have without withdrawals. Surprise! Math is mean.
The math gets brutal when you combine market losses with portfolio withdrawals. It's like trying to fill a bathtub while someone keeps pulling the drain plug.
When Does Sequence Risk Matter Most?
Sequence risk doesn't affect everyone equally. It matters most when:
You're near or in retirement. The decade before and after retirement is called the "retirement red zone" for good reason. Poor returns during this period have an outsized impact on how long your money lasts.
You have a fixed timeline. Whether it's a planned purchase, a business investment, or a career transition, any situation where you know you'll need the money at a specific time exposes you to sequence risk.
You're making regular withdrawals. The combination of withdrawals plus poor returns is what creates the problem. If you're still adding money to a portfolio, you're actually buying low—which is good.
You have limited flexibility. If you can't adjust your withdrawal rate or delay your timeline when markets drop, you're more vulnerable. Retirees on fixed budgets or people with immovable deadlines face higher sequence risk.
The Retirement Timing Lottery
One of the most sobering aspects of sequence risk is how arbitrary it can be. Two people who save diligently, invest wisely, and do everything "right" can have dramatically different outcomes based purely on when they were born.
Someone who retired in 1999 faced the dot-com crash, 9/11, and then the 2008 financial crisis within their first decade. That's like ordering a sandwich and getting food poisoning, then trying again and getting food poisoning again. Brutal.
Someone who retired in 2010 enjoyed one of the longest bull markets in history. Same sandwich shop, completely different experience.
Same strategies. Different luck. Welcome to the retirement lottery, where the prize is "did you pick the right decade to be born?"
This is why "just invest in stocks for the long term" doesn't work for everyone. Once you have a timeline (whether for retirement, a home purchase, or any major life goal), your relationship with market volatility changes completely. Volatility stops being an abstract concept and becomes "can I still afford this thing I've been planning for years?"
How to Manage Sequence Risk
The good news is that sequence risk isn't something you just have to accept. There are proven strategies to reduce it:
1. Build a Cash Buffer
Keep 1-3 years of expenses in cash or cash equivalents. This lets you avoid selling stocks during a downturn. Instead of locking in losses, you can spend from your buffer while your portfolio recovers.
This is boring. It feels inefficient in good markets. It's like wearing a seatbelt when you haven't had an accident in years. But it's insurance against being forced to sell at exactly the wrong time. And when that crash does hit, you'll feel like a genius for having it.
2. Create a Glide Path
Rather than maintaining a fixed allocation, gradually reduce stock exposure as you approach your goal. Think of it as landing an airplane. You don't drop altitude all at once (unless you're a terrible pilot, in which case, please don't fly planes).
For retirement, this might mean starting at 80% stocks at age 50 and gradually shifting to 60% by age 65. The goal isn't to eliminate volatility but to reduce it when it matters most. You're still on the plane, you're just descending at a controlled rate instead of doing a nosedive.
3. Use Medium-Term Portfolios Thoughtfully
Money you'll need in 2-7 years occupies an awkward middle ground. Too long to keep entirely in cash (you'll lose purchasing power), but too short to invest like it's retirement money.
This is where dedicated medium-term strategies become valuable. Rather than guessing or treating medium-term money like long-term money, you can design portfolios specifically around your timeline and risk tolerance. If you're interested in a systematic approach to this, this guide on where to park money you'll need in 2-7 years provides specific portfolio frameworks and a rebalancing spreadsheet built around managing sequence risk in the medium term.
4. Be Flexible with Withdrawals
If you have any ability to adjust your spending during down markets, use it. Even small reductions in withdrawal rates during the first few years of retirement can dramatically improve long-term sustainability.
Consider the 4% rule with a twist: in years when the portfolio is down, withdraw 3.5%. In years when it's up significantly, give yourself permission to spend a bit more. This flexibility alone can help navigate sequence risk.
5. Consider Delayed Retirement or Phased Retirement
If you're approaching retirement and markets drop significantly, even a 1-2 year delay can make an enormous difference. You're not withdrawing during the downturn, and you're giving your portfolio time to recover. Yes, working another year when you're ready to retire is about as fun as a root canal, but it beats running out of money at age 85.
Similarly, phased retirement (where you work part-time and make smaller portfolio withdrawals) can dramatically reduce sequence risk. You're pulling less money out, which leaves more capital invested to recover. Plus, you get to ease into retirement instead of going from 100 mph to zero overnight, which is probably better for your mental health anyway.
The First Five Years Are Critical
Research consistently shows that portfolio outcomes are largely determined by the first five years of retirement. If you experience strong returns early, you're likely in good shape even if later returns are mediocre. If you experience poor returns early, even strong later returns may not be enough to recover.
This is counterintuitive. We tend to think of retirement as a 30-year period where everything averages out. But because of sequence risk, the early years carry disproportionate weight.
The practical implication: be extra conservative early in retirement. You can always increase risk later if your portfolio is doing well. But you can't undo the damage of withdrawing too much during a bear market.
Beyond Retirement: Sequence Risk in Daily Life
While sequence risk is most commonly discussed in retirement contexts, it applies to any situation with a fixed timeline:
Saving for a home down payment. If you're planning to buy in 3 years and the market crashes in year 2, you're either delaying your purchase or accepting a much smaller down payment. "Sorry, honey, we can only afford the house with the mysterious stains and questionable wiring now."
Funding a child's education. College doesn't wait for markets to recover. If your 529 plan drops 30% the year before freshman year, you're paying tuition with depleted savings. Your kid's acceptance letter doesn't come with a "please wait for the market to bounce back" option.
Starting a business. If you've saved for years to launch a business and need to liquidate investments during a downturn, you're starting with less capital, or postponing your dream. Nothing says "entrepreneurial spirit" like watching your startup fund shrink by 40% before you even start.
Bridge funds for early retirement. Many early retirees plan to live off portfolio withdrawals until Social Security or pensions kick in. A market crash during this bridge period can derail everything. Turns out "retire early" has an asterisk that says "market conditions permitting."
In each case, the problem is the same: a forced timeline combined with market volatility. Life doesn't care that the market is down.
What Sequence Risk Isn't
It's worth clarifying what sequence risk is not:
It's not about avoiding risk entirely. Staying 100% in cash guarantees you'll lose purchasing power to inflation. That's not safety, that's slow-motion financial decline with a government guarantee.
It's not the same as market risk. Market risk is about volatility in general. Sequence risk is specifically about the timing of that volatility relative to when you need the money. One is "markets go up and down," the other is "markets went down exactly when I needed them to go up."
It's not an excuse for market timing. You can't predict when markets will crash. Anyone who tells you they can is either lying or selling something (or both). Managing sequence risk is about reducing vulnerability to bad timing, not predicting or avoiding it. You're building a better seatbelt, not trying to predict which roads have potholes.
The Bottom Line
Sequence risk is the reason why retirement planning isn't just about hitting a number. It's why "time in the market beats timing the market" has limits, because eventually, you run out of time. Turns out infinity isn't actually an investment timeline.
The good news is that you don't have to get the timing perfect. You just need to build portfolios and withdrawal strategies that can survive imperfect timing. Use cash buffers, adjust your asset allocation thoughtfully, maintain spending flexibility where possible, and match your investment strategy to your actual timeline.
Most importantly, recognize that money with different time horizons deserves different strategies. What works for a 25-year-old saving for retirement in 40 years doesn't work for someone who needs the money in 5 years. And that's okay. Your 25-year-old self and your 60-year-old self are basically different people with different needs. Plan accordingly.
Understanding sequence risk won't eliminate it, but it will help you plan around it. And in investing, that's often the difference between a comfortable outcome and a stressful one. Or as we like to call it, the difference between "enjoying retirement" and "working as a Walmart greeter at 75."
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