Two retirees can each average an 8% annual return over the same 30-year retirement and end up with wildly different outcomes. One is comfortable. One runs out of money by year 20. The difference isn’t the average return at all. It’s the order in which the good and bad years arrive. That problem is called sequence of returns risk, and it hits hardest in the first several years after you stop working.
Why the order of returns matters more than the average
While you’re still working and contributing to a portfolio, the order of market returns barely matters. New contributions keep buying shares at whatever price is available, good or bad. Once withdrawals start, that logic flips.
Selling shares to fund living expenses during a market downturn locks in losses permanently. Those shares are gone. They can’t recover when the market eventually rebounds. Retirement researcher Wade Pfau has written extensively on this dynamic. He’s shown that two portfolios with identical average returns but reversed sequences, strong early years versus weak early years, can produce dramatically different ending balances. The only difference is when the withdrawals overlapped with the downturns.
Morningstar’s retirement research has made a related point using its “safe withdrawal rate” studies. The widely cited 4% rule was built on historical sequences. In years when retirement begins right before or during a market decline, the safe starting withdrawal rate can fall meaningfully below that historical benchmark. The risk is concentrated almost entirely in the first five to ten years of retirement. A downturn in year 25 does far less damage than the same downturn in year one or two.
Building a buffer against bad timing
The standard defense is holding one to three years of planned withdrawals in cash or short-term bonds. That way, a market downturn doesn’t force you to sell stocks at depressed prices. During a down year, you draw from that buffer instead of selling equities. The stock portion of your portfolio gets time to recover before you need to touch it again.
Some retirees also build flexibility into their spending. They plan to trim discretionary expenses during a downturn rather than withdrawing a fixed amount regardless of market conditions. A retiree who can cut travel or dining spending by 10-15% in a bad year gives the portfolio room to breathe.
A bucket strategy is a common structural way to implement this. Split the portfolio into near-term cash, medium-term bonds, and long-term growth assets. When stocks are down, you spend from the cash bucket. When stocks are up, you refill the cash bucket from gains. This approach doesn’t require timing the market or predicting when the next downturn will hit. It just requires deciding in advance which bucket to draw from under which conditions.
Why early retirees face more of it
Someone retiring at 45 or 50 has a longer time horizon exposed to this risk than someone retiring at 65. There are simply more early years for a bad sequence to strike during. A 30-year retirement has more chances for a bad first decade than a 15-year one.
This is one reason early retirement plans built around a fixed withdrawal percentage, without a cash buffer or spending flexibility, are more fragile than they look on a spreadsheet. The spreadsheet uses long-run average returns. Real markets don’t deliver averages. They deliver sequences.
The FIRE community has learned this the hard way. Many early retirement plans were built on backtests showing a 4% withdrawal rate surviving every historical period. What those backtests hide is that some periods came close to failing. The retirees who made it through were the ones with flexibility, not the ones who stuck rigidly to a fixed withdrawal.
Understanding how withdrawal timing interacts with actual returns, not average ones, is closely related to how portfolios are measured in the first place. See this explanation of dollar-weighted return versus time-weighted return for the mechanics behind why the timing of cash flows changes real-world results.
What to do before you retire
The years right before retirement are the most dangerous. A market crash at age 63 is far worse than one at age 43, because you have less time to recover and you’re about to start withdrawing.
A few practical moves for the five years before retirement. Shift some assets into bonds or cash to cover the first few years of withdrawals. Consider delaying retirement by a year or two if the market drops sharply right before your target date. Build a cash cushion that covers at least two years of expenses. And stay flexible on spending, especially in the first decade.
None of this eliminates the risk. Nobody can control when a bear market arrives. But the planning matters most in the years immediately surrounding your retirement date, not decades into it.
