Sequence of Returns Risk in Retirement Explained
November 5, 2026
Why the Order of Investment Returns Matters in Retirement
Understanding how withdrawals and early losses can change the path of retirement savings
A retirement portfolio’s path matters when money is being withdrawn along the way.
Two retirement portfolios can experience exactly the same annual percentage returns in a different order and finish with different balances. The reason is withdrawals. Money taken out after an early decline is no longer available to participate in a later recovery. [1]
This is called sequence-of-returns risk. It matters when savings are funding regular expenses, particularly near the beginning of a long retirement. An average return cannot show whether the difficult years arrive before or after a substantial portion of the money has been withdrawn. [1]
Key takeaways
- The timing of gains and losses interacts with the timing and size of withdrawals. [1]
- A portfolio can distribute the same spending dollars and still end with a different balance because the return sequence changed.
- A fixed dollar withdrawal becomes a larger percentage of the remaining portfolio after a decline.
- Spending flexibility, investment mix, liquidity, and outside income are separate parts of a retirement-income plan. [2,3]
A two-year example with the same returns
Assume two hypothetical portfolios each begin with $1,000,000. Each pays out $40,000 at the end of each year, after that year’s investment return. Both experience one year of −20% and one year of +20%. Only the order changes.
| Step | Loss first | Gain first |
|---|---|---|
| Starting balance | $1,000,000 | $1,000,000 |
| Year 1 return | −20% | +20% |
| Year 1 value before withdrawal | $800,000 | $1,200,000 |
| Year 1 withdrawal | −$40,000 | −$40,000 |
| End of Year 1 | $760,000 | $1,160,000 |
| Year 2 return | +20% | −20% |
| Year 2 value before withdrawal | $912,000 | $928,000 |
| Year 2 withdrawal | −$40,000 | −$40,000 |
| End of Year 2 | $872,000 | $888,000 |
Table note: Original hypothetical calculation. Returns include all investment income; there are no additional cash flows, taxes, fees, or inflation adjustments. The example illustrates mechanics over two years, not a sustainable lifetime withdrawal rate.
Both portfolios distributed $80,000, yet the loss-first portfolio ends $16,000 lower. The first $40,000 withdrawal occurred before a 20% gain in one case and before a 20% loss in the other. Changing what remains invested changes the dollar outcome.
Without withdrawals, both would finish at $960,000: $1,000,000 × 0.80 × 1.20. The simple average of −20% and +20% is zero, but the compounded return is −4%. That compounding effect is separate from the additional $16,000 difference created by the withdrawal sequence.
A withdrawal removes resources that otherwise would participate in later investment returns.
Why early losses deserve attention
Regular withdrawals reduce the amount left to grow. If they occur while values are depressed, a subsequent gain applies to a smaller remaining base. The issue becomes more consequential when many future years of expenses still depend on that money. It does not mean every early loss leads to depletion. [1]
In the example, the planned $40,000 withdrawal initially equals 4% of $1,000,000. Relative to the $760,000 balance after the first loss and withdrawal, the same $40,000 is about 5.26%. The dollar amount has not changed, but it represents a larger share of what remains.
This also explains why a spending assumption should not be described only as “four percent.” Four percent of the initial balance, adjusted later for inflation, is different from four percent of the current balance each year. Those approaches produce different spending paths. [2]
Start with the amount the portfolio must provide
The retirement budget and the portfolio withdrawal are not necessarily the same amount. Social Security, pensions, employment, or other income may cover some expenses. The remaining gap is the amount that must come from savings, with additional attention to taxes and timing.
| A hypothetical spending gap: Suppose annual after-tax spending is $72,000 and spendable income from Social Security and a pension is $48,000. The remaining after-tax gap is $24,000. A withdrawal from a taxable retirement account may need to be larger than $24,000 to cover both the gap and its tax cost. These amounts are illustrative. |
A useful budget separates recurring essentials, flexible spending, and irregular expenses. A property-tax bill or a replacement vehicle should not disappear merely because the plan is expressed as a monthly average. The cash calendar makes the withdrawal assumption more realistic.
Different spending rules have different trade-offs
| Approach | How it works | What the household must absorb |
|---|---|---|
| Dollar amount adjusted for inflation | Starts with a dollar withdrawal and updates it for inflation. | Market declines can make the withdrawal a larger share of savings. |
| Percentage of current portfolio | Recalculates spending from the current balance. | Income can fall when the portfolio falls. |
| Flexible spending rules | Adjusts withdrawals within stated limits as conditions change. | Some spending cuts may still be needed; limits can constrain flexibility. |
Table note: General approaches described by Vanguard. None establishes a universally safe rate or guarantees that spending needs will be met. [2]
The practical issue is whether an adjustment can actually be made. A plan that assumes a spending cut should identify the expenses that could change and the amount involved. Medical costs, basic housing expenses, and other essentials may leave less flexibility than the total budget initially suggests.
Separate essential, flexible, and irregular expenses before assuming withdrawals can be reduced.
Liquidity and investment mix address different needs
Money intended for near-term spending has less time to recover from a decline than money intended for later years. That timing is part of asset allocation. A cash reserve may reduce the need for an immediate investment sale, but its size and replenishment rules still have to fit the whole portfolio. [3]
Holding more cash also changes the opportunity for long-term growth and leaves purchasing power exposed to inflation. Dividing investments into spending categories does not, by itself, eliminate market risk. The assets held, their costs, and the decisions about when to refill a reserve determine the financial result. [4,5]
Bonds can play a role in an investment mix, but bond funds can lose value as interest rates or credit conditions change. A reserve described as “conservative” should be examined for actual liquidity and price risk rather than assumed to behave like cash. [7]
Diversification spreads exposure across investments, while rebalancing brings a portfolio back toward its intended allocation. Neither guarantees protection from losses. A written approach can still help make spending and investment decisions consistent when markets become difficult. [3,4]
Include costs and required distributions
Investment fees reduce the amount left in a portfolio to earn future returns. Taxes can increase the gross amount that must be withdrawn to support a given spending budget. A projection that ignores both may describe a different cash-flow need from the one the household actually faces. [5,6]
Required minimum distributions, when applicable, are minimum account withdrawals under tax rules. They should be tracked separately from a chosen spending rule. Reducing discretionary spending does not, by itself, reduce the legally required distribution, and a required withdrawal does not necessarily mean every dollar must be spent on consumption. [6]
A practical review of withdrawal assumptions
- Write down the annual spending gap after accounting for other income, then estimate the gross withdrawal needed.
- State whether withdrawals occur monthly, at the beginning of a year, or at year-end when reviewing an illustration.
- Test an early decline, several weak years, and higher spending needs instead of relying only on one average return.
- Identify which expenses could change, when the decision would be made, and how a reserve would be replenished.
- Include fees, tax costs, and applicable required distributions in the cash-flow assumptions. [5,6]
Frequently asked questions
Does the order of returns matter without withdrawals
In the simplified example, a fixed starting balance with no contributions, withdrawals, or other cash flows ends at the same value under the same returns in a different order. Once cash flows are introduced, the sequence can change the result.
Does a good average return guarantee enough retirement income
No. Average returns do not specify the sequence of gains and losses, the withdrawal amounts, or the number of years the savings must support.
Can a cash reserve remove this risk completely
No. A reserve can provide liquidity, but the overall plan still faces investment risk, inflation, spending needs, and decisions about replenishing that reserve. [3,4]
Final takeaway
A retirement projection is more informative when it shows the withdrawals alongside the returns. Examining an unfavorable early sequence, a realistic spending gap, and workable adjustment rules reveals information that a single average return cannot provide.
Sources and fact checking record
| Verification scope: Reviewed September 22, 2026. Sequence risk, spending approaches, asset allocation, costs, and required-distribution distinctions were checked against the sources below. Every example and percentage was independently recomputed. No withdrawal rate, allocation, reserve size, or market outcome is presented as universally safe. |
| Marker | Primary-source support |
|---|---|
| [1] | Charles Schwab: Sequence-of-returns risk. January 30, 2026 explanation of return timing and withdrawals. The numerical example here is independently constructed, not copied from Schwab. |
| [2] | Vanguard: Spending strategies in retirement. Dollar-plus-inflation, percentage-of-portfolio, and dynamic spending approaches. Used for spending concepts, not its generalized RMD age statements. |
| [3] | SEC Investor.gov: Asset allocation and diversification. Investment horizon, risk tolerance, diversification, and rebalancing. |
| [4] | SEC Investor.gov: Allocation and rebalancing guide. Cash and inflation risk, risk-return trade-offs, and limits of diversification. |
| [5] | SEC: How fees and expenses affect a portfolio. Investment costs reduce the assets available to earn returns. |
| [6] | IRS: Required minimum distributions. Minimum required account withdrawals and general taxation of retirement distributions. No age-specific eligibility claim is made in this article. |
| [7] | SEC Investor.gov: Bond funds and income funds. Interest-rate, credit, and prepayment risks; bond funds can lose value. |
| Educational use only: This article provides general education, not individualized investment, tax, or legal advice. Examples are hypothetical. Market conditions, rules, and individual circumstances can change. |