The risk that only matters near retirement

Two people retire with identical portfolios, hold identical investments, and experience identical returns over ten years. One ends up with substantially more money than the other.

The only difference is the order the returns arrived in. That is sequence of returns risk, and it is the reason the years immediately around retirement are the most financially fragile of your life.

The demonstration

Both portfolios start at $1,000,000 and withdraw $40,000 a year. Both experience exactly the same ten annual returns — an average of 5.8% — but in opposite order. One gets the bad years first, the other gets them last.

• Bad years first — ends at $922,334
• Good years first — ends at $1,251,383

A difference of $329,048 from the same returns and the same spending.

Why order matters only once you are withdrawing

Here is the part that makes the mechanism click. Run the same two sequences with no withdrawals at all:

• Bad years first — $1,653,369
• Good years first — $1,653,369

Identical. Multiplication does not care about order. While you are accumulating and adding money, the sequence is irrelevant — only the average matters.

Withdrawals break that symmetry. Selling during a downturn means selling more shares to raise the same cash, and those shares are permanently gone before the recovery arrives. The portfolio that fell first has a smaller base to grow from, forever.

The window that matters

Sequence risk concentrates in roughly the five years before and after you stop working. Before that, you are still contributing and a crash is arguably good news — you are buying at lower prices. After that window, the portfolio has usually either survived or not.

A 40% drop at 35 is a buying opportunity. The same drop at 65, in the first year of withdrawals, can permanently reduce what the portfolio supports for the next three decades. Same event, opposite meaning, decided entirely by whether money is going in or coming out.

What actually helps

Hold one to three years of spending in cash or short bonds as you approach retirement. When markets drop, spend from that bucket instead of selling equities, and refill it in good years. It gives up some return in exchange for never being a forced seller — which is exactly the right trade in this window.

Stay flexible on spending. Trimming withdrawals modestly after a bad year improves portfolio survival dramatically in every study that permits it. A plan that can bend does not break.

Glide your allocation. Reducing equity exposure into the danger window and allowing it to rise again afterwards addresses the risk where it exists, rather than paying for caution across your whole life.

Keep some earned income early on. Part-time work in the first years of retirement covers spending that would otherwise be sold from the portfolio, and it lands precisely where the risk is concentrated.

What this says about the 4% rule

The 4% rule already accounts for this — it was derived from historical sequences including very bad starting years, which is why the number is 4% and not the 7% an average return might suggest. The gap between those figures is the sequence risk premium.

Which is worth remembering when a projection shows a comfortable average return. Averages are what you get over a lifetime. Sequences are what you actually live through.

The ten-year sequence above is illustrative, chosen to show the mechanism clearly rather than to model any particular market period.