Many people focus on how much money they need for retirement. However, not everyone knows about sequence of returns risk. Sequence of returns risk in retirement is the risk that market losses early in retirement can affect how long your money lasts.
If you are learning about retirement planning, you can read more educational articles on the Life Income Path blog to understand how retirement income works.
What Does Sequence of Returns Mean?
Sequence of returns refers to the order in which investment returns happen. The timing of gains and losses matters when you are taking money out of your savings.
This is very important during retirement because many people withdraw money from savings to live on.
Why Timing Matters in Retirement
When you are working and saving money, market ups and downs may not affect you as much because you are still adding money to your accounts.
But when you retire, you usually stop adding money and start taking money out. If the market goes down early in retirement while you are taking withdrawals, your savings may decrease faster.
This is the main idea behind sequence of returns risk.
Simple Example With Numbers
Here is a simple example.
Person A and Person B both retire with $500,000. Both withdraw $20,000 per year. Both average the same return over time. However, the order of returns is different.
Person A experiences market losses in the first few years of retirement.
Person B experiences market losses later in retirement.
Even though both people have the same average return, Person A may run out of money faster because losses happened early while withdrawals were happening.
This shows why the order of returns matters.
Why Early Losses Can Be a Problem
Early losses can be a problem because money is being withdrawn at the same time the account is going down. This means the account balance may drop faster.
When the account balance drops, there is less money left to recover when the market improves later.
This can affect long-term retirement income.
Sequence of Returns Risk vs Average Return
Many people think average return is the most important number. But in retirement, the sequence of returns can matter just as much as the average return.
Two people can have the same average return but very different outcomes depending on when losses happen.
This is why sequence risk is often discussed in retirement planning.
How People Try to Reduce Sequence Risk
There are different ways people try to reduce sequence of returns risk. The goal is usually to avoid taking withdrawals from investments when the market is down.
Some people plan ahead by:
Keeping some cash savings
Using multiple income sources
Adjusting withdrawals during market downturns
Planning when to start certain income sources
These strategies are meant to help manage withdrawals during different market conditions.
Using Multiple Income Sources
Many retirees use more than one income source. This may include:
Social Security
Savings
Pensions
Part-time work
Annuity income
Having multiple income sources can sometimes reduce the need to withdraw from savings during market downturns.
Why This Matters for Retirement Planning
Sequence of returns risk matters because retirement can last many years. The goal is often to make savings last as long as possible while providing income.
Understanding sequence risk can help people better understand how withdrawals, market changes, and timing all work together in retirement.
Summary
Sequence of returns risk in retirement is the risk that market losses early in retirement can reduce how long savings last. The order of investment returns matters when withdrawals are happening. Losses early in retirement can have a bigger impact than losses later in retirement.
Educational Closing
Retirement planning is not only about how much money is saved, but also about how and when money is withdrawn. Sequence of returns risk is one of the reasons retirement income planning is important. Understanding how timing, withdrawals, and income sources work together can help people better understand long-term retirement income planning.
If you have questions about retirement income planning or how different income sources work in retirement, you can visit the Life Income Path contact page to send a message and ask a general question.
This article is for educational purposes only and is not financial, tax, or legal advice.
