What is Sequence Risk?
Sequence of returns risk means that the order of investment returns matters as much as their average when you are withdrawing from a portfolio. During accumulation, the sequence is largely irrelevant because you are adding money. During decumulation, a market crash in the first few years forces you to sell assets at depressed prices to fund withdrawals, permanently reducing the portfolio's recovery potential.
The Numbers Tell the Story
Consider a $1 million retirement portfolio with $50,000 annual withdrawals. If the first three years return +10%, +8%, +12%, the portfolio remains above $950,000 after a decade. If those same returns are reversed to -20%, -15%, -10% in the first three years, the portfolio drops below $500,000 by year ten despite identical average returns over 30 years. The sequence alone can change portfolio longevity by over a decade.
Mitigation Strategies
The 'risk zone' spans roughly two years before through three years after retirement. Reducing equity exposure during this window is the most effective defense. The bucket strategy maintains 2-3 years of living expenses in cash and short-term bonds, avoiding forced stock sales during downturns. Flexible withdrawal rules that reduce spending during bear markets further protect against sequence risk.