Two investors retire on the same day. Same age. Same portfolio size. Same average annual return over the next twenty years. One of them runs out of money at seventy-nine. The other is still financially comfortable at ninety. The difference has nothing to do with discipline, savings habits, or investment choices. It has everything to do with when the market crashed.
This is sequence of returns risk. It's the single most misunderstood threat in retirement finance, and it is particularly dangerous because it's invisible during the accumulation phase. For the thirty years you spent building your portfolio, bad market years were annoying but survivable. You kept adding money. The market recovered. You moved on. The moment you begin drawing income from that portfolio, the math changes completely, and a loss at the wrong time can permanently impair a plan that looks perfectly adequate on paper.
This paper explains how sequence risk works, why it catches so many well-prepared retirees off guard, what the research says about its magnitude, the specific conditions that amplify it, and the strategies that can meaningfully reduce exposure. It also explains how the retirement planning calculator at plan.johnkoyle.com models this dynamic so you can see exactly where your own plan stands.
Five things this paper will help you understand:
First, why average returns are almost useless as a retirement planning tool, and what to use instead. Second, why the first five to seven years of retirement carry disproportionate weight over the entire thirty-year horizon. Third, the three conditions that combine to create worst-case sequence risk exposure. Fourth, four specific strategies, backed by research, that reduce sequence risk without requiring you to abandon equity growth. Fifth, how to have a productive conversation with your advisor about where sequence risk lives in your current plan.
There has never been a worse time to be uninformed about sequence risk. That's not an alarmist statement. It's a mathematical observation.
The S&P 500 delivered extraordinary returns through most of the 2010s, recovered sharply from the 2020 pandemic crash, and reached historically elevated valuations by the mid-2020s. The Cyclically Adjusted Price-to-Earnings ratio, known as the CAPE ratio and developed by Nobel laureate Robert Shiller, has spent the better part of the past decade at levels historically associated with lower forward returns over ten-year horizons. When valuations are stretched and a sustained bull market has lifted most portfolios significantly, the statistical probability of a meaningful correction increases.
That doesn't mean a crash is imminent, and no one can predict timing with accuracy. What it does mean is that the cohort of Americans retiring right now, or planning to retire in the next five years, faces a mathematically elevated risk of encountering a significant market decline in the early years of their retirement. And early-retirement declines are precisely the ones that do the most permanent damage.
Consider a hypothetical illustration. Two retirees, both starting with a $1,000,000 portfolio, both withdrawing $50,000 per year, both earning an average of 6% annually over twenty years. The first retiree experiences poor returns in years one through five followed by strong returns later. The second experiences the same returns in reverse order, strong early and poor later. The second retiree ends with substantially more wealth. The average return is identical. The outcomes are dramatically different. This is not a theoretical edge case. It is the mathematical structure of the problem.
For the wave of Americans approaching retirement today, many of whom have accumulated significant portfolios after a decade-plus of strong equity markets, sequence risk is the single most important concept to understand before transitioning from accumulation to distribution. Getting it wrong doesn't just mean a smaller portfolio. It can mean running out of money entirely.
Sequence of returns risk is the danger that the timing of withdrawals from a retirement portfolio, combined with poor early market performance, will permanently reduce the portfolio's ability to sustain income over the full retirement horizon.
During the accumulation phase, the order of returns doesn't matter. If you earn 20%, then lose 20%, then earn 15%, then lose 10% over four years, the math works out the same as if those returns had arrived in the opposite order. You're not withdrawing. The portfolio just grows or shrinks, and you wait for recovery.
The moment withdrawals begin, everything changes. Now you're selling shares to generate income. If the market is down and you're forced to sell at depressed prices, those shares are gone. They cannot recover for you because you no longer own them. The portfolio is permanently smaller, and the compounding that was supposed to carry you through your eighties and nineties has been quietly gutted.
Financial planners have a term for the most financially dangerous decade of a person's life: the Retirement Red Zone. It spans roughly five years before retirement through five years after.
Three things converge in the Red Zone to create maximum vulnerability. First, you're at peak savings, which means a market decline costs you more real dollars than at any previous point in your life. A 30% decline on a $200,000 portfolio at age thirty-five is uncomfortable. A 30% decline on a $1,200,000 portfolio at age sixty-three is potentially catastrophic and irreversible. Second, you're beginning or about to begin withdrawals. Once you start drawing income, you're on the wrong side of the sequence problem. Third, you have less time to recover. At thirty-five, you can wait a decade for a market to come back. At sixty-five, that patience carries a cost measured in lifestyle, not just dollars.
The financial planning industry spent decades building retirement projections around average annual return assumptions. Plug in 7% per year, run it forward thirty years, and you get a number. The problem is that real markets don't deliver smooth 7% annual returns. They deliver sequences: some years up 20%, some years down 30%, with enormous variation in timing.
Financial planner and researcher Michael Kitces has written extensively on this problem. A retirement plan built on average return assumptions is essentially assuming the best-case scenario of smooth, consistent returns. The further actual returns deviate from that smooth path, and real markets deviate substantially, the worse the actual outcome compared to the projection.
This is why Monte Carlo simulation, which models thousands of possible return sequences rather than a single average, has become the standard tool for serious retirement planning. It shows the range of outcomes, not just the expected one. A Monte Carlo success rate of 90% means that in 900 out of 1,000 simulated return sequences, the portfolio did not run dry before the end of the planning horizon. The retirement calculator at plan.johnkoyle.com uses Monte Carlo simulation for exactly this reason, running 500 scenarios to show where your plan stands across the realistic range of market possibilities.
The modern understanding of safe withdrawal rates in retirement traces directly to William Bengen, a financial planner who published a landmark paper in the Journal of Financial Planning in 1994. Bengen analyzed historical return sequences going back to 1926 and found that a retiree who withdrew 4% of their initial portfolio annually, adjusted for inflation each year, had never run out of money over a thirty-year retirement in any historical sequence. This became known as the 4% rule.
What Bengen's work revealed, perhaps more importantly than the 4% number itself, was the critical role of sequence. Retirees who retired just before major market downturns, the 1929 crash, the early 1970s stagflation, the early 2000s dot-com collapse, experienced dramatically worse outcomes than those who retired into favorable early-return environments, even when their long-run averages were similar. The 4% rule was essentially designed to survive the worst historical sequences, not the average one.
In 1998, three professors at Trinity University, Philip Cooley, Carl Hubbard, and Daniel Walz, published what became known as the Trinity Study, which analyzed withdrawal rate sustainability across multiple portfolio allocations and historical periods. Their work confirmed that sequence risk, not portfolio size or even asset allocation, was the primary determinant of retirement plan failure.
The Trinity Study also showed that the stock-to-bond mix mattered less than most people assumed. What mattered most was the withdrawal rate relative to portfolio size, and the luck of the sequence in the early years of retirement. A retiree with a 60/40 portfolio who retired in 1965, into the stagflationary sequence of the late 1960s and 1970s, fared dramatically worse than one with the same portfolio who retired in 1982, just before a sustained bull market.
Wade Pfau, professor at the American College of Financial Services and one of the most cited researchers in retirement income planning, quantified the damage from sequence risk in his 2012 paper published in the Journal of Financial Planning. Pfau found that the real portfolio returns in the first decade of retirement explained approximately 80% of the variance in how long the portfolio survived, across all historical sequences he studied.
This finding has significant practical implications. It means that a retiree who enjoys strong early returns has, statistically, already won most of the retirement sustainability battle. Conversely, a retiree who encounters a severe early sequence has, statistically, already experienced most of the damage that will ultimately determine whether the plan fails. The portfolio's long-run average return, over the full thirty-year horizon, is almost irrelevant by comparison.
DALBAR's annual Quantitative Analysis of Investor Behavior consistently finds that the average equity fund investor earns meaningfully less than the average equity fund, because investors make poor timing decisions. They sell after declines and buy after rallies, which is the behavioral equivalent of sequence risk self-inflicted. In the 2023 study covering twenty years ending in 2022, the average equity fund investor earned approximately 6% annually while the S&P 500 returned roughly 9.8% over the same period. The gap comes almost entirely from poor sequence decisions.
For retirees, the behavioral problem is particularly acute. A 30% market decline in year two of retirement is terrifying when you're watching your income source shrink. The emotional pressure to sell, to reduce risk, to do something, is enormous. But selling into a decline is precisely the action that permanently locks in sequence damage. The retirees who survive bad early sequences are the ones who had a plan in place before the decline arrived, not the ones who improvised after.
Michael Kitces and Wade Pfau co-authored research in 2013 examining whether the traditional retirement glide path, moving from equities toward bonds as retirement approaches, actually reduces sequence risk or simply reduces overall returns. Their counterintuitive finding was that a rising equity glide path in retirement, starting with a more conservative allocation at retirement and gradually increasing equity exposure over the early years, could actually produce better outcomes than the conventional declining-equity approach.
The logic: if a retiree holds fewer equities in the early years when sequence risk is highest, and gradually adds equities as the portfolio survives the critical first decade, the portfolio is less vulnerable to a devastating early-sequence hit while still capturing equity growth in later years when sequence damage is less consequential. This research directly challenges conventional wisdom about how to position a retirement portfolio at the transition date.
Not every retirement carries the same sequence risk. Three conditions, when they appear together, create worst-case exposure. Understanding them is the first step toward managing them.
The more money you withdraw from the portfolio each year, the faster you deplete it during a downturn. If Social Security, a pension, or other guaranteed income sources cover most of your spending, your portfolio withdrawal rate may be quite low, and sequence risk is manageable. If your lifestyle depends heavily on portfolio withdrawals because guaranteed income is limited, your exposure multiplies.
A portfolio sustaining a 3% withdrawal rate can survive sequences that would destroy the same portfolio at a 6% withdrawal rate. The withdrawal rate is the single most important variable in sequence risk management, more important than asset allocation, investment selection, or even the severity of the market decline itself.
High equity exposure during the Red Zone amplifies sequence damage. A portfolio that is 80% equities can drop 35-40% in a severe bear market. That's a devastating starting point for a retiree who has just begun withdrawals. The same portfolio at 50% equities might drop 20%, painful but survivable.
The challenge is that equities are also the primary driver of long-term portfolio growth. Reducing equity exposure too aggressively creates a different risk: longevity risk, the danger of outliving a too-conservative portfolio over a thirty-year retirement. The goal is not to eliminate equity exposure but to time the transition thoughtfully and consider buffer strategies that reduce the need to sell equities during early downturns.
When cyclically adjusted price-to-earnings ratios are elevated, forward ten-year returns historically trend lower. This is not a guarantee of a near-term crash, but it does mean the probability of experiencing a significant early-retirement decline is statistically higher than average. Retiring at the top of a historically stretched valuation cycle is the third element of a dangerous combination.
Robert Shiller's research on CAPE ratios, which smooth earnings over ten years to remove cyclical distortions, shows clearly that starting valuations predict long-run returns with meaningful accuracy. A CAPE ratio in the mid-to-high thirties, which the U.S. market has reached at various points in the 2020s, has historically been associated with below-average ten-year forward returns. That doesn't mean a retiree should avoid equities entirely, but it's an important input into how aggressively to be positioned at the retirement transition.
The most pervasive planning mistake in retirement finance is building a financial plan around a single assumed annual return. When a planner says 'your portfolio will earn 7% per year,' what they're actually doing is running a straight-line projection that has no resemblance to how markets actually work. That number produces a comfortable-looking plan that will be wrong in a specific way: it will overestimate how much you can safely withdraw.
The correct tool is a probability distribution of outcomes across many possible return sequences. Monte Carlo simulation, historical sequence testing, or scenario analysis using actual bad historical periods all produce more honest pictures of what a plan can sustain. Any advisor who is still using straight-line return projections for retirement income planning is operating with an outdated toolkit.
Many people think of retirement as a cliff: working on one side, retired on the other, with a portfolio that transitions overnight from accumulation to distribution. In practice, the most effective risk management happens in the years before the transition.
Retirees who plan their sequence risk management in advance, positioning a cash buffer, gradually de-risking in the years before retirement, stress-testing the plan against bad historical sequences, are dramatically better prepared than those who retire and then start thinking about it. By the time the market has declined 25%, it's too late to implement the strategies that would have protected the portfolio.
A large portfolio with a high withdrawal rate can be more vulnerable than a smaller portfolio with a low withdrawal rate. A retiree with $2,000,000 who needs $120,000 per year has a 6% withdrawal rate and faces significant sequence risk. A retiree with $1,200,000 who needs $48,000 per year has a 4% withdrawal rate and faces substantially less.
The number that matters is the ratio between what you withdraw and what you have, not the absolute size of the portfolio. Planning that focuses exclusively on accumulation targets, 'I need to reach $X million,' without addressing withdrawal rates and guaranteed income sources, misses the most important variable.
Every dollar of guaranteed income, from Social Security, a pension, an annuity, or rental income, is a dollar that doesn't have to come from the portfolio during a market downturn. Guaranteed income sources are natural sequence risk buffers because they're not correlated with equity market performance.
This is one reason the Social Security claiming decision matters so much to sequence risk management. A retiree who delays Social Security to age 70 and receives a significantly larger monthly benefit has meaningfully reduced the portfolio withdrawal rate in the early years of retirement. The Social Security delay pays 6-8% more per year of delay, guaranteed, inflation-adjusted, for life. That's a compelling buffer against the most dangerous sequence risk window.
The behavioral data from DALBAR is consistent and sobering. Investors systematically sell after declines and buy after rallies, producing outcomes significantly worse than simply holding. For retirees, this behavior is particularly costly because they're also withdrawing, which means selling into a declining market both to raise income and in response to fear.
Having a written plan that specifies exactly what you will and won't do during a market decline, before the decline happens, is one of the most effective sequence risk management tools available. Not because markets are predictable, but because behavior is predictable, and the plan creates a guardrail against the most predictable expensive mistake.
Sequence risk is manageable. The strategies that address it aren't exotic, and they don't require abandoning the equity growth that makes long retirements financially feasible. They do require planning in advance and executing with discipline.
One of the most practical and well-researched tools against sequence risk is maintaining one to two years of living expenses in cash or short-term, low-volatility assets at the point of retirement. During a market decline, withdrawals come from the buffer rather than from the equity portfolio. This gives equities time to recover before they need to be sold.
Harold Evensky and Deena Katz, pioneers in retirement income planning, formalized this approach as the 'two-bucket' system. The mechanics are simple: bucket one holds cash and short-term fixed income for near-term spending needs, bucket two holds the growth portfolio. The discipline is in replenishing bucket one systematically, from dividends, rebalancing, or bucket two when markets are favorable, and having the patience to draw from the cash buffer when they're not.
Delaying Social Security benefits to age 70 is, for most people with average or better health expectations, the highest-return, lowest-risk financial decision available in the years around retirement. Benefits increase by approximately 6 to 8 percent for each year of delay between age 62 and 70. At 70, the benefit is 24% higher than at the full retirement age of 67, and 77% higher than at 62.
From a sequence risk perspective, a larger Social Security benefit reduces the portfolio withdrawal rate during the early years of retirement, exactly the years that matter most. A retiree who can bridge the period between retirement and age 70 from savings or part-time income, then turn on a maximized Social Security benefit, has effectively reduced their sequence risk exposure in the critical window.
The retirement calculator at plan.johnkoyle.com models this tradeoff directly, showing the impact of claiming at 62, 67, and 70 on portfolio longevity across the range of Monte Carlo scenarios.
A fixed dollar withdrawal rate, such as $60,000 per year regardless of what markets do, is the structure that creates maximum sequence vulnerability. A flexible withdrawal approach, drawing a fixed percentage of the current portfolio value rather than a fixed dollar amount, automatically reduces withdrawals in bad years and increases them in good years.
This flexibility comes at a cost: income variability. Retirees who can tolerate some variability in their discretionary spending, cutting back on travel in bad market years, for instance, can substantially reduce sequence risk without maintaining a larger portfolio or accepting permanently lower income. The guardrails approach developed by Jonathan Guyton and William Klinger formalizes this with specific rules for when to reduce and when to increase withdrawal amounts based on portfolio performance.
Moving from an accumulation allocation to a distribution allocation is not an event that happens on retirement day. It's a process that should begin three to five years before retirement and continue through the early years of the distribution phase.
The Kitces-Pfau research on rising equity glide paths suggests that beginning retirement with a somewhat conservative allocation and gradually adding equity exposure as the portfolio survives the critical first decade may actually produce better long-run outcomes than maintaining a static allocation throughout. This doesn't mean being aggressively conservative at retirement, which creates its own longevity risk. It means being thoughtful about the timing of the transition and having a written plan for how the allocation will evolve.
Any serious retirement plan should be tested not just against average return assumptions but against the worst historical sequences. What would this plan have looked like for a retiree who started drawing income in 1929? In 1965? In 2000? In 2008? These historical periods represent the actual range of bad sequences that real markets have produced.
If the plan survives those historical sequences, the retiree can proceed with meaningful confidence. If it doesn't, the plan needs to be adjusted before retirement, not after. The retirement calculator at plan.johnkoyle.com uses Monte Carlo simulation with 500 scenarios, producing a success rate that reflects the realistic range of outcomes rather than a single projected path.
Sequence of returns risk is a topic that reveals a great deal about an advisor's depth and rigor. The questions below are designed to move beyond surface-level planning and test whether your advisor is genuinely equipped to address this risk.
If the answer involves a single assumed annual return, or a straight-line projection, the advisor is using an outdated planning framework. The correct answer involves Monte Carlo simulation, historical sequence testing, or a combination of both. Ask to see your plan's success rate across a range of return scenarios, not just the expected-return scenario.
An advisor who can't immediately tell you your withdrawal rate isn't managing your sequence risk. The answer should be a specific percentage, along with context about how it compares to historically sustainable rates at your planning horizon and what it implies for your vulnerability to a bad early sequence.
This question tests whether the advisor has a plan or just a projection. The answer should include specific mechanisms: a cash buffer, a withdrawal flexibility framework, a Social Security optimization strategy, or some combination. 'We'll reassess at the time' is not an adequate answer.
A sophisticated advisor should be able to walk through how delaying Social Security reduces your portfolio withdrawal rate in the early years of retirement, exactly the years that matter most for sequence risk. If the advisor treats the Social Security claiming decision as separate from portfolio sequence management, they're not doing integrated retirement income planning.
Ask specifically: what happens to my plan if I retire into a sequence similar to 1929, or 1965, or 2000? If the advisor can show you those scenarios and explain what the plan does to survive them, you're working with someone who understands sequence risk at a meaningful level. If the response is vague or defensive, the plan has probably not been stress-tested.
This is the operational question. Not the theoretical one about planning frameworks, but the specific question about what happens when things go wrong. Does the plan have a written protocol? Is there a cash buffer? Will Social Security cover a larger share of expenses if portfolio withdrawals need to be reduced? The answer should be specific and already documented, not improvised in response to the question.
The retirement planning calculator at plan.johnkoyle.com was built to model exactly the dynamics discussed in this paper. The Sequence of Returns Risk tab models exactly this dynamic. It shows your portfolio across scenarios where early years are poor and later years are strong, versus the reverse, so you can see the actual dollar difference in outcomes. The Monte Carlo tab runs 500 scenarios and gives you a success rate that reflects the realistic distribution of return sequences, not just the average one. Enter your current portfolio, your planned withdrawal amount, your expected Social Security benefit, and your retirement age, and the calculator will show you your plan's resilience across the range of what markets might realistically deliver.
John Koyle, AIF®, is the Co-Founder of Red Cedar Wealth Advisors, headquartered in Pocatello, Idaho. He holds the Accredited Investment Fiduciary (AIF®) designation, awarded by the Center for Fiduciary Studies (Fi360), which signifies completed coursework, a rigorous examination, and ongoing continuing education in fiduciary responsibility and prudent investment practices.
John serves individuals and families in or approaching retirement throughout eastern Idaho, the Pacific Northwest, and across the country via Zoom. Clients work directly with John, not a junior team. Red Cedar Wealth Advisors operates under Osaic Wealth, Inc. (Member FINRA/SIPC) and Osaic Advisory Services, LLC for investment advisory services.
Every client relationship is built on five integrated disciplines. The proportions shift with the client and the moment. The integration is constant. Most of the actual value sits in how these disciplines connect, not in any single one of them.
Retirement planning is a discipline that barely existed a generation ago. For most of modern history, people worked until they physically couldn't and then they died, usually fairly close together. The idea that an individual should spend decades saving, then spend decades drawing down those savings, with a plan that accounts for inflation, taxation, sequence risk, healthcare, longevity, and estate transfer, that's maybe forty years old.
Which means almost nobody your age grew up watching their parents do it properly. There's no cultural muscle memory. The advice industry backfilled that gap with rules of thumb that work sometimes and fail catastrophically the rest of the time. The 4% rule. 'You can take Social Security at 62.' 'Target-date funds will handle it.' These are not bad starting points. They are terrible ending points. Real planning is specific, personal, and built on principles that hold up across the full range of outcomes, not just the average one.
The tax code is a set of instructions Congress wrote to shape behavior. Aligning your financial life with those instructions is not aggressive planning. It is the planning. Roth conversion sequencing, capital gains compression on concentrated positions, charitable remainder trusts, Social Security timing, beneficiary coordination. None of these are obscure. They're all legitimate, all written into the code intentionally, and all under-used. Most CPAs handle compliance. The strategy work is a different discipline entirely.
Seventy percent of family wealth doesn't survive two generations. The reason isn't bad markets. The cause is failure to communicate, outdated documents, and no plan for preparing heirs. Beneficiary designations regularly override well-crafted wills. Trust structures created a decade ago no longer match current law or current family. The portfolio that built the wealth isn't the structure that transfers it. The work here is coordinating with your attorney to align documents, beneficiaries, gifting strategies, and trust funding with what you actually want to happen.
Every week, before any portfolio decision, John runs through four layers of market health: economic conditions, market internals, valuations, and sentiment. Each layer gets scored and those scores combine into a composite that maps directly to a portfolio posture, from aggressive on the positive end to defensive on the negative. The work is in the scoring. Once the scoring is done, the positioning follows. That removes one of the most dangerous things in investing: making it up as you go.
The protection gap quietly kills more plans than markets do. A significant net worth paired with inadequate liability coverage is a lawsuit away from a serious problem. Long-term care is more acute: a multi-year care event for one spouse can consume what was meant for the survivor. Most advisors relegate risk to a footnote because insurance conversations are uncomfortable. The math doesn't care. Coverage adequacy, umbrella sizing, long-term care planning, and life insurance structure sit alongside the portfolio in any complete plan.
These are the principles behind every plan John builds.
To begin a conversation, visit johnkoyle.com, use the retirement planning calculator at plan.johnkoyle.com, or reach John directly at john@redcedarwealth.com or (208) 915-8400. Initial consultations are complimentary and carry no obligation.