Sequence-of-returns risk: when bad years show up first

By Tom, CPA · Updated October 25, 2026

TL;DR: Two retirees can earn the exact same average return and end up with wildly different results, because withdrawals during early losses lock those losses in. The fixes are boring and effective: spending flexibility, a cash or bond buffer, some other income, and a withdrawal rate with margin.

Educational only, not tax, legal, or investment advice. Examples are illustrations, not predictions. Rules and limits change; verify current figures and talk to a qualified professional about your situation.

Here is a fun fact that nobody puts on a motivational poster: the stock market doesn't care when you retire. It will happily serve you its worst three years the moment you hand in your badge. This is called sequence-of-returns risk, and it's the reason a retirement plan can look great on average and still go sideways.

Captain Compound, our caped mascot of patient growth, has a nemesis. Her name is Doctor Drawdown, and her whole evil plan is timing. She doesn't need to win on average. She just needs to show up early.

CPA Warning Label: Averages are not a retirement plan. Side effects of believing they are include selling stocks at the bottom and explaining things to a spouse.

Act I: two retirees, one average

Illustration only. Two retirees, Fran and Larry, each start with $1,000,000 and withdraw a flat $40,000 a year (in today's dollars) at the start of each year for 30 years. Each experiences exactly the same 30 annual real returns, so they have the same average. The only difference is the order.

• Fran's order: great years first (+25%, +20%, +15%), then 24 steady years of +7%, then three bad years at the end (+5%, −10%, −20%).
• Larry's order: the same returns reversed: −20%, −10%, +5% first, then the steady years, then the great years at the end.

Both sets have a compound annual return of about 6.5%. Here's what happens, computed year by year:

Same average. Same withdrawals. A difference of roughly $2.8 million at the end. Larry didn't do anything wrong; he simply retired on Doctor Drawdown's schedule. In a harsher sequence, or with a higher withdrawal rate, a start like Larry's is exactly how portfolios run dry.

Act II: why the early years matter so much

When you're saving, a crash early on is almost a gift: you're buying shares on sale. When you're withdrawing, a crash early on forces you to sell shares at low prices to pay the bills. Those shares are gone. They can't participate in the recovery. The damage is permanent in a way that a paper loss during your working years usually isn't.

The risk is highest in roughly the first decade of retirement and in the years right before it. Later on, the portfolio has either grown enough to absorb a bad stretch or there are simply fewer years left to fund.

The accountant's version

Think of it as a cash-flow timing problem. Your liabilities (living expenses) are fixed and come due every month. Your asset values fluctuate. Selling volatile assets to meet fixed liabilities at the wrong time converts a temporary decline into a realized one. Every defense below is about breaking that link.

Act III: the defenses (none of which require a crystal ball)

1. A withdrawal rate with margin

The lower your starting withdrawal rate, the more bad luck you can survive. Early retirees often plan somewhere between 3.25% and 4%. See the 4% rule for the trade-offs.

2. Spending flexibility

The single most powerful tool is also the least exciting: spend a little less after bad years. Skip the inflation raise, postpone the big trip, delay the car. Guardrail strategies formalize this by setting a range for your withdrawal rate and adjusting spending when you hit the edges. Flexibility is not glamorous, which is probably why guru seminars rarely sell tickets to it.

3. A cash or bond buffer

Holding one to three years of spending in cash or high-quality short-term bonds lets you avoid selling stocks during a downturn. It has a cost: that money earns less over time. Read cash cushions and the bucket strategy for how to size and refill it.

4. Some other income

Even modest part-time income in the first years of retirement reduces how much you must withdraw while the sequence risk is highest. Earning $15,000 a year means withdrawing $15,000 less. See Coast FIRE vs Barista FIRE.

5. A sensible allocation

A portfolio that's 100% stocks has the most growth potential and the most exposure to a bad start. Some retirees hold more bonds at the start of retirement and gradually raise their stock share later (sometimes called a rising equity glide path). There's no single right answer; the point is to choose deliberately. See index-fund investing for FIRE.

6. A plan written before the crash

Decisions made during a market panic are made by the part of your brain that also thinks the stove might be on. Write your rules down now: what you'll cut, which bucket you'll draw from, and at what point you'd consider part-time work.

FIRE Danger Scale

• Level 1: withdrawal rate under 3.5%, flexible spending, cash buffer. Doctor Drawdown files a complaint.
• Level 2: 4% with some flexibility and other income. Reasonable.
• Level 3: 4% rigid, all stocks, no buffer, 50-year horizon. Exciting in the bad way.
• Level 4: 5% or more, rigid, “the market always goes up.” You have met Doctor Drawdown's favorite customer.
• Level 5: no plan at all, but a very confident spreadsheet. Spreadsheets do not feel fear. That's not a feature.

What to do this week

1. Write your “bad first year” plan: three specific expenses you'd pause if your portfolio fell 25%.
2. Decide how many years of spending, if any, you'd hold in cash or short-term bonds at retirement.
3. Check your planned withdrawal rate in the FIRE number calculator at 3.5% as well as 4%.

The bottom line

You can't choose your sequence of returns. You can choose how exposed you are to it. A little margin, a little flexibility and a little cash turn Doctor Drawdown from a supervillain into a mild inconvenience.

This article is general education and not advice. The cast (Captain Compound, Frugal Fran, Lavish Larry, Doctor Drawdown) is fictional, and so are the example households. Your numbers will differ.