Sequence of Returns Risk

While average annual returns in the double digits may seem impressive, longer lifespans present new risks for retirees. With retirement potentially spanning decades, your financial strategy needs to be built for long-term durability.

Sequence of returns risk is particularly critical during the early retirement window—typically the 10 years before and after you stop working. Known as the “retirement red zone,” this period can significantly affect the sustainability of your income strategy.

Historically, the S&P 500 has averaged over 10% annually from 1928 to 2021, including dividends. However, averages don’t reveal the full picture. The sequence of returns—when gains or losses occur—can make a major difference, especially once you begin making withdrawals. Early losses can drastically undermine your portfolio’s longevity.

This concept is known as sequence of returns risk—or simply, sequence risk. To make this idea more tangible, let’s look at a garden analogy followed by two hypothetical portfolio comparisons.

What is Sequence Risk?

Picture two identical vegetable gardens, each planted with the same seeds.

In Garden 1, a blight strikes early. Some crops grow, but early damage reduces the total harvest. Each time you gather vegetables for food, fewer remain to grow again.

In Garden 2, the plants flourish at first. A strong initial harvest allows you to store extra produce. Later, when the blight arrives, you already have enough food to weather the downturn.

This analogy captures the core of sequence risk. If your investments experience losses early in retirement—while you’re withdrawing income—recovering may be difficult. You could face lasting impacts to your financial security.

Scenario 1: Same Returns, Different Outcomes — Why Timing + Withdrawals Matter

Even when average returns are identical, the sequence of those returns—and whether you’re withdrawing income—can dramatically affect long-term outcomes. The table below compares three 21-year scenarios, all using the same total return set from 1996–2016 (S&P 500 with dividends):

Scenario	Return Order	Withdrawals	Return Timing Impact	Ending Balance	Outcome
1. No Withdrawals	Normal (1996–2016)	❌ None	No impact — no income drawn	$691,303	✅ Growth unaffected by sequence
2. Withdrawals with Positive Early Returns	Normal (1996–2016)	✅ $16,000/year +2% inflation	Strong early growth supports withdrawals	$192,100 (Year 21)	✅ Portfolio sustains full 21 years
3. Withdrawals with Negative Early Returns	Reversed (2016–1996)	✅ $16,000/year +2% inflation	Early losses compound with withdrawals	$0 (Depleted by Year 17)	❌ Sequence risk causes plan failure

Key takeaway: Sequence risk isn’t about how much return you get on average—it’s about when you get it. Early losses, combined with withdrawals, can cause irreversible damage to your retirement income strategy.

Scenario 2: Year-by-Year Comparison — Sequence Risk in Action

When retirees begin withdrawals, timing becomes critical. This side-by-side table shows how two identical portfolios perform under different return sequences. Portfolio B-2 experiences early losses—and runs out of money years earlier.

Year	Withdrawal	Portfolio A-1 (Positive Early Returns)	Portfolio B-2 (Negative Early Returns)
1	$16,000	$418,000 (+8%)	$368,000 (−8%)
2	$16,320	$432,600 (+7%)	$343,470 (−6.5%)
3	$16,646	$446,500 (+6.5%)	$318,010 (−6%)
4	$16,979	$458,000 (+5%)	$288,120 (−4.5%)
10	$18,785	$402,900	$97,450
17	$21,867	$289,800	$0 ❌ Depleted
21	$23,704	$192,100	—

How Can Sequence of Returns Risk Affect Your Retirement?

Imagine retiring in 2008—the same year the S&P 500 dropped 37%. Even with a market recovery, the initial decline may have caused lasting damage. For retirees already drawing income, the rebound came too late to prevent losses.

Some strategies aim to minimize “failure rates,” but Wade Pfau, Ph.D., CFA®, a prominent retirement researcher, challenges whether failure rate models are sufficient.

He explains: “Retirees either succeed or fail. There’s no partial failure. So, planning for a 10% or 20% failure rate may not reflect how retirees actually experience risk.”

Why Do These Strategies Fall Short?

Traditional withdrawal models may overlook real-life complexity. According to Pfau, focusing only on success or failure rates leaves out important considerations:

• Balancing higher early income with the risk of needing to cut spending later
• Some retirees may have more flexibility to reduce expenses if needed
• Other income sources beyond investments
• Chances of living longer than expected
• Legacy planning or charitable goals
• The length and severity of any income shortfall

His takeaway? Retirement strategies should reflect how people actually live—not just what works on paper.

What’s in Your Portfolio?

While research and averages are useful, your retirement plan should be personalized. The most effective approach depends on your unique financial situation, goals, and risk tolerance.

Partnering with a knowledgeable financial professional can help you navigate key questions and build a more resilient income plan.

Are you overly reliant on market performance? As inflation continues to rise, growing your nest egg matters—but so does protecting what you’ve already saved.

Ask yourself: Would your retirement income plan hold up under sequence risk? Now may be the right time to explore strategies that reduce your vulnerability to timing-related losses.

Risk-Averting Action Items

Since markets are unpredictable, your retirement income plan should be designed with flexibility in mind.

Discuss your investment mix with a financial professional and evaluate whether reallocating part of your savings into guaranteed income products could make sense for your goals.

Think broadly about protecting the wealth you’ve built. And make sure your strategy is built to maximize your actual spendable income—after fees, taxes, and inflation are considered.

How Fixed Annuities Can Offset Sequence Risk

One way to reduce the impact of early market losses is by shifting part of your portfolio into guaranteed income sources—like fixed annuities or fixed index annuities. These insurance-backed options offer steady income and protection from market volatility.

Both types of annuities help reduce sequence risk by providing reliable income without the need to withdraw from market-based investments during downturns. The key difference lies in growth potential: fixed annuities offer a set interest rate, while fixed index annuities are linked to a market index with upside potential and downside protection.

See comparison below:

Feature	Fixed Annuities	Fixed Index Annuities	Market-Based Investments
Principal Protection	✅ Yes – Fully protected	✅ Yes – Protected from losses	❌ No – Subject to market volatility
Guaranteed Lifetime Income	✅ Yes – Optional income rider	✅ Yes – Optional income rider	❌ No – Portfolio-dependent
Growth Potential	⚠️ Low – Fixed interest rate	✅ Moderate – Market-linked (up to cap or participation)	✅ High – Unlimited, but with risk
Helps Mitigate Sequence Risk	✅ Yes – Reliable income buffer	✅ Yes – Protects against downside in early retirement	❌ No – Highly exposed
Liquidity	⚠️ Limited – Often includes surrender schedule	⚠️ Limited – May include caps/spreads and surrender terms	✅ High – Typically liquid and flexible

Using either a fixed annuity or a fixed index annuity can create a steady, guaranteed income base—allowing the rest of your portfolio to stay invested for growth without being overexposed to sequence risk.

Using a Flooring Strategy to Reduce Sequence Risk

An income flooring strategy sets a foundation of guaranteed income to cover essential expenses in retirement. The idea is simple: first secure the income you need to live comfortably—then invest the rest for growth.

When paired with annuities, flooring can reduce or eliminate the need to withdraw from your investment portfolio during market downturns, helping you avoid the negative effects of sequence risk. This approach can create peace of mind while still leaving room for market participation.

Here’s how it typically works:

• Step 1: Identify your essential monthly expenses (housing, food, insurance, healthcare)
• Step 2: Layer guaranteed income sources—like Social Security and annuities—to meet or exceed those expenses
• Step 3: Allocate remaining assets toward growth, flexibility, or legacy goals

Income flooring works well alongside fixed and fixed index annuities because they offer predictable, lifetime payouts—independent of market performance. This allows your market-based accounts more time to grow and recover without being tapped during down years.

At Foxcove Financial, we help clients structure customized flooring plans using insured strategies tailored to their retirement needs. If you’re concerned about market volatility or timing risk, flooring may be a smart next step.

Plan to Manage Risk and Retire Comfortably

Your goal is to enjoy life today while preserving financial stability tomorrow. When you’re ready to build a durable retirement income plan, at Foxcove Financial we are here to help.