Clara Roades here. If you’ve been reading crawlingroad.com for a while, you know I believe long‑horizon wealth rests on two quiet pillars: compound interest and patience. But there’s a third pillar that doesn’t get enough airtime—the order in which your returns show up. In finance, we call this sequence of returns risk, and it bites hardest in the five years just before and just after you retire. Today I want to walk you through exactly why, using specific dollar amounts and a timeline you can feel.
What Is Sequence of Returns Risk?
Sequence of returns risk is the danger that the timing of investment losses—not just the average annual return—can permanently damage a portfolio you’re drawing from. Two retirees can earn the same average return over 30 years and end up with wildly different balances, simply because one hit poor returns early and the other hit them later.
This isn’t a theoretical edge case. It’s a mathematical reality that sits at the intersection of compound interest, withdrawal rates, and time horizon. When you’re accumulating, a bad year stings but it’s temporary; your contributions buy more shares at lower prices. When you’re decumulating—selling assets to pay for groceries, property taxes, and a trip to see the grandkids—a bad year means you lock in losses and have fewer shares left to catch the recovery. The portfolio shrinks from both sides: market losses and your own spending.
Why the First Five Years Are the Danger Zone
Picture two retirees, both 65, each with a $1,000,000 portfolio invested 60% in a broad U.S. stock index and 40% in intermediate‑term bonds. Both plan to withdraw $40,000 in the first year and adjust that amount by 3% annually for inflation. Both earn the exact same average annual return of 6% over the next 30 years. The only difference is the order of returns.
Retiree A: Bad Luck Early
Retiree A walks straight into a grinding bear market. Her portfolio loses 15% in Year 1, another 10% in Year 2, and breaks even in Year 3. She still takes her $40,000 withdrawal (plus inflation) each year. By the end of Year 3, her balance has dropped to roughly $710,000. Even though the market eventually roars back with double-digit gains in Years 4 through 10, the damage is done. She runs out of money at age 87.
Retiree B: Good Luck Early
Retiree B enjoys strong returns right away—12% in Year 1, 15% in Year 2, 8% in Year 3. Her portfolio swells to nearly $1.3 million before the inevitable bear markets arrive later. Because her withdrawals are a smaller percentage of a larger balance, the down years don’t threaten her solvency. She dies at 95 with over $600,000 remaining.
Same average return. Same withdrawal strategy. Radically different outcomes. The only variable was the sequence of returns in the first five years.
The Math Behind the Fragility
Why are the early years so powerful? Because of a concept called portfolio longevity. When you withdraw from a declining portfolio, you’re forced to sell more shares to meet the same dollar need. Those shares are gone forever; they can’t participate in the eventual recovery. This is sometimes called the “reverse dollar‑cost averaging” effect. During accumulation, volatility is your friend because you buy more shares when prices are low. During decumulation, volatility is your enemy because you sell more shares when prices are low.
Consider a simplified example. You own 10,000 shares of a fund priced at $100 per share, for a total of $1,000,000. You need $40,000 for the year. If the fund drops 20% to $80 before you sell, you must sell 500 shares to raise $40,000. You now have 9,500 shares. If the fund then recovers to $100, your portfolio is worth $950,000—still down 5% even though the share price fully recovered. You permanently lost 500 shares. If the same 20% drop happened in Year 20, you’d have far fewer years of withdrawals ahead, and the absolute dollar impact would be smaller because your portfolio would likely be larger (or smaller, but with fewer years to fund). The early years are uniquely sensitive because they set the base from which all future compounding—or de‑compounding—occurs.
How Big Is the Effect? A Dollar‑Specific Walkthrough
Let’s make this tangible with a 60/40 portfolio and a 4% initial withdrawal rate, adjusted for inflation. I’ll use historical S&P 500 and intermediate Treasury returns, but the pattern holds across most balanced portfolios.
Scenario 1: Retiring into a Bull Market (1995)
Suppose you retired on January 1, 1995, with $1,000,000. You withdraw $40,000 in Year 1 and increase it by 3% each year for inflation. The S&P 500 returned 37.6% in 1995, 23.0% in 1996, and 33.4% in 1997. By the end of 1999, your portfolio would have grown to roughly $1,800,000 after withdrawals. Even the dot‑com crash of 2000‑2002 and the 2008 financial crisis couldn’t derail you. By 2023, your portfolio would still be above $1,500,000 in nominal terms.
Scenario 2: Retiring into a Bear Market (2000)
Now start on January 1, 2000, with the same $1,000,000 and the same 4% withdrawal rule. The S&P 500 lost 9.1% in 2000, 11.9% in 2001, and 22.1% in 2002. By the end of 2002, your portfolio would have shrunk to about $580,000. Even with the recovery that followed, you’d be drawing from a much smaller base. By 2023, your portfolio would be under $200,000—and that’s with the benefit of a long bull market from 2009 to 2020. If you had retired just three years later, in 2003, your outcome would be dramatically better.
This isn’t a prediction. It’s a reminder that the first five years are the fulcrum on which a 30‑year retirement plan balances.
How to Protect Your Portfolio in the Danger Zone
You can’t control the market, but you can control your exposure to sequence risk. Here are four practical strategies, each with a specific dollar illustration.
1. Build a Cash Wedge Before You Retire
A cash wedge means holding two to three years of expected withdrawals in cash or short‑term Treasury bills as you enter retirement. If the market drops, you spend from the cash wedge instead of selling stocks or bonds at a loss. This gives your portfolio time to recover.
Example: If you plan to withdraw $40,000 per year, set aside $80,000 to $120,000 in a high‑yield savings account or a Treasury bill ladder. When a bear market hits, you draw from this cash reserve. In 2022, the S&P 500 fell 19.4% and the Bloomberg U.S. Aggregate Bond Index fell 13%. A retiree with a cash wedge could have avoided selling any assets at a loss that year, preserving the portfolio for the eventual recovery.
2. Adopt a Dynamic Withdrawal Strategy
A fixed 4% rule is simple but rigid. A dynamic rule—such as “withdraw 4% of the portfolio’s current value, with a floor and ceiling”—can reduce the risk of running out of money. For example, you might set a floor of $35,000 and a ceiling of $50,000. In a down year, you take less; in a strong year, you can take a little more. This small adjustment can add years to a portfolio’s life.
If our Year‑2000 retiree had used a dynamic rule with a $35,000 floor, she would have reduced her withdrawals during the 2000‑2002 bear market, preserving capital. By 2023, her portfolio would be roughly $400,000 instead of under $200,000—still not ideal, but a meaningful improvement.
3. Consider a Bond Tent
A bond tent is a temporary increase in bond allocation around the retirement date. You might shift from 60/40 stocks/bonds to 40/60 five years before retirement, then gradually glide back to 60/40 over the following 10 years. This reduces volatility precisely when sequence risk is highest.
Research by Wade Pfau and Michael Kitces has shown that a rising equity glide path—starting with more bonds and increasing stocks later—can improve retirement outcomes compared to a static allocation. The bond tent is a practical way to implement this idea without permanently reducing long‑term growth potential.
4. Keep Some Human Capital in Reserve
Part‑time work, consulting, or a small side business in the first few years of retirement can act as a shock absorber. Even $10,000 a year of earned income can reduce withdrawals enough to make a measurable difference. I’ve written before about how a ten-dollar weekly bump can reshape a retirement number during the accumulation years; the same principle applies in reverse during decumulation. A small income stream in the early years can be the difference between a portfolio that survives and one that fails.
What the Research Says
The concept of sequence risk isn’t new, but it’s been quantified in ways that make it impossible to ignore. The original Trinity Study (Cooley, Hubbard, and Walz, 1998) established the 4% rule, but it also highlighted that the worst‑case scenarios almost always involved poor returns in the first decade. Later work by Bengen (1994) and more recent analyses by Morningstar and Vanguard have confirmed that the first five years of returns explain a large portion of the variation in retirement outcomes.
For example, a 2021 Vanguard research paper found that for a 60/40 portfolio with a 4% initial withdrawal rate, the first five years of returns accounted for roughly 60% of the variability in whether the portfolio survived 30 years. That’s a staggering concentration of risk into a narrow window.
Frequently Asked Questions
Does sequence of returns risk matter if I am still accumulating?
No—in fact, during accumulation, a bad sequence of returns can actually help you. When you’re regularly investing, a market downturn lets you buy more shares at lower prices. This is why young investors should almost welcome bear markets. Sequence risk only becomes a threat once you start taking money out of the portfolio.
What if I retire with more than enough money? Does sequence risk still apply?
Yes, but the impact is smaller. If you have a 2% withdrawal rate instead of 4%, a bad early sequence is unlikely to cause you to run out of money. However, it can still reduce the amount you leave to heirs or charity. The risk scales with your withdrawal rate: the higher your spending relative to your portfolio, the more vulnerable you are to early poor returns.
Can I just invest more conservatively to avoid sequence risk?
Not entirely. Moving to a very conservative portfolio (e.g., 20% stocks) reduces short‑term volatility but introduces inflation risk—the danger that your purchasing power erodes over a long retirement. A balanced portfolio (50‑70% stocks) has historically provided the best trade‑off between sequence risk and inflation risk for retirees with a 30‑year horizon.
How do I know if I am in a “high risk” sequence environment right now?
You can look at valuation metrics like the Shiller CAPE ratio, which measures stock prices relative to 10‑year average earnings. When CAPE is high (above 25‑30), future returns have historically been lower, and sequence risk is elevated. As of early 2025, the CAPE ratio for the S&P 500 is around 35, suggesting that new retirees should be especially thoughtful about their withdrawal strategy and consider building a cash wedge or bond tent.
The Quiet Takeaway
Sequence of returns risk isn’t a reason to fear retirement. It’s a reason to plan for retirement with clear eyes. The first five years are a fragile bridge between accumulation and the long, slow drawdown that follows. You can reinforce that bridge with a cash wedge, a flexible spending plan, a bond tent, or a small income stream—ideally, a combination of all four.
At crawlingroad.com, I write for people who think in decades, not quarters. If you’re still in the accumulation phase, the best thing you can do today is keep saving and stay invested. If you’re within five years of retirement, take a hard look at your withdrawal plan and ask: What happens if the market drops 30% the year after I stop working? Answer that question honestly, and you’ll be ready for almost anything.