Sequence of Returns Risk Explained (And How to Reduce It)

Sequence of returns risk is the danger that the order in which your investment gains and losses occur, not just their average over time, can determine whether your retirement savings last.

Two retirees can earn the exact same average annual return over 30 years and end up in completely different financial positions, simply because one hit a bear market in year two of retirement and the other hit it in year twenty-five.

For anyone withdrawing money from a portfolio rather than adding to one, this risk deserves more attention than it usually gets.

Key Takeaways

• Losses in the first five to ten years of retirement do far more damage than losses later on, even if the average return over the full retirement period is identical.
• Morningstar’s 2025 research puts the base-case safe withdrawal rate for a 30-year retirement at 3.9% for 2026, up from 3.7% the year before, largely due to higher bond yields.
• Strategies like cash buffers, bond tents, guardrail spending rules, and flexible withdrawals can meaningfully reduce the odds of running out of money during a bad early stretch.

What Sequence of Returns Risk Actually Means

Picture two investors, each starting retirement with $1 million and withdrawing $40,000 a year, adjusted for inflation. Investor A retires into a market that drops 20% in year one and year two before recovering and averaging solid gains for the rest of the 30-year period.

Investor B retires into the same average return, but the bad years land at the end of the period instead of the beginning. Investor A is likely to run out of money well before year 30. Investor B, who had two decades of growth before the downturn hit, often finishes with a substantial balance left over.

The math behind this is not complicated once you see it. When a portfolio loses value and you’re also pulling money out of it, you’re selling shares at depressed prices.

Those shares are gone. They can’t participate in the recovery that follows. A portfolio that’s still growing, with no withdrawals coming out during the dip, simply rides the loss out.

This is why the timing of returns matters more than the average of returns for anyone in the withdrawal phase.

Financial advisor William Bengen first quantified this in his 1994 research, testing withdrawal rates against historical U.S. market data going back to 1926.

He found that a 4% initial withdrawal rate, adjusted annually for inflation, survived every 30-year period in his dataset, including retirements that began right before the Great Depression and during the high-inflation 1970s.

That research became known as the 4% rule, and it remains the starting point for most retirement withdrawal conversations even today.

Why 2026 Is a Relevant Year to Think About This

Retirement income researchers update their models constantly, and the numbers shift depending on current bond yields, stock valuations, and inflation expectations.

Morningstar’s “State of Retirement Income” report, released in December 2025, set the base-case safe withdrawal rate for a 30-year retirement starting in 2026 at 3.9%, up from 3.7% the prior year. The firm attributed the increase mainly to higher bond yields rather than stronger stock performance.

Their research also found that portfolios weighted too heavily toward stocks, somewhere above the 50-60% equity range, don’t necessarily support higher safe withdrawal rates, because the added volatility increases exposure to sequence risk right when it matters most.

Bengen himself revisited his own work in an August 2025 book. Using a more diversified mix (55% stocks, including small- and mid-cap exposure, 40% bonds, 5% cash), he raised his recommended starting withdrawal rate to 4.7% for a 30-year retirement. That’s a meaningful jump from the original 4%, and it shows how much these figures depend on asset allocation assumptions, not just market history.

Market conditions in early 2026 offer a live example. The S&P 500 returned roughly 17.9% in 2025 on a total return basis, but the path there wasn’t smooth.

The index fell nearly 19% in the first half of 2025 before recovering to finish the year well in positive territory. Anyone who retired in March 2025 and started withdrawals immediately experienced that drop firsthand, right at the start of their retirement, regardless of how the full year eventually played out.

Through the first several months of 2026, the S&P 500 has traded roughly flat to slightly down year to date, and the VIX has spent much of the year moving between the high teens and low 20s, touching as high as 35 over the trailing twelve months.

None of this is a crisis. It’s a reminder that volatility doesn’t announce itself in advance, and retirees don’t get to choose when it shows up.

Historical Examples Worth Knowing

The 1966 and 2000 starting points come up repeatedly in academic withdrawal-rate research because they combine early losses with years of subpar recovery.

They’re the scenarios that determine how low a “safe” withdrawal rate needs to be, since a strategy only counts as safe if it survives the worst historical sequence, not just the average one.

Strategies That Actually Reduce the Risk

There’s no way to eliminate sequence risk entirely, since nobody can predict market timing with precision. But several approaches have a track record of softening its impact.

• Hold two to three years of planned withdrawals in cash or short-term bonds, so a market downturn doesn’t force stock sales at the worst possible moment.
• Reduce equity exposure in the years immediately before and after retirement, then gradually increase it again once the early risk window passes. This is sometimes called a bond tent.
• Use guardrail withdrawal rules, where spending is cut temporarily after a bad market year and restored once the portfolio recovers, rather than sticking to a fixed inflation-adjusted amount regardless of performance.
• Delay Social Security if possible, since a larger guaranteed benefit later reduces how much needs to come from the portfolio during vulnerable early years.
• Consider partial annuitization for essential expenses, covering the non-negotiable costs (housing, food, insurance) with guaranteed income so market drops don’t threaten basic needs.

Morningstar’s research found that retirees willing to adjust spending based on portfolio performance, rather than committing to a fixed inflation-adjusted withdrawal, could safely start at rates as high as 5.7%, compared to the 3.9% baseline for a rigid plan.

That gap, nearly two full percentage points, represents a real difference in lifestyle over a 30-year retirement, and it comes entirely from flexibility rather than from taking on more investment risk.

Valuations matter too. Research from the Early Retirement Now blog, which has run one of the more detailed public analyses of withdrawal rates, has shown that when the CAPE ratio (a measure of how expensive stocks are relative to long-term earnings) climbs above 30, the failure rate for a straightforward 4% withdrawal strategy jumps well above its historical average.

Retirees starting out during expensive markets may want to lean more conservative on their initial withdrawal rate, then adjust upward later if conditions improve.

Who Should Pay Closest Attention

This isn’t an abstract concern for people decades away from retirement. It matters most for:

• People within five years of retirement, especially with portfolios concentrated in stocks.
• Anyone who retired in 2024 or 2025 and is taking early withdrawals during a choppy market.
• Early retirees planning for 40- or 50-year time horizons, since a longer withdrawal period means more opportunities for a bad sequence to appear at some point along the way.
• Couples who haven’t yet finalized Social Security timing, since that decision directly affects how much pressure falls on the investment portfolio in the early retirement years.

For this last group, running the numbers on guaranteed income sources before finalizing a withdrawal strategy tends to matter more than fine-tuning the stock-to-bond ratio.

Conclusion

Sequence of returns risk explains why two retirees with identical average returns can end up with very different outcomes, and why the years right around retirement carry more weight than any other stretch.

Building in cash buffers, flexible spending rules, and a realistic starting withdrawal rate gives a portfolio a better chance of surviving whatever order the market decides to deliver its returns.