How We Actively Manage Sequence of Returns Risk for Clients

Anthony Watson |



  • Sequence of Returns Risk has arguably the greatest influence on your potential retirement outcomes.
  • Withdrawing money in the presence of a negative sequence of returns can have a material adverse impact on your portfolio's longevity.

  • You cannot eliminate Sequence of Returns Risk, but there are strategies that can substantially reduce the adverse impact a negative sequence of returns can have.

We have written extensively about Sequence of Returns Risk (SoRR), but for good reason.  It is clear the transition from accumulation (or building savings) to decumulation (or living off of savings) presents an individual with many new risks that must be considered and managed.  Among the many new risks (see "Evaluating the Big Five Retirement Risks Every Retiree Faces" for more), SoRR is arguably the greatest when it comes to the magnitude of the potential effect it can have on your retirement outcomes.   

Magnitude of Threat Posed by Sequence of Returns Risk

Just a quick peak inside of an example Monte Carlo analysis quickly highlights the magnitude of threat SoRR can present:


Each blue line represents a scenario subjected to a possible sequence of returns (i.e., a path of annual returns during an individual’s lifetime) based on actual historical observations.  The worst-case observation, indicated by the red line, represents a possible scenario where this hypothetical retiree would run out of money at age 84.  The best-case observation, indicated by the green line, represents a possible scenario where this hypothetical retiree would pass at 94 with $4.18 million (in today’s dollars).  These outcomes are considerably different, but each is a possible outcome based on historical observation. 

Unfortunately, you cannot know the year-to-year sequence of returns you will experience during your lifetime.  This is precisely the risk posed by SoRR.  What we can do, however, is accept this unknown and have a game plan in place for how to react given whatever outcome is faced. 

Understanding The Math Behind Sequence of Returns Risk

From your high-school math class, you can probably recall the “Commutative Property of Multiplication,” which states that the order of the factors being multiplied does not change the product.  For example, 12 x 3 = 36, and 3 x 12 = 36, too.  It doesn’t matter whether the 12 or the 3 comes first in the equation.

Let’s further this example by having these numbers represent two different years of market returns.  So, earning 12.0% in year one, followed by 3.0% the next year, would leave you with a 15.4% return over the two years.  Even if we flipped the order of returns, the answer would still be 15.4% at the end of year two.  The problem is that you don’t live off of percentages.  (Nerdy side note – this is known as a Time Weighted Rate of Return, TWR, and is how money managers present performance to you).  You live off of dollars. 

What matters is not just the return earned but the amount of money to which the return was applied.  Let’s continue to build on our example.  Say you had $100,000 in year one and added another $100,000 at the beginning of year two.  Now, you will see that the order of returns matters.

So 12% on $100,000 in year one is $12,000, and 3% on $212,000 in year two is $6,360, leaving you with $218,360 (or a gain of $18,360) at the end of year two.  Now, let’s reverse the 12% and 3% returns.  Earning 3% on $100,000 in year one is $3,000, and 12% on $203,000 in year two is $227,360 (or a gain of $27,360) at the end of year two.  The second scenario yields $9,000 (or 49%) more return.  The amount of money the return is applied to matters a great deal.

It's Your Timing of Outflows, Given Your Sequence of Returns, That Matter

Applying this math to a more real-world example, it becomes clear that a retiree's outcome has far less to do with the average return they experience over their retired lives and far more to do with the actual sequence of annual returns they experience being applied to their investment balance.  This can be seen in the example below, where two retirees both start with $3,000,000 and take $150k annual withdrawals but end up with very different remaining amounts after just ten years, given the exact same average return of 4.0% over the time period:


The retiree in Scenario B was irreparably harmed by continuing to withdraw $150k per year from assets that were down in value earlier in retirement.  Not only did it take more assets to generate the $150k per year because of depressed market prices, but also those assets were gone from the portfolio and unable to participate in the ensuing market rebound.  The timing of outflows under Scenario B in the presence of a negative sequence of returns had a material adverse impact on the retiree.

Defending Against a Negative Sequence of Returns

We cannot control the return of the market in any given year, but with proper planning, we can control the timing of potentially harmful outflows.  

Managing Sequence of Returns Risk in the Near-Term

Income laddering is our primary tool to mitigate SoRR in the near term.  Generally speaking, as individuals approach retirement, they should look for a good time to begin laddering approximately 12 to 18 months of living expenses (the exact duration depends upon individual circumstances). 

Our best tool (given the yield environment today) to ladder income for a 12 to 18-month time frame is most often non-callable CDs or U.S. treasuries in three-month increments (typically, CDs offer slightly higher yields and provide greater flexibility).  When the CD on the bottom of the income ladder matures every three months, the proceeds are placed in a money market account to fund monthly “retirement paycheck” distributions to your operating checking account.  When a CD matures, we would look to buy a new rung (or CD) at the top of the income ladder as long as markets are in good health. 

You will experience many times during your retirement time horizon when markets will not be in good health.  Markets frequently fall in value (often steeply) in response to economic events (some lead to recession, some do not).  When this happens, we pause buying new CDs.  Recall we do not want to sell investments at a steep discount (i.e., have outflows during a negative sequence of returns event).  The good news under this strategy is that you will already have purchased 12 to 18 months of income, allowing you time to wait for markets to recover before resuming, thus insulating yourself greatly from the effects of a negative sequence of returns.

Managing Sequence of Returns Risk in the Intermediate-Term (and Emergencies)

Between April 1947 and April 2022, there were 14 bear markets, ranging in length from one month to 1.7 years, and in severity from a 51.9% drop in the S&P 500 to a decline of 20.6%.  So what do you do if market values are still depressed but you run out of laddered income?  Here is where having a combination of savings buffer and/or short-term credit availability in the form of a Pledged Asset Line of Credit (PAL) or Home Equity Line of Credit (HELOC) comes into play. 

Using idle savings is obvious, but using short-term credit is less obvious.  The logic here is that it is much better to pay a little interest expense for a brief period of time than to sell assets off when markets are down steeply.  When markets recover, you can liquidate investments to pay off whatever you borrowed under the line of credit.

A short-term line of credit is also an ideal source to mitigate “shock-spending” events.  What would you do if you suddenly had to come up with a large sum of money for some unpredictable (emergency) reason during a recession?  A line of credit could be your savior here, too.  Absent the line of credit, you would need to keep a larger savings buffer, which is essentially cash on the sideline not working for you (i.e., “cash-drag”) just in case a low-probability event occurs.

You Cannot Eliminate Sequence of Returns Risk

Because your particular sequence of returns is unknown, SoRR is ever-present.  While we can never completely eliminate the risk, we can take actions to insulate you greatly from the harmful effects a poor sequence of returns can have.  Given the magnitude of the destructive effect mismanaging a poor sequence of returns can have, these strategies are worth their “weight in gold” when it comes to making sure you make the most of your situation, whatever is thrown at you.

Sequence of Returns Risk Management Strategies Must Be Fine-Tuned to the Individual

These are the primary broad strategies we use to help our clients actively manage negative sequence of return events.  The level and mix of these strategies must be fine-tuned for each individual to be optimized.  Following these strategies can substantially narrow the range of possible outcomes from the wide range we saw in our early Monte Carlo analysis example of running out of money at age 84 to passing away at 94 with $4.18 million.    

If you would like help setting up your plan to actively manage Sequence of Returns Risk, we are here to help. You can click here to schedule an informal, introductory Zoom call to get started.