Sequence of Returns Risk: Why an Early Downturn Can Wreck a Retirement Portfolio (and the 4% Rule)

Does the Same Average Return Always Produce the Same Outcome?

Imagine two people who each retire with $1 million and invest it at the exact same average annual return over the next 25 years. Both withdraw the same inflation-adjusted amount every year for living expenses. If the average return is identical, it seems obvious that both should end up with the same amount of money 25 years later. In practice, they often don't. One retiree can still have a comfortable nest egg after 25 years, while the other runs out of money well before that. The difference comes down to the order in which the returns arrive, not just their average — a phenomenon known as sequence of returns risk. This lesson covers why that happens, and what the long-running 4% rule debate tries to say about how much a retiree can safely withdraw each year.

Accumulating Money and Spending It Down Are Two Different Games

During the accumulation phase covered in Why Invest? Compound Interest vs. Savings Accounts, sequence risk barely matters. Someone investing a fixed amount from every paycheck ends up with roughly the same final balance whether the downturn hits early or late in their career, as long as the long-run average return is the same. An early downturn can even help, since it lets the same contribution buy more shares at a lower price.

The problem starts the moment someone begins drawing money out. A retiree withdraws living expenses on a schedule, regardless of what the market happens to be doing. Withdrawing during a downturn forces the sale of a larger number of shares to raise the same dollar amount. Selling a larger share count at depressed prices means that even if the market later recovers, the now-smaller remaining position can't capture the full benefit of that rebound. In other words, withdrawing money during an early downturn structurally erodes the portfolio's own capacity to recover. That's exactly why sequence risk is almost exclusively a drawdown-phase problem, not an accumulation-phase one.

A Numbers Check: Same Returns, Reversed Order

The clearest way to see sequence risk is to take the same list of annual returns and simply reverse the order. Two retirees each start with $500,000 and withdraw $20,000 in year one, increasing that amount each year with inflation. Both experience the exact same five years of returns — just in opposite order.

Year	Retiree A's Return	Retiree B's Return
Year 1	−20%	+15%
Year 2	−10%	+12%
Year 3	0%	0%
Year 4	+12%	−10%
Year 5	+15%	−20%

The five-year average return is identical for both. But Retiree A was forced to withdraw living expenses while the portfolio was at its smallest — right in the middle of the Year 1–2 downturn — which meant selling a disproportionately large number of shares just as prices had fallen. Retiree A then enters the Year 4–5 rebound holding a much-reduced position. Retiree B, by contrast, got the gains first, entered the downturn years with an already-larger balance, and absorbed the Year 4–5 losses from a position of relative strength. Despite the identical average return and identical withdrawal schedule, the two retirees' actual ending balances diverge substantially. The lesson this simplified example illustrates: what determines whether retirement savings survive isn't the long-run average return — it's the sheer luck of exactly when the downturn happens to land.

Why the First 5–10 Years of Retirement Matter So Much

Because of this mechanism, financial planners treat the first five to ten years of retirement as the critical window for protecting a portfolio. A sharp downturn during that stretch leaves a permanently smaller base, and even a strong subsequent market recovery can't fully restore what was lost to early withdrawals at depressed prices. A downturn of the same magnitude occurring ten or fifteen years into a well-established withdrawal path tends to do far less damage, simply because the withdrawal rate relative to the (by-then more seasoned) portfolio has already proven sustainable. This means the specific calendar year someone happens to retire in isn't just a personal choice about when to stop working — it's also a matter of luck, determining which market regime a retiree's withdrawals happen to begin in. Retirees who began drawing down savings in the late 1960s, for instance — a period combining an early bear market with high inflation — are frequently cited as the worst historical case, producing the lowest safe withdrawal rate in the historical record.

What Is the 4% Rule?

The attempt to answer "given sequence risk, how much can I safely withdraw each year?" is what produced the 4% rule. In 1994, US financial planner William Bengen analyzed US stock and bond market data going back to 1926 and found that a portfolio split 50/50 between stocks and intermediate-term Treasury bonds could support an initial withdrawal of about 4.15% of the portfolio's value, with that dollar amount then increased each year only for inflation, and still not run out of money over 30 years — even starting from the worst historical retirement date. In 1998, researchers at Trinity University extended the analysis across a wider range of stock/bond mixes, finding that a 75% stocks / 25% bonds portfolio withdrawing 4% initially had roughly a 95% chance of lasting 30 years. That's how "4%" became the industry's standard reference point — now commonly called the Trinity Study.

One common misunderstanding is worth clearing up: the 4% rule does not mean recalculating 4% of the current portfolio balance every year. It means calculating 4% of the balance only once, in year one, then increasing that same dollar amount every year strictly by inflation — regardless of whether the portfolio has gone up or down since. That detail matters because it's precisely this "withdraw a fixed amount regardless of what the market is doing" feature that exposes a retiree to sequence risk in its most extreme form.

Criticism and More Recent Research

Even thirty years after it was published, the 4% rule remains the standard starting point for retirement planning — and it remains one of the most criticized numbers in personal finance. A few of the core objections:

First, Bengen's study projects historical data forward, and the post-1926 US market happened to include an unusually strong run for stocks that may not repeat. For that reason, Morningstar now publishes its own annual "safe withdrawal rate" estimate using a forward-looking method based on current bond yields and expected stock returns rather than historical data alone. Its 2026 estimate puts the highest safe starting withdrawal rate at about 3.9% for a portfolio holding 30%–50% in equities, assuming a 90% probability that money remains after 30 years — up slightly from 3.7% the year before, but still below Bengen's 4.15%. Notably, Morningstar's research found that portfolios with heavier equity exposure actually supported lower safe withdrawal rates, because the added volatility increases exposure to sequence risk even as expected returns rise.

Second, both the Bengen and Trinity research assumed a 30-year retirement. As life expectancy rises and early retirement becomes more common, a withdrawal period stretching to 40 or 50 years meaningfully raises the odds of running out of money at the same 4% rate. Monte Carlo simulations that extend the time horizon from 30 to 50 years have repeatedly shown the probability of a portfolio lasting the full period drop substantially.

Third, a rule built on US market data doesn't transfer cleanly to other countries. Investors elsewhere need to weigh their own stock and bond markets' historical performance, how much of their living expenses a public or employer pension already covers, and currency exposure. Understanding the underlying mechanism — that the order returns arrive in matters just as much as their average — is more useful than treating any single percentage as universal.

Practical Approaches to Managing Sequence Risk

Across the retirement-planning industry, the common thread in dealing with sequence risk is not fixing a withdrawal amount in total isolation from what the market is doing. A few frequently discussed approaches:

A cash or short-term bond buffer. Setting aside enough cash-equivalent or short-duration bond holdings to cover a few years of living expenses means a retiree doesn't have to sell equities at depressed prices during a downturn. This is often framed as a "bucket strategy" — near-term spending money, a medium-term bond-heavy bucket, and a long-term growth-oriented equity bucket.

Flexible withdrawal amounts. Trimming withdrawals in years with poor returns and allowing somewhat higher withdrawals in strong years can meaningfully raise the odds a portfolio survives, compared to a rigid inflation-adjusted schedule — at the cost of living expenses that vary more from year to year.

Tax-aware withdrawal sequencing. Choosing which account to draw from first among sources taxed differently — public pension, employer retirement accounts, personal retirement accounts, and ordinary taxable accounts — can increase after-tax income for the same total withdrawal. Delaying public pension income and bridging the gap with taxable assets in the meantime is one combination commonly considered. The optimal mix depends heavily on an individual's own asset mix and tax situation, so it resists a one-size-fits-all formula.

What these approaches share is that none of them are market-timing signals telling someone when to buy or sell. They're structural choices made at the withdrawal-design stage, aimed at reducing how much sequence risk can damage the portfolio in the first place.

Takeaway

• Sequence of returns risk means that two portfolios earning the identical long-run average return can end up with very different balances, purely because of whether downturns land early or late in the withdrawal period.
• Sequence risk barely matters during accumulation, but becomes central the moment regular withdrawals begin, since an early downturn forces selling more shares at depressed prices and permanently reduces the capacity to benefit from a later recovery.
• The 4% rule, drawn from Bengen's 1994 research and the 1998 Trinity Study, withdraws about 4% of the initial balance in year one and increases that dollar amount only by inflation afterward.
• More recent forward-looking research, such as Morningstar's, points to a more conservative safe withdrawal rate of around 3.9% for 2026, and finds that both a longer retirement horizon and higher portfolio volatility tend to push the safe withdrawal rate lower.
• Cash buffers, flexible withdrawal amounts, and tax-aware withdrawal sequencing are not timing strategies — they're structural ways to blunt the impact of sequence risk at the withdrawal-planning stage.

FAQ

Should I still just follow the 4% rule today?

Treat 4% as a historical US-data-based starting point, not a fixed answer. More recent research tends to recommend a more conservative withdrawal rate given current bond yields, longer life expectancies, and a given asset allocation, so it's safer to treat it as a reference to adjust for your own retirement horizon, asset mix, and pension income rather than a fixed rule.

Does holding fewer stocks eliminate sequence risk?

Not entirely. A higher bond allocation lowers volatility, but it also lowers long-run expected returns, which can mean a portfolio depletes more slowly but still depletes, just at a lower overall level. Morningstar's own research found that a 30%–50% equity allocation supported the highest safe withdrawal rates, so minimizing equity exposure isn't automatically the safer choice.

Does sequence risk matter for people who are still accumulating savings?

It becomes relevant as retirement approaches. A sharp downturn right before retirement is effectively the start of the withdrawal phase, so even those who haven't started withdrawing yet are commonly advised to gradually reduce portfolio volatility in the years leading up to retirement.

⚠️ This article is for informational purposes only and is not investment advice. The withdrawal rates and probabilities cited are reference figures based on specific research assumptions; actual retirement planning depends on individual assets, taxes, and life expectancy, and you are solely responsible for your own investment decisions.