Key Takeaways:
- The order of returns matters when money is entering or leaving an investment account.
- A simple two-year example shows why identical returns can produce different withdrawal outcomes.
- Flexible spending and an appropriate investment mix can be evaluated without assuming losses can be eliminated.
An average return leaves out the timing of cash flows. When you withdraw money from an account, the balance exposed to the next return changes. This is the practical issue behind sequence-of-returns risk in retirement.
Follow a two-year illustration
Start with a fictional $100,000 account and withdraw $10,000 at the end of each year. Assume the only returns are negative 20% and positive 25%, in opposite orders. Ignore fees, taxes, inflation and every other real-world complication.
In sequence A, $100,000 falls 20% to $80,000. The first withdrawal leaves $70,000. A 25% increase takes that to $87,500; the second withdrawal leaves $77,500.
In sequence B, $100,000 rises 25% to $125,000. The first withdrawal leaves $115,000. A 20% decline takes that to $92,000; the second withdrawal leaves $82,000.
The same two returns and the same scheduled withdrawals leave a $4,500 difference. Without withdrawals, both return orders would bring the original $100,000 back to $100,000. These invented returns demonstrate arithmetic, not a likely market path or a recommended withdrawal amount.
Identify the spending that must continue
List essential costs and dependable income before deciding which withdrawals could change after a loss. A plan cannot rely on flexibility if nearly all spending is committed. Identify actual purchases that could be postponed, reduced or funded differently.
Check the timing of withdrawals as well as the annual total. A large payment due soon creates a different access need from a discretionary purchase that can wait. Label cash reserved for known bills so it is not also counted as an emergency reserve.
Compare responses before a downturn
Evaluate asset allocation, diversification and rebalancing alongside the withdrawal plan. None guarantees a positive return. Holding more cash also has tradeoffs, including the possibility that purchasing power does not keep pace with costs.
Write a review rule that uses your spending needs and remaining resources, rather than one that reacts automatically to a single bad market day. Test whether reductions are practical and whether another income source is truly available.
The TIAA resource below discusses sequence risk; Investor.gov explains allocation and diversification. Use those concepts to ask a specific planning question: how would the household fund its next necessary withdrawals after an early loss, and what would have to change afterward?
Sources and tools
Related reading
General education for U.S. readers. Numerical examples are hypothetical, not forecasts or individual recommendations.
