How the ‘Sequence of Returns’ Can Derail Retirement Plans

For retirees, the market’s performance in the early years of their golden era may carry more weight than its long-term average. A cruel twist of timing — poor returns in the first few years — can irreparably damage even the most prudently constructed portfolio. This is the essence of “sequence of returns risk,” a phenomenon increasingly central to the study of retirement economics.

Consider two retirees with identical savings and identical average investment returns over 30 years. If one experiences negative market returns early in retirement, their portfolio is significantly more likely to be exhausted well before the other’s. Why? Because withdrawals during downturns lock in losses, diminishing the capital base and reducing its ability to recover.

This is no theoretical curiosity. History abounds with instructive episodes. A retiree embarking on withdrawals in the year 2000, at the apex of the dot-com bubble, faced a harsh initiation: the S&P 500 halved over the subsequent three years. For those following the vaunted “4% rule” — withdrawing 4% of their portfolio annually, adjusted for inflation — the ensuing drawdowns pushed withdrawal rates to dangerous heights. Though markets later recovered, few retirees possess the resolve to weather such a storm without altering course.

The global financial crisis of 2008 was similarly treacherous. A balanced 60/40 stock-bond portfolio shed roughly a quarter of its value. And yet, retirees who remained invested saw their portfolios regain ground by the mid-2010s. The lesson? Timing is merciless, but panic is fatal.

The Trouble with 4%

William Bengen’s famous 4% rule — derived from US market data — suggested that retirees could safely withdraw that proportion annually without outliving their assets. But global data have cast doubt on this assumption’s universality. A study by Wade Pfau, examining 109 years of returns in 17 developed nations, found that a 4% withdrawal rate would have failed in most of them. Japan, for instance, delivered a safe withdrawal rate closer to 0.5% for retirees in 1940.

That the United States’ experience in the 20th century was unusually favourable should temper confidence in simplistic rules. In a globally diversified context, and particularly for early retirees with longer time horizons, a more conservative withdrawal — perhaps 3–3.5% — is likely to be safer.

Spending Strategies: Flexibility Is the Virtue

The rigidity of fixed withdrawal strategies is their Achilles' heel. They are simple, yes, and offer predictability, but they do so at the expense of resilience. Academic research is increasingly aligned around a superior alternative: dynamic withdrawal strategies that adapt to market performance.

One such approach, the “guardrails” method devised by Guyton and Klinger, adjusts withdrawals upward in good years and trims them in bad ones, according to predetermined thresholds. These rules-based systems reduce the risk of ruin while allowing retirees to enjoy rising markets. The underlying principle is intuitive: if the portfolio shrinks, so should withdrawals; if it grows, retirees can afford a modest raise.

Fixed-percentage withdrawals — taking, say, 4% of the remaining balance each year — eliminate the risk of depletion altogether. But they come with a catch: income can vary dramatically from year to year, which is potentially unsettling for retirees with fixed expenses.

In short, the trade-off is between stable income and portfolio longevity. The optimal path lies somewhere in between. Retirees willing to tolerate moderate spending fluctuations are better positioned to preserve their capital over time.

Allocation and Adaptation

Asset allocation plays a decisive role in navigating sequence risk. The data suggest that neither extreme — 100% equities nor 100% bonds — offers optimal protection. Instead, balanced portfolios (typically between 50–70% equities) historically yield the best results. They harness equity growth while cushioning declines with fixed income stability.

Global diversification, too, matters. Retirees overly reliant on their domestic market risk synchronized downturns. A globally diversified equity allocation, combined with high-quality bonds, spreads risk and mitigates the impact of local economic shocks.

Some researchers have even advocated for “rising equity glide paths” — starting retirement with a lower equity share and increasing it over time. Though counterintuitive, the approach reduces exposure when portfolios are largest and most vulnerable, then adds risk only after surviving the perilous early years.

Others explore trend-following and risk-managed strategies. These promise smoother returns by reducing equity exposure during downturns. Though not foolproof, they are examples of how smart risk management can blunt the sharper edges of market timing.

Behaviour Matters More Than Models

No model, however elegant, can withstand poor investor behavior. Panic selling during a crash or overly exuberant spending after a rally can inflict more damage than the market itself. The academic literature is unequivocal: discipline is paramount. Retirees must resist the urge to abandon plans midcrisis or to splurge on the back of recent gains.

Similarly, failing to adjust withdrawal rates to changing life expectancy, or ignoring the possibility of a 40-year retirement, can prove ruinous. Planning to 90 is no longer enough if one might live to 100. Here, as elsewhere, conservatism is not cowardice, it is prudence.

A Process, Not a Product

The notion that retirement is a one-off decision — a magic number, a fixed rate, a single portfolio — is both popular and dangerous. The reality is more complex. Retirement is a multidecade journey, during which markets fluctuate, inflation rises and falls, lifespans stretch, and needs evolve. A robust plan is not static, it breathes.

Academic consensus now embraces a few central principles. Begin conservatively. Maintain a balanced, globally diversified portfolio. Choose a withdrawal strategy that flexes with conditions. Supplement investment income with guarantees, if possible, for essential needs. And above all, monitor and adapt. As one paper succinctly put it: “Just as important as having a plan is ensuring that the plan remains on track.”

In a world where outcomes are uncertain and the path to retirement is strewn with risks both visible and latent, flexibility and foresight are the surest safeguards. For those preparing to draw down their life savings, the order of returns may matter more than the returns themselves. And the capacity to respond wisely to adversity may matter most of all.