By Robert Balgac, Founder, Black Swan Insurance Group | October 5, 2026
Two retirees start with the same $500,000 and earn the same 7% average annual return over 20 years. One has money to spare at the end. The other runs out entirely.
Nothing separates them except when the good and bad years arrived.
This is sequence-of-returns risk, and it becomes dangerous the moment you start pulling money out of a portfolio instead of adding to it. For a $150K+ earner who has spent thirty years being told that average returns are what matter, it is the single most important correction in retirement planning — because averages stop being the relevant number the day withdrawals begin.
The short answer: Sequence risk is about the order of returns, not the average. Bad early timing combined with withdrawals can drain savings far faster than the average return suggests. Exposure peaks at the retirement transition and across the first several withdrawal years. Cash reserves, flexible spending, diversification and guaranteed income all reduce forced selling into a downturn. No single tactic removes the risk, and every option has a cost.
Key Takeaways
- Sequence risk is about return order, not average return
- Bad early timing plus withdrawals can drain savings faster than expected
- Exposure peaks at the retirement transition and the first several withdrawal years
- Cash reserves, flexible spending, diversification and guaranteed income reduce forced selling
- No single tactic removes the risk; every option carries a trade-off
What It Actually Is
The chance that the order in which returns occur, combined with ongoing withdrawals, shortens how long savings last. It matters most when retirement begins during a downturn, because that is when a concentrated run of poor returns does the most damage.
Two portfolios can post identical long-term averages and finish decades apart in value.
Why Selling Low Is So Destructive
When a portfolio drops and you still need a fixed dollar withdrawal, more shares must be sold to produce that cash. Fewer shares remain to participate when the market recovers. That is the mechanical core: a temporary paper loss becomes a permanent hole.
During accumulation this barely stings, because new contributions buy shares at lower prices. Once you retire and start drawing instead of adding, that cushion disappears entirely.
A Worked Illustration
Pacific Life's hypothetical comparison makes it concrete. Two investors each start with $200,000 and withdraw 5% — $10,000 — in year one, with annual increases after.
Both see the same S&P 500-based average annual return of 10.36% over 20 years, 1989 to 2008. Only the order is reversed.
- Investor A gets strong returns early, weaker years later: $268,704 in total withdrawals and a $614,841 ending balance
- Investor B hits a decline right after retiring, followed by more losses over eight years: $239,346 in withdrawals and $0
Same average return. Same withdrawal plan. Opposite outcomes. The illustration excludes fees, taxes and inflation, so treat it as a teaching tool rather than a forecast.
How It Differs From Other Risks
- Market risk — investments losing value, regardless of timing
- Inflation risk — purchasing power eroding over time
- Longevity risk — outliving your savings
- Interest-rate risk — rate changes affecting bond values and income
- Tax risk — changing rules or brackets affecting after-tax withdrawals
- Behavioural risk — the temptation to panic-sell after losses
Sequence risk is what happens when market risk collides with withdrawals at the wrong moment.
What It Does to Retirement Income
When a portfolio loses value early, every subsequent withdrawal comes from a smaller pool. Even a strong rebound a few years later reaches fewer assets, and growth on a smaller base produces smaller dollar gains.
Essential expenses do not pause for a bad market. Mortgage, groceries, healthcare and utilities keep arriving whether the market is up or down 20%, which leaves most retirees little room to skip a withdrawal even when it means selling at a loss.
Inflation compounds it. Most retirees adjust withdrawals upward, so the dollar figure grows every year even as the portfolio shrinks. After early losses that produces a double squeeze: rising income needs against a declining base.
What changes the severity: the withdrawal rate relative to portfolio size; portfolio volatility and allocation; retirement length; which accounts you tap first and the tax treatment; and how much outside income — Social Security, a pension, annuity payments — reduces reliance on the portfolio.
Vanguard research comparing retirees facing favourable against unfavourable sequences, using constant real-dollar withdrawals over 35 years, found that even with similar long-term averages a poor early sequence led to a 31% higher chance of outliving savings, 11% lower retirement income, and 37% smaller bequests.
In Vanguard's example a hypothetical retiree starting withdrawals in 1973 exhausted a $500,000 portfolio after 23 years. A retiree starting one year later, in 1974, still held roughly $300,000 for most of retirement. One year of difference.
The Behavioural Trap
A rough early sequence pressures more than the spreadsheet. Watching a portfolio drop right after the paycheck stops can trigger panic selling, an abandoned allocation, or extra risk taken to make it back. Those reactions lock in damage a steady plan might have recovered from.
Warning signs: retiring with little cash or liquid reserves; depending almost entirely on portfolio withdrawals; inflexible spending with no discretionary cushion; and a concentrated, volatile portfolio.
Panic is not a strategy. But neither is blind trust that the averages will save you in the one decade they cannot.
When the Risk Peaks
Sequence risk is not constant. It clusters around one window: the years just before retirement and the first several after, when a portfolio shifts from being built up to drawn down.
Before retirement, a decline shortly before you stop working shrinks the balance funding the entire retirement before a single withdrawal. That can force a delayed date, a scaled-back plan, or a revised strategy, with no chance to recover before withdrawals begin.
After retirement, the portfolio has less time to recover and you are not adding meaningful new capital. One widely cited analysis found returns during the first 10 years of retirement explained about 77% of the final outcome, while returns in the final 20 years explained about 5%.
Morningstar's 2025 analysis reinforces it. Modelling fixed, inflation-adjusted withdrawals over 30 years, even the second-worst return quintile in the first five years produced a 10.3% portfolio failure rate. Retirees seeing gains in every one of those first five years faced roughly 4%. A single gain after year one cut failure risk roughly in half.
There is no fixed window. The high-risk period depends on withdrawal rate relative to portfolio size, remaining market exposure, spending flexibility, life expectancy and horizon, and how much guaranteed income is already in place. Two people retiring the same day can face very different exposure.
What the Critics Get Right
Anyone who suspects that "sequence risk" gets used as a lead-in to sell guaranteed products is reading the genre correctly.
Critics are right that the risk is real and the recommended solution is frequently whatever the writer sells. They are right that cash reserves and flexible spending — the two most effective responses — cost nothing and require no product. And they are right that an annuity or an insurance policy bought to address sequence risk introduces its own costs, surrender periods and counterparty dependence.
So the honest hierarchy: build the cash buffer, adopt spending guardrails, diversify the income sources you already have. Guaranteed products address the residual risk for some households, sized to essential expenses, after the free measures are in place.
What Actually Reduces It
Cash Reserves and Buckets
One to five years of near-term spending in cash or short-term fixed income means a market drop does not force selling stocks at a loss. The common three-bucket version splits assets into cash for near-term needs, income-generating investments for the medium term, and growth assets for the long haul.
Trade-offs: cash loses purchasing power to inflation; reinvestment risk appears when short-term instruments mature in low-rate periods; and too much liquidity drags long-term growth.
Flexible Spending and Guardrails
Dynamic withdrawal strategies cut spending after a decline and allow raises when markets recover, rather than taking the same inflation-adjusted amount regardless. Modelled comparisons find dynamic strategies can support a higher starting withdrawal rate than a fixed approach.
Simpler versions work too: delaying a major discretionary purchase after a down year, skipping an inflation increase during a rough market, or trimming discretionary spending until the portfolio recovers.
Diversification Across Assets and Income
Spreading across stocks, bonds, cash and account types manages swings, though it cannot stop every asset falling at once in a broad downturn. Income diversification matters just as much, because payments that keep arriving in a slump reduce the need to sell depressed assets.
Useful layers: portfolio withdrawals timed to conditions; Social Security and pension payments; annuity payouts sized to essential bills; and cash-value policy access where the design genuinely supports it.
Guaranteed Income
Social Security, pensions and certain annuity contracts can cover essential expenses without selling market-based assets in a slump.
- Fixed annuities — a guaranteed rate and predictable payouts
- Fixed indexed annuities — returns linked to an index while limiting downside
- Variable annuities — market-linked growth potential with higher fees and no guarantee against loss
- Immediate annuities — payouts beginning shortly after a lump-sum deposit
Guarantees depend on the issuing insurer's claims-paying ability, and surrender periods restrict access. Size any guarantee to essential expenses rather than to the whole portfolio.
Where a Cash-Value Policy Fits, and Where It Does Not
A properly structured, funded and managed permanent policy can offer potential tax-advantaged access to cash value, which some households use as a buffer to avoid selling equities in a down year. That is a legitimate application of an asset you hold for protection reasons anyway.
It is a poor reason to buy one. Not everyone needs permanent coverage, and a policy purchased specifically to manage sequence risk carries cost of insurance, surrender charges and lapse risk that a cash reserve does not. Where the protection need is temporary, term insurance covers it far more cheaply and leaves the sequence problem to be solved with cash.
The Ultimate IUL Blueprint
If you already hold or are considering permanent coverage, the Blueprint covers whether its cash value could realistically serve as a buffer: funding levels, loan timing, the MEC line and what to demand from an illustration.
Who Is Most Exposed
Higher Exposure
- Retiring within the next five years, or in the first five years of withdrawals
- Household income of $150K+ with most assets in market-exposed accounts
- A high withdrawal rate relative to portfolio size
- Little or no guaranteed income beyond Social Security
- Inflexible spending with no discretionary cushion to trim
- Thin cash reserves, forcing sales in any downturn
Lower Exposure
- Several years of expenses held in cash or short-term fixed income
- Essential expenses substantially covered by Social Security, a pension or an annuity
- Genuine willingness to cut discretionary spending after a bad year
- A long horizon before withdrawals begin
- Diversified income sources that do not all depend on the same market
Risks to Understand
Not everyone should buy an IUL. Sequence risk is real, but a cash reserve and a bond ladder address it more directly and far more cheaply.
- Averages are the wrong measure once withdrawals begin, and planning on them is the root error
- The first ten years explain roughly 77% of the final outcome in one widely cited analysis
- Inflation-adjusted withdrawals increase the dollar draw exactly as the portfolio shrinks
- Essential expenses do not pause, which removes the option of simply not withdrawing
- Panic selling converts a recoverable loss into a permanent one
- Cash reserves lose purchasing power, so the buffer has a real cost
- Annuity guarantees depend on the insurer and surrender periods restrict access
- A cash-value policy is not a cash reserve — cost of insurance, surrender charges and lapse risk all apply
- No strategy eliminates the risk, and any that claims to is misdescribing itself
Find Out Where You Actually Stand
This starts with the Tax-Free Wealth Blueprint Fit Review. If you earn $150K+ and are within five years of drawing income, we model a poor first sequence against your actual withdrawal plan, size the cash buffer that would prevent forced selling, test spending guardrails, and price a guarantee only for essential expenses if a gap remains. If it does not fit, we will tell you that too — and often the answer costs nothing but a change in the withdrawal rule.
Frequently Asked Questions
What is sequence-of-returns risk in one sentence?
The risk that the order of your investment returns, combined with withdrawals, causes your savings to run out sooner than the average return would suggest.
When is it most dangerous?
Around the retirement transition and the first several withdrawal years. Research suggests the first decade explains the large majority of the final outcome.
Does a bigger portfolio solve it?
It reduces the withdrawal rate, which helps substantially. It does not eliminate the risk, because the mechanics of selling into a decline apply at any size.
What is the cheapest way to reduce it?
Cash reserves and flexible spending. Neither requires buying anything, and both directly address the mechanism — being forced to sell depressed assets.
Should I buy an annuity for this?
Possibly, sized to essential expenses rather than to the whole portfolio, and after the cash buffer and spending guardrails are in place. Review surrender periods, fees and the insurer's strength first.
Can life insurance cash value work as a buffer?
Where a policy already exists and is well funded, sometimes. It is a weak reason to buy one, because a cash reserve does the same job without cost of insurance, surrender charges or lapse risk.
Sources
- Pacific Life — The impact of the sequence of returns
- Morningstar — The biggest risk for new retirees
- Vanguard — Safeguarding retirement in a bear market
- NAIC — Buyer's Guide to Fixed Deferred Annuities
- NAIC — Life Insurance
Disclosure: This article is educational and is not personal tax, legal or investment advice. Indexed universal life is life insurance first. The illustrations referenced are hypothetical and exclude fees, taxes and inflation; they are teaching tools rather than forecasts. Annuity and insurance guarantees are subject to the claims-paying ability of the issuing insurer. Investments can lose value. Actual results depend on policy design, carrier, crediting options, caps, participation rates, expenses, funding and ongoing management. This strategy is not appropriate for everyone. Policy loans and withdrawals reduce cash value and the death benefit, and can create tax consequences if the policy lapses or becomes a modified endowment contract. Illustrated values are not guarantees; actual results depend on policy terms, crediting, costs and funding. Consult your own tax, legal and financial professionals for advice specific to your situation.
And remember, it's not what you earn, it's what you keep… enjoy the ride.
