What the risk actually is
Investment advisory services described on this page are offered through Avinci Wealth Management, Inc., a Registered Investment Adviser registered in California, Arizona, Illinois, Texas, and Nevada. This page is general information for educational purposes and is not individualized investment advice or a recommendation of any strategy or product. All investing involves risk, including possible loss of principal.
Sequence of returns risk describes a straightforward observation. If you take two identical sets of annual returns and reorder them, a portfolio that is being drawn down can end up in a materially different place, even though the average return over the period is the same.
The idea is counterintuitive because most people's financial experience is built during accumulation, where it applies with much less force. A lump sum with no money going in or out arrives at the same ending value regardless of the order in which the returns occurred. Regular contributions make the order matter somewhat, but the average return remains a reasonable guide to that experience.
Retirement inverts the mechanics. Once money is coming out, the order stops being a matter of presentation and becomes a matter of how many shares remain to recover.
During accumulation, average returns can be an important measure. During retirement withdrawals, the sequence of those returns can become just as important.
Why withdrawals change the math
The mechanism is not complicated. In a year when prices have fallen, funding a withdrawal requires selling a larger number of shares to raise the same amount of money. Those shares are permanently gone from the portfolio. When prices recover, the recovery applies to a smaller base.
The effect compounds. A decline early in retirement reduces the asset base at the same time as withdrawals continue, which means the portfolio enters the recovery smaller than it would otherwise have been, and each subsequent withdrawal represents a larger share of what remains. A decline of the same size twenty years later lands on a portfolio that has already had two decades of compounding behind it and a shorter remaining horizon to fund.
This is why two households retiring two years apart, with similar portfolios and similar spending, can have genuinely different experiences. Neither made a better decision. They encountered a different order.
The window of exposure
The exposure is not evenly distributed across retirement. It tends to concentrate in the years immediately before and after the retirement date, when withdrawals may begin and there may be less time to recover from significant market declines.
It begins before retirement because a decline in the final working years reduces the balance that the whole plan is sized against, and there is limited time left to rebuild it from contributions. It extends afterward because the portfolio is at its largest relative to remaining lifetime withdrawals, so a reduction in that period affects the most years.
The practical consequence is that this is a planning problem with a deadline. The responses below are considerably easier to put in place before the window than during it, which is the argument for having the conversation some years ahead of a retirement date rather than at it. Retiring in three years covers what else belongs in that window.
What can be done about it
There is no way to control the order of returns. What can be influenced is which assets fund the early years, and how much has to be withdrawn from them.
| Approach | How it addresses the risk | Trade-off |
|---|---|---|
| Holding near-term spending in more stable assets | Near-term withdrawals can be funded without selling growth assets during a decline | Holding more in stable assets may reduce long-term growth, and the reserve has to be deliberately refilled |
| Flexible discretionary spending | Reducing withdrawals in a poor year lessens the number of shares sold at depressed prices | Requires discretionary spending to have been identified in advance, and the flexibility to actually reduce it |
| Adjusting allocation along a glide path | Reduces exposure to a sharp decline during the most sensitive window | A more conservative allocation may reduce growth across a retirement that could run thirty years or more |
| Other reliable income sources | Income not dependent on portfolio value reduces how much has to be withdrawn in any year | Depends on what is available; any product-based option carries its own terms, costs, and guarantees subject to the issuer |
| Delaying the retirement date | Shortens the drawdown period and allows more time to rebuild | Not always available or desirable, and the decision is about more than arithmetic |
A general description of approaches in common use, not a recommendation. Whether any is appropriate depends on individual circumstances, and none eliminates investment risk.
Most plans use some combination rather than one. The combination depends on how large the essential spending gap is, how much of the budget is genuinely discretionary, and what other income the household has. That is why the expense projection is the input to this decision rather than a separate exercise.
Where tax planning intersects
There is an awkward interaction worth naming, because the two most common pieces of advice for the early retirement years pull against each other.
The years between retiring and the start of required distributions often carry lower taxable income, which makes them the natural window for Roth conversions. A conversion adds taxable income, and the tax on it generally has to be paid from somewhere. Doing that in a year when markets have fallen can mean selling more of a depressed asset to cover the tax bill, which is the same problem the rest of this page describes.
That does not make conversions unwise during a downturn. Converting assets after a market decline may allow a greater number of shares to be converted at a lower valuation, which is one reason the opposite argument exists, although the actual tax consequences depend on the individual's circumstances. The point is that it is a genuine trade-off rather than a rule, and it has to be modeled against the withdrawal plan in the same projection. Roth conversion planning covers the multi-year modeling side.
California adds its own layer. Because California generally taxes taxable IRA and 401(k) distributions as ordinary income and generally does not provide the preferential state tax rate for long-term capital gains available under federal law, the gross amount that has to be withdrawn to fund a given level of spending can be larger here than the federal calculation alone suggests.
What none of this does
None of the approaches above eliminates market risk, guarantees a portfolio will last, or prevents losses. They change which assets fund the early years and how much has to be sold during a decline. A plan can be well constructed and still require adjustment, and any projection depends on assumptions that will not match what actually happens.
What planning can reasonably do is make the exposure visible in advance, identify which spending can flex, and establish what would trigger a change. A household that has decided ahead of time how it would respond to a poor first year is in a different position from one deciding in the middle of it.
How Avinci approaches it
Avinci Wealth Management is a Registered Investment Adviser registered in California, Arizona, Illinois, Texas, and Nevada, firm CRD #327780, headquartered at 23929 Valencia Blvd, Suite 404 in Santa Clarita, with additional offices in Beverly Hills and Woodland Hills. When providing investment advisory services, Avinci Wealth Management is subject to its fiduciary obligations under applicable investment adviser law.
Under the Retirement Blueprint, a poor early market is modeled as an explicit scenario rather than assumed away, with the essential and discretionary split from the expense projection used to show what would have to be protected and what could flex. Founder Lindahl Lucas personally oversees the development of each Retirement Blueprint.
Avinci receives advisory fees for investment advisory services. Separately, insurance and annuity products may be offered through our affiliated insurance agency, Lucas Insurance Services, which may receive commissions from issuing insurance companies. This compensation arrangement creates a conflict of interest and is disclosed in our Form ADV. Where a product with guaranteed income features is discussed as one approach to this risk, that conflict is disclosed before anything is placed.
Important disclosures. This material is for informational purposes only and should not be construed as individualized investment, tax, or legal advice, or as a recommendation to buy or sell any security or insurance product. Consult your CPA or attorney before acting on anything described here.
Registration. Investment advisory services are offered through Avinci Wealth Management, Inc., a Registered Investment Adviser, firm CRD #327780, registered in California, Arizona, Illinois, Texas, and Nevada. Registration as an investment adviser does not imply a certain level of skill or training. Our Form ADV Part 2A brochure describes our services, fees, and conflicts of interest, and is available on request and through our IAPD record. The firm can also be verified through the SEC adviser search and, where applicable, FINRA BrokerCheck.
Investment risk. All investing involves risk, including the possible loss of principal. Diversification, asset allocation, and time-segmented approaches do not ensure a profit or protect against loss in declining markets. No strategy guarantees that a portfolio will last for any particular period. Past performance is not indicative of future results.
Projections. Financial projections and retirement models described here are hypothetical and illustrative in nature, are based on assumptions provided by the client and on market data, and do not guarantee future results.
Insurance and risk. Insurance and annuity products are offered through our affiliate, Lucas Insurance Services, which may receive commissions from issuing insurance companies on products it places. This compensation arrangement creates a conflict of interest and is disclosed in our Form ADV. Guarantees associated with annuity and insurance contracts are subject to the claims-paying ability of the issuing carrier, and product features, costs, and surrender terms vary by contract.