Investor Corner/The wider picture/Macro and Market Context
5.1.4 Sequence of Returns Risk (Deeper)
Sequence of returns risk becomes especially acute in the withdrawal phase of retirement. Poor returns arriving in the first few years of withdrawal can force selling at low prices and permanently reduce a portfolio's ability to recover, and higher early equity exposure increases this specific risk.
Revisiting why this risk concentrates early in retirement
A retiree withdrawing a fixed amount each year from a portfolio that also happens to fall sharply in its first two or three years of retirement is forced to sell a larger proportion of units at those depressed prices to fund the same fixed withdrawal amount. This permanently reduces the remaining unit count available to eventually benefit from the market's later recovery, in a way that a bad early stretch during the earlier accumulation phase, with no withdrawals happening yet, simply does not.
Why the first several years carry disproportionate weight
The mathematics of this risk mean that returns experienced during roughly the first five to ten years after retirement withdrawals actually begin have a disproportionately large influence on whether a retirement corpus ultimately lasts through its full intended duration, compared to returns experienced in later years of that same retirement.
Practical ways to manage this specific risk
Holding a cash or short duration buffer covering a couple of years of planned withdrawals, so that equity holdings are not forced to be sold during an early downturn, and being willing to flexibly reduce withdrawals temporarily during a market decline rather than sticking to a rigid fixed amount, are both commonly used, practical ways to manage this specific concentrated risk.
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