Sequence of Returns Risk (the Trap Right After Retirement)

Sequence of Returns Risk is the risk that, during the phase of retirement when you withdraw money each month, if poor returns cluster early on, your assets are permanently damaged and cannot recover.

The key lies in 'withdrawal.' If you sell stocks to cover living expenses during a downturn, those stocks are gone forever and cannot rise again later when the market recovers. So no matter how good the long-run average return is, the result changes completely depending on when the bad years come (the sequence).

The essence of this risk is that the same -30% decline leaves a deep wound on your assets if it comes in years 1–3 of retirement, but is generally recoverable if it comes in years 27–30 of retirement.

Consider a widely used example. Both people retire with about $1,000,000 (roughly ₩1 billion), withdraw about $60,000 (roughly ₩60 million) at the end of each year, and their average return over the first five years is identical at 6% per year. The only difference is the 'order' in which the returns appeared.

In this case, the person whose bad years clustered early ends up, five years later, with roughly $80,000 (about ₩80 million) or more less than the person whose good years came early—a calculation that appears repeatedly in various sources. The average is the same and the withdrawals are the same, yet a single difference in sequence created the gap.

Why? If the bad years come early, living expenses are drawn out of an already-shrunken asset base, so even when good years arrive later, you have to start from a far smaller principal. Conversely, during the accumulation phase (when you only contribute and don't withdraw), the sequence has almost no effect on the final result. Without withdrawals, changing the order of multiplication gives the same outcome.

Right after retirement is when your assets are the largest they'll ever be, and at the same time when money starts flowing out every month. This early window where these two overlap is called the 'retirement risk zone.'

Researcher Wade Pfau analyzed that the compound return of the first 10 years of retirement explains about 77% of the final retirement outcome. In other words, the success or failure of 30 years of retirement is largely swayed by the market luck of the first 10 years.

Historically, early declines can be fatal. The S&P 500 fell about -49% during the dot-com collapse (2000–2002) and about -56% during the global financial crisis (2007–2009). Someone who retired in early 2000 suffered from big declines and withdrawals overlapping from the start, whereas someone who retired around 2009, near the bear-market bottom, was relatively better off, starting from an already-lowered point.

This risk can't be eliminated entirely, but you can greatly reduce it by preparing so that you don't have to sell assets under duress during an early downturn.

First, a cash bucket. Set aside 1–2 years of living expenses in cash, deposits, and the like, and hold 3–7 years in stable assets such as bonds. When stock prices fall, drawing living expenses from these buckets instead of selling stocks lets you avoid the worst choice—selling stocks in a downturn.

Second, there is the 'bond tent' strategy, which temporarily raises the bond weight only during the risk zone around retirement and then lowers it again afterward.

Third, flexible withdrawals. Instead of a fixed amount each year, withdrawing a set percentage of remaining assets (spending less in bad years and more in good years) greatly reduces sequence risk. The commonly cited '4% rule' is also a starting point for thinking about such a safe withdrawal rate.

What's important is that these concepts focus not on predicting future returns, but on designing so that 'you can endure whenever the bad years come.'