Your account balance is a single number. It cannot tell you two things that matter a great deal to how your retirement actually plays out. First, when a downturn happens relative to when you start withdrawing. Second, how long you will need the money to last. Both are well studied, both are measurable, and neither shows up on a statement.
Sequence of returns risk: it is not only what you earn, it is when
The concept was first measured carefully by financial planner William Bengen in his 1994 paper on safe withdrawal rates. That same research is where the well known four percent rule comes from.[1] Bengen's deeper point, often lost in the shorthand, is that the order of your investment returns matters as much as their average.
Here is why. While you are still saving, a market downturn is a paper loss. It is uncomfortable, but temporary, because you are not selling anything. The moment you start withdrawing income, that changes. A downturn now forces you to sell more shares to raise the same amount of cash, which locks in a loss on money that can never take part in the recovery. Two retirees can start with identical portfolios and earn the exact same average return over thirty years, and still end up far apart, purely because one met their downturn in year two and the other met it in year twenty two.
| Retiree | Early years | Later years | Average return over 30 years |
|---|---|---|---|
| A | Weak | Strong | Same |
| B | Strong | Weak | Same |
Both retirees earn an identical average return. Retiree A, who withdraws during the early weak years, typically ends up with meaningfully less money later, because the shares sold during the downturn never get to recover. This is a simplified illustration, not a projection of any specific portfolio or outcome.
Research from economist Wade Pfau estimates that roughly 77 percent of how a retirement portfolio ultimately performs can be explained by the market returns of just the first ten years of withdrawals.[2] That window, from about five years before retirement through the first decade after, is sometimes called the retirement red zone, because a near peak balance combined with active withdrawals leaves very little room for error.
The four percent rule is built on historical averages. It is a useful starting reference point, but it cannot promise that your personal thirty year sequence of returns will look like the average one, because averages are a statistical construct and real markets deliver their returns in a specific, unpredictable order.
Longevity risk: the flip side of good news
The second risk your balance cannot show you is the mirror image of the first. What if you simply live a long time? It sounds strange to call that a risk, because living a long and healthy life is the goal. From a planning standpoint, though, it means your money has to stretch further than a standard life expectancy estimate assumes.
Most people underestimate their own odds here. According to the Longevity Illustrator built by the American Academy of Actuaries and the Society of Actuaries, a 65 year old in average health has roughly a coin flip chance of living into their late eighties or nineties. For a married couple, the odds that at least one spouse lives well into their nineties are higher still.[3] A plan that quietly assumes retirement ends at age 85 can leave a healthy, active couple with a real gap in their final decade, right when they have the least ability to adjust by going back to work.
The actuarial community puts it simply. A retirement plan should not be built to reach the average life expectancy. It should be built to survive well past it, because roughly half of all 65 year olds will.
See where you stand on both. The calculator shows your Stability Score, which is the share of your spending covered by income you cannot outlive, regardless of markets or how long retirement lasts.
Check my Stability Score →Why dependable income addresses both at once
Here is what makes these two risks worth discussing together. The same fix helps with both. Dependable income, the kind that does not move with the market, is never sold at a loss during a downturn, because there is nothing to sell. That takes it out of the sequence of returns conversation for whatever portion of spending it covers. And because it is designed to continue for as long as you live, it does not run out on a fixed date the way a portfolio drawn down at a preset rate eventually can, which takes a bite out of longevity risk too.
That is the logic behind pairing dependable income with continued growth investing in our Two Portfolio Strategy™. You let your Income Portfolio absorb these two risks for your essentials, and you let your Growth Portfolio keep working for everything beyond that floor. Your Stability Score (PSI™) is simply a way of tracking how much of your life already sits on that safer footing.
Common questions
What is sequence of returns risk?
Sequence of returns risk is the danger that poor market returns early in retirement, while you are withdrawing money, can permanently damage how long your savings last, even if your average return over the full retirement matches someone who never had an early downturn.
What is longevity risk?
Longevity risk is the possibility of living longer than your retirement plan assumed, which means your savings need to stretch further than expected. For a 65 year old couple, there is roughly a 50 percent chance at least one spouse lives into their nineties.
Does the four percent rule account for these risks?
The four percent rule is based on historical average outcomes and does not guarantee any individual retiree will experience an average sequence of returns or an average lifespan. It is a useful starting reference point, not a personalized guarantee.
Sources
- William P. Bengen, Determining Withdrawal Rates Using Historical Data, Journal of Financial Planning, October 1994. The original paper establishing what became known as the four percent rule and formalizing sequence of returns risk.
- Wade Pfau, Retirement Researcher, "Why Sequence of Return Risk Matters for Your Retirement Income."
- American Academy of Actuaries and Society of Actuaries, Longevity Illustrator, an actuarial survival probability tool for individuals and couples.