Sequence of returns risk: why the order of good and bad years matters

Same average, different outcome

Picture two retirees with identical portfolios, identical spending and identical average returns over their retirements. The only difference is order: the first gets a run of poor years right after retiring and strong years later, while the second gets the strong years first.

While saving, the order of returns doesn't change where you end up, as long as you don't add or withdraw money. Once withdrawals begin, it does. The first retiree is selling investments at low prices to fund spending, so fewer units are left to benefit when markets recover.

The second retiree's early gains build a cushion. When the poor years arrive later, the balance is larger and fewer years of withdrawals remain, so the damage is smaller.

Why the early years are so sensitive

The years just before and after retirement are often when a portfolio is at its largest, and when withdrawals are about to start. A loss in that window hits the biggest balance and the longest remaining stretch of spending at the same time.

Withdrawals also lock in losses. Selling $40,000 of investments after a decline uses up more units than selling the same amount at higher prices, and those units are gone for good.

In Canada, required RRIF minimums add another layer. From 71 the minimum withdrawal starts at 5.28% of the January 1 balance and rises each year, so some selling happens regardless of market conditions. The RRIF minimum tool shows the schedule for any balance.

Wen's plan on a steady path

Suppose Wen, 64, lives in Saskatchewan and plans to retire next year. She has $480,000 in her RRSP, $130,000 in her TFSA and $90,000 in a non-registered account, and will add $7,000 to her TFSA before retiring. Her CPP estimate is $1,150 a month at 65, she qualifies for full OAS, and she'd like to spend $46,000 a year after tax.

With illustrative returns of 6% before retirement and 5% after, and 2% inflation, her savings reach about $733,843 at 65. On a steady path, the money lasts to 95 with about $300,297 left after tax.

That result assumes the same return every single year, which never happens. To see the effect of order, the planner runs her plan through 500 market paths that share the same average but vary from year to year.

Adding modest ups and downs

With volatility set at 6%, representing a portfolio with relatively mild swings, 89% of the simulated paths keep Wen's spending whole to 95. About 2% run short before 90 and about 11% before 95.

The range of outcomes is fairly narrow. At 75, her combined balance runs from about $425,949 at the 10th percentile to about $625,789 at the median. The weakest paths are the ones where poor years cluster early.

Volatility here is a planning input, not a description of any particular investment. It's a way to ask how much the plan depends on smooth markets.

When the swings get bigger

Doubling the volatility to 12%, with the same average return, tells a different story. The success rate falls to 63%. About 9% of paths run short before 85, about 23% before 90 and about 37% before 95.

The spread widens in both directions. At 75, the 10th percentile is about $251,025 and the median about $584,545. By 80, the weakest 10% of paths are down to about $109,239, and by 85 they're empty.

Because the average return is identical in both runs, the drop in success comes entirely from bigger swings, and in particular from paths where the bad years land early. That's sequence risk in a single comparison.

A Canadian wrinkle: taxes and account order

Where withdrawals come from matters during a downturn. Money taken from an RRSP or RRIF is taxable, so funding $46,000 of spending means selling more than $46,000 of investments, and in a falling market those extra sales come at low prices.

TFSA withdrawals aren't taxable and don't count as income, so the amount sold matches the amount spent. Non-registered accounts fall somewhere in between, depending on how much of each sale is a capital gain.

Large taxable withdrawals can also push income toward the 2026 OAS recovery threshold of $95,323, above which 15% of the excess is recovered. In a year when markets are down, that combination can make an expensive year more expensive.

Approaches people use to manage the risk

Sequence risk can't be removed, but it can be softened. Retirees and planners discuss several approaches, each with its own trade-offs:

• Flexible spending: trimming discretionary spending after a poor year reduces how many units have to be sold at low prices.
• Working a little longer: in Wen's case with 12% volatility, retiring at 66 instead of 65 raises the success rate from 63% to 69%. The part-time work guide looks at phased options.
• A spending buffer: holding a few years of planned withdrawals in lower-volatility savings so investments aren't sold in a downturn.
• Delaying CPP or OAS: larger lifetime pensions reduce how much the portfolio has to supply in later years.
• Using the TFSA strategically: TFSA withdrawals don't count as income, which can make them a flexible reserve in a poor year.
• Reviewing the withdrawal order: the withdrawal order tool compares sequences of account withdrawals for the same plan.

Reading your own results

If your own plan looks fine on a steady path but shows a wide spread in the simulation, that's a sign the outcome leans heavily on market timing. Comparing two or three volatility settings shows how much.

The Monte Carlo guide explains success rates and percentile bands in more detail, and the 4% rule guide shows how sequence risk affects a common rule of thumb. You can run your own numbers in the retirement plan tool.

Tax estimates on this site exclude Quebec provincial income tax, so Quebec residents will see incomplete tax figures in these results.