What is sequence of returns risk and why is it important?

When you’re far away from retirement and just looking to maximize your investments’ returns, there is some truth to the idea that it doesn’t matter when you get positive market returns.

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After all, the market has consistently risen and fallen on many occasions over the last 100 years or so: it’s what it does. Over time, though, it has always increased in value. So, in the years leading up to retirement, as long as you don’t cash in any losing investments, the sequence of returns doesn’t matter too much.

However, this is not the case once you retire. At that point, you’ll switch from growing your wealth to drawing from it to provide you with retirement income. This is when the sequence of returns becomes really important and can have a huge impact on how long your savings will last.

How the sequence of returns risk impacts retirees 

When you first retire, it’s not wise to put all your money into a cash savings account. Canadians are living much longer than even a couple of generations ago, with the average 65-year-old Canadian expected to live to around 84. You may therefore need your money to last 20 years or even more, which means you’ll probably need returns that are considerably higher than the interest you’ll find in a typical savings account.

You also need to ensure that your money doesn’t lose its value, so you need returns that can keep up with (or exceed) the rate of inflation. To accomplish this, your portfolio needs to be comprised of both equities (shares in publicly traded companies) and fixed income (typically bonds, which are loans made to governments and companies). Equities provide greater growth potential, while fixed income assets typically provide more security.

When you start withdrawing money from your retirement savings, you open yourself up to sequence of returns risk. This is because regular withdrawals reduce the overall dollar value of your portfolio.. That dollar value is the base from which your investment returns build off of.  Lower the base, lower the amount received from the investment returns it generates.

When your portfolio loses value (has negative returns) early in your retirement, the base amount that can generate positive returns becomes smaller, meaning your growth potential is less. Added to that is the fact that you’re withdrawing from this amount, which also reduces its value (and can make that deficit permanent). 

How sequence of returns risk can cause very different outcomes

Let’s look at three hypothetical scenarios to illustrate how sequence of returns risk works:

Investors A, B and C all have a retirement portfolio of $1 million and all receive cumulative returns of 25% over the first five years of their retirement.1 However, each one’s sequence of returns is different:

  • Investor A experiences positive returns in the first three years, and negative returns in the final two years.
  • Investor B has consistent returns of 5% every year.
  • Investor C experiences negative returns in the first two years, and positive returns in the final two years. 

This is how the investors’ returns work out in those first five years of retirement:

Year Investor A Investor B Investor C
1 20% 5% -7%
2 13% 5% -5%
3 4% 5% 4%
4 -5% 5% 13%
5 -7% 5% 20%

If none of those investors drew any money out of their investment portfolio over this five-year period, their portfolios would all end up at the same value, albeit having taken very different routes: 

As you can see, Investor C’s portfolio dropped below $900,000 in the first two years, before rallying, and Investor A’s portfolio shot up to almost $1.5 million before dropping down. Investor B’s portfolio just saw a constant increase of 5%.

We start to see a difference in total portfolio value (and the effects of sequence of returns risk) when the investors withdraw $60,000 from their portfolios every year:

We can see that Investor C’s portfolio is worth almost $82,000 less than Investor A’s. However, the difference in the value of their portfolios increases considerably over time. In the chart below, the same sequence of returns is repeated over a 30-year period:

While investor A’s portfolio remains pretty robust, at over $760,000, Investor C’s portfolio runs out of money by year 27. While this is a purely hypothetical scenario, similar results can happen in the real world where an investor experiences considerable declines in their portfolio’s value early on in their retirement. 

How to manage sequence of returns risk

A well-diversified retirement income portfolio can provide a measure of downside protection during periods of market volatility, while also offering growth potential when markets rise. This portfolio can extend well beyond the traditional mix of stocks and bonds, to include investments that provide a guaranteed base-level of income.

One such option is a term annuity, which is the epitome of “fixed income”. An annuity will provide you with a regular income for a set period of time (for example, the next five years) regardless of how the markets perform. If there is a sharp drop in the markets at the beginning of your retirement, you can leave your investments untouched for five years that the annuity lasts. After that time, your investments may have recovered and increased in value, so you can start to draw income from them (or buy a new annuity to cover the next five years).

Laddering a portion of your fixed income holdings can also help minimize sequence of returns risk. For example, you could buy bonds that mature after one, two, three, four and five years and draw on that money to meet your income needs. Income from these bonds won’t be affected if the stock market crashes when you first retire, and you will have five years for your investments to regain ground before drawing from them.

Finally, a cash reserve strategy involves putting some of your assets into cash (or cash equivalents) to cover periods of potential market decline. For example, you could hold three years’ worth of retirement income in cash equivalents, like guaranteed investment certificates (GICs). These are very safe investments, with guaranteed interest rates and different terms, such as one, three and five years.

Rather than withdrawing money from investments that have dropped in value, you could cash in your short-term GICs. If a stock market decline persists for several years, you could then cash in your mid- and long-term GICs as you need the money. This strategy ensures that you don’t touch any assets affected by the market crash, and so it helps you avoid sequence of returns risk.

Each of these options may have a place within your well-diversified retirement income portfolio, and may allow you to ride out declines in your stock holdings.

Help with minimizing sequence of returns risk

Your IG Advisor will be able to suggest the best strategies to avoid sequence of returns risk, based on their knowledge of your overall financial plan. What works for one investor might not be appropriate for another, so it’s important to adopt the strategy that’s right for your individual circumstances.

If you’re approaching retirement, call your IG Advisor to discuss the best strategies to minimize sequence of returns risk for you. If you don’t have an IG Advisor, you can find one here.


1 For the purposes of these examples, we use simple returns, rather than compound returns.  


Written and published by IG Wealth Management as a general source of information only. Not intended as a solicitation to buy or sell specific investments, or to provide tax, legal or investment advice. Seek advice on your specific circumstances from an IG Wealth Management Consultant.

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