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Sequence of returns risk means the timing of investment gains and losses can change the outcome when money is entering or leaving a portfolio. During retirement, an early fall combined with withdrawals can leave fewer assets to recover later. The average return alone does not capture that problem. A useful plan tests uneven years, separates essential spending from flexible spending and identifies the limitations of a calculator that assumes the same return every year.
A two-year example makes the problem visible
Start with a fictional $500,000 portfolio. Withdraw $30,000 at the end of each year. Ignore tax, fees and inflation for now so only the order of returns changes.
In the first path, year one returns negative 20%. The balance falls to $400,000 and then the $30,000 withdrawal leaves $370,000. Year two returns positive 25%, taking it to $462,500 before the second withdrawal. The final balance is $432,500.
In the second path, year one returns positive 25%. The balance reaches $625,000, then falls to $595,000 after spending. Year two returns negative 20%, leaving $476,000 before the withdrawal and $446,000 afterwards. The returns are identical, just reversed. Yet the second path finishes $13,500 ahead because the withdrawals interacted with the timing of the market movements.
| Return order | Year 1 after withdrawal | Year 2 before withdrawal | Final balance |
|---|---|---|---|
| −20%, then +25% | $370,000 | $462,500 | $432,500 |
| +25%, then −20% | $595,000 | $476,000 | $446,000 |
Without withdrawals, the same example ends differently
Remove the withdrawals. The first path becomes $500,000 multiplied by 0.8 and then by 1.25, returning to $500,000. The reverse order also returns to $500,000. That is why a chart of investment returns alone cannot fully explain a retirement spending experience.
Notice another trap: negative 20% and positive 25% have a simple arithmetic average of positive 2.5%. The portfolio without withdrawals has gained nothing over the two years. Averages need to be interpreted carefully, particularly when percentages apply to changing balances.
The example is deliberately short and artificial. It does not estimate the probability of a market fall or suggest that real returns alternate neatly. Its purpose is to show why the timing of cash flows belongs in the calculation.
Withdrawals can turn a temporary fall into a smaller recovery base
A market fall reduces asset values. Selling some of those assets to pay living costs reduces the number of assets still invested. A later recovery then applies to a smaller remaining portfolio. The household cannot assume that returning market prices automatically restore the amount available before spending.
Suppose a holding falls from $100 per unit to $80. Raising $8,000 requires selling 100 units at the lower price rather than 80 units at the original price. That leaves 20 fewer units participating if prices later recover. This illustration ignores transaction costs and distributions, but the arithmetic shows the cash-flow pressure.
It does not follow that every retiree should avoid selling after a fall. People need money for real expenses. The planning question is how to fund those expenses while understanding the trade-offs and constraints, rather than assuming a recovery makes the timing irrelevant.
A cash reserve has a job and a cost
A separate reserve may help meet near-term spending without immediately selling growth investments. It can also earn less than other assets over some periods and lose purchasing power to inflation. Its size should reflect the household’s commitments and the wider strategy, not a universal internet rule.
For example, if a household’s annual portfolio-funded gap is $24,000, an illustrative $48,000 reserve represents two years of that gap before interest, tax or changes in spending. It is not two years of total household spending if other income covers part of the budget. Define which number the reserve is meant to support.
Ask how the reserve would be replenished. A rule that says “use cash during bad markets” is incomplete if it never says when to rebuild cash or what happens after a prolonged weak period. Record the process and discuss it alongside investment allocation and pension requirements.
Diversification changes exposure but cannot remove every risk
MoneySmart describes diversification as spreading investments across assets, sectors and markets to reduce the impact of some holdings performing poorly. That is relevant to retirement risk, but a diversified portfolio can still fall. It cannot guarantee that living costs will be funded for a particular number of years.
Avoid treating a long list of funds as proof of diversification. Different products can hold overlapping assets or respond to the same market conditions. The important question is the underlying exposure and how it fits the planned withdrawals.
This article does not specify an allocation. A person with flexible spending, another income source and a long horizon may face different trade-offs from someone relying on the portfolio for essential costs. An appropriate assessment considers the ability to tolerate losses as well as the emotional response to them.
Test the budget response before the market falls
Write down the essential spending that cannot be easily changed, then identify adjustments that are realistic. Housing, health, insurance and family commitments may leave less flexibility than a broad annual number suggests.
For a fictional $54,000 budget with $42,000 of essential or committed costs, the flexible part is $12,000. Reducing total spending by $6,000 requires cutting half of that flexible category. That is a meaningful lifestyle change, not a minor accounting adjustment.
Consider whether the response remains possible if the market fall coincides with illness, job loss or a major repair. A promise to earn extra income is weaker if the same economic conditions could reduce work availability. Household resilience depends on how those risks combine, rather than checking each one in isolation.
Account-based pension rules still apply
If money is in an Australian account-based pension, minimum annual payments may apply even when markets fall. MoneySmart explains that these pensions are subject to minimum withdrawal requirements and are not lifetime income guarantees.
A required withdrawal does not necessarily mean all of that money must be spent immediately. However, moving it to another account can change tax and government-payment treatment. Check the current rules and your own circumstances instead of treating an investment strategy as a way to ignore payment obligations.
Early retirees also need to separate preserved super from accessible investments. A reserve inside a super account does not automatically solve a cash shortage before legal access. The source and accessibility of each planned withdrawal matter as much as the headline total.
How to read an Elaris projection honestly
A constant-return model is useful for seeing the effect of contributions, spending and fees under stated assumptions. It gives a reference path. It does not reproduce the two sequences shown above, price a guarantee or provide a statistical success rate.
Use the model to organise inputs, then keep a separate stress worksheet. Record a lower starting balance, a spending increase, a delayed super access assumption where relevant and the response you would consider. Do not describe these chosen scenarios as probability ranges.
If you use a historical or simulation tool elsewhere, check which markets, time periods, taxes, fees and spending rules it includes. A percentage labelled “success” only describes that model’s definition and inputs. It should not be mistaken for a promise about your own future.
Distinguish a stress test from a forecast
A chosen negative-return year is an experiment, not a prediction. State the size of the fall, when withdrawals occur and what follows. If you compare two paths, change only the order of returns at first so you can see the mechanism clearly.
After that, test a separate spending or timing change. For instance, moving a planned $20,000 purchase from year one to year three changes the amount exposed to the intervening market path. Whether postponement is practical is a household question. Showing both cash flows makes that question visible, while a single average-return line would hide it. Keep the example labelled so its neat numbers are not mistaken for a realistic market forecast.
FAQ: Does sequence risk matter while I am still saving?
Cash flows also affect accumulation. Regular contributions buy at different prices, and a large loss close to a planned work change can leave less time to recover. The retirement example focuses on withdrawals because spending makes the effect especially easy to see.
FAQ: Will holding more cash always solve it?
No. Cash may reduce the need for immediate asset sales but introduces other trade-offs, including lower growth potential and inflation exposure. A reserve needs a purpose, a size you can justify and a replenishment process. There is no one cash amount that suits every household.
FAQ: Can a higher average return cancel an early loss?
It might improve a projection, but the actual timing of gains and losses still matters when withdrawals continue. Increasing the return assumption on a smooth chart does not address that risk. Test the cash flows and the market path separately.
FAQ: What should I take to a retirement adviser?
Bring the expected spending gap, accessible and super balances, current investment exposures, fees, debts and proposed retirement timing. Include the fallback budget and questions about weak early markets. A clear worksheet helps the discussion focus on the decisions rather than reconstructing basic information.
Put the next step into practice
Use your own confirmed figures and keep outstanding questions visible. Core tools are free, with no bank connection or compulsory account.
Open the Freedom Clock ↗Sources and editorial notes
Sources checked 23 October 2026. Worked examples are fictional illustrations. Rules, eligibility and product terms can change; use the official source for your circumstances.
- MoneySmart: develop an investing plan ↗
- MoneySmart: investment diversification ↗
- MoneySmart: account-based pensions ↗
General information, not an individual financial or legal assessment. AI-assisted drafting with source checks; independent professional review has not been completed. How we prepare our guides · Suggest a correction