Sequence of Returns Risk: How to Get the Most Investment Income Without Running Out of Money

Did you know there’s a secret hiding in plain sight that average rates of return will never tell you? In this episode, we’ll discuss the Sequence of Returns and the risk they pose to your future income. Then, we’ll show you exactly how to minimize the risk. We’ll also look at how to mitigate sequence of returns risk in a simple, practical way so you aren’t relying on luck or timing to secure long-term income.

So if you want to get predictable income from an unpredictable investment portfolio, NOT run out of money, and see exactly why you should supplement your investments with non-correlated assets … all so you can plan ahead and not be stressed with figuring out retirement income when it’s too late, tune in now!

To understand the giant risk posed by the sequence of returns, let’s lay a quick foundation.

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Where Does Investing Fit in the Cash Flow System?

Investing is just one step in the path to time and money freedom.

That’s why we have created the 3-step Business Owner’s Cash Flow System.  It’s your roadmap to take you from just surviving to a life of significance, purpose, and financial freedom.

The first step is keeping more of the money you make by fixing money leaks, becoming more efficient, and profitable.  Then, you’ll protect your money with insurance and legal protection, and Privatized Banking.

Finally, you’ll put your money to work, increasing your income with cash-flowing assets.

The Lie in Average Rates of Return

Investment performance is often measured by the average rate of return.

What is an average? It’s simply all the returns over a period, divided by the number of years.

But the average rate of return often doesn’t even come close to mapping onto our actual experience. In fact, positive averages don’t even mean you’ll come out ahead on the money you put in.

Why?

In this article, I highlight the disparity between the average vs. real rate of return.

Here’s the main reason that averages don’t even come close to telling the whole story:

Negatives have a much greater impact on your account balance than corresponding positive returns. This is one of the key reasons the sequence of returns matters so much, because the timing of losses heavily influences your real experience—even when the averages look good.

For instance, if you lose 20% on $100K, you would have $80K. To recover your loss, you wouldn’t just need a 20% gain. That would only get you to $96K. It would take a 25% gain, a value greater than the percentage of loss, to bring your balance back to $100K.

With that out of the way, there’s another deception that lies in average returns.

Negative 20%, plus a positive 25% lands you at a total return of 5%. Divide that by 2 years, and you get an average of 2.5% return per year. But your experience gave you a 0% actual return over those two years.

So, saying you had a 2.5% average return gives a misleading impression that you’re increasing your account balance with growth.

But it gets worse.

The Order of Returns Matters

Not only do losses make a huge impact on account value, but so does their timing.

That’s because early losses shrink your portfolio and make it very difficult to recover.

Late losses don’t do as much damage. Instead, they skim a little off the top of a more substantial account.

Taking Income After Losses Is A Giant Mistake

If you’re using your investment account for income after a year of losses, you further depress account values.

Imagine you were taking 4% from your investment account per year as income.

If your returns are -20%, your 4% withdrawal amplifies the negative to a 24% loss.

In fact, you may need to increase your withdrawal percentage to get sufficient income, further worsening the outlook and handicapping your future performance.

To see exactly how these risks affect you, let’s compare the outcomes of two identical investment portfolios of $500K, with an annual withdrawal of $20,000 per year, increased by 2.5% for inflation.

We’ll use the actual performance of the S&P 500 for the year 2000 through 2015. The only difference between the two portfolios is that we’ll reverse the sequence of the returns by flipping the order. This comparison shows just how destructive the sequence of returns can be when withdrawals line up with early losses instead of later ones.

The first portfolio (Jane) limps through really rough negative returns for the first three years, and then has relatively smooth sailing for the last twelve.

The second portfolio (Jim) gets the smooth sailing for the first twelve years, and then gets pummeled with the negative returns at the end.

Again, the starting balance is the same, the withdrawals are equal, and the returns are the same. The only difference in these examples is the sequence of the returns.

The difference is striking.

Early losses give Jane an ending balance of $74,300, while late losses give Jim an ending balance of $344,290.

Jane has about $270K less money than Jim.

The only reason? She got dealt an unfortunate order of the same exact cards.

Why Sequence of Returns is a Risk

Sequence of returns uncovers two enormous risks: the structure of the market itself and the way people respond to it. You can’t control the order of future returns, and you can’t predict whether a down year will hit at the beginning, the middle, or the end of your retirement. That uncertainty becomes dangerous when you’re relying on that investment account for ongoing income.

Market Volatility and Timing

Again, market volatility isn’t the real danger – timing is. Losses that occur early in retirement have a much deeper impact because your account hasn’t had time to grow through compounding. When a down year hits at the beginning, any withdrawal accelerates the damage. Even a modest income draw amplifies the effect, because you’re selling more shares after a decline just to meet spending needs. 

This is why two portfolios with the same average return can have drastically different outcomes depending solely on the order of returns.

Behavioral Factors

Another layer of risk is human behavior. When markets dip, most people become more cautious, anxious, or reactive. This emotional pressure leads to panic selling, reducing equity exposure at exactly the wrong time, or withdrawing extra funds out of fear. These decisions compound losses and make it far harder for the portfolio to recover. Behavioral factors don’t just influence performance—they multiply the downside of a bad sequence of returns by turning temporary market movements into long-term setbacks.

So, how do you minimize the risk that taking income when your investment experiences a loss will run your investment into the ground?

Non-Correlated Assets to the Rescue!

What if you had another source of income that you could use in years your investment suffered a loss?

If you hit the pause button on withdrawing income after a loss, you would give your investment time to rest, instead of hitting the horse while it’s already down.

Then, you could resume taking income every year you had positive returns.

The improvement is tremendous.

Dr. Wade Pfau, Professor of Retirement Income at The American College, advocates exactly that.

In his white paper: Integrating Whole Life Insurance into Retirement Income Planning, Pfau gives an academic and compelling case for how to deflate sequence of return risk. He says that you should use non-correlated assets as a buffer against the sequence of return risk.

This strategy will preserve your investment portfolio and minimize the sequence of return risk, giving you more income during later years.

Using the same example above, here’s how Jane’s portfolio with early losses would perform if she suspended her income from the investment every year following a loss.

By taking income from another source instead of the investment portfolio in just four out of the fifteen years, about $88K in total, her ending balance increased to $249,974.

That means that she gained $175K more in her investment account by giving up $88K of income during down years.

What Spending Strategy Could Eliminate Sequence of Return Risk?

When people ask “what spending strategy could eliminate sequence of return risk”, they are really asking how to avoid pulling income from an account that has just taken a hit. Because the danger isn’t the market itself, it’s withdrawing at the wrong time. A spending strategy that works around market losses can dramatically reduce exposure to the ups and downs of the sequence of returns.

The simplest way to approach this is to avoid taking income from an account in the same year (or years) it suffers a decline. Instead, you draw from a stable, non-market asset: something that didn’t drop in value. This creates a buffer, of sorts, giving your investments time to recover before you resume taking income. 

In practice, this is one of the most effective ways to understand how to mitigate sequence of returns risk, because it separates your lifestyle income from market volatility.

The research is pretty clear. When retirees switch to a protected income source during down years – such as a guaranteed asset, a cash-value reserve, or any non-correlated bucket – the long-term sustainability of the portfolio increases dramatically. The spending strategy isn’t complicated, it simply requires deciding which account to spend from, depending on whether the market is up or down.

So Here’s How to Minimize Sequence of Return Risk

The moral of the story is that you can’t control the timing of future returns. But you can take back control by planning ahead to have another source of income for years.

Having an outside source of income from an account that won’t suffer the same volatility as your investment is the best remedy.

Cash, a checking or savings account, or an annuity will suffice for this strategy.

But our favorite tool is Specially Designed Whole Life Insurance. Not only do you get guaranteed cash value you can use as an income source, you also gain a guaranteed death benefit that will provide your legacy and free you up to take more income from your investments during your lifetime.

You have the power to shrink your sequence of return risk. That means you’ll preserve your portfolio, so you can take out more income for a longer period of time, with less fear of running out of money.

But here’s the kicker: you need to act now. If you get to the future, and your only asset is an investment account, there won’t be much you can do. But planning ahead and storing cash in a non-correlated buffer asset will give you peace of mind and so many more options in the future.

Get Whole Life Insurance Today

If you would like to assess your complete financial picture and find your personal best strategy to maximize your cash flow and control, we can help.

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By the way, we have a free Quick and Easy Privatized Banking Guide that outlines just how whole life insurance gives you the most powerful storage tank for your cash, PLUS it boosts investment returns, so you can more quickly get to the point where you never run out of cash.

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