Yes, sequence of returns risk is the risk that markets don’t perform well when you are taking withdrawals from your portfolio. A period of sharply negative returns in your portfolio can have a more negative effect on your portfolio when you begin to take withdrawals.

The table below illustrates what is meant by sequence of returns risk. As a hypothetical example, the left-side illustration—“no withdrawals”—in the table on the next page shows a portfolio with no additions or withdrawals, starting with $1 million in portfolio value, for 20 years. In the “poor early years” scenario, the portfolio returns –15% each year for three years in a row at the beginning of the 2-year period, and then returns 10% per year each year thereafter. In the “poor later years” scenario, the portfolio starts with the same amount, but returns 10% per year in the first 17 years of the 20-year period, and then returns –15% each year in the last three years of the 20-year period. The average annual return for both “poor early” and “poor later” portfolios is the same. The ending balances in both scenarios are also the same.

The story changes significantly if withdrawals are taken from the portfolio. The right-side illustration—“annual withdrawals”—shows the impact of a $50,000 (5% of the initial portfolio) withdrawal, increased every year thereafter by 2%, to increase withdrawals with inflation. The ending balance in the “poor early years” and “poor late years” portfolio are significantly different. Both portfolios experience the same average annual returns over the time period. Both take the same withdrawals. The “poor early years” example runs out of money in year 18. The “poor later years” portfolio ends with over $1,300,000—more than it started with. The impact of poor early years, in other words, is significant.¹