If you’re nearing retirement or already in it, you may have decided to follow the popular 4%-plus-inflation annual withdrawal strategy to help your nest egg last as long as you do. But before you commit to an inflexible plan, be sure to evaluate the hazards of sequence-of-returns risk—a specific type of financial risk that could deplete your portfolio in later years.
Consider two hypothetical scenarios in the chart below—Ms. Westwood’s portfolio on the left and Ms. Eastwood’s on the right.
Both start with a $500,000 nest egg, but Ms. Westwood is retiring into a generally rising market. Though she experiences some negative returns in later years, the early momentum allows her nest egg to grow, even as she takes withdrawals from it. On the right, Ms. Eastwood experiences identical gains and losses, but in reverse order. Because Ms. Eastwood’s losses come early, her regular withdrawals are helping to starve her portfolio—already weakened from losses. Gains recouped in later years come too late to reverse the damage. By Ms. Eastwood’s 23rd year of retirement, her portfolio would have evaporated.