Introduction
Intuitively, a downturn in the stock market early in the career of a worker will have much less impact on eventual retirement wealth than a stock market downturn at the end of retirement. (The downturn in the market early in a worker’s career only affects a small portion of savings, while a downturn at the end of career will affect all savings.)
Equally intuitively, a market downturn at the beginning of retirement will be substantially more detrimental to the retiree than a market downturn nearing the end of life. A depletion of retirement wealth due to adverse market returns at the onset of retirement, perhaps at age 62, substantially increases the likelihood a retiree outlives retirement savings.
The order of investment returns can matter as much as (or more than) the average return itself. This paper includes:
1. A review of the literature on sequence risk.
2. A simulation of the impact of sequence of returns on wealth accumulation during working years.
3. Empirical evidence on how stock market losses early in retirement can substantially reduce wealth and disrupt retirement outcomes.
Literature Summary
There is substantial literature in both academic journals and the financial press documenting the importance of sequence of returns on adequacy of retirement savings.
The literature shows that the best financial outcomes for retirees occur when returns in working years are robust at the end of a worker’s career and returns in retirement are robust at the beginning of retirement.
Some key studies in this literature include:
- Wade Pfau: Regression-based evidence showing that late-career returns dominate wealth accumulation, while early-retirement returns dominate decumulation.
- Michael Kitces: Explores sequence risk for both savers and retirees and advocates strategies like rising equity glidepaths. Particularly, he frames the early years of retirement as a 'danger zone' for depletion risk.
- Morningstar (John Rekenthaler): Illustrates how identical average returns can lead to widely different retirement outcomes depending solely on sequencing.
- Vanguard Research: Demonstrates how retiring into bear markets significantly increases the likelihood of running out of money under fixed withdrawal rules.
- David Blanchett & Larry Frank: Examine adaptive withdrawal strategies that can mitigate sequence risk.
- David Bernstein (2025): In 'The Retirement Date Lottery: Why 2000 and 2007 Retirees Lived Different Financial Realities,' Paper documents financial stress on cohort retiring in 2000, a group experiencing two major market downturns in the first decade of retirement.
Worker Phase Example
The impact of sequence of returns on the accumulation of retirement wealth during working years was illustrated by a simple simulation model. The assumptions of the model, the results of the analysis, and the discussion of these results are presented below.
Modeling Notes
- Career length: 30 years
- Starting salary: $60,000, growing at 2% annually
- Savings rate: 5% of wages years 1–10, 6% years 11–30
- Contributions made at year-end (no return in contribution year)
- Baseline returns: steady 7% annually
- Scenario 1 (early-career shock): –30% in year 1, 0% in years 2–4, then 7% thereafter
- Scenario 2 (late-career shock): 7% through year 26, then –30% in year 27, followed by 0% in years 28–30
End-of-Career Wealth Comparison
Interpretation
- Under steady returns, portfolio grows to ~$383K.
- A shock early in the career causes manageable loss—compounding and higher contributions help recover.
- A late-career shock causes a dramatic reduction (~$217K) since the portfolio was largest at retirement—most of wealth was exposed.
