Why retirements fail on the descent
Two retirees, the same million dollars, the same ten years of returns in a different order. One ends $271,000 ahead. Why the order of returns matters more than the average once you start taking money out.
PROTECTING YOUR SAVINGS
Two people retire with the same million dollars.
The first retires in October 2007. He has $1,000,000 and a plan he read in a book: take $40,000 a year, don't touch the rest. It's a good plan. It's what the research said to do.
Seventeen months later, the S&P 500 has lost more than half its value. He keeps taking the $40,000 because that's the plan, which means he sells whatever he has to sell to raise the cash. Some of those sales happen at prices 40% below where they were the month he retired.
The second retires in March 2009. Same million, same plan, same $40,000 a year. She is starting at the bottom of the worst market in seventy years, which does not feel lucky at the time.
Now give them both the same ten years. Not similar years. The same years, the same set of annual returns, just arriving in a different order.
Same average return. Same withdrawals. One account ends about $271,000 ahead of the other, and it isn't the one with the better investing skill. Neither of them has any skill. They just got the same years in a different sequence.
That's sequence-of-returns risk. Recognizing how it can make two retirees with the same plan and market end up differently helps you make more informed choices and feel more confident in your retirement planning.
Why it happens
When you're taking money out, a bad year does two things at once. It shrinks the account, and it forces you to sell at low prices to raise the cash you're living on. Those shares are gone. They don't come back when the market recovers. The recovery happens on whatever is left, which is fewer shares than you started with.
Put differently: the account can recover in percentage terms and still not recover in dollars. A 35% loss needs a 54% gain just to get back to even. If you were selling through the loss, you need more than that, because the shares you sold are not there to do the gaining.
The retiree who gets the bad years first is not making a mistake. He is following the plan he was told to follow. That's the uncomfortable part. The 4% rule came from a 1994 study by financial planner William Bengen, and it has been repeated to retirees ever since as a target number. It's a reasonable rule. It just doesn't protect you from the order of returns, because nothing in the rule can.
What you can and can't control.
You cannot control the order. Nobody can. This isn't a hedge or a disclaimer. It's the reality of the situation. The sequence of future returns is unknown when you need to plan for it, and it remains unknown.
What you can control is whether you're a forced seller.
The two retirees above are identical in every way except that one has to sell into a falling market to pay for groceries. If the first retiree had income from somewhere other than the portfolio, he wouldn't have had to sell at those prices. He could have let the account sit through the drawdown and taken his income from the other source. The shares would have stayed put and participated in the downturns.
That's the whole idea behind a floor.
What a floor actually is
A floor is a portion of your money set aside so that a defined share of your income is not tied to the market. Mechanically, it usually works in one of two ways.
The first is a guaranteed-income product, like an income annuity. You hand over a lump sum and, in exchange, receive a contractual payment for life. The amount is set at the start and does not move with the market. The trade-off is that you give up access to the lump sum and any upside it might have earned.
The second is a product with a protected value, often called a buffer or a floor. You get a stated level below which the account won't fall over a set period, in exchange for a cap on how much it can rise. A typical version might protect against losses in a year while capping your gain at 6.5%. You give up some upside to get a bottom.
Either way, the point is the same. You are buying the ability not to sell at the worst possible moment. That ability has a price, and the price is upside.
Two things to know before you decide whether that trade is worth it. The guarantee is only as strong as the insurer's ability to pay claims, so even a seemingly solid floor or guaranteed-income product carries some risk. Understanding these limitations helps you make more informed decisions about risk-mitigation strategies like floors.
The quiet part
The first retiree in the chart isn't ruined; they leave with $818,000 and are doing well. The ten-year scenario shown above is just a mild example.
If we consider deeper early losses or extend the timeline, the gap isn't just $271,000 anymore. It's the difference between a portfolio that can sustain itself and one that runs out of money while you're still alive.
This is really what the sequence is all about, and it explains why the topic gets so much attention, even though it's invisible in most averages you see quoted. Neither of these two people experienced the market failing them—the issue was how the sequence played out. And that's something neither of them could have predicted.
Beachrock is an educational company. This article explains how these concepts work and is not financial, tax, or legal advice. Fixed indexed annuities are insurance products, not securities or bank products. Guarantees are subject to the claims-paying ability of the issuing insurance company. Not FDIC insured.
