At year-end, $5,000 of bills must come out of your portfolio. The bills arrive whether your investments have had a good year or a bad one.
You and another investor each start with $100,000 and pay those bills for three years. Both portfolios earn the same three annual returns in reverse order. Yours gets the loss first and ends with $4,725 less.
Nobody spent more. The difference is which returns were still ahead when the money left.
The bill changes the question
Sequence-of-returns risk is the effect of return order on a portfolio that takes in or pays out money. Once you depend on withdrawals, an average return cannot tell you whether the bills are covered.
Each expense has its own time horizon: how long before you need the money. Next year's bills cannot wait decades, even if the rest of your portfolio can.
Say your portfolio earns these annual total returns, including investment income:
- Loss early: −20%, +10%, +25%.
- Loss late: +25%, +10%, −20%.
All amounts are in US dollars, before fees, taxes and inflation, with no new contributions. Withdrawals come once a year, after that year's return.
First let all the money stay invested
Leave all $100,000 invested for three years. The early-loss portfolio falls to $80,000 in year one; the late-loss portfolio rises to $125,000. Yet both end year three at $110,000.
Multiplying $100,000 by 0.80 × 1.10 × 1.25 gives $110,000 whichever order you put those three factors in. Every dollar experiences all three returns.
The paths differ; the ending balances agree. This works because we reversed the same returns, with no money added or removed. New contributions change the calculation: a dollar arriving in year two never experiences year one's return.
Take the same dollars out
Put the $5,000 bills back. Each year has two steps: apply the return, then subtract the withdrawal.
In the first early-loss year, $100,000 × 0.80 − $5,000 = $75,000.
The $75,000 left is what earns next year's 10%. That adds $7,500, then the next bill removes $5,000. Continue the early-loss path, before and after each $5,000 withdrawal:
| Year | Return | Before | After |
|---|---|---|---|
| 1 | −20% | $80,000 | $75,000 |
| 2 | +10% | $82,500 | $77,500 |
| 3 | +25% | $96,875 | $91,875 |
Reverse the returns and the balances after withdrawals become $120,000, $127,000 and $96,600. Both portfolios have paid out $15,000. The gap left invested is $96,600 − $91,875 = $4,725.
A fixed bill takes a bigger bite out of a smaller portfolio. Paying it after the early loss leaves fewer assets to earn the later gains. Money spent during a slump cannot join the recovery.
Recovering from a drawdown does not replace the assets used to pay bills. Early gains help here, but returns and spending after year three still decide how long either portfolio lasts. This example cannot establish whether $5,000 a year is sustainable.
Flexibility has a price
Suppose $1,000 of next year's spending can wait. Try a simple rule in the example: after a negative year, cut the following year's withdrawal to $4,000; after a positive year, return to $5,000. The decision uses the year just finished, without needing to predict the next one.
On the early-loss path, withdrawals of $5,000, $4,000 and $5,000 leave balances of $75,000, $78,500 and $93,125. You finish $1,250 ahead of fixed spending, but have spent $14,000 instead of $15,000; the extra $250 is the final year's 25% gain on the $1,000 left invested.
You bought a larger balance by spending less. The extra $250 depends on the final year's gain; money left invested is still exposed to losses. A postponed bill still needs funding after these three years.
Cash buys time
Here, a cash reserve means money set aside inside the portfolio for upcoming bills; emergency savings stay outside this example. It can pay those bills while you leave falling investments alone. Carve the reserve out of the $100,000 and the rest of the portfolio gets smaller by the same amount.
The trade-off is less growth potential for the money held in cash. Cash can also lose buying power to inflation. As you spend the reserve, it needs replenishing; a long slump can outlast it. A buffer buys time; it cannot buy certainty.
For your next withdrawal, two facts matter: when it is due and how many dollars can change. Here, the end-of-year-two bill can fall from $5,000 to $4,000 because $1,000 can wait. If every dollar is essential, $5,000 remains the amount the plan must cover.
That constraint belongs in your investment policy. You can build that policy now, or take the optional retirement withdrawals step to set a practical spending rule. The remaining analytics and US tax and account details refine the plan when they fit your needs.
In short
- Reversing the same returns leaves the same ending balance when no money enters or leaves.
- With fixed withdrawals, an early loss can leave less invested for later spending.
- A spending cut keeps money invested by giving up something you planned to buy.
- A cash reserve buys time, but it can run out before investments recover.