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Let’s say you’re a retiree sitting across the desk from an adviser and hear that the stock market averages 7% to 10% a year. You exhale in relief.
If your portfolio grows at that rate, surely there will be more than enough money to last through a comfortable retirement.
But averages are a magician’s trick and conceal more than they reveal. If you’re nearing or already in retirement, the order in which gains and losses arrive can mean the difference between decades of financial security and running out of money halfway through life’s final act.
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Let’s say you also have $1 million invested in a balanced portfolio. If the market averaged 7% every year like clockwork, retirement math would be simple. Withdraw 4% annually, allow for inflation, and the account would seemingly last forever.
This is the promise behind the famous “4% rule” that has circulated for nearly three decades.
The only problem is that markets don’t move in straight lines. As a retiree, you’ll experience lurches, stalls, surges and sometimes collapses.
By year 25, you may still have money left to pass on to your heirs, while they could be broke by year 18, despite identical averages, initial amounts and withdrawal patterns. That’s quite a difference.
Why the 4% rule fails today
The 4% rule, popularized in the 1990s, is based on historical data that no longer reflects today’s environment. It assumed higher bond yields, lower valuations and a different inflation landscape.
Using the same rule now ignores the tremendous risk that you might not have the luxury of waiting decades for markets to rebound.
When you withdraw money during a downturn, you’re selling shares that might never recover — especially if the downturn lasts several years. The math simply doesn’t work in your favor anymore.
Many financial advisers rely on Monte Carlo simulations to estimate success probabilities, often saying you have a “90% chance of not running out of money.” But these models depend on flawed assumptions about averages and market behavior.
They offer statistical comfort but don’t account for the real-life sequence of returns you will face. For those unlucky enough to experience the downturn sequence, these models provide little reassurance.
The real risk few acknowledge
What makes the sequence of returns so dangerous is that its effects are invisible until it’s too late. You might not notice the damage as withdrawals quietly erode your savings. And years later, you could be faced with the harsh reality that your savings can’t support you through your 80s or 90s.
This is a structural risk you face once you start withdrawing funds. Unlike a younger person in their 30s or 40s, you can’t just ride out a bear market. Time is against you, expenses keep coming and, for many, life expectancy keeps extending.
Smarter ways forward
This is why more and more financial professionals are recommending strategies that prioritize income stability over market averages. These include:
- Guardrails and flexible withdrawals that adjust based on market conditions, not fixed rules
- Diversified income sources such as annuities, pensions or laddered bonds that aren’t solely tied to equities
- Bucketing strategies that hold near-term spending in safer assets so you can avoid forced sales during downturns
- Tax-aware withdrawals that coordinate taxable, tax-deferred and tax-free accounts to make your resources last longer
The takeaway
While the wealth management industry loves averages because they look good on paper and offer reassurance, you don’t live your life by averages. You live your life by sequences. If those sequences start with market losses, your retirement math can fall apart fast.
Don’t rely on outdated rules of thumb or glossy projections. Developing a resilient strategy means facing the uncomfortable truth that your first years in retirement are the most risky.
Ignoring the sequence-of-returns trap can mean the difference between lifelong comfort and financial distress.
Ezra Byer contributed to this article.
The appearances in Kiplinger were obtained through a PR program. The columnist received assistance from a public relations firm in preparing this piece for submission to Kiplinger.com. Kiplinger was not compensated in any way.
