Why the sequence matters, not just the average
Imagine two retirees who both average 6% annual returns over 20 years. Retiree A experiences bad returns first (years 1–5) then recovers. Retiree B experiences good returns first then declines later.
Despite identical long-run averages, Retiree A may run out of money significantly sooner. Why? Because Retiree A is selling shares at depressed prices in the early years to fund withdrawals. Those sold shares never participate in the eventual recovery. Fewer shares compounding during the good years means less recovery from the same percentage gain.
Retiree B, by contrast, accumulates more shares during the good early years. When the bad years arrive, the portfolio is larger and can absorb withdrawals more comfortably.
A concrete example
Two portfolios, each starting at $1,000,000, withdrawing $50,000 per year (5%):
- Portfolio A: Years 1–5 average –10% annually, then recovers to average 15% for years 6–20
- Portfolio B: Years 1–5 average +15% annually, then falls to average –10% for years 6–20
Over 20 years, the math of the same average plays out very differently. Portfolio A may be exhausted by year 15. Portfolio B survives with assets remaining.
The numbers are illustrative, but the dynamic is real and has been studied extensively by researchers.
How dividend investing reduces this risk
This is one of the strongest arguments for dividend income in retirement. When income comes from dividends, you don't need to sell shares to fund living expenses — even during market downturns.
A stock portfolio that drops 30% still pays its dividend (assuming the dividend is maintained). You receive the same quarterly check whether your portfolio is up or down. You never have to crystallize losses by selling at a bad time. Your shares remain intact to participate in the eventual recovery.
This is the core psychological and practical advantage of dividend income over a total return withdrawal strategy during market stress.
Other ways to manage sequence risk
- Cash buffer: Hold 1–2 years of living expenses in cash. Spend from cash during downturns rather than selling investments.
- Flexible spending: Reduce discretionary spending in down years rather than maintaining fixed withdrawals.
- Bond ladder: Use maturing bonds to fund near-term expenses, leaving equities untouched during downturns.
- Annuity floor: Use a portion of assets to create guaranteed income that covers basic expenses regardless of market conditions.
Related terms
- Safe withdrawal rate — the percentage annual withdrawal considered survivable across most historical scenarios
- Total return — the approach most exposed to sequence risk when withdrawals are required
- DRIP — not relevant during drawdown, but why dividend income differs from selling