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Why Withdrawals in Market Downturns Suck – Understanding the Sequence of Returns

March 2022

It’s no secret that any market — stocks, bond, real estate, cryptocurrency, etc. — goes up and down. What may not be so clear is how this affects your life when it comes to withdrawing money. Here we will discuss what sequence of returns is, why it matters, and why taking withdrawals in a market downturn sucks.


The Basics

The “sequence of returns” refers to the order in which investment returns are realized. Let’s work with this example. Let’s say your investment generates the following returns:


Year 1: Investment earns 20%.

Year 2: The investment loses 30%.

Year 3: The investment gains 40%.


An amateur look at these numbers might suggest that this investment earns a 30% return after three years (up 20%, down 30%, up 40% = up 30%) or that the average return per year is 10% (30% divided by 3). None of this is accurate.

What is true is that a $100K investment over these three years has a 17.6% return overall and an annualized return of 5.553%. To understand why this is true, you have to take into account the sequence of returns.

To take into account the sequence of returns is to watch what happens when you put this investment through its paces. Let’s say you invested $100K.


Year 1: Investment earns 20%. Your $100K plus 20% is $120K.

Year 2: The investment loses 30%. $120K minus 30% is $84K.

Year 3: The investment gains 40%. $84K plus 40% is $117,600.


You started with $100K and three years later you have $117,600, a gain of $17,600. On the $100K investment, that’s a total return of 17.6% after the passing of three years.

Most financial professionals will then also get the annualized rate of return — that is, calculate the rate of return you would need on an annual basis to have your $100K equal $117,600 at the end of three years. That answer? 5.553%. Need proof? Go back to the original $100K investment and put that annualized return through its paces (values rounded).


Year 1: $100K plus 5.553% is $105,553.

Year 2: $105,553 plus 5.553% is $111,414.

Year 3: $111,414 plus 5.553% is $117,600.


Make two important notes here: Both the 17.6% overall return and the 5.553% annualized return — which are both positive numbers — included a year in which the investment was down 30%.

Why It Matters

Here’s where sequence of returns really matters when you’re withdrawing money: If you have to take out money in a down year, there is less money in the investment to grow when the market rebounds.

Let’s go back to the above example and assume a planned $20K withdrawal every year.


Year 1: Investment earns 20%. Your $100K plus 20% is $120K. $20K withdrawal leaves $100K.

Year 2: The investment loses 30%. $100K minus 30% is $70K. A $20K withdrawal leaves $50K. Ouch.

Year 3: The investment gains 40%. $50K plus 40% is $70K. Notice that without the withdrawals, you would have had $117,600, and of course, a $20K withdrawal here in this example in Year 3 would leave $50K, leaving the balance even lower.


This is why withdrawing money in market downturn sucks:  There’s less money available to make money when the market rebounds.

What To Do

Predict the future. In a perfect world, we’d be able to anticipate a down year, which rarely happens. Sometimes, though, it is possible to skip a withdrawal or reduce it substantially. For example:


Year 1: Investment earns 20%. Your $100K plus 20% is $120K. $20K withdrawal leaves $100K.

Year 2: The investment loses 30%. $100K minus 30% is $70K. Don’t take the withdrawal.

Year 3: The investment gains 40%. $70K plus 40% is $98K. A $20K withdrawal in this example in Year 3 would leave $78K, which certainly feels better than $50K.


Take larger withdrawals in big years. Sometimes we do have really good years and it can make sense to take out that extra money in anticipation of the lower year, even if you don’t necessarily see it coming. For example, let’s change the return in Year 1.


Year 1: Investment earns 40%. Your $100K plus 40% is $140K. Take a $40K withdrawal instead of $20K. That leaves $100K.

Year 2: The investment loses 30%. $100K minus 30% is $70K. Don’t take a withdrawal.

Year 3: The investment gains 40%. $70K plus 40% is $98K. A $20K withdrawal in this example in Year 3 would leave $78K, which again feels better than $50K.


This is typically where I will get pushback because investors often want as much money in growth mode as possible and they’re often reluctant to take that larger withdraw in a strong year.  Recency bias will also have them believing that next year will be just as good or better. While I understand that sentiment and this bias, check in with yourself about possible outcomes and identify what feels best for you and what you’re willing to risk.  To be crude about it, this is an exploration of your dynamic with fear and greed.  This is where financial planning can help you make pragmatic decisions, as this is where planning becomes less about The Plan and more about plan-ning. You should be reviewing your plan and making decisions regularly about potential returns and outcomes and making midflight corrections.

Planning Implications

Here’s where to be mindful around future projections as you are putting your withdrawal plan in place (the “sequence of withdrawals”).

Be careful of “straight-line” projections. Sure, an investment may historically return 5.553% annualized. But (1) that doesn’t mean it will in the future; and (2) that doesn’t mean there will be no down years. Down years happen. Regularly. Be prepared for that both emotionally and financially.

Be careful of Monte Carlo simulations. Financial advisors use these often to tell you what your potential success rate will be. These simulations and their statistical outputs may give you a sense of security, but they’re only good as the data going in and they ultimately pick a “midline” which may or may not imitate your actual experience.

Remember that life happens. Inflation can cause you to withdrawal more money later in your withdrawal plan than at the beginning. There can be one-time large withdrawals (replace a roof or a car or take that once-in-a-lifetime trip). These can impact your balances as well. Be sure to build these into your plan.

Consider time-blocking money. If you have enough cash set aside to meet obligations while the market takes a downturn and/or you reserve enough money in more conservative investments, you will worry less about the impact of your withdrawals on your overall plan because they will ultimately be built into it.  This also gives you the flexibility to have a block of money in a more aggressive stance.


Taking withdrawals during down years is likely to happen, and they don’t have to be fatal.  Once you understand the sequence of returns and build your sequence of withdrawals around it, you can minimize taking large withdraws during down years and ultimately increase your chances of overall financial success.


Lanning Financial Inc. is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.

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