How NOT to Fail at Retiring Early (Sequence of Returns Risk)

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In my previous investment article, we talked about how to guard against Black Swan events. To recap, Black Swan events are things that cause the stock market to crash. They’re unpredictable, and that’s why they’re bad. Examples of this include the Brexit, the oil crash, and the Great Financial Crisis of 2008.

Black Swan events and stock market crashes are a fact of life: They can and will happen during your investing lifetime. And while you’re working and accumulating wealth, stock market crashes are easy (well, easier) to see as a buying opportunity rather than a reason to panic-sell and run away because you don’t actually need that money to fund your everyday life. In fact, that’s what the principle of Rebalancing forces you to do: treat stock market crashes as buying opportunities by telling you to sell what’s gone up (bonds) and buy what’s gone down (equities).

The problem gets even harder to deal with if you’re already retired. The idea behind retirement is that every year you sell off a piece of your (hopefully sizeable) investment portfolio and use it to fund your living expenses for the coming year. You can see where this can go badly fast.

Let’s say you have a $1M portfolio and your living expenses are 4%, or $40k. On a great year, if your portfolio goes up 15% turning your $1M into $1.15M, it’s super fun to sell! You withdraw $40k leaving $1.11M in your account and pat yourself on the back for being a genius.

But if a stock market crash happens and your portfolio goes down 15%, turning your $1M into $850k, selling is decidedly NOT super fun. Taking a withdrawal leaves you with $810k, and you are now down 19%. In fact, because you’ve sold and locked in your losses, it will be even harder to climb back up to your original $1M. Markets will need to deliver a 23.5% gain just to get you back to your break-even point.

Now, I’ve claimed before that these boom/bust cycles don’t matter over the long term. In fact, over 15-year time periods, the S&P500 has never lost money. So none of this should matter, right?

Right, but only when you’re in the accumulation phase. When you’re retired and living off your portfolio, the busts absolutely matter, and the timing is especially important.

Timing is Everything... Photo by Eckhard Pecher @ Wikipedia
Timing is Everything… Photo by Eckhard Pecher @ Wikipedia

Let’s take a simple boom/bust cycle.  Say the stock market has this repeatable pattern: gain for 15% for 4 years, then crashes by -15% for 2. Why did I pick this pattern? Well for one, this works out to be about a 4% yearly return, which should theoretically support a 4% withdrawal rule (but just barely). And second, stock market crashes, while painful, tend not to last more than 2 years of continuous declines.

OK, so let’s say you’re a early retiree like us that quits work and starts withdrawing 4% of their $1M portfolio, and you happen to start your retirement just on an up cycle. What does your first 6 years looks like?

Note that all gains/losses are real, after-inflation figures, so inflation is automatically accounted for.

YearPortfolio Gain/LossWithdrawalTotal

Not bad, not bad at all. In Scenario A where we retire in a rising market, we happily withdraw our 4% rule and watch our portfolio rampage higher, and when the crash happens our portfolio gets hammered but not quite enough to drop it below its starting point. The next expansion will therefore keep pushing our portfolio up over time and we end up with what in finance terms is known as “a fuckload of money.”

Pictured: One Fuckload
Pictured: One Fuckload

But what if we retire right at the start of the downturn rather than the start of the rally? Well them, our picture looks…not so rosy.

YearPortfolio Gain/LossWithdrawalTotal

Uh-oh. In Scenario B, our retiree had to withdraw during 2 down markets, and as a result, he was down to a shitty $648k after 2 years! Even the subsequent multi-year bull market wasn’t enough to get him back to his starting point, so when the next crash happens he’ll get hurt even more. This causes his portfolio to grind down and down, until we’re left with this.


And remember, this is the exact same stock market! The only difference between Scenario A and Scenario B is when they decided to pull the trigger. And since nobody can tell whether they’ll be in a rising market or a falling market over the next two years, it’s basically luck of the draw as to who makes it out of retirement with their portfolio intact.

Remember the Trinity study I wrote about where I said that a 4% withdrawal rate yielded a 95% success rate for retirement? The 5% that didn’t make it failed because of this. If someone retired right as a sharp decline happened in the stock market, that investor sold at the worst possible time and their portfolio never recovered. And the worst part is that nobody knows if a bust is right around the corner.

This is what’s known as Sequence of Return risk, as is something even many early retirees don’t understand.

So what’s an early retiree to do? Well, we actually had to answer this question for ourselves when we retired at 31, and here’s how we guarded against this happening to us.


As a first line of defence, we joined every major religion and prayed really really hard that a stock market crash wasn’t around the corner. Because we didn’t know which diety would answer us, we diversified and asked them all. You can index religions too, apparently!

Live Nomadically

On the off chance that Strategy #1 didn’t work, we realized we needed to make our spending “bouncy.” Yeah, I know, it’s a term I just made up, but basically we needed to come up with a plan to reduce our spending if the stock market refused to co-operate, and that plan ironically is to travel more.

When we talk about our Nomadic lifestyle, it may seem we’re bragging about how great our life is. And don’t get us wrong, that is a big part of why we keep talking about it. But in actuality, our constant travelling is an essential part of our retirement strategy. You see, life in North America is hella expensive. To our surprise, living in Eastern Europe or Southeast Asia caused by day-to-day spending to drop by half! So by simply allocating more time to low-cost countries like Hungary, Thailand, or Vietnam, we can easily reduce our living expenses to $20,000.

We summarize this aspect of our retirement planning thusly: If shit hits the fan, we’re moving to Thailand.

Now what does this do to our unlucky retiree in Scenario B if we implement our Nomadic lifestyle?

YearPortfolio Gain/LossWithdrawalTotal

Much better. Here, our retiree didn’t get hit as badly by the crash, getting out with $684k vs $648k, and as a result, he has more money in the market when the rebound happens. This causes him to pretty much wind up back at his initial starting position by the time the next crash happens. Here’s what his portfolio now looks like over time.


Again, much better. Over our 45 year retirement, our portfolio just kinda zig zags up and down between two points but doesn’t go much up or down over the long term. But hey, we don’t run out of money so whatever.

So that’s the effect Nomadic Living can have on your finances. Your fixed costs (i.e. a mortgage, car payments, etc.) naturally disappear, and when anything unexpected happens, you can just switch countries where the costs of living are appropriate for you. This is also why we hate houses. If something happens in our city like the cost of food goes nuts or our mortgage rates shoot higher, we have no choice but to just sit there and watch our portfolio slowly grind downwards into dust. But since we live out of a backpack, we can just shrug and hop a plane to Ecuador. The fact that living Nomadically is objectively awesome is just an added bonus.

But still, even in this scenario, our portfolio is still slightly negative, and we don’t like that. That’s why in addition to living Nomadically, we also…

Keep a Cash Cushion

Because a stock market crash tends not to last more than 2 years, the first 2-3 years of your retirement are the most critical since they determine whether you’re retiring in sunny Scenario A or doom-and-gloomy Scenario B. To hedge against this, we kept a cash cushion equal to 3 years of our living expenses outside our portfolio. This ensures that in the case that we end up in Scenario B, we can essentially wait out the storm and withdraw nothing. What does this first few years of retirement look like now?

YearPortfolio Gain/LossWithdrawalTotal

Woo-hoo! At the end of our first 6-year cycle, using this cash cushion strategy, we are now higher than where we started! That means that going forward we can expect an upward trajectory like this.


So those are the main ways we use to guard against Sequence of Return Risk. Other things we’ve previously talked about such as Rebalancing of course help even more as they make the recoveries sharper, but that’s just showing off at this point.

So how has this actually worked out on the ground? Well, turns out it may not have been needed. We’re still glad we had it though, because in our first year of retirement the oil crash happened in late 2015, sending world markets in a dive and hammering the TSX specifically by a stunning -12%. Because we were globally diversified with lots of assets in fixed-income, we emerged break-even in 2015, but it sorta started looking like we may have hit Scenario B, retiring right as world markets were about to collapse. But then, everything just sorta worked out and as of August 2016 the S&P 500 is sitting at an all-time high. So now it’s starting to look like we’re actually in Scenario A.

Funny how things work out, but I guess that’s how our Engineering brains work. Hope for the best but plan for the worst.

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45 thoughts on “How NOT to Fail at Retiring Early (Sequence of Returns Risk)”

  1. please correct me if i’m wrong in understanding how you’re talking about your cash cushion, but that set up would require an additional $80,000 sitting in cash, or a starting balance of $1,080,000 compared to the other options of $1,000,000 starting balance. (I’ve assumed a $40,000/year allowance per your “high” spending example)

    1. Correct. When we both gave our notices, my boss asked me to stay on an additional 6 months to help train my replacement and I agreed since we had a good relationship. That’s where this additional cash cushion came from, plus some unexpected income from taking the commuted value of the DB pension my company offered.

  2. Thanks Wanderer. It doesn’t look like you account for replenishing your cash cushion in Scenario B-2 – or did I miss something?

    Because presumably you would need that cushion again in year 7/8 for the next 6 year cycle.

    1. Oddly enough, no. The cash cushion is only required for the first 2-3 years of retirement. After that, the strategy of reducing our living expenses by travelling is sufficient to generate that positive sawtooth pattern you see there.

    1. Yeah, we didn’t include this part in our “How we got here” series because we didn’t want to make an already complicated story more complicated. What actually happened is when I tried to quit at the end of 2015 my boss asked me to stay for 6 months because he was going on paternity leave and I agreed to help him out since we had a good relationship. We were willing to accept just using our Nomadic lifestyle as our only Sequence of Return hedge when we handed in our notice, and this gave us the additional Cash Cushion hedge as well.

  3. I’m using the cash cushion approach. Limit my withdrawals in a market downturn. Also helps me sleep at night knowing a severe market crash means I *may* have to sell something a couple years into the bear market. And I can always economize for those couple of years to stretch my cash as long as possible.

    For the very early retiree, being flexible is the magic ointment that will keep the long term portfolio healthy.

  4. Why do you assume that you must eat away at capital to support living? And hence worry about market timing ?
    A more stable approach would be to have a portfolio which generates the required (or better greater than expenses) cash flow i.e. an income stream (dividends etc.) independent of the equity value.
    Surpluses (to expenses) get carried forward (slush fund/cash buffer) deficits come form the slush fund.
    Bonus is that the underlying equities generally will also usually have capital growth resulting in an expanded capital base and/or the dividends also grow giving more cash flow.
    Google: Dividend Aristocrats/Kings to find companies that have paid out steady dividends for over 100 years in some cases
    As for living nomadically – that works fine while you’re at your current age and perhaps for a couple of decades more but eventually I found life on the road becoming tiresome (lived out of backpack for several years).

    1. Great points, and totally agree. I will likely write another post about how the allocation of your portfolio changes your withdrawal strategy because of exactly that: the proportion of capital gains vs dividends that makes up your annual withdrawal. Gotta tackle only one topic per article 🙂

      And sure, I get that living nomadically might get tiresome if we get arthritis or something, but let’s cross that bridge when we get there in like 30-40 years…

  5. What about dollar crash ? Some say the next thing is inflation, how would you move to Thailand if your dollars lose purchasing power ?

    1. Inflation is always per-country, so if inflation jumped in Canada (or wherever), I’d switch to another country where inflation is more tame. As for the dollar crashing, that did happen just this year when oil crashed. We were in Thailand at the time, and as a result our 50 baht bowl of noodles went from costing $1.90 to $2.00. Meh.

  6. Thanks for a great explanation of sequence of returns risk. There are many articles on building a portfolio but not enough on how to draw one down.

  7. One thing I didn’t catch. I assumed with the 4% rule, you would take 4% of the new balance each year so if your portfolio increased you’d withdraw more the next year and vice versa. Is that right or would you really withdraw the same amount of 40,000 each year?

    1. The 4% rule is based on a retiree setting their withdrawal rate at the point of retirement, and then withdrawing that set amount adjusted for inflation, and in that scenario you have a 95% success rate on a 30 year retirement. By building in the ability to drop our withdrawal during market downturns, we goose our success rate to effectively 100%.

  8. Hey! Great Article!

    I’ve been following a similar strategy for the past 12 years without really realizing its a strategy!
    I’ve been living / traveling in affordable countries where I’m able to live well for just the cost of rent / Mortgage payment in any major Canadian city.
    I’m mostly investing in blue chip dividend stocks and preferred shares ( down 30% due to low interest rates ouch!)
    However I live completely off my Dividends and thus never have to sell in a downtown and try not to let my portfolio value bother me instead I pay attention to Monthly / Annual Income from Dividends and try to make sure that keeps growing. Really enjoy your blog! keep up the good work!
    La buena vida!

    1. Congrats! Life is pretty great when you can do that, huh? Now that I’ve actually lived like this for a year I don’t think I could ever go back to the “work-a-job-to-pay-the-mortgage” grindstone.

    1. It’s funny you should mention this, because this is exactly the decision we’re trying to wrestle with right now. As naturally risk-averse engineers, we entered retirement with a fairly conservative 60/40 split. After our first year, however, we’ve found that by using Nomadism to control costs combined with small amounts of income we’ve made from our book and freelance web development, our costs have fallen BELOW the dividend yield of our portfolio, meaning that we’re actually cash flow POSITIVE in our first year of retirement. So as our portfolio grows, it makes very little sense to buy more fixed income since our yield is already enough to live on, which means that over time our equity allocation will naturally drift upwards. This study seems to suggest that this effect is not so crazy as we thought.

  9. I call myself a Millennial Hippie and I feel, as a Baby Boomer (just on the edge), that I am living in a “Matrix” lifestyle compared to my friends. In the past two years I have walked away from the Baby Boomer life and I am practicing retirement. I have downsized to owning nothing but a car and I am living rent free while I bridge towards withdrawing from my portfolio, which I can access at 55. I housesit in less expensive countries during the winter to get used to the nomadic life. I have increased my focus on my personal health and fitness level so I can continue to travel and earn defer income by doing workaway jobs (room & board provided) and I am building a remote income base doing consulting work. All of this to maintain a free lifestyle and to make choices I want to make for as long as I am able to make them work. My portfolio sits at less than $200,000 and I am going for it!

  10. A good book that explains the withdrawal phase of retirement is Darryl Diamond’s “Retirement Blueprint”.

    He recommends a 5% plus inflation withdrawal from years of retirement planning.

  11. Great post, keep them coming (but don’t burnout please :))! I’ve been binge reading your site for the past couple hours.

    Isn’t the 4% rule assuming you will draw down your portfolio over the years? Can you elaborate how to make your portfolio last for 40-60 years?

    1. The 4% rule will not cause you to draw down your portfolio. Historically, on average the market has returned 8-11% annually, so by withdrawing only 4%, you will be retaining your principal and living off only the gains and dividends.

      Check out You’ll see that 4% withdrawal rate on $1Mill portfolio gives you a success rate of 82.6% over 60 years (the failures are due to withdrawing at the beginning in a down market. That’s why you need to mitigate sequence of return risk). If you use a 3% withdrawal rate, you get 100% success rate over 60 years.

      Also, this is assuming that humans are insanely stupid and would never change their withdrawal rate even if their portfolio goes down. Most people could easily reduce their withdrawal rate, or get a side gig to supplement it.

      We also have 2 backup plans for when the market crashes. 1) live off the dividend of 3% and if that fails, 2) live off the cash cushion we’ve build outside the portfolio, which covers 3-5 years of living expenses.

  12. Thank you for addressing this! None of the other FIRE folks has- possibly because most seem to be earning some sort of income from blogging, consulting, etc that keeps them afloat. This posting answered a million of my questions and has put me even closer to FIRE.

    1. Glad it was helpful! We’re engineers so the urge to analyze “What could go wrong?” is always there. Nothing in life is risk free, but as long as you have backup plans AND backup plans for the backup plans, you’re good to go.

      Best of luck on your path to FI!

      1. Fellow engineer and Boomer (1964) here trying to learn from the youngsters. This old dog is learning new tricks.

        I own a home and have 6 years left to go on the payments. While I love the home and the memories I just want to get away from the debt and maintenance. FIRE at 59 isn’t early by most standards, but it’s better than 65 or 67.

  13. What do you think about withdrawing more during Boom years to offset the Bust years that you know will come?

    While you can’t be certain of the % gain/loss in advance, you know the average % gain that you are depending on to live. Yeah, you might miss out on some sweet massive gains by pulling money out of the market – but the idea is not to get rich, the idea is to have enough money to live.

    I haven’t tried running the numbers but it seems like this method would work. The trick, I think, would be to figure out the added % to withdrawal during Boom years.

  14. Hi W,

    Having a cushion will ensure that one has peaceful nights without worries. I note that your portfolio is in index investing. The portfolio is uder the advice of your financial advisor.

    a) Does your portfolio also include stocks?
    b) Do you invest on your own?
    c) How is your retirement lifestyle so far?


  15. Thanks for the great analysis. I am really glad I found your blog, as it contains so much useful information. Keep up the good job, guys!

    Can you please clarify if the dividends consumed (not re-invested) also count as withdrawals? Just trying to figure out how to properly calculate the 4% withdrawal from my portfolio.

    1. Dividends consumed counts as withdrawals. So in our case, we get 3.5% in dividends and fixed income. 0.5% is from capital gains. So added together that gives us 4%.

  16. I’m doing the same with a 2 year spending cushion. It was killing me to have this sit in cash and devalue with inflation, so I hold my cushion in a shot term bond ETF (TSX:XSB). The difference is that my cushion now generates a small amount of income rather than sit idle. It comes with a small amount of risk, but not something I worry about.

  17. Hello,
    Thanks for all the info. I find your cushion idea attractive. Since you said that it’s not in your portfolio, where do you place that money since it must be around 100 000$. I’m looking for idea for our own cushion.

    1. Part of it is in a HISA (High interest savings account) currently paying 2.9% interest. The rest is being used in the Investment Workshop to show readers how to invest.

  18. Hi Guys, I have to say that I love your site and what you have shown people can do them selves. I think its awesome that you’ve been able to retire early and live off of your portoflio through careful rebalancing. I did have one question though, only because I have not been able to find it here. How do you safeguard against inflation. I’m not certain about rent prices in Canada, but I know in sunny SoCal (I live outside of L.A.). Rent is astronomical and only seems to keep rising year after year. Any feedback on how you guys achieve this is appreciate. Hope you guys are doing well!

    1. Thanks, guppy and welcome to the blog! To answer your question about taxes, investment income isn’t taxed the same way as earned income. After you retire, your income drops to zero, and if you structure your portfolio correctly, your taxes should be close to zero. We wrote articles about it here:

      That being said, in the last 2 years, we’ve had unexpected income beyond the basic personal amount. So in that case, we’ve paid taxes on the earned income from our passion projects. If you retire and don’t earn a single cent, this would not be the case.

  19. Hi,
    Thank you for this post! Very new to this FIRE path.

    Question –
    1. The column where it reads “Portfolio Gain/Loss”, is the gain/loss attributed only to dividends (which are reinvested) or dividends+capital gains?

    2. You mentioned you obtain the 4% thru 3.5% (in dividends and fixed income) + 0.5% (from capital gains). How is that calculated?


  20. Reading this in 2020.

    This COVID-19 situation is no doubt a black swan event.

    wondering how are you approaching this.


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