Standard retirement calculators use a fixed annual return rate and apply it consistently across the entire projection period. Enter 7% and the model assumes 7% growth every single year for the next 30 years. This produces a clean, predictable projection, but it glosses over a risk that can make or break a retirement plan: the order in which returns occur.
Sequence of returns risk is the concept that the sequence of annual returns matters as much as the average return, particularly when you are withdrawing money from the account. Understanding this risk has a direct implication for what return rate you should enter in a 401(k) calculator.
What Sequence of Returns Risk Actually Means
Here is a simple illustration. Suppose Investor A earns returns of +20%, -5%, +15%, +10% over four years. Investor B earns returns of +10%, +15%, -5%, +20% over the same four years. The average annual return for both investors is identical at 10%.
If neither investor contributes or withdraws anything during this period, their ending balances will be essentially the same. The order of returns did not matter during pure accumulation.
Now suppose both investors retire and begin withdrawing $5,000 per month from their accounts at the start of year one. Investor A, who starts with a 20% gain, can fund year one withdrawals from strong portfolio performance. Investor B, who starts with +10% and then enters a -5% year when the balance is even higher, faces a more volatile sequence but still manages.
The real damage happens when the sequence starts with a large negative return early in retirement. An investor who retires into a 30% market decline and immediately begins selling shares to fund living expenses is depleting their portfolio at the worst possible time - buying into volatility at low prices helped during accumulation, but selling at low prices during withdrawal accelerates portfolio depletion.
Why This Affects Accumulation Planning, Not Just Retirement Drawdown
Most discussions of sequence of returns risk focus on the withdrawal phase. But there is an implication for accumulation planning too, and it relates directly to the return rate you enter in your retirement calculator.
Standard retirement calculators use a smooth, constant return rate. They do not model volatility. A calculator that shows $1.2 million at retirement using 7% per year does not know whether those 30 years included a severe market decline in year 28, just before retirement. If it did, the actual balance would be lower - potentially much lower - than the smooth projection suggests.
This is the argument for using a conservative return rate assumption even if you believe your long-run average will be higher. A 7% return assumption in a smooth calculator implicitly assumes the average is what you actually receive, uniformly, year after year. By using 5.5% or 6% instead of 7.5%, you are building in an informal buffer against the possibility that your returns are front-loaded with poor years that reduce the value of later contributions.
The Practical Implication for Your Projection
If you are more than 15 years from retirement, the sequence of returns risk is less acute. You have time to recover from poor early returns, and dollar-cost averaging into a down market actually works in your favor. Your monthly contributions buy more shares when prices are low.
As you get within 10 years of retirement, sequence risk becomes more relevant. At this point, the conservative return assumption matters more because you have less time to recover from a bad sequence, and your balance is larger - meaning a 30% decline is a larger absolute dollar loss than it would have been at the beginning of your career.
A practical response to this is a gradual shift to a lower return rate assumption as you approach retirement. At 30, using 7% is reasonable for a broad equity portfolio. At 55, with more bonds in the mix and a shorter recovery window, 5.5% to 6% may be more appropriate.
The 401(k) Calculator lets you adjust the return rate and see immediately how it changes your projected balance. Dropping from 7% to 6% in your late fifties is not pessimism - it is a more accurate reflection of the return environment for a de-risked portfolio with a shorter time horizon.
Vanguard has published research on sequence of returns risk and its practical implications for retirement income planning. Their analysis consistently supports using conservative return assumptions and building in a margin of safety rather than optimizing for the most likely outcome.
How Dollar-Cost Averaging Partially Mitigates Sequence Risk During Accumulation
During accumulation, the monthly contribution pattern you follow provides a natural hedge against sequence risk. When markets fall, your contributions buy more shares. When markets rise, your existing balance grows. This dollar-cost averaging effect means that poor early returns are not as damaging during accumulation as they are during drawdown.
The compound interest mechanics of accumulation with regular contributions are different from the compound mechanics of accumulation without contributions. Because you are constantly adding new money, a down market does not simply reduce your balance - it also creates buying opportunities that benefit your future returns.
This is why sequence of returns risk is primarily a retirement drawdown concern, not an accumulation concern. But it still has implications for how you plan. If your monthly contributions are doing some of the heavy lifting via dollar-cost averaging, you should be less dependent on a high fixed return rate assumption to hit your target.
What to Do With This Information
For most people, the most practical takeaway is to use a conservative return rate in their 401(k) projections rather than the historical average. The article on how your 401(k) return rate shapes retirement math covers this in detail, including specific balance comparisons at 5%, 7%, and 9% with the same contribution inputs.
Beyond that, the closer you get to retirement, the more you should think about transitioning your portfolio allocation from growth-oriented (higher expected return, higher volatility) to income-oriented (lower expected return, lower volatility). This transition directly reduces sequence of returns risk because it lowers the potential for a severe early-retirement decline.
Schwab provides resources on the gradual transition from accumulation to distribution that address this allocation shift. The core principle is consistent: do not wait until the day you retire to de-risk. Start the transition gradually, 5 to 10 years before your target retirement date.
Run your 401(k) Calculator scenarios with this in mind: use an age-appropriate return rate that reflects both your current allocation and the allocation you expect to hold as you approach retirement. The projection will be more honest, and your planning will be more robust to the uncertainty that sequence of returns risk introduces.
At EvvyTools, the calculators are designed to make these kinds of targeted what-if analyses quick and concrete. Understanding the risk is the first step; running the numbers with a conservative assumption is the second.
Sequence of returns risk does not require you to overhaul your entire retirement strategy. It requires one change: use a return rate assumption that builds in a margin of safety, so that a poor-sequence scenario still produces an outcome you can live with. The rest follows from that one disciplined choice.
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