Understand how the order of investment returns can dramatically impact your retirement portfolio, even with the same average return.
$748,325
Final portfolio value
$243,761
Final portfolio value
Portfolio Difference: $504,564 (67.4%)
With identical average returns of 8%, the sequence makes a dramatic difference. The favorable sequence leaves you with 3.1x more money than the unfavorable sequence after 30 years of 4% withdrawals.
Sequence of returns risk refers to the potential impact that the order of investment returns can have on a portfolio from which regular withdrawals are being made. This risk is particularly important during the early years of retirement when your portfolio is at its largest.
Even if two different sequences of returns yield the same average return over time, the actual outcome for a retiree can be dramatically different depending on whether negative returns occur early or late in retirement.
As a dividend-focused ETF, SCHD is popular among retirees who use it to generate income. Understanding sequence risk is crucial because it can determine whether your SCHD-heavy portfolio will last throughout your retirement, regardless of the ETF's long-term average performance.
SCHD's focus on quality dividend stocks has historically provided some downside protection during market corrections compared to the broader market. During the 2020 COVID-19 market crash, for example, SCHD declined less than the S&P 500 and recovered more quickly.
| Market Event | S&P 500 Decline | SCHD Decline | SCHD Relative Performance |
|---|---|---|---|
| 2015-2016 Selloff | -13.3% | -10.5% | +2.8% |
| 2018 Q4 Correction | -19.8% | -15.2% | +4.6% |
| 2020 COVID-19 Crash | -33.9% | -31.2% | +2.7% |
| 2022 Bear Market | -25.4% | -16.8% | +8.6% |
However, this relative outperformance during downturns doesn't eliminate sequence risk entirely. SCHD still experiences significant drawdowns during bear markets, and withdrawals made during these periods can permanently damage your portfolio's long-term growth potential.
To understand why sequence matters so much, consider a simple example. Let's compare two hypothetical return sequences over three years with the same average return (6.7%):
For an accumulation portfolio with no withdrawals, both sequences would result in the identical ending value. But for a retirement portfolio with annual withdrawals, the outcomes are dramatically different:
With a starting portfolio of $500,000 and annual withdrawals of $25,000, Sequence A (poor early returns) results in an ending value of $381,000, while Sequence B (good early returns) results in an ending value of $466,000—a difference of $85,000 (22%) in just three years.
SCHD has several characteristics that can help mitigate sequence of returns risk, but investors should understand both the advantages and limitations:
47%
Average reduction in portfolio longevity when experiencing poor sequence in first 5 years
3-5x
Higher impact of market declines in early retirement years compared to later years
10-15%
Lower withdrawal rates typically needed after experiencing early negative returns
SCHD's focus on companies with consistent dividend growth can provide a buffer against sequence risk:
SCHD's methodology specifically screens for companies that have consistently increased dividends over time, which can provide more reliable income even during market downturns.
Create three distinct portfolios to manage short, medium, and long-term needs:
During market downturns, withdraw from your cash bucket while leaving your SCHD investments untouched, giving them time to recover.
Instead of withdrawing a fixed percentage or amount:
This flexibility can substantially extend portfolio longevity when facing poor return sequences.
Maximize SCHD's dividend characteristics:
By relying primarily on dividends rather than selling shares, you reduce the impact of sequence risk considerably.
Create a base level of guaranteed income:
This approach ensures your basic needs are covered regardless of market performance, allowing your SCHD investments time to recover from downturns.
For a $1 million retirement portfolio with a 4% withdrawal need ($40,000/year):
This allocation provides approximately $16,400 in annual dividend income from SCHD alone (at 3.9% yield), covering 41% of annual withdrawal needs while maintaining growth potential.
A retiree who began withdrawals in 2000 faced devastating sequence risk:
However, value and dividend-focused investments (similar to SCHD's approach) performed significantly better during this period:
The 1970s presented a different kind of sequence risk—high inflation combined with poor market returns:
Companies with characteristics similar to SCHD holdings performed relatively well:
"The historical evidence is clear: retirees who experienced poor returns in their first 5-10 years had dramatically different outcomes than those who began retirement in favorable markets, even when the long-term average returns were identical."
Sequence of returns risk refers to the potential impact that the order of investment returns can have on a portfolio that is experiencing withdrawals. Even with identical average returns over time, experiencing negative returns early in retirement can significantly reduce portfolio longevity compared to experiencing those same negative returns later in retirement.
SCHD focuses on high-quality companies with strong dividend histories, which tend to be less volatile than the broader market. Its consistent dividend income reduces the need to sell shares during market downturns, and these companies typically have better downside protection during market corrections. However, SCHD is not immune to market declines and should be part of a broader risk management strategy.
While the traditional 4% rule provides a starting point, the safe withdrawal rate depends on your specific situation. For a portfolio with significant SCHD allocation, a flexible withdrawal approach is often more appropriate. Using primarily dividend income (currently around 3.9% for SCHD) as your withdrawal baseline can improve sustainability, with occasional adjustments based on market conditions.
While SCHD has many attractive qualities, it's generally not recommended as a single holding. Diversification across asset classes, including bonds, international stocks, and perhaps other dividend ETFs with different focuses, can further reduce sequence risk. A diversified approach helps ensure that poor performance in one area doesn't devastate your entire portfolio during critical early retirement years.
There's no one-size-fits-all answer, but many financial planners suggest that quality dividend ETFs like SCHD might comprise 30-50% of an equity allocation in retirement. For a traditional 60/40 portfolio, this would mean approximately 18-30% in SCHD. The appropriate allocation depends on your income needs, risk tolerance, and other income sources like Social Security or pensions.
Your personal sequence risk depends on several factors: 1) Your withdrawal rate (higher rates increase risk), 2) Your retirement horizon (longer periods increase risk), 3) Your asset allocation (more stocks generally increase short-term risk), and 4) Your flexibility to adjust spending. Our calculator above helps you visualize potential outcomes based on these variables and historical or hypothetical return sequences.