Picture this: two individuals retire at the same time. They have the same amount of money saved and withdraw the same amount from their nest egg.

Ten years later, one retiree still has a good amount of money left, while the other is running dry. We’re looking at the same situation but with widely different outcomes. What’s happening here is a phenomenon called sequence of returns risk.

In this week’s Money Wisdom Question Series, Heath Grossman, CFP® explains how this risk can make or break your retirement plan.

Average Returns Don’t Tell the Whole Story

If your investment averages a 10% annual return, it may not have grown steadily each year. Its trajectory could have been more volatile with ups and downs along the way. But either way, Wall Street would say the investments performed the same because they had the same average annual rate of return.

Wall Street’s math wouldn’t produce the same outcome for someone in early retirement. If that person withdraws from their investments during a market downturn, they may shorten their portfolio’s lifespan.

Why Market Volatility Matters

Market volatility can often work in your favor when you’re younger and still saving in your retirement accounts. But that same math can work against you in retirement.

Selling investments at lower prices locks in losses. A 20% loss in the first year of retirement is far more damaging than a 20% loss in the 20th year. That’s where taking a slow-and-steady approach can be more beneficial.

Shifting Your Investment Mindset

A major mindset shift needs to occur as you approach retirement. You must start focusing on steady, consistent growth and protecting against major downside risk to some degree. You should not be taking extreme risks and white knuckling your way through market swings. That’s why it’s important to have a plan in place to help manage volatility when it happens.