What does "sequence of returns" risk refer to?

"Sequence of returns" risk specifically refers to the potential negative impact on a retirement portfolio caused by the order in which investment returns occur, particularly in the early years of retirement. When retirees withdraw funds from their savings while facing lower or negative returns, it can significantly diminish the portfolio’s longevity and overall health. This is due to the compounding effect of losses being amplified by subsequent withdrawals, which could result in depleting the retirement savings faster than expected.

If the market performs poorly initially, retirees may find themselves in a position where they have to sell investments at a loss to generate income, further exacerbating the impact of their withdrawals. Thus, this type of risk underscores the importance of strategies to manage withdrawals and maintain a stable income stream, particularly in the early years of retirement.

In contrast, the other options refer to different aspects of market dynamics and financial planning, such as broader economic conditions, interest rate fluctuations, and tax policy changes, which, while important, are separate from the specific challenges posed by the timing and order of investment returns in relation to withdrawals during retirement.