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Sequence of returns risk is a great topic for retirement. I’ve discussed it a few different times:
But the only point of this blog post is to share a very simple spreadsheet example that illustrates exactly how it works.
Here’s the spreadsheet. If you’d like your own copy to play with, go to File –> Make a Copy.
Here’s what to look at.
- You’ll see two examples. A “Good” sequence and a “Bad” sequence.
- The two examples are identical except for the portfolio returns. They have the same starting values and the same annual withdrawal amounts.
- The sequences themselves are identical-but-opposite. The “Good” sequence starts at 10% and decays down to (-10%). The “Bad” sequence does the opposite, growing from (-10%) up to 10%. When averaged, these two sequences are IDENTICAL!
So if you have two identical investors with two identical AVERAGE returns, shouldn’t their results be the same?
No!
Because the sequence really matters.
We see here that the “GOOD” investor ends with ~$700K, while the “BAD” investor runs out of money.
By the time the “BAD” investor had any positive returns, their balance was so low that the positive growth still could not keep up with the annual withdrawals.
This is the sequence of returns risk at play.
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