Sequence of returns: why the order matters more than the average
While you are saving, the order of returns does not matter. Once you are withdrawing, it is the whole game.
Understand the single largest risk of the first years of retirement.
How Sequence of returns: why the order matters more than the average works, in one picture
The same argument as the text, as a chain. Each step is what makes the next one possible.
The market moves first, and recovers first
Shares fall before the data does and start climbing while the news is still uniformly awful. Waiting for the news to improve means buying after the recovery has happened.
- 1
When you are accumulating, order is irrelevant
If you are adding money and taking none out, a good year followed by a bad one produces exactly the same result as the reverse. The average is all that matters, and this is why most retirement advice can safely ignore sequence.
- 2
When you are withdrawing, order is everything
Now a crash in year one is catastrophic, because you are selling assets at depressed prices to fund your living costs, and those units are gone. They cannot participate in the recovery. The same crash in year twenty is survivable and possibly trivial.
Identical average return, identical portfolio, completely different outcome, decided entirely by when the bad years happened to land.
This is why 'the market returns 8% on average' is dangerously incomplete advice for anyone who has stopped earning.
- 3
The defences are unglamorous and they work
Hold a cash or bond buffer of a few years' spending, so a crash never forces you to sell shares. Be flexible about withdrawals, taking less in bad years. And consider being more conservative in the years immediately around retirement, then re-risking later.
- 4
Run it, do not assume it
Model your plan against the actual worst sequences in history rather than a smooth average. If the plan only survives an average, it is not a plan, it is a hope.
You know how many years of spending you could fund without selling a single share.
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While you are saving, the order of returns does not matter. Once you are withdrawing, it is the whole game.
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