Beware of Sequence of Return Risk
07 Aug 2015
We all know the story of the tortoise and the hare. The media love the hare. The tortoise is boring. But we all know who wins in the end. Steady and slow. The race isn’t to the swift.
While establishing your plan for withdrawing from investments, beware of the impacts of “sequence of return.” The timing of your good and bad years makes a major difference. The math doesn’t lie. So before you let yourself be wowed by an investment’s average annual return over the past decade, ask some questions. These might include what is the year-over-year rate of return, how consistent has it been, and what is the volatility? Because remember, slow and steady wins the race.
For example, If you retired in 2007, began withdrawing from your investments, and a market crash was the first thing you experienced, you’d be in much worse shape than someone with the same investment who retired two years later and the market went up. This is because constant dollar withdrawals in a declining market would represent a larger proportion of your investment as compared to the same constant dollar withdrawal schedule in a rising market. But from the perspective of average return a decade later, both scenarios could result in very similar calculated rates of return.