Sequence of returns risk
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Sequence of returns risk is the danger that poor returns in the first years of retirement shrink your savings for good. Spending while prices are low means selling more units for the same money, and units sold cannot share in a later recovery.
Same returns, a different order
Take ₹1 Cr and spend ₹10 L at the start of each of two years. The two years’ returns are the same both ways, a fall of 20% and a rise of 20%; only their order changes.
| Year 1 | Year 2 | Ends with | |
|---|---|---|---|
| Fall first | ₹90 L after spending, then −20%: ₹72 L | ₹62 L after spending, then +20%: ₹74.4 L | ₹74.4 L |
| Rise first | ₹90 L after spending, then +20%: ₹108 L | ₹98 L after spending, then −20%: ₹78.4 L | ₹78.4 L |
The same two returns leave ₹4 L between them after only two years. Over decades of spending the gap grows, and a bad start can be the difference between savings that last and savings that run out.
(An illustration: the same spending each year, no inflation and no tax.)
Why it hurts once you spend, and not while you save
While you are investing, a fall lets you buy units cheaper. Once you are spending, the same fall makes you sell them cheaper. The way the money flows turns the same fall from a help into a harm.
Ways to soften it
- Keep a few years of spending out of shares, so this year’s bills are not paid by selling shares after a fall. The three-bucket retirement strategy does this, at a cost when debt earns less than prices rise.
- Test a bad start: Market slump (Pro) shows what a slump in your first years would do to your plan.
- Test many futures: Simulated markets (Pro) run your plan through 2,000 simulated markets, each year’s return drawn at random around the one you typed, with a market volatility you set for each investment, and say how often your savings last. See how often savings last at each withdrawal rate in the same 2,000 markets.
A plan that works only when returns arrive steadily has not been tested.
Try it
Run your own figures in Phase 2 · Burndown.
Both calculators also work in dollars, with US federal tax brackets.
Questions
What is sequence of returns risk?
The risk that the order of returns, above all poor returns early in retirement, shortens how long your savings last, even when the average return is the same.
Does it matter while I am still working?
Much less. While you are putting money in, falling prices can work for you. The risk is greatest in the years just before and after you start spending your savings; Phase 1’s Market slump (Pro) tests your last working years.
Can I avoid it?
No. Keeping the next few years’ spending out of shares, and testing your plan against bad years, soften it; nothing removes it.