Timing is Everything

A simply complex, but vital contributor to the success of your retirement plans is the sequence of your investment returns. Many investors assume that a given sample of returns will yield the same outcome, and they would be correct in a world with infinite liquidity. But in the real world, when the money is gone, the game is over.

The Power Hidden In Order

In the realm of finance, the sequence of returns refers to the order in which investment gains or losses occur over time. For retirement planning, it becomes a crucial factor, as the order of positive and negative returns can significantly impact the overall value of a portfolio.

Financial math can almost seem like a trick at times. A 10% gain and a 10% loss does not actually equal break-even. If you have $100,000 and earn 10%, you now have $110,000. But if you lose 10% of $110,000, or $11,000, you now have only $99,000, which is 1% less than your starting point. Run this math backwards, losing 10% before regaining it, and you will find the same outcome. This effect is amplified the greater the magnitude of gains and losses experienced.

The Impact Of Timing

An interesting wrinkle is the effect that the sequence of returns can have on the outcome for investors who take regular withdrawals from their account. To illustrate this effect, consider a recent example. For all intents and purposes, the five-year period from 2018 through 2022 was a pretty typical list of returns for the S&P 500 overall.

• 2022: -18.04%
• 2021: 28.50%
• 2020: 18.06%
• 2019: 31.20%
• 2018: -4.23%

Fast forwarding through some math, if you invested $1 million in the S&P 500 index on December 31, 2017 and withdrew $50,000 from your account on December 31, 2018 and every New Year’s Eve thereafter, by the end of last year your account balance would have been approximately $1.275 million.

But let’s play a game of what if. Re-arrange the exact same annual returns in ascending order, beginning with a -18.04% return in 2018 and ending with a 31.20% return in 2022, and the final balance changes significantly.

• Year 1: -18.04% -> $769,600
• Year 2: -4.23% -> $687,046
• Year 3: 18.06% -> $761,126
• Year 4: 28.50% -> $928,047
• Year 5: 31.20% -> $1,167,598

As you can see, the ending balance is now just $1.17 million, 8% less than the original result, or about 1.75% less per year over the five-year average.

If you flip the numbers around yet again, experiencing the best returns first, you see the opposite.

• Year 1: 31.20% -> $1,262,000
• Year 2: 28.50% -> $1,571,670
• Year 3: 18.06% -> $1,805,514
• Year 4: -4.23% -> $1,679,140
• Year 5: -18.04% -> $1,326,223

Your final balance in this scenario is 4% higher than the opposite order of returns, 13.6% higher, or about 2.5% per year on average.

Moral Of The Story

Don’t lose money early in your retirement. Well, sure. But for that matter, it would be sound advice to never lose money at all if that were within our control. However, the example offers a valuable lesson on the importance of managing risk, especially early in your retirement years as you start relying on your assets to cover living expenses.

If you are unsure whether your current investments are the proper fit for your overall retirement plan, please schedule a free consultation. I would love to learn more about how I can improve your long-term strategy.