Does the Sequence of Investment Returns Really Matter?
I’ve heard, and I’m sure you have heard as well, cautionary advice regarding the sequencing of returns on your retirement investment portfolio.
The idea is that identical returns, with a different order or sequence, can dramatically affect your ability to make withdrawals in retirement and retain principal.
Q: Wait a minute! Don’t brainwash me into thinking, “Down 5%, up 10%, down 3%, up 20%” is ANY different in ANY order or sequence!
A: You are correct. (Your retirement nest egg) x 0.95 x 1.10 x 0.97 x 1.2 is the same no matter how you order those returns. It’s called the commutative property of multiplication and was probably taught in 5th grade, plus or minus.
Q: Then why does the financial world want me to be aware of what they are calling the “sequencing risk” ?
A: The mainstream financial world assumes you will be taking withdrawals from your “retirement nest egg” on a somewhat regular basis. Accordingly, when you reduce your principal by the amount of a withdrawal, this reduction causes the subsequent sequence of returns to really matter.
In other words, when you begin taking withdrawals, your account balance suffers greater when the lower returns come first, rather than when the higher returns come first. (Assumption: withdrawal amount remains the same.)
Q: “Taking withdrawals” from my retirement nest egg sounds a lot like “killing the goose that lays the golden eggs”. Haven’t you advised against that in previous articles?
A: Remember, I give ideas, not advice. But otherwise, yes.
Q: If I own a portfolio of income-producing real estate, and the monthly cash flow is what sustains my retirement, it seems like my return would not be affected at all by what happens in the “stock market”.
A: Now you’re catching on.
As you think about that, pay attention to the vehicles in which you save for retirement, and the different ways in which you plan to ultimately make withdrawals. If you invest for cash flow rather than capital appreciation, you won’t have to worry about a “sequencing of returns” risk.
Until next time,
Dr. Lee Newton
What real estate investing, building science, or development questions do you have? I’ll be happy to answer them here. Send them to Lee@CEassets.com.
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Disclaimer: I give ideas, not advice.