# The Danger of Sequence of Return’s Risk

What is Sequence of Returns risk?

Sequence of returns risk is the risk produced by the order your investment returns are delivered on an annual basis by your portfolio. If you lose money at the beginning of your retirement versus later in retirement, you may run out of money sooner depending on the value of the losses and gains. A portfolio that loses money early in retirement may not be able to recover when income is systematically taken from it. This is because money taken out will never have a chance to earn a rate of return in the future. It will be spent. Consequently, average rates of return are no longer relevant when your goals change from growing your nest egg to living off it.

Take a look at this example comparing average return values to how your account value responds when using real money.

 Beginning Account Value Year 1 2 3 4 Average \$100,000 +25% – 25% +25% – 25% 0% Actual Account Value 125000 93750 117188 87891 -12%

Notice that the average rate of return over 4 years in our example was 0%, but you actually lost 12% of your money. How can this be, you might ask? It’s because with real money you are not only losing 25% (yr 2) of your growth in a down year, you are also losing 25% of your beginning balance. You have to earn more than your loss just to break even. If you lose 50% one year, it takes a 100% gain just to get back to even. That’s if you stay in and stress doesn’t force you to pull out at or near the bottom. When you add fees and taxes to your losses on each withdrawal, it gets worse.

When growing your money, the order of returns doesn’t matter. You will still end up with the same amount of money over a given time period (2 year minimum) no matter how you change the order. But as soon as you begin taking withdrawals from your account, the math formula needed to model your values on a year by year basis changes from average annual return to a geometric mean calculation.