Sequence of returns: same average, different outcome

Why the order of returns can matter

When you are building a portfolio, the order of returns does not change the final value. When you are drawing money out, it does. This is sequence of returns risk, and a three-year example shows it.

The setup

Start with ₹1 crore. Three years of returns: −20%, 0% and +20%. The average is 0%. Run them in two orders.

Without withdrawals (order does not matter):

• Order A, −20%, 0%, +20%: 100 × 0.8 × 1.0 × 1.2 = ₹96 lakh
• Order B, +20%, 0%, −20%: 100 × 1.2 × 1.0 × 0.8 = ₹96 lakh

Identical. Multiplication does not care about order. Note the result is ₹96 lakh, below the starting ₹1 crore, even though the simple average is zero. That is the same effect shown in our post on why a 50% fall needs a 100% gain.

Now withdraw ₹10 lakh at the start of each year

Same three returns, same withdrawals, and the portfolio that met the fall first ends with ₹8 lakh less. That is about 11% less than the other.

Why early falls hurt more

In Order A the fall hit when the portfolio was at its largest, then a withdrawal took money out at the low. Those units were sold cheap and could not take part in the recovery. In Order B, the gain came first, so more money was already in hand when the fall arrived.

The same ₹10 lakh withdrawals cost more when they follow a fall because a larger share of the remaining portfolio is being sold.

What it means for retirement planning

• The first few years carry extra weight. A bad stretch right after retiring is harder to recover from than the same stretch ten years in.
• An average return is not enough. A plan that works at a steady 8% may not work if the returns arrive unevenly. Tools like the SWP calculator assume a steady rate, so treat their result as the best case.
• Withdrawal rate matters. The lower the share you take, the less a bad start hurts. See retirement corpus at different withdrawal rates.

Ways people manage it

1. A buffer. Keep one to two years of spending in liquid or short-duration debt, so a fall does not force equity sales.
2. Flexible spending. Trim withdrawals after a bad year if you can.
3. Gradual de-risking. Reducing equity before retirement lowers the damage of an early fall, a theme in asset allocation by age.
4. Bucket drawdown. Draw from the safest bucket first and refill it in good years, as in SWP for retirement income.

This post is educational, not financial advice. The returns are assumed for illustration and are not forecasts.