Stay the Course by Embracing Sequence Risk

Updated: Jun 14

If you are saving for retirement you may have concerns about a major downturn in the stock market. Many individuals panic and sell their stock portfolio when markets are down because they don’t fully understand the ‘sequence of returns’ risk.

Three sailboats in rough waters.
Can you stay the course?

What exactly is the “sequence of returns”?

The phrase describes the yearly variation in an investment portfolio’s rate of return. For most investors, their returns will be driven by stock market fluctuations. Most people accumulate assets, including stocks, bonds, and real estate, while they are working and saving for retirement. They take distributions from their investment portfolios during their retirement years.

The Path to Great Fortune is Not Linear

Take a look at the graph below from BlackRock. Three investors start portfolios with sums of $1 million. Each of the three portfolios averages a 7% annual return across 25 years. However, the returns and value of each portfolio vary widely from year to year.

Before retirement, average return matters more than sequence.
Source: BlackRock. This graphic looks at the effect the sequence of returns can have on your portfolio value over a long period of time. Other factors that may affect the longevity of assets include the investment mix, taxes and expenses related to investing. This is a hypothetical illustration. This illustration assumes a hypothetical initial portfolio balance of $1,000,000 with no additions or withdrawals and the hypothetical sequence of returns noted in the table. These figures are for illustrative purposes only and do not represent any particular investment, nor do they reflect any investment fees, expenses or taxes.

In two scenarios (A & C), during the first five years, the returns range from -7% to +22%. In the third scenario (B), the return is a steady 7% every year. Each portfolio accumulates the same total of $5.4 million after 25 years. This is because the average annual return is the same hypothetical 7% after 25 years.

Stay the Course

Different portfolio strategies (mix of stocks, bonds, and real estate) can wind up with similar wealth levels. Although, the change in value each year can vary widely from portfolio to portfolio. The graph above assumes that each investor evaluated their financial ability to hold onto their investments through periods of declining and rising prices. They did not sell during market downturns.

Choose The Path That Works for You

It’s important to remember that investing involves risks, and investment decisions should be based on your own goals, time horizon, and risk tolerance. The return and principal value of investments will fluctuate as market conditions change. When sold, investments may be worth more or less than their original cost. Investment returns are not guaranteed and your financial advisor should illustrate the potential fluctuations in your portfolio before putting your hard-earned money to work. He should provide you with an estimated –– although not guaranteed –– average annual return for your portfolio.

Final thought.

Want to know how much sequence of returns risk might affect your investment portfolio? Spend five minutes learning your ability to stay the course. Try our risk tolerance tool today. Once you've completed the evaluation, we can compare your portfolio to your risk tolerance. This will help you stay the course during stock market fluctuations.

If you have a net worth over $2 million and need help from a wealth manager, the Peak Wealth Planning team can assist you.

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About the Author

Peter Newman is a Chartered Financial Advisor (CFA) and president of Peak Wealth Planning. He works with individuals nationwide that have accumulated wealth through company stock, ESOP shares, real estate, or running a business. Peter applies his unique background to help clients achieve their specific goals and enjoy peace of mind.

Peak Wealth Planning provides concierge services to meet your wealth management needs. Services include: financial planning, investment management, esop diversification, retirement income, insurance, and estate planning advice. Peak Wealth Planning is a fee-based financial advisor based in Champaign, Illinois, and Fraser, Colorado.