Sequence of returns

Year	S&P 500	3-month T.Bill
2013	32.15%	0.07%
2014	13.52%	0.05%
2015	1.38%	0.21%
2016	11.77%	0.51%
2017	21.64%	1.39%

Sequence of returns typically has the word risk added to the end of it. Sequence of returns risk. Sequence of returns is thankfully named like what it is - a sequence or series of money or returns. So a sequence of returns might be for something like the stock market where each year the amount of money you get fluctuates with the market.



The sequence of returns can also be for a rental

Year	Interest	Taxes and insurance	Misc Expenses	Rent	Profit
2012	2245.67	883.92	1200 Regime Fee 2500 Roof	6480	-349.59
2013	1914.14	2402.5	1200 Regime Fee	6300	783.36
2014	1250.45	1893.39	1200 Regime Fee 140 heating and air	6925	2441.16

Most sequences do not have a straight line up to prosperity. There are bumps along the way. Roofs need to be replaced, markets take a down turn and some sequences can break someone trying to live on a fixed income stream. This is where the word 'Risk' gets added to sequence of returns.

Year	S&P 500	3-month T.Bill
1999	20.89%	4.51%
2000	-9.03%	5.76%
2001	-11.85%	3.67%
2002	-21.97%	1.66%
2003	28.36%	1.03%

A common example that gets bandied about is the difference between a 50% decline and the amount of an increase you would need to get back to your starting number with say 600,000 dollars.

Year 1	Year 2
-50%	50%
300,0000	450,000

Year 1	Year 2
-50%	100%
300,000	600,000

As you can see it takes a 100% increase (about 10 years at normal market growth) to recover from a 50% decline. The problem is compounded when trying to withdrawal money from these stashes of cash in retirement.

A 4% withdrawal of 600,000 is 24,000 dollars and we budget based on a dollar amount more than a percentage, our costs are relatively fixed - housing, transportation, insurance, food etc. What this means is that due to the sequence of those returns the total cash you have might not last.

Year	Year 1	Year 2	Year 3	Year 4
Return	-50%	50%	7%	4%
Cash	300,000	414,000	417,300	409,032
After Expenses	276,000	390,000	393,300	385,032

This risk is what is known as sequence of returns risk. It is actually very likely to hit people that target a specific number to retire at as that number is most likely to be hit during a bull market. If that bull market has been on a real tear up the fall can be quick and painful. This is why the numbers financial planners throw out there are so huge- 1 Million or 3 Million dollars. What they are really saying is that you need enough money to take a 50% decline and then live on that reduced amount for several years while the market finds a bottom so at the end of all that you have 600,000 dollars to live off of.

A way to make sure that you are on track is to look at your cash and adjust it for a 3% inflation so that your buying power is not reduced.

Year	Year 1	Year 2	Year 3	Year 4
Return	3%	3%	3%	3%
Cash	600,000	618,000	636,540	655,636.2

If the amount of money in your bank account goes down below it's inflation adjusted value it's time to consider tightening the belt, going back to work, downsizing, deferring vacations etc to counter this risk.