Sequence of returns

In simple terms

If you invest a lump sum and leave it alone, the order of good and bad years does not matter: 1.2 × 0.8 is the same as 0.8 × 1.2. But most people are not doing that. They are either adding money (saving for a goal) or taking money out (in retirement or as a goal arrives). Then the order of returns, the sequence, matters a great deal.

A lump sum: order does not matter

Withdrawals: early losses hurt most

Now suppose ₹1 lakh is withdrawn at the end of each year, as a retiree might.

This is sequence-of-returns risk. It is why a market crash in the first years of retirement can do lasting damage even if markets recover later.

Contributions: the opposite effect

For someone adding money regularly, such as through a SIP, the effect reverses.

The danger zone

Putting the two together, sequence risk is greatest around the point when a portfolio is largest and cash flows change direction:

• in the last years before a goal or retirement, when a fall hits the largest balance and there is little time to recover;
• in the first years of withdrawals, when losses are locked in by selling.

Reducing sequence risk

Common approaches include:

1. Reducing equity as a goal approaches, as the asset allocation lesson describes, so a late crash hits a smaller share of the money.
2. Holding several years of withdrawals in safer assets, such as short-term fixed income, so that withdrawals in a bad year do not require selling shares at low prices.
3. Flexible withdrawals: taking less in bad years where possible.
4. Planning with cautious return assumptions, rather than the average return.

None removes risk entirely; each trades some expected return for more certainty when it matters most.

Why it matters

Retirement planning and goal planning often assume a steady average return. Real returns arrive in an unpredictable order, and with money flowing in or out, the order can matter as much as the average. Understanding sequence risk explains why portfolios should become more conservative near goals and in early retirement.

Limitations

The examples use made-up returns and simple yearly cash flows. Real sequences, costs and taxes differ. No one can know the future order of returns, which is exactly why planning for bad sequences matters.

Common mistakes

• Planning withdrawals from the average return.
• Holding a near-retirement portfolio mostly in equity without a cash buffer.
• Stopping a SIP after early losses, when continuing buys at lower prices.
• Assuming a recovery will always come in time.

Try it yourself

1. Write down five yearly returns that include two bad years.
2. In a spreadsheet, calculate the result of ₹10 lakh with ₹1 lakh withdrawn each year, in your order and in reverse.
3. Repeat with ₹1 lakh added each year instead.
4. Note how much the order changed each result, and what that implies for your own goals.