Sequence of Returns Matters Too

August 11, 2020

My Dear Reader,

While perusing both social media and in talking with friends and family over the weekend, I tend to see much of the same content but repeated, but with different numbers. In an age of stock market speculation and it’s forces propping up the market and its returns,  I believe it’s important to revisit the fact that a great day or week here and there is just as important as consistency. Of course, this would mean that we would have to go with the less attractive option of lower, but compounding growth, but that’s another topic for another day. My point is that the sequence of returns matters just as much as actual returns and I hardly ever see this discussed. Perhaps because it seems a bit too heavy for the general public, and we’ve discussed the depth of arrogance within the financial industry, but nonetheless I believe you can understand this simple concept.

From 1989 until 2014, the S&P 500 experienced an average rate of return of 11.96%, and this healthy average rate of return helped sell many Americans on the idea of market returns.  Instead of relying on their company’s pension, as their fathers had, the American retirement plan and partial responsibility for the comprehensiveness and effectiveness of that plan now fell on the employer.  For those who were fortunate enough to live through both the Regan boom and the internet boom of the late 1990s and early 2000s, investment in the safe standard and poor index yielded a great retirement. As we can see by this first chart, if someone had one million dollars invested in 1989, and retired in 2014 they were able to withdraw 100,000 dollars each and every year and still earn more money over time, due to the gains in the market.  However, if we simply invert the yields of the S&P 500 over that same period of time and attempt to withdraw 100,000 dollars each and every year during that time period, we would end up running out of money before 2014.  

So what’s the conclusion, and why does this matter to you?  If we look at both examples, we can see that the average rate of return for both accounts is 11.96%.  If we took away the results and asked you to pick the winning account, you would only have a 50/50 chance of actually being able to use the account beyond 2014.  This means that the listed average rate of return is almost useless if the sequence of returns is not also on display. 

To Your Creation and potential,

Kevin Prendiville