Sequence of Returns Risk: Why “Time In The Market” Doesn’t Always Work.

2/3/2025.   “It’s About Time in the Market, Not Timing the Market” is a common catchphrase of the financial industry, because it stresses the importance of staying invested and not trying to guess when to jump in or out.  

Timing the market – attempting to pick the best moments for entering or exiting investments – is hard to do with any reliable outcome.   It involves getting two decisions right in succession, firstly when to jump in (or out), and secondly when to jump out (or in).

• Irrational fear can cause undisciplined investors to ‘get out at any cost’ just as declining markets are bottoming out.
• ‘Fear of missing out’ (FOMO) can cause irrationally exuberant investors to pile into markets close to the top of a bull run, just before a major pull-back. 

Remembering the Mantra of “Time in the Market” Helps Investors Take a Breath and Think

For investors with a time-horizon of many years, ‘Time in the Market’ is simple common sense.  In the long run, share prices go up as company values rise in concert with underlying growth of the economy.  

So, ignore those urges to react to the daily noise, and let time do the work for you.  Young investors shouldn’t care about market volatility – just keep accumulating for the future, and see every market decline as gift.

Sequence of Returns Risk

However, for retirees or those close to retirement, blindly following the "time in the market" advice is a dangerous gamble.  As you run out of working years, your investment priorities must shift from growth to capital preservation and income generation.  A major market downturn in the early years of retirement can be devastating - because you won’t have the time or the means to recover from losses. 

‘Sequence of returns risk’ refers to the impact that the order of investment returns can have on a portfolio, particularly during the withdrawal phase.  This risk is significant if you’re retired and relying on your investments to generate income.  It's not just the average return that matters, but also the timing of those returns.

Negative returns early in retirement can destroy a portfolio's longevity.  When you withdraw money from a portfolio during a market downturn, you are locking in losses and reducing the ability to recover.  This early depletion of assets increases the chance that you outlive your savings.

Example Of Sequence Of Returns Risk

Consider two hypothetical retirement scenarios, each with similar parameters:

• Starting portfolio size: $1m
• Withdrawals: $50,000 first year, rising 3% annually in line with inflation
• Period: 20 years
• Average Annual Return: 4%, broken down as follows - 

Retiree A

• Years 1-3: 13% p.a.
• Years 4-10: 5.5% p.a.
• Years 11-13: negative -10% p.a. 
• Years 14-20: 5.5% p.a.

Retiree B

• Years 1-3: negative -10% p.a.
• Years 4-10: 5.5% p.a.
• Years 11-13: 13% p.a. 
• Years 14-20: 5.5% p.a.

The only difference between A and B is the sequence in which average investment returns are delivered.  In both cases, the average annual return is identical (about 4% p.a. CAGR).

The chart below shows the outcomes.  (Click to enlarge.)

We can see that for Retiree A, a few growth years early on creates a long-lasting benefit.  In contrast, for Retiree B, a few years of negative returns early on could lead to the retiree running out of money, unless he or she cuts back on withdrawals. 

It’s easy to see how the wrong investment strategy in retirement can cause disaster.  (Even though, that same strategy might be a good one for someone with many years to go before retirement.)

“Time in the Market” Doesn’t Work if You Don’t Have The Time

One of the recurring issues in the financial advice industry is that clients are too often shown retirement cash-flow illustrations that assume stable annual returns.  The problem is that markets don’t behave that way – they can be highly volatile.  Overconfidence and a false sense of security aren’t helpful in early retirement.  

For example, an investor buying the S&P 500 on 24th March 2000, at the peak of the DotCom bubble, would have to wait almost 7 years before breaking even again.  (Even with reinvesting dividends.)  

And after ten years, this investor would have experienced a NEGATIVE annualised return (CAGR) of -0.95% p.a.  After fifteen years, a positive annualised return of just 3.5% p.a.  

(Click to enlarge)

In fact, it would take this same investor about 25 years – until the start of 2025 – to realise an annualised return (CAGR) of about 7.1% p.a., still below the enigmatic ‘long term average return’ of the S&P 500 (8% - 10% p.a. depending on period).

Stable Returns Protect Against Sequence of Returns Risk

Let’s add Retirement Funds C & D to our earlier chart.  Fund C experiences stable 4% annual returns (i.e. identical to A & B).  Fund D experiences stable 6% annual returns.

(Click to enlarge)

We immediately see that relatively modest but stable returns can be a better and safer option for the retiree.  They help avoid the risk that a market downturn permanently destroys capital which was an essential part of the retirement income plan.

Ask your financial advisor about ways to achieve more stable returns.