Enter the investment details and return timeline into the calculator to estimate the impact of sequence of returns risk.
Related Calculators
- Drop Retirement Calculator
- Asset Depletion Calculator
- Return on ETF Calculator
- Cagr End Value Calculator
- All Personal Finance Calculators
Sequence Of Returns Risk Formula
Sequence of returns risk is evaluated by modeling the portfolio value with ongoing cash flows (withdrawals or contributions) and then comparing outcomes across different return orders. A commonly used cash-flow-aware model (matching the “Sequence Simulation” tab) is:
\begin{aligned}
B_0 &= P_0 \\
B_t &= (B_{t-1}+CF_t)\,(1+R_t),\quad t=1,\dots,n \\
FV &= B_n
\end{aligned}- Where FV is the final portfolio value after n periods
- P₀ is the initial principal (starting portfolio value)
- CFt is the net contribution/withdrawal at the start of period t (negative for withdrawals), and Rt is the return during period t
If there are no cash flows (all CFt = 0), the model simplifies to the standard compounding formula FV = P₀ × ∏(1+Rt), and the order of returns does not change the final value. Sequence of returns risk arises because cash flows cause different returns to apply to different dollar amounts at different times.
What is a Sequence Of Returns Risk?
Definition:
Sequence of returns risk is the possibility that the order or timing of investment returns can profoundly impact a portfolio’s value, especially when withdrawals are being taken (and, more generally, when cash flows occur during the timeline). With a lump-sum investment and no intermediate cash flows, reordering the same returns produces the same ending value.
How to Calculate Sequence Of Returns Risk?
Example Problem:
The following example outlines the steps and information needed to calculate the Sequence Of Returns Risk.
First, determine the initial value of the portfolio. In this example, the starting amount is $100,000, and you withdraw $10,000 at the beginning of each year.
Next, identify the series of returns for each period. Let’s assume annual returns over three years, such as -10%, +5%, and +8%.
Finally, calculate the final portfolio value using the cash-flow-aware formula above (withdrawal at the start of each year):
B1 = ($100,000 − $10,000) × (1 − 0.10) = $81,000
B2 = ($81,000 − $10,000) × (1 + 0.05) = $74,550
B3 = ($74,550 − $10,000) × (1 + 0.08) = $69,714
FV = $69,714. If the same returns occurred in reverse order (+8%, +5%, -10%) with the same withdrawals, the ending balance would be $73,404, a difference of $3,690—illustrating sequence of returns risk.
FAQ
How does sequence of returns risk differ from average returns?
Average returns summarize performance over time but do not capture when gains and losses occur. Sequence of returns risk focuses on the order of returns, which matters when cash flows occur (especially withdrawals). With no intermediate cash flows, reordering the same set of returns does not change the ending value.
Does diversification reduce sequence of returns risk?
Diversification can help mitigate overall volatility, thus reducing some impact of poor returns in any given period. However, it does not eliminate sequence of returns risk entirely, as the timing of market fluctuations can still affect investment outcomes.
Who is most affected by sequence of returns risk?
Retirees and individuals drawing on their portfolios are typically most affected, as regular withdrawals during market downturns can lock in losses and reduce the amount invested for eventual market recoveries. Those in the accumulation phase may be less affected due to ongoing contributions that can benefit from lower prices in down markets.