Understanding Sequence of Returns Risk
What is Sequence of Returns Risk?
Sequence-of-returns risk is the idea that the order of investment returns matters, not just the average return. For example, if you experience losses early in retirement (when your portfolio is larger), those losses have a bigger impact than if you experience the same losses later. Even if two scenarios have the same average return, the one with early losses might deplete the portfolio faster. This is especially important when you're withdrawing money—bad early years can significantly reduce how long your portfolio lasts, even if average returns are good. This visualization helps illustrate this concept using randomized paths.
How This Simulator Builds Hypothetical Paths
This simulator uses a simple Monte Carlo-style model. It generates multiple random paths, each using the same average return and volatility you specify, but in different random sequences. For each path, it simulates annual returns from a normal distribution (with your chosen mean and standard deviation), then applies those returns year by year along with your contributions. The result is many different paths that all use the same average assumptions but show different outcomes due to the random sequence of returns. This is a simplified mathematical model, not a representation of real market behavior.
Why Early Bad Years Can Matter Even If Averages Match
Early bad years can have a disproportionate impact because losses occur on a larger balance, and there's less time to recover. For example, if you lose 20% on a $1,000,000 portfolio, you lose $200,000. If you lose 20% later on a $500,000 portfolio, you lose $100,000. The early loss is larger in absolute terms, and the remaining balance has less time to grow back. This is why sequence-of-returns risk is particularly important in retirement when you're withdrawing money—bad early years can significantly reduce portfolio longevity even if average returns are good. This visualization shows how different sequences can lead to very different outcomes.
What This Tool Does NOT Model (Real Market Behavior, Fees, Taxes, etc.)
This simulator is a simplified educational tool and does not account for many real-world factors: Real Market Behavior: It uses normal distributions, not real market dynamics, fat tails, or extreme events. Market Correlations: It doesn't model how different asset classes move together or apart. Taxes: It does not model taxes on returns, withdrawals, or distributions. Fees: Trading costs, expense ratios, and other fees are not included. Personal Circumstances: Your risk tolerance, goals, time horizon, and other personal factors are not considered. Actual Probabilities: The percentiles and distributions are descriptive statistics from this toy model, not real probability estimates. Always consider these factors when making real investment decisions.
How to Interpret Percentile Bands at a Basic Level
Percentile bands show the spread of outcomes across all simulated paths at each year. The 50th percentile (median) is the middle path—half of the paths are above it, half are below. The 10th–90th percentile band shows where 80% of the paths fall (10% are below, 10% are above). The 25th–75th percentile band shows where the middle 50% of paths fall. Wider bands mean more variation between paths, which typically happens with higher volatility or longer horizons. However, these are not real probabilities—they're just descriptive statistics from this simplified model. In reality, you cannot know which percentile your actual path will fall into, and real markets behave differently from this model.
Note: This visualization is for educational purposes only and does not provide personalized financial, tax, or investment advice. It does not predict future market performance, assign real probabilities, or recommend specific investments or strategies. It is a simplified mathematical illustration, not a forecast, guarantee, or investment recommendation. Always consult with qualified financial advisors and do your own research before making investment decisions.
Frequently Asked Questions
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