Skip to Content

Not All Total Returns Are Created Equal

Return sequences can help performance as well as hinder it.

An illustrative image of John Rekenthaler, vice president of research for Morningstar.

Good Timing

This article addresses what is commonly called sequence risk, but that term is inadequate. The topic could just as well be called “sequence opportunity.” The point is that sometimes the order in which total returns transpire becomes important. That order may be harmful, but it also may be greatly helpful.

Let’s consider first how sequencing affects investors who are accumulating assets. Assume a 401(k) participant. Each year she invests an inflation-adjusted $10,000 into her 401(k) plan. She does not begin until age 35, but once she starts her timing appears to be excellent, as her portfolio gains an annualized 15% during its first decade. The next decade its performance slows, but its annualized return remains satisfactory, at 8%. During her final 10 years of employment, the portfolio earns only 1% per year. Throughout her career, the annual inflation rate has been 3%.

At retirement, the account has a nominal value of $1,076,401, which sounds impressive. However, when adjusted for inflation, the amount drops to $443,463—a disappointing total, given that the employee contributed $300,000. One would have hoped for a cheerier result than that, given how wonderfully the portfolio performed during its inaugural decade.

The problem, of course, is that the employee’s account was small when the returns were strong. Sure, it’s nice to book a 15% gain on a $90,000 stake, as occurred during the participant’s Year 7, but it’s better yet to do so when the account holds several hundred thousand dollars. For accumulators who save on an ongoing basis, constantly placing new moneys into their portfolios, evening parties beat morning affairs. (This statement does not apply to single-purchase investors. If no assets enter or exit the account, the return sequence is immaterial.)

Bad Timing

Now assume identical portfolio performance, except in reverse order. The 401(k) account gains 1% annually in the first decade, 8% through the second, and 15% during the third. In that case, the employee would finish with a cool $2,535,347, which equals $1,044,529 in current dollars. Switching the order of the returns increased the retirement fund by 136%!

The chart below shows each portfolio’s progression, along with that of a third possibility: a 401(k) account with the same 30-year total return, but achieved steadily, with fixed annual performances. The figures are computed in real terms.

Portfolio Growth

($10,000 Annual Investment for 30 Years, in Real $)
A line chart showing the growth of three portfolios, in inflation-adjusted terms, that have the same annualized total return for their investments, but with a different sequence of returns.

As one would expect, the consistent portfolio lands in the middle. It, however, is not the Goldilocks solution. The lesson is clear: The more backloaded the investment performance for 401(k) investors, the larger their nest eggs.

The Sequence Effect During Retirement

After the employee retires, the analysis reverses. The earlier that high portfolio returns arrive, the happier the retiree’s situation. The scenario that had previously disappointed now becomes very attractive. With 15% annual gains feeding its kitty, the portfolio that begins with a bang will grow during the initial retirement decade, even while sustaining an ambitious withdrawal rate. Barring a financial-market catastrophe, our investor’s investment future will be secure.

For example, withdrawing 6% each year from the portfolio, adjusted for inflation—an amount that far exceeds the customary 4% rule of thumb for portfolio spending over a long period—presents no problems whatsoever. By the end of Year 10, the portfolio’s real value will have increased by 93%. As the 401(k) account has become much larger, while also supporting a shorter time horizon, the retiree can withdraw even more from her assets, if she desires.

But woe betide the retiree who lives in the mirror universe. She receives a puny 1% annualized gain—which translates to a loss, in real terms—for the decade after she stops working. Her portfolio cannot withstand such withdrawals. By Year 10, it has shrunk to only 28 cents on the dollar. The retiree’s spending plan has been irredeemably destroyed. Even an immediate bull market cannot rescue her.

Bankrupt, Surviving, and Booming

Here are the paths for the two portfolios, along with that of the neutral portfolio that consistently matches their average annualized rate of return. In each case, I have assumed the aforementioned 6% annual withdrawal rate and a starting value of $600,000. (The actual number is irrelevant, but better to show dollars for this illustration than percentages.) The figures once again are in real terms.

Portfolio Withdrawals

(Starting Value of $600,000, % Annual Withdrawal Rate, in Real $)
A line chart showing the dollar performance of three retirement portfolios, in inflation-adjusted terms, that have the same annualized total return for their investments and the same annual withdrawal rate of 6%, but with a different sequence of returns.

By Year 16, the second retiree is already busted. The fixed-return portfolio fares much better, managing to survive the full three decades. However, it will soon vanish, becoming depleted during Year 32. Meanwhile, the first retiree’s account finishes a 30-year horizon substantially above its beginning value.

Let’s combine these two exercises. This column’s final chart depicts the after-inflation spending amounts achieved by three hypothetical investors. Each observed this article’s conditions by contributing $10,000 annually into a 401(k) plan for 30 years and then spending that portfolio over the next 30 years. Each also received the same compounded rate of total return, before and after retirement.

However, their timing was markedly different. Lucky Starr was doubly blessed, benefiting from high portfolio returns while approaching retirement, and then once it commenced. Bad Luck Betty suffered the opposite fate. Finally, Steady Edie received the same investment result, year after year, decade after decade.

Annual Portfolio Income

($10,000 Annual Investment for 30 Years, 30-Year Retirement Horizon, in Real $)
A bar chart showing three possible retirement spending rates, for three hypothetical investors who experienced the same average investment returns during 30 years of saving while working, and then the same average investment returns during 30 years of retirement. The only difference among them is the timing of those returns.


The order in which investment returns arrive is typically regarded as a risk faced by retirees. While correct, in that inopportune losses can sink retirement portfolios, that tale is incomplete. For one, return sequences can help performance as well as hinder it. For another, the sequence of returns also affects employees who are continually adding to their portfolios. Their retirement fortunes are therefore determined not only by how much they save and how well their investments perform but also by when the tides flow.

The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.

The opinions expressed here are the author’s. Morningstar values diversity of thought and publishes a broad range of viewpoints.

More in Rekenthaler Report

About the Author

John Rekenthaler

Vice President, Research
More from Author

John Rekenthaler is vice president, research for Morningstar Research Services LLC, a wholly owned subsidiary of Morningstar, Inc.

Rekenthaler joined Morningstar in 1988 and has served in several capacities. He has overseen Morningstar's research methodologies, led thought leadership initiatives such as the Global Investor Experience report that assesses the experiences of mutual fund investors globally, and been involved in a variety of new development efforts. He currently writes regular columns for and Morningstar magazine.

Rekenthaler previously served as president of Morningstar Associates, LLC, a registered investment advisor and wholly owned subsidiary of Morningstar, Inc. During his tenure, he has also led the company’s retirement advice business, building it from a start-up operation to one of the largest independent advice and guidance providers in the retirement industry.

Before his role at Morningstar Associates, he was the firm's director of research, where he helped to develop Morningstar's quantitative methodologies, such as the Morningstar Rating for funds, the Morningstar Style Box, and industry sector classifications. He also served as editor of Morningstar Mutual Funds and Morningstar FundInvestor.

Rekenthaler holds a bachelor's degree in English from the University of Pennsylvania and a Master of Business Administration from the University of Chicago Booth School of Business, from which he graduated with high honors as a Wallman Scholar.

Sponsor Center