A Critique of the “Sequence of Investment Returns”

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Products like the Manulife Income Plus or Sunwise Elite Plus sell their solutions based on the concept of sequence of returns. The idea is that the sequence of your investment returns in a significant determinant of whether you outlive your money in retirement.

The math here works because by drawing out your savings each year, you are declining your overall asset base. So both good and bad returns in the earlier part of your retirement have a bigger impact. While the math is all true, the solution isn’t to pay high fees for a guaranteed income product.

But there is something significantly wrong with this concept.

The investment reality misses a key principle.

What is missing is the fundamental fact that after a year or period of poor investment performance, the market will overcompensate with stronger-than-average returns to get back to its “normal” level. What this means is that as long as you stick to your investment discipline, you will get better investment performance after poor performance, and it will then carry you back on target.

A Critique of the Sequence of Investment Returns

The most recent example has been 2008, 2009 and 2010. Based on the sequence of returns research, if your first year of retirement was in 2008, then you lost out on the sequence of returns. The investment industry says instead, you should invest a lump sum amount in a guaranteed product with high fees that will get charged every year of your retirement instead.

What actually happened is that after the TSX total return index returned -34 per cent in 2008, it has averaged 25 per cent returns over 2009 and 2010. Of course, if you invested in a guaranteed withdrawal benefit product, you wouldn’t have been able to invest in anything more risky than a balanced portfolio and you would have missed much of the strong returns of the past two years.

What the real message should be is: Don’t pull your money out of the market after it falls 20 per cent. Better yet, if you have other investments, it might be time to add to your stock position once the market drops 20 per cent.

The key to investment growth is to have some long-term discipline. When it comes to the sequence of returns affecting your retirement income, remember that even after a rough winter, spring always comes.