Managing The Sequence Of Returns Risk

Many investors are concerned with rewards while ignoring the risks associated with a specific investment. One of the most ignored forms of risk is the risk of a sequence of returns. This frequently results in an undesirable consequence or a disastrous investing experience. In this article, Henil Shah discusses what sequence of returns risk is and how you, as an investor, should address it

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The equity market is fraught with uncertainty, and many experts are still unable to fathom the present level at which equity indices and stocks trade. Many valuation matrices appear to be exaggerated. Even the finest skilled investors might be caught off-guard by the quick and rapid fluctuation in the stock market. For example, despite the discovery of corona virus in November 2019, equity markets throughout the world continued to rise, only to plummet by about 40 per cent in February and March 2020. This resulted in a significant decrease in the value of investors' portfolios.

Managing risk is one of the most important parts of investing at this time. We have seen that many investors are just focused on the return and neglect the risk that a specific investment entails. This frequently leads to a bad consequence or a disastrous investing experience. In such cases, investors often exit a specific investment or asset class for good. Is this to say that investing in such an asset class was a terrible idea? Absolutely not! The sole mistake was underestimating the inherent risk with that asset. One of the most commonly disregarded risks is the risk of sequence of returns.

Defining Sequence of Returns Risk

One of the most underrated risks in investing is sequence risk, often known as sequence of returns risk. Furthermore, this risk is more visible in retirement. Let us look at an example to better grasp this. Assume you begin with a portfolio of 25 lakhs and withdraw 2.5 lakhs at the end of each year for the next five years. Furthermore, assume you get total returns of 10 per cent in the first year, 12 per cent in the second year, 14 per cent in the third year, 16 per cent in the fourth year and negative 20 per cent in the fifth year. With this, you would have *20.16 lakh at the end of the fifth year.