Sequence of returns risk is perhaps one of the biggest risks people face as they transition into retirement that a lot of people (likely most) aren't even aware of. In this video we'll look at how sequence risk could affect you when you begin to take withdrawals from your portfolio in retirement.
How's it going, everybody? It's Ryan here. Okay, so we're going to talk about sequence of returns risk. Now, this is arguably one of the biggest risks that people face as they start to transition into retirement that most people aren't even aware of. It's not one of the more common types of risks. It's not like inflation risk. We know we need to make sure our money keeps up with the cost of living, or tax risk and the risks that tax rates could increase and, of course, that means our investments could be taxed more and that can make our investment dollars not last as long. So there's certain risks we're all very well aware of, but what I've found over the years is that most people aren't aware of what sequence of returns risk is. And where sequence of returns risk can really affect you is in the years leading up to retirement, really the last few years or so up, until the first few years after retirement. Really, that period of about five years right before you retire up until about five to seven years after you retire is a critical period.
Others have called it the retirement red zone, because a lot can go wrong there and if you make certain mistakes it can really affect your overall long term plans for retirement. And one of those things to make sure that you're planning for, or at least making sure that you have a plan to minimize or even perhaps eliminate, is sequence of returns risks. So in this video, I'm going to show you exactly what sequence of returns risk is so you're at least aware of what this potential risk is. We won't go through any of the solutions here today. I'll do that in some other videos. But with that, let's go and get started. So I'm going to share my screen. All right, so what we're looking at here, and I hope you can see this well, but what we've got here is look at this as this is the left side and this is the right side. This is a hypothetical $1 million lump sum investment.
Now, understand that this is completely hypothetical. It's not based on any investments, it's not even based on any market index, nothing at all. It's just random rates of return that I plugged into the spreadsheet. Also, in this I'm not including any taxes that could very well be having to be paid in the real world or fees or costs or anything like that. This is just to understand the concept of what sequence risk is all about. All right, so here's what we're looking at. Here's a $1 million lump sum, and we're showing this for 30 years. So I'll scroll down here. And I've got a random rate of return and it's kind of random. Let me explain what I mean. So what we'll see here is I've gotten a minus 10 the first year, then a minus 12, then a 17, 9, 14, and so on. These are all random rates of return. Now, here's the key thing, is that what I did here, although they're random rates of return, I made sure that the average of all these turns out to be 7%.
So if you added up all these rates of return, divided them by 30, you would get seven. And you can see our handy dandy Excel does all the math here for me, and it'll show right there it's 7%, which I don't know, that's too small for you to see. But that is an average rate of return of 7%. on the right side here, these are the exact same rates of return but in the exact opposite order. So where this started at a minus 10, minus 12, and then 17, this ended with that. So on this side, they experienced the minus 10, minus 12, and then the 17. And then we're here. This side, this ended at the last was at 15, 12, and then 11 before that. Here was 15, 12, and then 11. So, again, same rates of return, exact opposite order. Does it matter the order of the rates of return on your average rate of return? Absolutely not. So if we add all these up, you can see our handy dandy Excel will show us that this is exactly a 7% rate of return.
And over a 30 year period that we've got here, $1 million invested, no matter what order of rate of return that you had, you would still end up with exactly the same amount of money, which is $6,336,405.44. This side and this, side left and right. Exactly the same amount to the penny. "All right, so Ryan, what's the big deal here?" So the big deal is that sequence of returns risk does not affect you if you're investing a lump sum and you're not taking withdrawals or making additions to it. Where it does affect you is when you get into retirement presumably and now you're taking withdrawals from the account. Or this is how it could affect you. So let me show you what I mean. So everything on here is exactly the same except now we're going to show withdrawals of $70,000 per year. So, again, you'll see the very first year, on the left side, started at minus 10, minus 12. Over here, it ends at minus 10, minus 12.
So, again, same exact rates of return as you saw on the other spreadsheet there, but in the exact opposite order. Again, the only thing different is the withdrawal, $70,000 a year. Now, that's a 7% withdrawal rate initially, which is probably too high. Your situation could obviously vary, but 7% is certainly a high withdrawal rate. We're not factoring in inflation. Again, I just want to make this simple just to show the concept. That's all this is for. So, on the left side, we invest a million bucks. After 30, actually no, after 30 years we're getting into the negative. So after 20 years, after 20 years, we have $34,000 in the account. So sometime between that 20th and 21st year there, we start to get into negative territory, which in the real world, you're not going to have negative money. It just means that your account value is now zero. I could have just made these all zeros down before, but that's the idea.
So, in this scenario, their money only lasted for about 20 years. 21st year, they're in the negative. They're basically at zero. On the right side, over here, after 20 years, they've got $1.4 million. They have more money in the account than they started. Remember, they started with $1 million. So they took out $70,000 for 20 years, which is, what? $1.4 million. And they still have about $1.4 million left over. At the end of 30 years, they're still doing great. They've taken out $70,000 now per year for 30 years, which is $2.1 million, and they still have almost $1.2 million left over. You can see that right here. So, again, this is the same rates of return in the exact opposite order, but it's a huge difference on where they end up in the future. So, obviously, this could be a potential issue, and one of the things that comes up is it's not just an issue here. You'll see right here, hopefully, my cursor right there in that 21st year where they're completely out of money here on the left side, it's not just bad here.
And let's say, by the way, this is somebody that retires when they're 65. Well, 65 means they would have ran out of money at 85, 20 years down the road. Well, it's not just bad here, but look, how much money is in the account here in, let's say, year 12. There's $430,000 in there, and they're only in year 12 if they were 65 when they started this. They're only 77. So it's not just bad here because they're out of money, but it's bad here because they know that they're going to probably run out of money. Taking out $70,000 per year with only $430,000 leftover, that's a huge withdrawal rate that early on being only in this example in their 70s. So what is the issue there? Well, obviously, the issue is that more than likely they're going to run out of money and they do run out of money based upon these rates of return. But the issue is that one of the things that's important when planning for a good retirement is to make sure that you can minimize the stress that you're going to have.
I mean, nobody likes stress, but it's certainly not nice to have to experience the stress of being in your late 70s, early 80s and knowing that you haven't run out of money yet, but it's going to happen and you have to make hard decisions. Are you going to if you can even afford to reduce your lifestyle? And you probably have to. You have to do something. So you have to start taking less money from your portfolio over time and maybe you're going to have to make some other sacrifices to help reduce your overall cost of living. So I think you get the idea. There's a lot that we can say about this, but this is the concept of what sequence of returns risk is all about. It's yet just another risk in retirement that you need to make sure that you plan for. So if you have questions on this, let me know. Take care.