What is sequence risk?
Whenever cash flow is introduced into your portfolio by withdrawing funds, you open yourself up to sequence-of-returns risk. However, it does not affect an investment without cash flow.
What is the impact?
Sequence risk causes similar portfolios to experience different balances. In the example below, an investor has R1m invested at a 10% annualised return over three years. If there is no cash flow (regardless of the sequence of returns), the future value of the investment stays the same. Once cash flow occurs, however, the order in which you experience returns impacts the future value of your investment.
In base case 1, the investor withdraws R100,000 in year two, when he experiences a -30% return. This investor now has…
