Understanding Sequence Risk (And Why it Matters to Investors)
Author: Bill DeRoche
February 13, 2026
Differing rates of return can impact the value of a portfolio over time, but taking steps to reduce the probability and magnitude of major drawdowns through less volatile strategies or by allocating to “hedging’ investments that are uncorrelated to traditional stocks and bonds may help mitigate the risk of return variability.
Buoyed by strong economic fundamentals and earnings growth expectations, global equity markets have been remarkably resilient to mounting geopolitical tensions and hazards associated with new advances in artificial intelligence so far this year. But almost three and a half years into the current bull run, the possibility of a serious correction is hard to ignore and recent bouts of heightened volatility should be a reminder to investors of another risk that is inherent to the irregular ebb and flow of share prices over time.
In fact, sequence risk – or “sequence of returns” risk to be more exact – may be one of the most underappreciated, yet destructive threats to equity investors, and how they choose to mitigate its effect on returns is paramount to achieving their desired long-term objectives.
This is especially true of those nearing retirement. Too many people have been forced to re-enter the workforce of late – not only because of higher inflation, which has elevated the cost of living – but also because the order of their investment returns hasn’t worked in their favour.
But sequence risk isn’t just a retiree’s concern. It can be a danger to anyone with a portfolio that has cash flowing into it during the accumulation phase of the individual’s investment cycle or flowing out of it during the divestment stage normally reserved for later in life (as opposed to a static portfolio without cash flows whose cumulative wealth is unaffected by the order of investment returns).
Take, for example, the following three prescribed hypothetical scenarios based on an initial $100,000 investment. In each case, we’ve assumed an annual average return of 6% with yearly inflows of $10,000 over the first ten years and yearly outflows of $20,000 over the final five years. What’s different about each of these scenarios, however, is the variability of returns from one year to the next and the order of those returns.
Prescribed Scenario 1
Initial $100,000 investment, constant 6.0% return per annum with no return variability.
| Start of Year | Start of Year Portfolio Value | Year Return | Return Value | End of Year Portfolio Value Prior to Cash Flow | End of Year Cash Flow | End of Year Portfolio Value |
| 1 | $100,000 | 6.00% | $6,000 | $106,000 | $10,000 | $116,000 |
| 2 | $116,000 | 6.00% | $6,960 | $122,960 | $10,000 | $132,960 |
| 3 | $132,960 | 6.00% | $7,978 | $140,938 | $10,000 | $150,938 |
| 4 | $150,938 | 6.00% | $9,056 | $159,994 | $10,000 | $169,994 |
| 5 | $169,994 | 6.00% | $10,200 | $180,193 | $10,000 | $190,193 |
| 6 | $190,193 | 6.00% | $11,412 | $201,605 | $10,000 | $211,605 |
| 7 | $211,605 | 6.00% | $12,696 | $224,301 | $10,000 | $234,301 |
| 8 | $234,301 | 6.00% | $14,058 | $248,359 | $10,000 | $258,359 |
| 9 | $258,359 | 6.00% | $15,502 | $273,861 | $10,000 | $283,861 |
| 10 | $283,861 | 6.00% | $17,032 | $300,893 | $10,000 | $310,893 |
| 11 | $310,893 | 6.00% | $18,654 | $329,546 | ($20,000) | $309,546 |
| 12 | $309,546 | 6.00% | $18,573 | $328,119 | ($20,000) | $308,119 |
| 13 | $308,119 | 6.00% | $18,487 | $326,606 | ($20,000) | $306,606 |
| 14 | $306,606 | 6.00% | $18,396 | $325,003 | ($20,000) | $305,003 |
| 15 | $305,003 | 6.00% | $18,300 | $323,303 | ($20,000) | $303,303 |
Arithmetic Average: 6.00%
Geometric Average: 6.00%
Standard Deviation: 0.00%
*Standard deviation measures how much an investment’s returns can deviate from the expected mean return, indicating its volatility.
Source: AGF Investments Performance returns presented are hypothetical and for illustrative purposes only. Trading costs and other fees associated with the portfolio are not included.
Prescribed Scenario 2
Initial $100,000 investment, average 6.0% return per annum with return variability. Worst return happens in Year 1 with return linearly increasing by 2% per annum with best return in Year 15.
| Start of Year | Start of Year Portfolio Value | Year Return | Return Value | End of Year Portfolio Value Prior to Cash Flow | End of Year Cash Flow | End of Year Portfolio Value |
| 1 | $100,000 | -8.00% | ($8,000) | $92,000 | $10,000 | $102,000 |
| 2 | $102,000 | -6.00% | ($6,120) | $95,880 | $10,000 | $105,880 |
| 3 | $105,880 | -4.00% | ($4,235) | $101,645 | $10,000 | $111,645 |
| 4 | $111,645 | -2.00% | ($2,233) | $109,412 | $10,000 | $119,412 |
| 5 | $119,412 | 0.00% | $0 | $119,412 | $10,000 | $129,412 |
| 6 | $129,412 | 2.00% | $2,588 | $132,000 | $10,000 | $142,000 |
| 7 | $142,000 | 4.00% | $5,680 | $147,680 | $10,000 | $157,680 |
| 8 | $157,680 | 6.00% | $9,461 | $167,141 | $10,000 | $177,141 |
| 9 | $177,141 | 8.00% | $14,171 | $191,312 | $10,000 | $201,312 |
| 10 | $201,312 | 10.00% | $20,131 | $221,443 | $10,000 | $231,443 |
| 11 | $231,443 | 12.00% | $27,773 | $259,217 | ($20,000) | $239,217 |
| 12 | $239,217 | 14.00% | $33,490 | $272,707 | ($20,000) | $252,707 |
| 13 | $252,707 | 16.00% | $40,433 | $293,140 | ($20,000) | $273,140 |
| 14 | $273,140 | 18.00% | $49,165 | $322,305 | ($20,000) | $302,305 |
| 15 | $302,305 | 20.00% | $60,461 | $362,766 | ($20,000) | $342,766 |
Arithmetic Average: 6.00%
Geometric Average: 5.65%
Standard Deviation: 8.64%
*Standard deviation measures how much an investment’s returns can deviate from the expected mean return, indicating its volatility.
Source: AGF Investments Performance returns presented are hypothetical and for illustrative purposes only. Trading costs and other fees associated with the portfolio are not included.
Prescribed Scenario 3
Initial $100,000 investment, average 6.0% return per annum with return variability. Best return happens in Year 1 with return linearly decreasing by 2% per annum with worst return in Year 15
| Start of Year | Start of Year Portfolio Value | Year Return | Return Value | End of Year Portfolio Value Prior to Cash Flow | End of Year Cash Flow | End of Year Portfolio Value |
| 1 | $100,000 | 20.00% | $20,000 | $120,000 | $10,000 | $130,000 |
| 2 | $130,000 | 18.00% | $23,400 | $153,400 | $10,000 | $163,400 |
| 3 | $163,400 | 16.00% | $26,144 | $189,544 | $10,000 | $199,544 |
| 4 | $199,544 | 14.00% | $27,936 | $227,480 | $10,000 | $237,480 |
| 5 | $237,480 | 12.00% | $28,498 | $265,978 | $10,000 | $275,978 |
| 6 | $275,978 | 10.00% | $27,598 | $303,576 | $10,000 | $313,576 |
| 7 | $313,576 | 8.00% | $25,086 | $338,662 | $10,000 | $348,662 |
| 8 | $348,662 | 6.00% | $20,920 | $369,581 | $10,000 | $379,581 |
| 9 | $379,581 | 4.00% | $15,183 | $394,765 | $10,000 | $404,765 |
| 10 | $404,765 | 2.00% | $8,095 | $412,860 | $10,000 | $422,860 |
| 11 | $422,860 | 0.00% | $0 | $422,860 | ($20,000) | $402,860 |
| 12 | $402,860 | -2.00% | ($8,057) | $394,803 | ($20,000) | $374,803 |
| 13 | $374,803 | -4.00% | ($14,992) | $359,811 | ($20,000) | $339,811 |
| 14 | $339,811 | -6.00% | ($20,389) | $319,422 | ($20,000) | $299,422 |
| 15 | $299,422 | -8.00% | ($23,954) | $275,468 | ($20,000) | $255,468 |
Arithmetic Average: 6.00%
Geometric Average: 5.65%
Standard Deviation: 8.64%
*Standard deviation measures how much an investment’s returns can deviate from the expected mean return, indicating its volatility.
Source: AGF Investments Performance returns presented are hypothetical and for illustrative purposes only. Trading costs and other fees associated with the portfolio are not included.
The question, then, for most investors is how to solve for this particular risk. For instance, financial planning that estimates a compound annual growth rate over the lifetime of a portfolio is a critical part of the equation. Moreover, the best financial plans make cautious assumptions concerning asset returns while also planning for divestments that can be longer and larger than expected.
Beyond that, certain rules governing withdrawals from a portfolio can also help ensure investors do not outlive retirement assets, which, as they peak, are more susceptible to negative asset returns. The most common of these rules is the 4% rule proposed by William Bengen in 1994. Mr. Bengen, using historical market returns, determined that a 4% withdrawal rate was the maximum withdrawal rate that would ensure a generic retirement portfolio would last at least 30 years over any period since 1926.
Still, even the best laid plans (and rules-based discipline) have limitations when it comes to sequence risk. What’s needed just as much is a dynamic mindset that allows investors to make strategic updates to their portfolios over time. This could mean changes to the withdrawal as the actual return sequence plays out or it could mean adjusting the risk and return characteristics of the portfolio to reduce the probability and magnitude of a major drawdown in the portfolio – either through less volatile strategies or by allocating to “hedging’ investments that are uncorrelated to traditional stocks and bonds.
Either way, it’s important that investors understand how differing return sequences and cashflows can impact the value of a portfolio over time. While sequence risk is greatest just prior to retirement and through the early years of withdrawals, it may also influence performance throughout an investor’s life span and should not be underestimated.
The views expressed in this blog are those of the author and do not necessarily represent the opinions of AGF, its subsidiaries or any of its affiliated companies, funds, or investment strategies.
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