Timing vs. Average Return: Which Impacts Your Investments More?

When should you be most cautious when investing? Conversely, when can you take the most risk during your investing time horizon?

Let’s start with three basic scenarios to illustrate what is most important in each stage of investing, great start/bad end, steadily average, and bad start/great end:

All of these hypothetical scenarios cover a 30-year investment horizon and most importantly the average return over this period for each scenario is the same—exactly 5% for all of them.

The portfolio in purple at the top is called the great start/bad end scenario because returns are above average at the beginning. This simulates a bull market, as illustrated by nine years of positive returns shown by the purple bars, with the first one being a 20% gain. Conversely, these returns turn negative at the end of the scenario, ending with a negative 20% return in the last year simulating a bear market.  Combined, the average over this entire period is 5% as mentioned earlier. 

The second scenario is appropriately labeled ‘steadily average’ because every yearly return is exactly 5%, which of course makes the average 5% as well.

The last scenario is called bad start/great end because it is the exact opposite annual return sequence of the first scenario, so this one ends with the bull market (that the first scenario started with) but starts with the bear market—exactly the opposite of the first scenario and of course also averaging a 5% return.  

Now that we have the scenarios down, let’s start with the most intuitive calculation and assume we are making a one-time $100,000 investment in each of these three scenarios over 30 years.

As you can see on the chart, without additional contributions or withdrawals, these scenarios may have different balances during the investment period, however, their identical average returns of 5% put them all at the same ending balance at the end. The average return determined 100% of each scenario’s outcome.

Now let’s look at what changes if instead of investing a lump sum amount at the start, we simulate accumulation years and invest ten thousand dollars each year using these same three investment scenarios:

This cumulative three hundred-thousand-dollar investment over 30 years grows to:

  • $485K for the great start/bad end scenario

  • $664K for the ‘steadily average’ scenario

  • $948K for the bad start/great end scenario

The takeaway here is that the timing of the bull market and bear market simulations now matter, with the bear market simulation being the preferred to start with while the portfolio balance is at its lowest. The bull market simulation happening at the end is more beneficial as these outsized returns have a more meaningful impact on a now larger account value.

The last and most important calculation simulates the retirement years and here we assume a starting portfolio value of one million dollars with annual withdrawals of 4% that are adjusted upward each year for inflation of 2.5%. We say this is the most important calculation because the results produce the greatest disparity of outcomes:

As you can see on the chart:

  • The bad start/great end scenario shows the starting balance being completely wiped out in the 22nd year, leaving a zero balance and no further income for the last eight years of the 30-year period!

  • The ‘steadily average’ portfolio accommodates the withdrawals over the entire 30 years with an ending balance of $585K

  • The great start/bad end scenario these same withdrawals over this entire period, and ends with a balance of one million five hundred and ninety two dollars, which is about a million dollars more than the ‘steadily average’ portfolio! Keep in mind that the cumulative withdrawals were the same for each scenario, which was approximately 1.75 million and the average return was the same at 5% for each scenario, despite the significant differences in outcomes!

The most important takeaway here is the fact that in retirement, the timing of bull and bear markets is very important, and mitigating the effects of a bear market early in your retirement years is critical!

Here at Compass, we pride ourselves in customizing solutions to reduce volatility during these critical time periods.

Have questions or want to speak with our team directly? Contact us.

Robert Amato, CFP®, CIMA®

Principal

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This article may not be copied, reproduced, or distributed without Compass Wealth Management’s prior written consent.

Compass Wealth Management is a Registered Investment Advisor. Advisory services are only offered to clients or prospective clients where Compass Wealth Management and its representatives are properly licensed or exempt from licensure. This article is solely for informational purposes and is not intended to be relied on as a forecast, research, or investment advice, and is not a recommendation, offer, or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by Compass Wealth Management to be reliable, are not necessarily all-inclusive, and are not guaranteed as to accuracy. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Investments involve risks.

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