Investing Is More Than Just Numbers: Exploring Why A × B ≠ B × A

Investment returns rarely follow a straight path, much like family life. While I may forget specific details (such as where we camped ten years ago, how we celebrated my son’s fifth birthday, or the first book my daughter read aloud), it doesn’t diminish the joy and challenges of family life—a point I occasionally try to convey to my spouse.

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I used to perceive investing in a similar light. My emphasis was on long-term averages, enduring market volatility without worrying about short-term fluctuations, believing that, much like cherished family memories, the specifics of returns carried little weight.

As I age, I realize that in our personal lives, the exact details of past events—even down to a campsite, a birthday, or a first book—are less significant than the experiences themselves. However, in the realm of investing, I’ve come to understand that it’s not just the long-term average return that counts; the timing of how and when we achieve above-average returns during our lives is vital.

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This may seem obvious, yet within an industry where individuals are eager to fully fund their retirement, the importance of market cycle timing is just beginning to resonate. It’s reminiscent of a math principle: A x B equals B x A, where the order doesn’t matter.

However, investing operates differently. Here, the sequence of returns can significantly impact outcomes.

This concept is known as sequence risk: the risk that the timing of gains or losses can dramatically affect your overall outcome. Consider this scenario: Two investors start saving in their mid-20s, contributing the same monthly amount and achieving the same investment returns over 40 years, but with one key difference in order: Investor A sees the best returns early, while Investor B receives them later.

The results are striking. Investor A reaps the benefits of the highest return on their initial contribution before their savings grow significantly and encounters the worst return at the end, affecting their overall portfolio. Meanwhile, Investor B compounds the best returns on a fully matured savings and only faces the worst returns on their initial, smaller contributions.

It appears that timing is often crucial.

Does the order of returns always play a critical role? Not always. It becomes a lesser concern when beginning with a substantial lump sum or inheriting significant wealth. For affluent families, compounding legacy assets can be so impactful that timing may matter less. However, most other investors who rely on regular contributions to build their savings find it safer to avoid sequence risk by smoothing out returns. This approach usually leads to lower average returns and less chance for notable gains over time.

Just as timing affects the growth of savings, it is also crucial when those savings are withdrawn during retirement (the decumulation phase). In this phase, the order of returns matters for everyone because withdrawals deplete the portfolio size. Experiencing positive returns early means that each withdrawal represents a smaller fraction of the total, extending the sustainability of savings and promoting greater growth over time.

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Of course, sequence risk is minimized if withdrawals are trivial compared to total assets. However, for those planning to deplete their savings during retirement, the opposite issue arises. They become particularly vulnerable to negative returns early in their retirement. For retirees, smoothing returns might lower the average expected return and lessen the benefits of strong early gains post-retirement.

Therefore, for the majority of investors, sequence risk is a consideration that cannot be ignored. Just as timing shapes life experiences, it similarly affects investment outcomes. With fewer legacy assets and new savers starting with smaller amounts, strategies must factor in the timing of returns to protect savings and optimize results.

David Crosoer is chief investment officer at PPS Investments.

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