Another Perspective on Sequence of Returns through Low Volatility Investing

Financial advisors and retirees should be aware of the profound impact that a low volatility portfolio can have on investment performance and, consequently, retirement spending sustainability.

Sequence of returns discussions typically focus on the downside or risk involved with the path of investment returns. 

For example, sequence of returns risk describes the potential damage to a portfolio when negative investment returns occur at the early stages of an investment horizon—particularly if the beginning investment horizon coincides with the onset of retirement.

There is less discussion and awareness, however, of the impact that the sequence of investment returns can have on the upside of portfolio performance. 

In the current issue of the CFA Institute Magazine, professional investor Roger Clarke discusses the work he has done in the field of low volatility investing.

The case for low volatility is largely based on the critical distinction between arithmetic investment returns and geometric or compound returns.

As Clarke discussion in the interview, lower volatility portfolios outperform when the sequence of investment returns are compounded over time:

“A portfolio that declines by 50 percent and then appreciates by 50 percent has the same average return as a portfolio that declines by 10 percent and then appreciates by 10 percent.  But the portfolio with wider swings has a compound return of -25 percent while the less volatile portfolio has a compound return of -1 percent.”