Educational brief
Sequence Risk in ETF Investing
Why return order matters for contribution-based portfolios even when average returns are similar.
Updated
In short
Two portfolios with the same average return can end with different outcomes if return order differs during contribution years.
Key takeaways
- Return sequence changes compounding paths even with equal mean returns.
- Early losses or gains can materially alter long-horizon outcomes.
- Policy robustness should be tested on many rolling start dates.
Full analysis
What sequence risk actually means
Sequence risk is the impact of return order on outcomes. Two periods with identical average returns can produce different portfolio paths if gains and losses arrive in different order.
For contribution-based investors, early negative returns can change units accumulated and recovery trajectories in ways that averages fail to show.
Why averages are insufficient
Averages compress path information. They are useful for broad expectation setting but weak for policy design that must survive real volatility.
Rolling-window tests and percentile outcomes provide a better picture of how fragile or resilient a contribution policy is.
How to reduce sequence sensitivity
Use diversified ETF allocations, explicit contribution cadence, and predetermined rebalance rules. These do not eliminate sequence risk, but they can reduce uncontrolled variation.
Compare decisions by downside containment and recovery stability, not just upside capture.
How to apply this
Use this topic as one module inside a broader simulation process: define contribution rules, test across rolling windows, and compare drawdown and recovery behavior across regimes before selecting a policy.