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The Role of Luck

Updated: Mar 4, 2019

Sometimes luck is better than skill. That is truer for investing than many aspects of life. In sports and academics, for instance, luck may play a role, but skill usually wins out in the end. That is simply not true when it comes to your portfolio.

Timing is more important than you probably realize.

The best way to illustrate the power of luck in investing is by considering two individuals entering retirement. Each follows the same investing approach, has the same mindset, and manages their financial affairs identically. And yet, they can have drastically different results.

Meet George and Nancy. They don’t know each other, but both retire at age 65 with a portfolio worth $850,000. They both hold 60% stocks and 40% bonds in their portfolios and maintain that mix throughout retirement. They both withdraw $50,000 a year for living expenses, and both increase that amount for inflation each year. They both die at age 90.

The only difference between the two is that George receives the actual historical returns for a 60% stock and 40% bond portfolio, and Nancy receives those returns in reverse order. Aside from that, all else is identical.

Knowing just those facts, I suspect most people would think George and Nancy end up with roughly the same portfolio values at their death. After all, they conducted themselves identically.

Here are George’s results during select time periods of his retirement.

George was able to live the way he wanted. He never ran out of money. In fact, he ended up with a little money left over. Perhaps he used that to help his family or to benefit his favorite charity. All in all, George did just fine.

How about Nancy? How did she fare? Keep in mind, the only difference between her situation and George’s was the order of the portfolio returns she collected in retirement. Here are Nancy’s results.

Nancy ends up leaving behind more than $1 million. Her estate could make a substantial difference to her family or to charitable causes.

Was Nancy that much smarter than George? Was she a savvier investor? No and no. She just happened to get lucky.

You see, George received an average return of around 7% in the first half of retirement and around 10% in the second half of retirement. He received bigger returns when he had less money working for him, due to the withdrawals he made in the first half of retirement.

Nancy had the opposite experience. She received a 10% annual return right off the bat, before her portfolio was burdened by years of withdrawals. That made all the difference. It didn’t matter that the second half of retirement produced lower annual returns for Nancy. She was already set.

Two people who conducted their financial affairs the same. The only difference was the sequence of their returns. One ends up with nearly $1.2 million more than the other.

Luck was the difference. And in investing, like it or not, luck can make all the difference in the world.

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