Volatility drag calculator
Two investments can average the same return and leave you with very different money. A bumpy ride compounds to less than a smooth one, and once you are paying in or drawing out, the order the good and bad years arrive in starts to count as well.
Your investment
Smooth against bumpy
Why an average return is not the return you get
Averages are worked out by adding and dividing. Money is worked out by multiplying. Those two facts pull in different directions, and the space between them is volatility drag.
The quickest demonstration takes two years. Your fund gains 20%, then loses 20%. Average return: zero. Your £10,000 becomes £12,000, then loses a fifth of the bigger number, and you finish on £9,600. Down 4% on a 0% average, and nobody took a fee. The loss bites a larger pot than the gain ever grew, so the round trip never quite gets home.
Stretch that over an investing lifetime and the gap gets serious. On the figures this page starts with, £10,000 growing at a steady 6% for 20 years reaches £32,071. The same £10,000 averaging 6% through years of +21% and −9% lands on £26,198. A £5,873 difference from the same headline return, because the real compound rate was 4.93%, not 6%.
A rule of thumb worth carrying
Drag runs at roughly half your volatility squared, each year. Broad equity funds wobble around 15%, which costs about 1.1 percentage points a year. Something twice as jumpy at 30% costs about 4.5 points, which is most of the return people bought it for. This is the arithmetic behind the dull advice to diversify: spreading money across assets that misbehave at different times lowers the wobble, and lowering the wobble raises what you actually compound, even when the average return has not moved at all.
When the order of the years matters
Here is the part that surprises people. Leave a lump sum alone and the order of returns is irrelevant. Good years first, bad years first, shuffled at random, the same set of multiplications lands on exactly the same pot every time. Try it above with the monthly amount set to zero.
Put £200 a month in, though, and the same returns in a different order finish £11,519 apart. A regular saver quietly wants the bad years early: contributions buy in cheap while prices are down, then ride the recovery on a bigger pile of units. Retirees face the mirror image. Drawing an income means selling units to fund it, and selling into an early crash means shares sold cheap that are never there for the rebound. That is sequence of returns risk, and it is why the years either side of retirement carry more weight than any others.
What to do about it
Nobody can flatten markets, but the response is well worn: diversify to cut volatility, keep costs down because fees compound against you in exactly the same way, and around retirement hold a couple of years of spending in cash so a bad run never forces a sale. Use the investment calculator for smooth-growth projections, then come back here to see what a realistic ride does to them, and the retirement age calculator to test whether your date survives a rough decade.
Common questions
What is volatility drag?
The gap between an investment’s average yearly return and the compound return you actually earn. A year of +21% followed by a year of −9% averages 6%, but multiplies out to less than two steady years of 6%. The wobblier the ride, the bigger the gap — roughly half the volatility squared each year.
Does the order of investment returns matter?
For a lump sum left alone, no — the same yearly returns multiply to the same result in any order. Order starts to matter as soon as money flows in or out. Regular savers do better when the bad years come early, because contributions buy in cheaply; retirees drawing an income are hurt most by early bad years, which is called sequence of returns risk.
How big is volatility drag in practice?
A useful rule of thumb is half the volatility squared. At 15% volatility, typical for a broad equity fund, the drag is about 1.1 percentage points a year — a 6% average becomes roughly 4.9% compound. Diversification earns its keep by cutting volatility, which shrinks this gap without necessarily giving up average return.
These results are estimates for general information only and are not financial advice. Investment returns are not guaranteed and past performance tells you nothing about the future. Read the full disclaimer.