Sequence risk refers to the order in which investment returns occur. It is one of the most underappreciated risks and is particularly relevant for new retirees who have shifted from a saving / wealth creation phase to spending their investments.
Unlike general market volatility—which only matters if you sell—sequence risk could force retirees to withdraw money during market downturns, potentially locking in losses that may never be recovered.
If you experience poor returns early in retirement, your portfolio may suffer lasting damage, even if markets later recover. Conversely, strong early returns can set you up for much greater financial security.
In this week’s blog, we look at the potential impact of sequence risk and some strategies to mitigate it.
When investing, your capital is at risk. The value of your investment (and any income from it) can decrease and increase, and you may receive back less than you invested, especially when investing for a short timeframe (we generally recommend a horizon of at least 5 years). Neither simulated nor actual past performance is a reliable indicator of future performance. Investments should be considered over the longer term and align with your attitude towards risk and financial circumstances.
The Hidden Danger of Bad Timing
The impact of sequence risk is strikingly illustrated in the following two examples.
Example 1: 2000 to 2023 (and back again)
Imagine two retirees, each starting with £1 million in a global equity portfolio and withdrawing £50,000 per year (5% of the starting value), adjusted for inflation.
- Investor 1 retired in 2000, just before the dot-com crash and the 2008 Global Financial Crisis. Although markets rebounded later, the early losses proved devastating. Their portfolio ran out after just 20 years.
- Investor 2 is a time traveller who experienced the exact same investment returns but in reverse order. Retiring in 2023, they began with strong market growth and enjoyed a near-uninterrupted bull run for 15 years. The result? Their investment pot remained largely intact by the end of the period.
Same total returns, different order—one retiree ends up with nothing, the other still has £1 million. This is depicted in the chart below.
Source: Albion Strategic Consulting via LinkedIn
Example 2: Stochastic Cashflow Modelling
The second chart is taken from a previous blog: Risk-Based Guardrails.
Our stochastic cashflow modelling (running hundreds of retirement scenarios using historical data) shows that retirement outcomes can vary massively due to the sequence of returns.
For example, by age 100, this particular portfolio is projected to range from £2.5 million in the 10th percentile scenario to £9.5 million in the 90th percentile—a £7 million difference primarily because of what year the individual was deemed to have retired, not how much they saved or spent.
How Can You Protect Yourself?
What can be done to hedge against sequence risk? Here are some practical strategies:
1. The Bucket Approach
Hold enough cash or low-risk investments to cover 2-3 years of spending, aka. a ‘Retirement Cash Cushion’. This allows you to avoid selling investments during temporary market downturns.
However, some research (notably by Michael Kitces) suggests that regular portfolio rebalancing achieves a similar outcome—as you naturally sell assets that have done well and buy those that have underperformed.
2. Reduce Spending in Tough Years
This is a strategy we particularly like.
A "Risk-Based Guardrails" approach (covered in the previous blog mentioned above) offers a dynamic approach to retirement spending. Retirees adjust their spending based on market conditions—taking a pay rise after strong years and a pay cut after poor ones.
In our first example, Investor 1 would have been forced to cut back in the initial years of retirement and again through 2007-08. While unfortunate, this would have greatly boosted their chances of not depleting their savings.
3. Conservative Cashflow Planning
Use conservative investment return and inflation assumptions in your financial models.
The assumptions we use in our cashflow modelling might seem overly cautious. For example, we currently assume 3.5% annual inflation and a 6.25% nominal return for someone fully invested in equities—well below the 9.4% our preferred 100% equity portfolio has delivered over the last 15 years.
However, planning with conservative numbers not only increases the probability that you'll save enough for retirement but also creates a high likelihood that outcomes will exceed forecasts, providing additional flexibility for spending or gifting.
4. Consider an Annuity
Annuities are regaining popularity as they remove market risk entirely. Using a portion of your retirement savings to purchase an annuity provides guaranteed income regardless of market performance, helping to reduce sequence risk.
5. Be Open to Working Again
This final point might sound flippant, but being open to "unretiring" can be effective.
Many retirees return to work part-time, primarily to combat boredom or to maintain a sense of purpose. But having this flexibility can also be an effective way to mitigate sequence risk if markets deliver a particularly nasty downturn at the wrong time.
Conclusion
As you can see, sequence risk isn't just about average returns—it's about when those returns happen. Incorporating these strategies into your retirement planning can help protect against this often-overlooked but significant risk to your financial security.
Happy Thursday!
