Sequencing Risk

Sequencing Risk in Retirement: What It Is and How to Manage It

Two retirees can earn the same average return and still finish with very different balances. What makes the difference is the order in which the returns arrive. Here’s how sequencing risk works, and the practical steps you can take to manage it.

Key Takeaways

Sequencing risk is the risk that poor returns arrive early in retirement, while you are drawing an income.

It matters most in the years just before and after you retire, when your balance is usually at its largest.

Selling investments after a fall in your investment values to fund your income can lock in losses.

A clear income plan, a cash buffer, and investments chosen for reliable income can help reduce the impact.

What Is Sequencing Risk?

Sequencing risk (also called sequence-of-returns risk) is the risk that the order of your investment returns, not just their average, affects how long your retirement savings last. While you are still adding to your savings, you have time to recover from a market fall. Once you are drawing an income, a fall early in retirement means selling more of your investments at lower prices. That leaves less invested to benefit when markets recover.

A Simple Example

Two retirees each start with $500,000 and withdraw $30,000 at the start of each year. Both have one year of –15% and one year of +15%. The only difference is the order.

Illustrative example only. Not a forecast. Excludes fees and taxes.

With the same returns and the same withdrawals, the two retirees end up $9,000 apart after just two years. Without withdrawals, both would finish at exactly $488,750. Drawing an income is what turns the order of returns into a real cost, and over a 20 to 30-year retirement that gap can compound.

When Does Sequencing Risk Matter Most?

The risk is highest in what is often called the “retirement risk zone”, roughly the five to ten years either side of retirement. In this window your balance is usually at its largest, you have less time to recover from losses, and you are starting to rely on your savings to cover everyday living costs.

How to Manage Sequencing Risk: A Step-by-Step Guide

The advice below does not take into account your personal situation.

Step 1: Work out the income you need

Split your spending into essentials (housing, food, utilities, health) and extras (travel, gifts, renovations). Then work out how much of the essentials will be covered by steady sources such as the Age Pension, and how much needs to come from your investments.

Step 2: Hold a cash buffer

Keeping one to three years of planned withdrawals in cash or cash-like investments means you don’t have to sell growth assets after a fall. It gives markets time to recover before you need to draw on them.

Step 3: Give each part of your money a job

Many retirees use a simple “bucket” approach: cash for near-term spending, income-producing investments to top up the cash, and growth assets for the long term. When the middle bucket produces regular income, you rely less on selling assets at the wrong time.

Step 4: Look for income you can rely on

Investments that pay regular, consistent income help fund your spending without selling down capital. The goal is to be confident in your income and confident in your capital, which means knowing what you are likely to receive, how often you will receive it and what stands behind your investment. All investments carry risk, including income investments, so understand how the returns are generated before you invest. Review the product disclosure statement for more detailed information about the risks of a product and how they are managed.

Step 5: Choose your investment providers carefully

In retirement, who manages your money matters as much as what you invest in. Questions worth asking:

Track record: How has the manager performed through different market cycles, including downturns?

Income consistency: Has income been paid regularly, and where does it come from?

Capital protection: What secures your investment, and how are risks such as concentration managed?

Liquidity: How and when can you access your money, including in stressed markets?

Transparency: Are holdings, valuations and performance reported clearly and regularly?

A provider with a long record of disciplined management and consistent income can make your plan easier to stick to when markets turn.

Step 6: Stay flexible with withdrawals

When markets fall, trimming discretionary spending or drawing on your cash buffer can protect your long-term balance. Account-based pensions have minimum annual drawdown rates, so check what applies to you.

Step 7: Review regularly and get advice

Review your plan at least once a year and after any major market or life event. A licensed financial adviser can help tailor a strategy to your circumstances.

Frequently Asked Questions

Is sequencing risk the same as market risk?

No. Market risk is the chance that your investments fall in value. Sequencing risk is about when those falls happen relative to your withdrawals.

Can sequencing risk be eliminated?

Not entirely, but you can reduce its impact with a cash buffer, a reliable income stream, diversification and flexible spending.

Does sequencing risk matter before I retire?

Yes. A large fall in the years just before retirement can reduce the balance you retire with and leave less time to recover. Planning ahead of time is usually easier than reacting after a fall.