When planning for retirement, many people focus on average returns, portfolio size, and withdrawal rates. But there's a lesser known yet critical concept that can make or break a retirement plan: sequencing risk.

What is Sequencing Risk?

Sequencing risk is the risk that the order in which investment returns occur will negatively impact a portfolio’s long-term sustainability. For example, if the market drops while you're making significant withdrawals, such as during retirement, your investment fund may erode faster than expected. This risk is especially important to consider when drawing down from pensions or investment accounts.

Why It Matters in Retirement

During the accumulation phase (working years), market dips are frustrating but temporary. Your ongoing contributions and time in the market help you recover. In retirement, though, you're no longer adding money; you're taking it out. If you experience market losses early on, you may end up withdrawing from a shrinking pot, locking in those losses and reducing the amount available to benefit from future market growth.

Key Aspects of Sequencing Risk

1. Early Losses Are More Harmful – If an investor experiences poor returns early in retirement while making withdrawals, their portfolio may deplete faster, leaving less capital to recover when markets rebound.
2. Market Volatility Matters More During Withdrawals – Unlike during accumulation (when losses can be recovered with future gains), withdrawals lock in losses, reducing future growth potential.
3. Same Average Return, Different Outcomes – Even if two investors have the same long-term average return, the sequence/timing of those returns can lead to significantly different financial outcomes.

Examples

Let’s take two retirees, Alice and Bob, both starting with a £1 million pension pot and withdrawing £50,000 per year.

Scenario 1: Alice (Poor Early Returns)

Even though the market recovers in Year 3, Alice’s pot has already shrunk significantly due to early losses and withdrawals.

Scenario 2: Bob (Strong Early Returns)

Despite facing the same negative returns as Alice, Bob’s early gains provided a buffer, meaning his pension pot is still larger.

Over time, even if their average return over 30 years is the same, Alice is more likely to run out of money compared to Bob as the gap will widen dramatically over longer periods. This is sequencing risk in action.

Ways to Mitigate Sequencing Risk

Fortunately, there are practical steps you can take to reduce the impact of sequencing risk:

1. Use a Cash Buffer – Keep 2-3 years of living expenses in a low-risk account to avoid withdrawing from investments during downturns.
2. Flexible Withdrawal Rates – Reduce withdrawals in bad years and increase them in good years.
3. Invest in Annuities – A guaranteed annuity can provide stable income, reducing reliance on market performance.
4. Horizon Planning Investing - Use lower risk funds for short term needs and higher risk funds for longer term investing. Use prevailing conditions at the time as to which is best to take income from to meet needs.
5. Delay Withdrawals if Possible – If you’re still earning an income, consider deferring pension withdrawals to allow your investments more time to grow.
6. Diversifies Portfolio – Spread your investments across asset classes (e.g., bonds, property, dividend-paying equities) to reduce exposure to any one market's downturn.

Sequencing risk isn't just a theoretical concept, it has real-world consequences for your financial security in retirement. By understanding how the order of returns impacts your portfolio and taking steps to manage that risk, you can make your retirement savings last longer and reduce the risk of running out of money.

Planning ahead, staying flexible, and working with a financial adviser can help you build a retirement strategy that’s resilient in all market conditions.

If you need any help with your retirement planning, do not hesitate to contact us on 01935 848764.

Your eventual income may depend on the size of fund when accessed, interest rates and legislation.