Sequence of returns risk — sometimes called sequence risk — is one of the most important and underappreciated risks facing retirees. It refers to the danger that poor investment returns early in retirement permanently impair your portfolio, even if long-term average returns are perfectly adequate. The order in which returns occur matters enormously when you are making ongoing withdrawals.
Why the Sequence of Returns Matters
During the accumulation phase (building your super), sequence of returns matters very little. If you contribute regularly, poor years early on mean you buy more units at lower prices — a benefit. The final balance depends on the average return, not the sequence.
In retirement, the sequence is reversed. You are withdrawing, not contributing. A severe market fall early in retirement means:
- You sell more units to meet the same dollar drawdown requirement
- Fewer units remain to recover when markets eventually rebound
- The portfolio never fully recovers — even if long-run average returns look fine on paper
A Simple Example
Two investors each start retirement with $600,000 and draw $30,000/year.
| Year | Investor A returns | Investor B returns |
|---|---|---|
| Year 1 | –20% | +15% |
| Year 2 | –10% | +10% |
| Year 3 | +15% | –10% |
| Year 4 | +20% | –20% |
Both investors experience the same four years of returns — just in opposite order. The average return is identical. Yet Investor A (bad years first) will have a substantially lower portfolio balance at year 4 — because they withdrew from a declining balance when the portfolio was smallest.
The Danger for Australian Retirees
Australian retirees are exposed to sequence risk primarily through:
- ASX share market volatility: The ASX 200 has fallen 30–50% in significant crashes (GFC, COVID, early 1990s recession)
- Account-based pension drawdowns: Minimum drawdowns of 5%+ per year mean you are selling assets regardless of market conditions
- No remaining salary income: Unlike accumulation phase, there is no salary to rebalance or top up a falling portfolio
The Impact Is Asymmetric
The damage from a large early loss is disproportionate to the benefit of a large early gain:
- $600,000 → falls 30% → $420,000. Needs to rise 43% just to get back to $600,000
- $600,000 → rises 30% → $780,000. Falling 30% returns to $546,000 — still above start
This asymmetry means protecting the downside in early retirement is more important than chasing upside.
Strategies to Manage Sequence of Returns Risk
1. Bucket strategy
Hold 1–2 years of spending in cash — you don’t need to sell growth assets to fund near-term expenses during a downturn. See Bucket Strategy for Retirement Australia.
2. Flexible drawdown
In years of poor returns, reduce discretionary spending and draw less from investments. Flexibility in drawdown amounts — spending less in bad years — meaningfully reduces sequence risk.
3. Part Age Pension as a buffer
A Part Age Pension provides a floor of income that doesn’t depend on portfolio performance — reducing the mandatory drawdown from your investment portfolio during market downturns.
4. Conservative asset allocation at the start of retirement
Holding more defensive assets (cash, bonds) in the early years of retirement reduces the magnitude of early losses — at the cost of some long-run return potential.
5. Annuities
A guaranteed lifetime annuity removes the sequence risk entirely for the portion of income it covers — but at the cost of flexibility and potential estate value. See Annuities Australia.
6. Avoid retiring at a market peak
Timing retirement during or after a major market downturn (rather than at a peak) reduces the probability of a severe loss in the critical early years. This is difficult to control deliberately.
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Frequently Asked Questions
How do I protect myself from sequence of returns risk? A combination of strategies is most effective: holding 1–3 years of spending in cash (bucket strategy), maintaining flexible drawdowns, ensuring you qualify for at least a part Age Pension, and considering a modest allocation to annuities for guaranteed base income.
Does sequence risk apply during accumulation phase? It does — but to a much lesser degree. Regular contributions during poor markets (dollar cost averaging) actually benefit from lower prices. The sequence risk impact is most severe when you switch from contributing to withdrawing — the retirement transition.
Is sequence risk worse in Australia than other countries? The ASX is more concentrated in financial services and resources than the US market — this can lead to periods of higher volatility. The Age Pension and super system do provide structural buffers (Age Pension income, tax-free pension phase) that partially offset sequence risk.
This article provides general financial information only. Past investment returns are not a reliable indicator of future performance. For advice tailored to your situation, speak with a licensed financial adviser through the ASIC financial advisers register or MoneySmart.