Sequencing risk (also called sequence-of-returns risk) is one of the most significant — and least understood — risks in retirement planning. It refers to the danger that a series of poor investment returns at the beginning of retirement can permanently impair your retirement income, even if average returns over the long term are reasonable.
Why Sequencing Risk Matters in Retirement
During the accumulation phase (working years), the order of returns doesn’t matter much. Whether you get good returns early or late, the compound effect over 30+ years evens out significantly.
In the drawdown phase (retirement), the order matters enormously. Here’s why:
- You are making regular withdrawals from your portfolio
- A large loss in the early years forces you to sell assets at low prices to fund withdrawals
- Those sold assets cannot recover in value when markets rebound — they’re gone
- The remaining portfolio is smaller, so even a full recovery doesn’t restore your original position
A Simple Example of Sequencing Risk
Two retirees both average 5% returns per year over 10 years, but in different orders:
| Year | Retiree A returns | Retiree B returns |
|---|---|---|
| 1 | −20% | +20% |
| 2 | −15% | +15% |
| 3 | +10% | +10% |
| 4–10 | Moderate positive | Moderate positive |
Both average the same return — but Retiree A, who experienced losses early in retirement while making withdrawals, will have a significantly smaller final portfolio than Retiree B. Retiree A may even run out of money.
Sequencing Risk Is Worst in the First 5–10 Years of Retirement
Research generally shows that sequencing risk is most severe in the first 5–10 years of retirement. Experiencing a major market downturn in this window (e.g., a GFC-style event in the year you retire) can permanently reduce your sustainable withdrawal rate.
Strategies to Manage Sequencing Risk
1. The Bucket Strategy
Divide your retirement assets into “buckets” with different time horizons:
- Bucket 1 (0–3 years): Cash and short-term deposits — funds needed in the near term, not exposed to market risk
- Bucket 2 (3–10 years): Conservative to balanced investments — defensive assets that refill Bucket 1 over time
- Bucket 3 (10+ years): Growth assets — invested for long-term capital appreciation
See The Bucket Strategy for Retirement.
2. Flexible Withdrawal Strategy
- In good market years, take higher withdrawals
- In poor market years, take the minimum required and draw from cash reserves instead of selling growth assets at depressed prices
3. Annuities as a Floor
Purchasing a lifetime or fixed-term annuity creates guaranteed income that is not exposed to market risk. This base income reduces the pressure to sell growth assets during downturns.
4. Diversification
A diversified portfolio (Australian shares, international shares, bonds, property, cash) dampens volatility — reducing the likelihood of the extreme early losses that sequencing risk is most dangerous with.
5. Working Part-Time in Early Retirement
If the market is down in early retirement, working casually reduces the drawdown on your portfolio — allowing growth assets time to recover before you need to sell them.
Sequencing Risk and the Minimum Pension Drawdown
Account-based pension holders must draw down a minimum percentage each year (4% under age 65, rising to 14% at 95+). During a market downturn, this minimum withdrawal forces asset sales — a form of sequencing risk exposure that cannot be entirely avoided.
For more: Super Strategies, The Bucket Strategy, Annuities in Australia, Account-Based Pension Guide. For advice on managing sequencing risk in your retirement, speak with a licensed financial adviser via MoneySmart.