Sequence of return risk is the danger that the timing of withdrawals from a pension pot will negatively impact the overall rate of return available. Suffering large losses early in retirement is far more damaging than the same losses later, because early losses are compounded by ongoing withdrawals. This is one of the most significant risks in pension drawdown planning.
Why Sequence Risk Matters More Than Average Returns
Two clients with the same average annual return of 5% over 20 years in drawdown can end up with vastly different outcomes if one experiences the market crash early and the other late. Despite identical averages, the client who suffers the crash first runs out of money significantly sooner. The order of returns is what matters when withdrawals are ongoing.
5 Strategies to Manage Sequence of Return Risk
1. Cash Buffer / Bucket Strategy
Hold 1–2 years of planned withdrawals in cash. During a downturn, withdrawals come from the cash bucket rather than forcing the sale of depressed assets. The cash bucket is replenished during strong markets.
2. Flexible Withdrawal Strategy
Build in explicit flexibility from the outset. Clients who can reduce drawdown by 10–20% during a significant fall without materially affecting lifestyle dramatically improve plan resilience. This requires mapping discretionary vs non-discretionary spending.
3. Liability Matching with Guaranteed Income
Ring-fence core, non-discretionary spending needs with guaranteed income — state pension, defined benefit, or annuity. Drawdown then funds discretionary spending that can flex with markets, removing pressure to sell in downturns for essential costs.
4. Genuine Diversification
True diversification includes geography, factor exposure (value vs growth), and alternative assets — not just equities vs bonds. The goal is ensuring some part of the portfolio holds up when equity markets fall sharply.
5. Dynamic Asset Allocation (Glide Path)
Gradually shift from growth to defensive assets in the years immediately before and after retirement. This reduces exposure to a severe drawdown at the worst possible time — a strategy well established in target date funds and replicable in bespoke drawdown portfolios via annual rebalancing.
Modelling Sequence Risk
Stochastic modelling tools running thousands of simulated scenarios are the most robust way to demonstrate sequence risk to clients and test drawdown strategy resilience. Probability of plan success (targeting 80–90%+ across all simulations) gives a more honest picture than a straight-line growth assumption.
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This article is for general information for financial advisers. Always conduct full suitability assessments for retirement income planning.