Two investors could experience the exact same average return over a 20-year retirement, yet end up in dramatically different financial positions purely because of the order in which good and bad years occurred. This is the essence of sequencing risk — a concept that matters far more near and during retirement than it does during the years of building a pension, and one that catches many investors by surprise because it runs against the intuitive idea that only the average return matters in the end.
What sequencing risk actually is
Sequencing risk describes how the order of investment returns affects an outcome, specifically when regular withdrawals or contributions are being made alongside those returns. During the accumulation phase — when someone is contributing money regularly and not withdrawing — the order of returns matters relatively little to the final outcome, since money is being added throughout regardless of whether the good years came first or last. During retirement, when someone is instead withdrawing money regularly, the order suddenly matters a great deal, because a poor return in an early year, combined with a withdrawal, permanently reduces the capital available to benefit from any recovery later on.
A simplified illustration
Imagine two hypothetical retirees, each starting retirement with £300,000, each withdrawing £15,000 a year, and each experiencing the exact same set of annual returns over ten years — just in reverse order of each other. Retiree A experiences a run of poor returns in the first few years of retirement, followed by strong returns later. Retiree B experiences the same returns in the opposite order — strong first, poor later. Even though both experience an identical average return over the full ten years, Retiree A is likely to end up with meaningfully less money than Retiree B, because Retiree A's early withdrawals were taken from a portfolio already reduced by poor early returns, permanently shrinking the base available to benefit from the later recovery — whereas Retiree B's early withdrawals came from a portfolio still benefiting from strong initial growth.
Why this matters most near retirement
The reason sequencing risk is discussed specifically in the context of retirement, rather than throughout an entire investing life, is the combination of a large accumulated pot and the start of regular withdrawals. Earlier in an investing life, ongoing contributions mean poor early returns simply mean units are bought more cheaply, which can even be beneficial in the long run. Once withdrawals begin, poor early returns instead mean units are being sold at depressed prices to fund income, permanently locking in losses on that portion of the portfolio in a way that a poor year experienced only during accumulation does not.
Ways to manage sequencing risk
A cash or short-term bond buffer
Holding one to three years of anticipated withdrawals in cash or short-term, lower-volatility assets means that during a market downturn, income can be drawn from this buffer rather than by selling equities at a depressed price. This buys time for equity markets to potentially recover before those assets need to be touched again.
Flexible withdrawal rates
Rather than withdrawing a fixed amount regardless of market conditions, some retirees adjust withdrawals downward during a market downturn — spending a little less from the portfolio during difficult years — reducing the extent to which units are sold at depressed prices.
Maintaining diversification
A well-diversified portfolio across asset classes, regions and sectors is less likely to experience the most severe possible falls than a concentrated one, reducing the potential magnitude of a poor sequencing event, even if it cannot eliminate the risk entirely.
Partial annuitisation
Some retirees choose to convert a portion of their pension into a guaranteed income through an annuity, removing that portion entirely from sequencing risk, while leaving the remainder invested and exposed to markets — a way of partially, rather than fully, managing the risk.
Reviewing the withdrawal strategy itself
Comparing a natural-yield approach (drawing only the income a portfolio naturally generates) against a total-return approach (drawing a set percentage regardless of the source) can also affect exposure to sequencing risk, and is discussed in more detail elsewhere.
| Strategy | How it addresses sequencing risk | Trade-off |
|---|---|---|
| Cash/bond buffer | Avoids selling equities at depressed prices during a downturn | Cash and short-term bonds typically earn less over the long run than equities |
| Flexible withdrawals | Reduces units sold during poor years | Requires accepting lower spending in some years |
| Diversification | Reduces the severity of the worst potential falls | Does not eliminate the risk of a poor sequence entirely |
| Partial annuitisation | Removes sequencing risk entirely from the annuitised portion | Reduces flexibility and gives up potential future growth on that portion |
Sequencing risk and the choice between drawdown and an annuity
Sequencing risk is one of the central reasons some retirees consider converting at least part of their pension into a guaranteed income through an annuity, rather than remaining fully invested in drawdown throughout retirement. An annuity, once purchased, removes sequencing risk entirely for the portion of the pension converted, since the income is fixed regardless of subsequent market performance. This comes at the cost of giving up potential future growth and the flexibility to adjust withdrawals, which is why the decision is a genuine trade-off rather than a straightforward choice — covered in more detail in the specific comparison between drawdown and annuities.
Partial protection through phased annuitisation
Some retirees phase this decision, using drawdown for some years or purchasing a series of smaller annuities over time rather than committing the entire pension to an annuity at a single point, spreading the specific timing risk of when an annuity is purchased across several points rather than a single moment, in much the same way pound-cost averaging spreads the timing risk of a single lump-sum investment.
Testing a retirement plan against a poor early sequence
Given that averages alone do not reveal sequencing risk, financial planning tools that specifically model a range of possible return sequences — rather than a single assumed average annual return applied uniformly across the whole retirement — give a more realistic sense of how robust a specific withdrawal plan is. Some planning approaches specifically stress-test a plan against a historically poor sequence of early returns, checking whether the plan would have survived even the least favourable historical starting periods, rather than only checking whether it works under an average, smoothed assumption that may understate the real risk involved.
A worked example
Suppose a hypothetical retiree begins drawdown with a £400,000 SIPP, planning to withdraw £20,000 a year (5%), and holds it entirely in a global equity fund. In the first year of retirement, the fund falls by 20% due to a market downturn, reducing the pot to £320,000 before the £20,000 withdrawal, leaving £300,000. In the second year, the fund recovers by 25%, but recovering from a smaller base of £300,000 (rather than the original £400,000) means the recovery in pounds is smaller than the initial fall — illustrating how an early fall, combined with a withdrawal taken from the reduced pot, has a lasting effect even after markets recover. Had the same retiree instead held two years of withdrawals (£40,000) in cash, they could have drawn from that cash buffer during the downturn year rather than selling equity fund units at the reduced price, leaving more of the equity holding intact to benefit from the subsequent recovery.
Sequencing risk is not just a retirement problem
While most relevant to retirement drawdown, a milder version of sequencing risk can also affect anyone withdrawing a lump sum for a specific near-term goal — a house deposit, for example — where a market fall shortly before the money is needed cannot be recovered from by waiting, because the money must be used regardless of market conditions at that point.
Why sequencing risk is often underestimated
Sequencing risk is easy to underestimate because it does not show up in a simple long-term average return figure at all — two entirely different sequences of returns, one disastrous and one comfortable, can produce identical average annual returns over the full period, while producing dramatically different real-world outcomes for a retiree drawing an income throughout. This is a genuinely counter-intuitive feature of retirement investing, since most other financial planning intuitively focuses on average expected returns, which is a perfectly reasonable approach during accumulation but becomes an incomplete and potentially misleading way of thinking about risk once regular withdrawals begin.
Communicating sequencing risk within a household
Where a retirement is being planned jointly, for example by a couple, it is worth both parties understanding sequencing risk together, since a poorly timed early downturn can materially affect joint retirement plans in ways that are easy to underestimate if only one partner has engaged with the underlying mechanics. Discussing in advance how a significant early market fall would be handled — for example, agreeing to draw from a cash buffer rather than immediately reducing spending in a panic, or agreeing on a specific trigger point at which spending would be reviewed — can reduce the risk of a reactive, poorly considered decision being made under the stress of an actual downturn.
Key takeaways
- Sequencing risk describes how the order of investment returns, not just their average, affects outcomes when regular withdrawals are being made.
- It matters far more during retirement drawdown than during the accumulation years, because withdrawals combined with poor early returns permanently reduce the capital base.
- A cash or short-term bond buffer covering a few years of withdrawals is a widely discussed way to reduce exposure to a poorly timed downturn.
- Flexible withdrawal rates, broad diversification, and partial annuitisation are other approaches that can help manage this risk.
- The risk also applies, in a milder form, to any lump sum needed for a near-term goal, not just full retirement drawdown.
- Always check current HMRC and FCA figures and allowances, as these change from tax year to tax year.