Sequencing risk
The danger of poor investment returns arriving early in retirement, while you are also drawing income.
The order of returns matters enormously once you start withdrawing. Two retirees experiencing identical average returns can end up with very different outcomes depending on when the bad years fell.
A downturn early in retirement forces you to sell more units to fund the same income, permanently reducing the capital available to participate in the eventual recovery.
The standard defence is a cash or defensive buffer covering two to three years of income, so withdrawals can be funded without selling growth assets at depressed prices.
The bucket approach is a common structural response. Holding short-term needs in cash, medium-term needs in defensive assets and long-term needs in growth assets lets each pool be drawn on at an appropriate time rather than selling whatever has fallen most.
Same average, different result
A 20% fall in year one while withdrawing income does far more permanent damage than the same fall in year fifteen, even if the average return across the period is identical.
The bit people get wrong
Sequencing risk is largely irrelevant while you are accumulating — a downturn then simply means buying at lower prices. It becomes critical the moment withdrawals begin.
Common questions
How do I protect against it?
Hold two to three years of income needs in cash or defensive assets, reduce withdrawals in poor years where possible, and consider guaranteed income for essential expenses.
Should I move everything to cash at retirement?
No. That trades sequencing risk for longevity and inflation risk. The aim is a buffer, not abandoning growth assets across a retirement lasting decades.
When is the risk highest?
In the few years either side of retirement, when the balance is at its largest and withdrawals are beginning.