Sequence of returns risk — a plain-English guide.
When you're accumulating, the order of good and bad years doesn't matter — the final pot is the same regardless. When you're withdrawing, the order is everything. Bad early years while taking income can permanently damage a pension pot, even if later years are strong.
- ▸Sequence of returns risk is the danger that poor investment returns early in retirement — combined with ongoing withdrawals — permanently deplete a pension pot.
- ▸Two portfolios with identical average annual returns over 20 years can produce wildly different outcomes if one experiences losses in the first few years while withdrawing.
- ▸The risk is highest in the first 5–10 years of drawdown, sometimes called the 'retirement risk zone.'
- ▸Mitigation strategies include holding a cash buffer, using a bond allocation glide path, flexible (dynamic) withdrawals, and partial annuitisation.
Why bad early years hurt more than bad late years
During the accumulation phase — while saving into a pension — the order of annual returns does not affect the final outcome. A portfolio that returns +20%, -10%, +15% over three years ends up at the same value as one that returns -10%, +15%, +20%. The compound arithmetic is the same.
In drawdown, this symmetry breaks. The difference is withdrawals.
When you withdraw a fixed amount from a falling portfolio, you are selling more units to generate the same cash. Those units are permanently removed — they cannot participate in any subsequent recovery. If the portfolio then rebounds, it does so from a smaller base. The combination of falling prices and forced selling locks in losses in a way that accumulation does not.
A bad year late in retirement, by contrast, happens when the pot is already smaller (after years of withdrawals). The absolute loss is smaller and there is less remaining life for it to compound through.
This asymmetry is the essence of sequence risk. It means that the path of returns matters, not just the destination.
A worked example: same average returns, different outcomes
Consider two retirees, both starting with a £250,000 pot and withdrawing £12,500 per year (5%). Both experience the same set of annual returns over 10 years — but in opposite order.
Retiree A (bad years first):
| Year | Return | Start of year | Withdrawal | End of year |
|---|---|---|---|---|
| 1 | -15% | £250,000 | £12,500 | £201,875 |
| 2 | -10% | £201,875 | £12,500 | £170,438 |
| 3 | -5% | £170,438 | £12,500 | £150,041 |
| 4 | +5% | £150,041 | £12,500 | £144,418 |
| 5 | +8% | £144,418 | £12,500 | £142,471 |
| 6 | +12% | £142,471 | £12,500 | £145,567 |
| 7 | +15% | £145,567 | £12,500 | £153,027 |
| 8 | +10% | £153,027 | £12,500 | £154,581 |
| 9 | +8% | £154,581 | £12,500 | £153,447 |
| 10 | +12% | £153,447 | £12,500 | £157,860 |
Retiree B (good years first):
| Year | Return | Start of year | Withdrawal | End of year |
|---|---|---|---|---|
| 1 | +12% | £250,000 | £12,500 | £266,000 |
| 2 | +8% | £266,000 | £12,500 | £273,780 |
| 3 | +10% | £273,780 | £12,500 | £287,408 |
| 4 | +15% | £287,408 | £12,500 | £316,144 |
| 5 | +12% | £316,144 | £12,500 | £340,081 |
| 6 | +8% | £340,081 | £12,500 | £353,787 |
| 7 | +5% | £353,787 | £12,500 | £358,351 |
| 8 | -5% | £358,351 | £12,500 | £328,559 |
| 9 | -10% | £328,559 | £12,500 | £284,453 |
| 10 | -15% | £284,453 | £12,500 | £231,160 |
Both experienced the same average return (roughly 4% per year). Both withdrew the same total amount (£125,000). But Retiree A ends with £157,860. Retiree B ends with £231,160 — £73,300 more — purely because their good years came first.
Extend this over 25–30 years and the divergence becomes even more dramatic. Retiree A's pot is on a trajectory toward depletion. Retiree B's pot is sustainable.
Mitigation: cash buffer, glide path, flexible withdrawals
Sequence risk cannot be eliminated in drawdown — it is inherent to the combination of withdrawals and market exposure. But it can be managed.
Cash buffer. Holding one to three years of income in cash or near-cash (money market funds, short-term gilts) means that in a downturn, withdrawals come from the buffer rather than from selling equities at depressed prices. The buffer is replenished when markets recover. This does not change the portfolio's average return, but it changes the sequence by avoiding forced sales at the worst time.
Glide path (lifestyling at retirement). Shifting the portfolio toward a higher bond allocation in the years immediately before and after retirement reduces volatility during the highest-risk window. A common approach is 60/40 equity/bond at retirement, gradually increasing equity again later in retirement when the pot is smaller and the state pension provides a baseline.
Flexible (dynamic) withdrawals. Reducing withdrawals in years when the portfolio has fallen — even modestly — dramatically improves long-term sustainability. Research by Guyton and Klinger found that cutting withdrawals by 10% following a down year, and increasing by 10% after a strong year, extended portfolio survival by several years compared with rigid fixed withdrawals. See safe drawdown rate UK for more on dynamic strategies.
Partial annuitisation. Buying an annuity with part of the pot to cover essential spending removes that portion from market risk entirely. The drawdown portion then only needs to cover discretionary spending, which can be reduced in bad years without threatening the essentials. The annuity calculator shows what guaranteed income a portion of the pot would provide.
Each strategy has trade-offs — a cash buffer drags on long-term returns, a glide path reduces upside, flexible withdrawals mean income volatility, and annuitisation is irreversible. Most practical approaches combine two or more.
The pension drawdown calculator models pot survival under different return assumptions, which is the starting point for assessing sequence risk exposure.
- •Sequence of returns risk cannot be eliminated in drawdown — only managed. No withdrawal strategy guarantees the pot will not run out.
- •Worked examples use illustrative returns and are not forecasts. Actual market returns may be worse than any historical scenario.
- •Mitigation strategies involve trade-offs. A cash buffer reduces returns in good years; flexible withdrawals mean income is not guaranteed.
- ▸Research by Guyton and Klinger found that dynamic withdrawal strategies — reducing spending after down years and increasing after strong years — extended portfolio survival by several years compared with rigid fixed withdrawals. [Journal of Financial Planning]
- ▸The 'retirement risk zone' — the period from five years before retirement to ten years after — is when sequence of returns risk is highest, because the portfolio is at its largest and withdrawals are beginning. [Wade Pfau / Retirement Researcher]
This is factual information, not financial advice. If you're unsure what's right for your situation, speak to an FCA-regulated financial adviser.