Sequencing Risk: Why the Order of Investment Returns Matters in Retirement

Imagine two investors, both of whom earn an average annual return of 6% over 25 years and both of whom withdraw 4% of their initial portfolio each year in retirement. In terms of the arithmetic, these investors appear identical. Yet depending on the sequence in which those returns occur, one might end their 25-year retirement with a thriving portfolio, while the other runs out of money entirely.

This phenomenon — known as sequencing risk, or sequence of returns risk — is one of the most critical and least intuitive concepts in retirement planning. It is particularly relevant for internationally mobile HNW individuals who are approaching, or have entered, the decumulation phase of their financial lives.

Why Sequence Matters: The Maths

The mechanism is straightforward once explained. In the accumulation phase — when you are adding money to a portfolio — poor returns early are relatively benign. Future contributions are made at lower prices, which means you accumulate more units. A bear market early in an accumulation programme can actually enhance long-run outcomes through pound-cost averaging.

In the decumulation phase — when you are withdrawing money — the dynamic reverses. Early poor returns are devastating because:

1. Your withdrawals are forced at depressed prices, locking in losses.
2. The portfolio balance from which future returns are earned is permanently reduced.
3. Good returns later in retirement are applied to a smaller capital base, so they cannot compensate.

Numerical illustration (simplified):

Investor A and Investor B both start with £1,000,000 and withdraw £40,000/year (4%).

• Investor A: Returns -20%, -15%, then 15 years of +12%. By year 17, the portfolio is exhausted.
• Investor B: Returns 15 years of +12%, then -15%, -20%. By year 20, the portfolio still has over £1.2 million remaining.

The average return is similar in both cases. The outcome is entirely different.

This illustrates why standard return calculations — presenting an average annual return without regard to sequence — are deeply misleading when applied to drawdown portfolios.

When Sequencing Risk Is Greatest

The retirement red zone: The five years immediately before retirement and the first five to ten years of retirement represent the period of greatest sequencing risk. The portfolio is typically at its largest (maximum exposure in absolute terms), and withdrawals begin immediately — removing the ability to "wait out" a bear market.

Research by David Blanchett at Morningstar and others shows that a significant market decline in the first five years of retirement meaningfully increases the probability of portfolio exhaustion, regardless of long-run average returns.

Active drawdown phase: For investors using a portfolio in drawdown (SIPP drawdown, offshore bond withdrawals, or general investment account), sequencing risk is active throughout retirement, not just at the start.

Fixed income transition: Moving aggressively into "safe" assets too early in the transition to retirement can eliminate sequencing risk while creating a different problem: insufficient growth to sustain inflation-adjusted withdrawals over a 25–35-year retirement horizon. The balance is genuinely difficult.

Measuring Sequencing Risk

Sequencing risk is best understood through Monte Carlo simulation — running thousands of random return sequences (consistent with historical volatility and average returns) and observing what percentage of scenarios result in portfolio exhaustion within the investor's expected retirement horizon.

Key outputs from a Monte Carlo model:

• Probability of ruin (PoR): The percentage of scenarios in which the portfolio runs out of money before the end of the planning horizon (typically age 90 or 95).
• Safe withdrawal rate (SWR): The initial withdrawal rate that produces a PoR below the investor's specified tolerance (typically less than 5%). The "4% rule" — originated by William Bengen in 1994 using US historical data — suggests a 4% initial withdrawal rate from a balanced portfolio is sustainable over 30 years in most historical scenarios. However:
  • The 4% rule was derived from US data; the UK and global evidence suggests 3–3.5% may be more appropriate for global portfolios.
  • Current low real yields and high equity valuations may produce below-historical average future returns, suggesting lower sustainable withdrawal rates.
  • The rule assumes constant real withdrawals — actual spending in retirement is rarely constant.

Strategies to Mitigate Sequencing Risk

1. Cash flow matching and liability-driven investing (LDI)

Match near-term portfolio withdrawals to low-risk, defined-maturity assets:

• Hold 2–5 years of planned withdrawals in cash and short-dated gilts
• Invest the remainder in growth assets (equities, alternatives)

This ensures that withdrawals in the early years of retirement are funded from the safe bucket, not forced sales of equities during a potential bear market. Only when the growth portfolio has recovered and grown does it "refill" the safe bucket.

Implementation: A £2 million portfolio with £80,000/year planned withdrawals might hold £400,000 in a cash and short-gilt "safe bucket" (5 years of withdrawals) and £1,600,000 in a diversified growth portfolio. In a market downturn, withdrawals are funded from the safe bucket — giving the growth portfolio time to recover.

2. Dynamic withdrawal rates

Rather than withdrawing a fixed inflation-adjusted amount, adjust withdrawals based on portfolio performance:

• In years of strong growth, maintain or slightly increase withdrawals.
• In years of poor performance, reduce withdrawals temporarily.
• Guardrails approach (Guyton-Klinger): if the withdrawal rate rises above a defined upper bound (e.g., 5.5%), reduce withdrawals by 10%; if it falls below a lower bound (e.g., 3%), increase withdrawals by 10%.

Flexible spending reduces the severity of sequencing risk by limiting withdrawals in bad years — at the cost of spending flexibility.

3. Annuity as partial sequencing risk hedge

A lifetime annuity purchased with a portion of the retirement portfolio provides a guaranteed income stream regardless of market performance — eliminating sequencing risk for the annuitised portion. The tradeoff is loss of capital flexibility and inflation risk (unless an inflation-linked annuity is purchased — which will be at a lower initial income level).

For internationally mobile investors, cross-border portability of annuity income and the withholding tax treatment of annuity payments in the country of residence are important considerations.

4. Reducing equity concentration in the red zone

In the five years approaching retirement, gradually reducing equity exposure and building up more stable, shorter-duration assets reduces the potential severity of a sequencing event. This is sometimes called a "glide path" — a gradual de-risking as retirement approaches.

Caution: Reducing equity exposure too aggressively too early creates its own risk. With life expectancies extending toward 90 for healthy 65-year-olds, a 25–30 year retirement horizon still requires meaningful equity exposure to sustain real income.

5. Income diversification: multiple pillars

Sequencing risk is most dangerous when the investment portfolio is the only source of retirement income. Multiple income sources reduce the severity of forced portfolio withdrawals in bad years:

• State pension (full new UK State Pension: around £12,548/year for 2026/27; State Pension age currently 66, rising to 67 between 2026 and 2028)
• Defined benefit pension (if applicable — guaranteed income; no sequencing risk)
• Rental income from direct property
• Business income or royalties
• Interest from annuities or structured income products

For HNW investors with diverse income sources, portfolio withdrawals may be modest relative to portfolio size — reducing sequencing risk naturally.

6. Geographic diversification of withdrawal timing

For internationally mobile investors with assets in multiple jurisdictions, thoughtful timing of withdrawals from different sources can manage both sequencing risk and tax exposure. Drawing from assets in one jurisdiction during poor years in another, or timing realizations around periods of tax residence in lower-tax countries, can reduce both the portfolio impact of sequencing events and the tax payable on withdrawals.

The Special Case of SIPP Drawdown

UK SIPP drawdown is the primary decumulation vehicle for many HNW investors. Key points relevant to sequencing risk:

• No obligation to purchase an annuity — flexible withdrawals allowed throughout.
• Investments within the SIPP remain in a portfolio exposed to market movements.
• Withdrawals are taxed as income — sequencing risk interacts with marginal income tax rate fluctuations.
• The 25% tax-free cash entitlement can be taken progressively — either by crystallising the fund in stages under flexi-access drawdown, or via uncrystallised fund pension lump sums (UFPLS, where each withdrawal is 25% tax-free and 75% taxable) — or taken in full at outset. The timing decision has sequencing implications.

Pension freedoms introduced in 2015 gave UK investors much greater flexibility in decumulation — and therefore much greater exposure to sequencing risk that was previously managed by mandatory annuity purchase. This makes a structured decumulation strategy more important, not less.

Compliance Note

Sequencing risk and retirement income planning are complex and depend significantly on individual circumstances including life expectancy, spending patterns, other income sources, tax position, and jurisdiction of residence. The "4% rule" and other rules of thumb are illustrative starting points, not guarantees. Annuity rates and guaranteed income products vary significantly and should be compared and reviewed with independent advice. The value of investments can fall as well as rise and investors may get back less than they invested. This guide is educational and does not constitute personal financial advice. Specialist decumulation advice from a qualified adviser is strongly recommended.

How Global Investments Can Help

Global Investments advises internationally mobile HNW clients on all aspects of decumulation planning — including sequencing risk analysis, SIPP and offshore bond withdrawal strategies, income source diversification, and cross-border tax efficiency. We use stress testing and Monte Carlo modelling to provide an honest assessment of portfolio sustainability across a range of return scenarios. Contact our team to discuss your retirement income strategy.