Sequencing of Returns Risk in Drawdown: How to Protect Your Pension in a Market Downturn

Of all the risks facing someone drawing income from a pension, sequencing of returns risk — sometimes called "pound-cost ravaging" — is among the most dangerous and least understood. It is the risk that poor investment returns early in retirement permanently deplete a drawdown portfolio, even if those same average returns would have been adequate if experienced in a different order.

This guide explains the mechanics of sequencing risk, why it is more severe in drawdown than in accumulation, and the strategies used by financial planners to manage it.

Nothing in this guide constitutes personal financial advice. Pension drawdown decisions depend on individual circumstances and should be made with the support of a regulated financial adviser.

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Why Sequence Matters in Drawdown (But Not in Accumulation)

During the accumulation phase — when you are saving into a pension — the order of returns matters relatively little. Poor returns early on are offset by the fact that most of your future contributions are made after the downturn, buying units at lower prices. This is the well-known benefit of pound-cost averaging.

In drawdown, the dynamic is reversed. You are selling units rather than buying them. When markets fall and you continue drawing income, you are selling units at depressed prices. Each withdrawal removes units permanently — they cannot participate in any future recovery. The portfolio is both shrinking from withdrawals and damaged by the fall. When markets recover, the remaining pot is smaller and has fewer units to benefit from the rebound.

A simple illustration: Two retirees both start with £500,000 and draw £25,000 per year. Over 25 years, both experience the same average annual return of 5%. The difference is sequence:

• Retiree A experiences strong returns in early years and poor returns later. The portfolio sustains withdrawals comfortably and leaves a modest estate.
• Retiree B experiences poor returns in the first five years (say -15% annually) and strong returns later. The portfolio is devastated early — by year 5, after five years of negative returns and £125,000 in withdrawals, the pot may have fallen to £250,000 or less. Even a strong recovery from that base cannot restore the original trajectory.

The maths is unforgiving: an identical average return over 25 years produces very different outcomes depending on when the poor years fall.

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The Cash Buffer Strategy

The most widely used practical defence against sequencing risk is the cash buffer (sometimes called the "bucket strategy"):

How it works: Keep two to three years of expected income withdrawals in cash or near-cash (money market funds, short-dated gilts, National Savings). Draw your retirement income from the cash buffer rather than directly from the investment portfolio. Replenish the cash buffer from the investment portfolio when markets are positive.

Why it works: In a market downturn, you stop drawing from the investment portfolio and live off the cash buffer instead. You give the investments time to recover before selling. This avoids the "selling units at distressed prices" problem.

How much cash: Most financial planners recommend two to three years of gross income (including other income sources like State Pension). If your total income need is £30,000 per year and your State Pension provides £10,000, your pension drawdown need is £20,000 per year — so a buffer of £40,000–£60,000 is appropriate.

The cost: Cash earns less than the long-term return of equities. The drag from holding 10–15% of a portfolio in cash is typically 0.3–0.5% per year on the total portfolio. This is the cost of the insurance; most planners consider it well worth paying.

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Asset Allocation and the Glide Path

Many retirees approach drawdown with an asset allocation that is too conservative — having been shifted by lifestyling to a heavy bond or cash weighting approaching retirement. Post-Pension Freedoms, this is often inappropriate:

The traditional lifestyling problem: Default workplace pensions typically "lifestyle" — gradually shift from equities to bonds and cash — in the final 10 years before a target retirement date. This made sense when most retirees bought annuities at retirement. With drawdown, the investment horizon can extend 30+ years beyond retirement, making an aggressive de-risking at 65 potentially costly in lost real returns.

A more appropriate approach for drawdown: Maintain a diversified growth portfolio (broadly 50–70% global equities, 20–30% bonds, the remainder in alternatives, infrastructure, or real assets) throughout drawdown, with the cash buffer providing near-term income needs. The equity allocation can reduce gradually as age increases, but a 65-year-old in drawdown with a 25-year horizon is still a long-term investor.

Inflation risk is also sequencing risk: If inflation runs significantly above expectation for the first five years of retirement — as it did in 2021–2023 — the real purchasing power of both cash and bonds falls. A portfolio with too little equity exposure faces both inflation erosion and insufficient recovery potential. Sequencing risk applies not just to nominal portfolio values but to real spending power.

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Natural Income Strategy

An alternative to total-return drawdown is the natural income strategy: drawing only the income naturally generated by the portfolio (dividends, bond coupons, property income) and never selling capital.

Advantages: Removes the forced-selling problem almost entirely. In a market downturn, dividends may be reduced but are rarely eliminated by 30–40% as equity prices may be. Capital is preserved.

Disadvantages: In low-yield environments, natural income may be insufficient to meet spending needs. Many post-2015 portfolios generating 2–3% natural yield would not have provided adequate income without capital drawdown. The strategy also concentrates the portfolio in income-generating assets, potentially at the cost of total return.

Practical hybrid approach: Draw natural income from the portfolio to meet base income needs. Sell capital selectively — only in positive market years — to meet discretionary expenditure or top up the cash buffer. This limits the occasions on which distressed selling occurs.

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The Floor and Upside Model

Some financial planners use a "floor and upside" framework to manage sequencing risk structurally:

The floor: A guaranteed income base covering essential expenditure — State Pension, any defined benefit pension, annuity purchased with part of the pot. This floor is immune to market movements.

The upside: The remaining pension pot is invested in a growth portfolio, knowing that it is not relied upon for essential income. Withdrawals from the upside portfolio are discretionary — they can be deferred in poor market years.

For a retiree with a State Pension of £10,000 and a modest DB pension of £8,000, essential expenditure of £20,000 per year leaves only a £2,000 gap to be funded from drawdown. A market downturn that reduces the drawdown portfolio does not imperil essential living standards. This dramatically reduces sequencing risk by limiting the reliance on the volatile portfolio.

This model makes a strong case for retaining DB pensions rather than transferring them: the guaranteed floor is itself the primary defence against sequencing risk.

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Dynamic Withdrawal Strategies

Rather than drawing a fixed income regardless of market conditions, dynamic withdrawal strategies adjust income in response to portfolio performance:

The guardrails method: Set an upper and lower guardrail for the portfolio value. If the portfolio grows above the upper guardrail, increase income by a small amount. If it falls below the lower guardrail, reduce income by a small amount. This "automatic stabiliser" prevents both over-withdrawal in bad years and under-spending in good years.

Proportional withdrawal: Draw a fixed percentage of the portfolio value each year (say 4%). In good years, income rises; in bad years, it falls. This eliminates sequencing risk entirely — by definition, withdrawals are proportional and cannot exhaust the pot. The risk is that income in bad years may be uncomfortably low.

Both strategies require psychological flexibility — the willingness to reduce spending in poor market years. Not all retirees have fixed costs flexible enough to accommodate this.

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The 4% Rule and Its UK Limitations

American financial planners have long used the "4% rule" — draw 4% of the initial portfolio value per year, adjusted for inflation — as a sustainable withdrawal rate. Research by Bengen (1994) and the Trinity Study found this rule survived historical US market scenarios with a 30-year drawdown period in the vast majority of cases.

UK caveats: The 4% rule was derived from US historical data. UK equity and bond market performance has historically differed from the US (lower returns, different volatility profile). UK retirees also face uncertain State Pension, different tax treatment of withdrawals, and potentially longer drawdown periods (30–35 years for a 60-year-old). Most UK financial planners recommend 3–3.5% as a more conservative sustainable withdrawal rate for UK drawdown portfolios.

In 2026, with higher gilt yields and more competitive annuity rates, revisiting whether a partial annuity purchase provides better value than full drawdown for the base floor income is worth doing. Annuity rates at current levels make the cost of the annuity floor much lower than it was in 2020–2021.

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How Global Investments Can Help

Global Investments works with internationally mobile retirees and high-net-worth individuals managing substantial pension drawdown portfolios, often alongside overseas property income, currency exposure, and other assets. Managing sequencing risk in a multi-currency, multi-jurisdiction context requires careful modelling of both market scenarios and real spending needs.

Our network of regulated financial advisers can model your specific drawdown portfolio, apply a cash buffer and asset allocation strategy appropriate to your circumstances, and integrate guaranteed income sources (State Pension, DB income, annuity) with your SIPP or personal pension drawdown plan. Contact our team to arrange a retirement income planning review.

The value of pensions and investments can fall as well as rise. Past performance is not a guide to future returns. This guide is informational only and does not constitute regulated financial advice.