Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 283

Sequencing risk can hit retirement outcomes

It has been an extraordinarily good period for retirees in recent years, with the stock market recording one of the longest bull markets in history. But bull markets typically end with a bear market, and while no-one knows for sure when that may occur, retirees should be preparing for a change in sentiment.

October 2018 was a bruising month for equity markets, and we think volatile markets are here to stay. While all investors understand that market volatility can affect the value of their retirement savings, many do not realise there is another type of risk lurking in the shadows that could be of greater concern for those nearing retirement. It is called sequencing risk.

The sequence, or order in which your investment returns occur, can have a dramatic impact on the health of your retirement savings. Retirees therefore need to look at strategies that can help them during this vulnerable period.

What is sequencing risk?

A portfolio is exposed to sequencing risk if there are contributions coming into a portfolio, or if withdrawals are coming out of the portfolio to fund retirement. A portfolio with no contributions or withdrawals has no sequencing risk because with multiplication, changing the order of numbers has no impact on the result.

The example below shows two investors, A and B, who both start out with an investment of $350,000. Both investors achieve an average rate of return of 5% per annum over the 11-year period.

Investor A’s portfolio experiences negative returns in the early years of his retirement. Investor B’s portfolio experiences the negative returns later on, exactly reversing the annual timing of the same returns. As neither investor is making withdrawals from their portfolio, at the end of the final year both investors have an identical balance of $549,512.

No sequencing risk

This example is for illustrative purposes only.

A tale of two investors

The concept of sequencing risk could kick in during that phase when an investor moves from the accumulation stage (saving for retirement) to the decumulation stage (living off retirement savings).

Negative investment returns early in retirement can be problematic for retirees. If an investor experiences a higher proportion of negative returns in the early years of their retirement, it will have a long-lasting negative effect on their retirement savings. This will reduce the amount of income they can withdraw over their retirement years.

Here we apply the same example above, but this time, Investor A and Investor B are withdrawing $25,000 per year to fund their retirement. They both have identical starting super balances of $350,000. They both have an average return of 5% p.a. over the 11-year period. However, in this case, Investor A’s retirement balance is $169,475 lower than Investor B’s retirement balance. This is the impact of sequencing risk.

The impact of sequencing risk

The impact of sequencing risk

This example is for illustrative purposes only.

While Investor B’s portfolio balance grows in the early years of her retirement, for Investor A, negative returns just after retirement have a devastating effect. This is because he is withdrawing funds as his portfolio is losing value and is therefore holding fewer shares that could benefit from positive returns down the track.

How to reduce sequencing risk when it matters most

The timing of share market falls can dramatically impact the length of time a retiree's capital will last. The good news is that there are ways to structure an SMSF or retirees’ assets to manage the risk. These include diversification into uncorrelated asset classes and holding cash to reduce withdrawals from an equity allocation during heavy market falls.

Another strategy is to set aside a portion of retirement savings in an investment that is not as impacted by market or index returns, such as a defensive equity solution. It may reduce vulnerability to an early retirement stock market decline that causes the most harm to retirees. However, if a retiree is at a point where their retirement savings meet their needs and objectives, they should consider dialing down the risk of their investments.

Investors who are exposed to sequencing risk in early retirement may need to work longer or reduce their living standards, so having an effective plan to manage this risk is essential.

 

Aaron Binsted is a Portfolio Manager at Lazard Asset Management. This article is general information and does not consider the circumstances of any investor.

 

RELATED ARTICLES

Risk in retirement: five strategies for finding the right balance

What can retirement savers do in bleak markets?

The five-act future if we knew we’d live to 100

banner

Most viewed in recent weeks

The case for the $3 million super tax

The Government's proposed tax has copped a lot of flack though I think it's a reasonable approach to improve the long-term sustainability of superannuation and the retirement income system. Here’s why.

7 examples of how the new super tax will be calculated

You've no doubt heard about Division 296. These case studies show what people at various levels above the $3 million threshold might need to pay the ATO, with examples ranging from under $500 to more than $35,000.

The revolt against Baby Boomer wealth

The $3m super tax could be put down to the Government needing money and the wealthy being easy targets. It’s deeper than that though and this looks at the factors behind the policy and why more taxes on the wealthy are coming.

Meg on SMSFs: Withdrawing assets ahead of the $3m super tax

The super tax has caused an almighty scuffle, but for SMSFs impacted by the proposed tax, a big question remains: what should they do now? Here are ideas for those wanting to withdraw money from their SMSF.

The super tax and the defined benefits scandal

Australia's superannuation inequities date back to poor decisions made by Parliament two decades ago. If super for the wealthy needs resetting, so too does the defined benefits schemes for our public servants.

Are franking credits hurting Australia’s economy?

Business investment and per capita GDP have languished over the past decade and the Labor Government is conducting inquiries to find out why. Franking credits should be part of the debate about our stalling economy.

Latest Updates

Superannuation

Here's what should replace the $3 million super tax

With Div. 296 looming, is there a smarter way to tax superannuation? This proposes a fairer, income-linked alternative that respects compounding, ensures predictability, and avoids taxing unrealised capital gains. 

Superannuation

Less than 1% of wealthy families will struggle to pay super tax: study

An ANU study has found that families with at least one super balance over $3 million have average wealth exceeding $19 million - suggesting most are well placed to absorb taxes on unrealised capital gains.   

Superannuation

Are SMSFs getting too much of a free ride?

SMSFs have managed to match, or even outperform, larger super funds despite adopting more conservative investment strategies. This looks at how they've done it - and the potential policy implications.  

Property

A developer's take on Australia's housing issues

Stockland’s development chief discusses supply constraints, government initiatives and the impact of Japanese-owned homebuilders on the industry. He also talks of green shoots in a troubled property market.

Economy

Lessons from 100 years of growing US debt

As the US debt ceiling looms, the usual warnings about a potential crash in bond and equity markets have started to appear. Investors can take confidence from history but should keep an eye on two main indicators.

Investment strategies

Investors might be paying too much for familiarity

US mega-cap tech stocks have dominated recent returns - but is familiarity distorting judgement? Like the Monty Hall problem, investing success often comes from switching when it feels hardest to do so.

Latest from Morningstar

A winning investment strategy sitting right under your nose

How does a strategy built around systematically buying-and-holding a basket of the market's biggest losers perform? It turns out pretty well, so why don't more investors do it?

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.