Retirement insights
Investment risk around retirement isn't only about how far markets rise or fall. Once you start drawing an income, the order in which returns arrive can matter just as much.
Imagine you've spent decades building your retirement savings and, just as you're preparing to finish work, share markets fall sharply.
If you're 45 and still accumulating, a downturn is uncomfortable, but you have years of contributions and returns still ahead of you. In fact, the contributions you make during the fall buy in at lower prices.
At 65, the picture can be quite different. You're no longer adding money. You're starting to take it out. And the money you take out during a downturn is money that isn't there when markets recover.
That difference has a name: sequencing risk.
Sequencing risk, sometimes called sequence of returns risk, is the risk that poor investment returns arrive at an unfavourable time. Usually that means around the transition into retirement, and in the first years of drawing down your savings.
The idea takes a moment to sit with, because we're used to thinking about investing in terms of average returns. If two people earn the same average return over the same period, surely they end up in the same place? While you're contributing and not withdrawing, broadly yes. Once money is coming out, no.
Morningstar Australia has explained why average returns alone don't tell the full story once cash flows are introduced, using historical returns from an Australian superannuation investment option. Two members can experience exactly the same returns over a period and finish with materially different balances, purely because of the order those returns occurred in while they were making withdrawals.
You're earning, contributing and buying investments. You're generally not relying on the portfolio to pay the bills. A fall is unpleasant to look at, but every contribution during that fall is buying at lower prices, and time is on your side.
Contributions have stopped, or slowed to a trickle. Money is going out instead of coming in, and funding that income may mean selling investments. When values are down, you have to sell more of them to raise the same dollars.
That's the heart of it. Selling after a substantial fall means giving up more units of your investments for the same amount of income. Those units are permanently gone, so when the recovery arrives, there is less capital left to enjoy it. A market that eventually bounces back doesn't necessarily bring your balance back with it.
Consider two hypothetical retirees. Both retire at the same age with $1,000,000. Both withdraw $60,000 at the start of every year. Both experience exactly the same twenty annual investment returns.
The only difference is the order those returns arrive in. Retiree A enjoys a good run early. Retiree B meets the poor years first.
Retiree A, favourable sequence
$764,117
Balance after 20 years
Retiree B, unfavourable sequence
$81,186
Balance after 20 years
Source: FI Advice. Hypothetical example for illustrative purposes only.
| Year | Retiree A return | Retiree A balance | Retiree B return | Retiree B balance |
|---|---|---|---|---|
| 1 | 7.0% | $1,005,800 | -14.0% | $808,400 |
| 2 | 9.0% | $1,030,922 | -9.0% | $681,044 |
| 3 | -2.0% | $951,504 | 4.0% | $645,886 |
| 4 | 13.0% | $1,007,399 | 12.0% | $656,192 |
| 5 | 6.0% | $1,004,243 | 7.0% | $637,925 |
| 6 | 10.0% | $1,038,667 | -3.0% | $560,588 |
| 7 | 3.0% | $1,008,027 | 15.0% | $575,676 |
| 8 | 8.0% | $1,023,869 | 9.0% | $562,087 |
| 9 | 14.0% | $1,098,811 | 6.0% | $532,212 |
| 10 | -5.0% | $986,871 | 11.0% | $524,155 |
| 11 | 11.0% | $1,028,826 | -5.0% | $440,947 |
| 12 | 6.0% | $1,026,956 | 14.0% | $434,280 |
| 13 | 9.0% | $1,053,982 | 8.0% | $404,223 |
| 14 | 15.0% | $1,143,079 | 3.0% | $354,549 |
| 15 | -3.0% | $1,050,587 | 10.0% | $324,004 |
| 16 | 7.0% | $1,059,928 | 6.0% | $279,844 |
| 17 | 12.0% | $1,119,919 | 13.0% | $248,424 |
| 18 | 4.0% | $1,102,316 | -2.0% | $184,656 |
| 19 | -9.0% | $948,508 | 9.0% | $135,875 |
| 20 | -14.0% | $764,117 | 7.0% | $81,186 |
This is a simplified hypothetical example prepared by FI Advice for illustrative purposes only. It does not represent actual investment returns and does not take into account an individual's objectives, financial situation or needs.
Same money in. Same money out. Same returns. A very different retirement. If you'd like to test numbers closer to your own, our retirement income calculator and super projection calculator are a useful starting point.
Sequencing risk exists at every stage of life, but it bites hardest in a fairly narrow window, the last few years of work and the first several years of retirement.
Research published by the Actuaries Institute has examined sequencing risk across a range of Australian asset classes, describing it as receiving poor returns at an especially unfavourable time, around retirement, and particularly in the years just after it, when balances are high and cash flow has turned negative.
There is no single answer, and anyone offering one should be treated carefully. What follows are planning considerations, each with trade-offs, and each worth weighing against your own circumstances. Morningstar Australia has discussed flexible withdrawals, investment strategy and bucketing in similar terms, emphasising that none of them are free of compromise.
Holding an appropriate amount in cash can mean you draw on that, rather than selling growth assets, during a significant downturn. The trade-off is that cash held for years generally earns less over time.
A considered allocation to defensive investments can reduce how sharply a portfolio moves. The balance needs to suit your timeframe, not just your comfort in a bad month.
Spreading exposure across different asset classes, regions and sectors reduces reliance on any single market behaving well in the years that matter most.
Where circumstances allow, easing back on discretionary spending after a significant market fall means fewer assets sold at depressed values, and more capital left to recover.
Separating short-term spending money from long-term growth assets is one possible approach. It has trade-offs and isn't automatically better than a well-structured diversified portfolio.
Age Pension entitlements, defined benefit income, part-time work or rental income all reduce how heavily your invested capital has to work in any given year.
The obvious reaction to all of this is to take the risk off the table entirely, shift to cash, wait for calmer weather, then step back in. It feels safe. It rarely is.
A retirement can last 20 or 30 years, and sometimes longer. Over that horizon, an excessively conservative portfolio introduces a different set of risks: inflation quietly eroding what your income buys, the possibility of outliving your savings, lower expected long-term returns, and the very real difficulty of deciding when to return to markets. Recent Australian commentary published by Morningstar Australia has specifically cautioned against trying to solve sequencing risk by switching a diversified retirement portfolio to cash and attempting to time the way back in.
Growth risk, inflation risk, longevity risk and sequencing risk all sit on the same table. Sequencing risk is something to manage thoughtfully, not something to eliminate by taking on a different risk instead.
The risk isn't simply that markets fall. Downturns are a normal, expected part of long-term investing, and they will happen during your retirement.
The risk is being forced to sell investments at an unfavourable time in order to fund your retirement.
That's why retirement planning isn't only about how much you've accumulated. It's about how your investments are structured, where your retirement income will come from, and how your strategy responds when markets don't behave the way you hoped. If you'd like the wider picture first, our Australian retirement planning guide walks through how much you may need and where it can come from.
Plan, grow, prosper, the growing part doesn't stop the day you retire.
If you'd like to understand how your investments, superannuation and retirement income strategy work together, speak with FI Advice about developing a retirement plan.
This article contains general information only. It has been prepared without taking into account your objectives, financial situation or needs. Before acting on any of this information you should consider its appropriateness, having regard to your own circumstances, and seek personal financial advice. Past performance is not an indicator of future performance. References to third-party research are provided for context only and do not imply any endorsement of FI Advice.
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