What Is Sequence of Returns Risk?
Sequence of returns risk — sometimes called sequence risk or pound cost ravaging — is the danger that poor investment returns in the early years of your retirement will permanently damage your pension pot, even if markets recover strongly later. It is widely considered the single biggest financial risk facing anyone in pension drawdown.
The concept is counterintuitive. During your working years, when you are saving into a pension, the order of investment returns does not matter. Whether you get good years first or bad years first, your final pot will be the same as long as the average return is the same. This is because you are only adding money, never withdrawing it.
But in drawdown, everything changes. You are now withdrawing money from your pot. When markets fall early in your retirement, you are forced to sell more units of your investments at lower prices to fund the same level of income. Those units are gone forever — they cannot participate in any future recovery. This is why two retirees with identical average returns over 25 years can end up with vastly different outcomes, depending purely on when the bad years occurred.
A Worked Example: Why Order Matters
Consider two retirees, both starting with £500,000 and withdrawing £20,000 per year. Both experience the same set of annual returns over 10 years, but in reverse order:
| Year | Retiree A Returns | Retiree A Balance | Retiree B Returns | Retiree B Balance |
|---|---|---|---|---|
| Start | — | £500,000 | — | £500,000 |
| 1 | -15% | £405,000 | +18% | £570,000 |
| 2 | -10% | £344,500 | +12% | £618,400 |
| 3 | +2% | £331,390 | +8% | £647,872 |
| 4 | +5% | £327,960 | +5% | £660,266 |
| 5 | +8% | £334,196 | +2% | £653,471 |
| 6 | +5% | £330,906 | +5% | £666,145 |
| 7 | +8% | £337,378 | +8% | £699,436 |
| 8 | +12% | £357,864 | +2% | £693,425 |
| 9 | +18% | £402,279 | -10% | £604,083 |
| 10 | +12% | £430,553 | -15% | £493,470 |
Both experienced identical average returns. But Retiree A, who suffered losses early, has approximately £63,000 less after 10 years. Over a 30-year retirement, this gap widens dramatically, and Retiree A faces a real risk of running out of money while Retiree B remains comfortable.
Why Sequence Risk Is Unique to Drawdown
Sequence risk does not affect everyone equally. It is specifically a problem when you are making regular withdrawals from a declining portfolio:
- Annuity holders — no sequence risk. The insurance company bears all investment risk. Your income is guaranteed for life regardless of market conditions
- People still saving — sequence risk works in reverse (it actually benefits you). Buying when markets are low means you acquire more units at lower prices, which boosts returns when markets recover
- Drawdown retirees — fully exposed. You are selling investments to fund income, and selling at low prices locks in losses
How to Protect Yourself Against Sequence Risk
1. The Cash Buffer Strategy
Hold 1-2 years of planned withdrawals in cash or very short-term bonds. When markets fall, you draw from the cash buffer instead of selling investments at depressed prices. When markets recover, you replenish the buffer. This simple strategy can dramatically reduce sequence risk.
2. The Bucket Strategy
Divide your pension into three buckets based on when you need the money:
- Bucket 1 (cash, 1-2 years) — immediate income needs, held in cash
- Bucket 2 (bonds, 3-7 years) — medium-term needs, held in bonds or cautious funds
- Bucket 3 (equities, 8+ years) — long-term growth, held in diversified equities
You spend from Bucket 1, refilling it from Bucket 2 periodically, and refilling Bucket 2 from Bucket 3. This means you never need to sell equities in a downturn. Learn more in our drawdown investment strategy guide.
3. Flexible Withdrawals
Being willing to reduce your withdrawals during market downturns is the single most effective protection against sequence risk. Even a modest 10-15% reduction in withdrawals during poor years can add years to the life of your pension. If your essential costs are covered by the State Pension, reducing discretionary drawdown withdrawals during a market crash is far easier to manage.
4. Partial Annuitisation
Using part of your pension to buy an annuity that covers your essential expenses removes the need to withdraw from your drawdown pot for basics. This means your drawdown pot only needs to fund discretionary spending, which can be reduced in bad years. The combination of guaranteed annuity income plus flexible drawdown is one of the most robust approaches to managing sequence risk.
5. Phased Retirement
Rather than fully entering drawdown on a single date, phased retirement allows you to gradually crystallise your pension. This spreads your exposure to market timing and reduces the impact of entering drawdown just before a major market fall.
6. Asset Allocation Glide Path
Consider a more conservative asset allocation in the years immediately before and after retirement, then gradually increasing equity exposure as you move through your sixties and seventies. This "retirement glide path" reduces exposure to sequence risk during the danger zone while maintaining growth potential for the later years of drawdown.
Sequence Risk in Recent History
Retirees who entered drawdown at certain times have experienced very different outcomes due to sequence risk:
- Retiring in 2007 (before the financial crisis) — markets fell 30-40% in the first two years of retirement. Combined with withdrawals, many pots suffered permanent damage
- Retiring in 2009 (after the crisis) — markets recovered strongly, providing excellent early returns that built a protective buffer
- Retiring in early 2020 (COVID crash) — a sharp initial drop followed by rapid recovery. Those who maintained withdrawals through the crash recovered, but those who panicked and increased withdrawals suffered
What to Do If You Are Already in the Danger Zone
If you have recently entered drawdown and markets have fallen, do not panic. Here is what to do:
- Reduce non-essential withdrawals — even temporarily cutting back can make a big difference
- Avoid selling equity investments — use cash reserves or bond holdings to fund income
- Do not make dramatic changes — selling everything and moving to cash locks in your losses permanently
- Reassess your withdrawal rate — recalculate based on your current pot value, not the original value
- Seek professional advice — a pension adviser can help you navigate market volatility and adjust your strategy