By Paul Mitchell | Financial and Retirement Planning Coach
Find him here at: Your Smart Retirement Coach
Sequencing Risk- What is it?
Picture this: Two investors start retirement with identical pension pots, make the same withdrawals, and achieve the same average investment returns over their retirement. Yet, one runs out of money while the other has plenty left. How is this possible? The answer lies in something called ‘sequencing risk’ – one of the most overlooked threats to retirement planning in the UK today.
What Makes Sequencing Risk So Important Now?
The recent market volatility, coupled with high inflation and changing pension freedoms, has made this risk more relevant than ever. As a financial coach with 35 years of experience as a Chartered Financial Planner, I’ve seen how this hidden risk can significantly impact retirement outcomes.
Understanding Sequencing Risk Through Real Examples
Consider Michael’s story. He retired in early 2022 with a £500,000 pension pot, planning to withdraw £25,000 annually. The market downturn in his first year meant he had to sell more units of his investments to achieve his income needs, leaving fewer units to recover when markets improved. This real-world example shows how the sequence of returns can dramatically affect long-term retirement income sustainability.
Why Traditional Investment Thinking May Not Help
Many people understand that investments can go up and down. However, when you’re withdrawing money regularly from your pension pot, the timing of these ups and downs becomes crucial. Think of it like rowing a boat – heading into waves is very different from having them behind you.
The Mathematics Behind the Risk
Let’s explore how sequencing risk works through detailed examples. While I can’t provide specific investment advice, understanding these numbers can help you have better conversations with regulated financial advisers.
Starting with a £400,000 pension pot, let’s compare two scenarios that have the same average return but in different sequences. We’ll calculate the exact impact of each scenario.
Scenario 1: Negative Returns Early
Starting value: £400,000
Year 1:
- Market falls 20%: £400,000 × 0.80 = £320,000
- Withdrawal: £20,000
- End of year value: £300,000
Year 2:
- Market rises 25%: £300,000 × 1.25 = £375,000
- Withdrawal: £20,000
- End of year value: £355,000
Year 3:
- Market rises 15%: £355,000 × 1.15 = £408,250
- Withdrawal: £20,000
- Final value: £388,250
Scenario 2: Negative Returns Late
Starting value: £400,000
Year 1:
- Market rises 15%: £400,000 × 1.15 = £460,000
- Withdrawal: £20,000
- End of year value: £440,000
Year 2:
- Market rises 25%: £440,000 × 1.25 = £550,000
- Withdrawal: £20,000
- End of year value: £530,000
Year 3:
- Market falls 20%: £530,000 × 0.80 = £424,000
- Withdrawal: £20,000
- Final value: £404,000
Visual Illustration of Sequencing Risk
The graph below illustrates how the same investment returns in different orders can lead to very different outcomes:
Start Year 1 Year 2 Year 3
£300k £350k £400k £450k £500k
Negative Returns Early Negative Returns Late
Impact of Return Sequence on Retirement Portfolio
This visualization shows:
- The blue line represents Scenario 2 (negative returns late)
- The red line represents Scenario 1 (negative returns early)
- Both start at £400,000
- Both experience the same returns but in different orders
- The gap between the lines shows the impact of sequencing risk
Notice how the portfolio experiencing negative returns early (red line) struggles to recover, even with subsequent positive returns. This happens because:
- Early losses combined with withdrawals reduce the number of investment units
- Fewer units remain to benefit from later positive returns
- The effect compounds over time
Think of it like a race where both runners cover the same total distance but face headwinds at different times. The runner who faces headwinds when tired (late in the race) performs better overall than the runner who faces headwinds when fresh (early in the race).
The Current UK Retirement Landscape
The retirement landscape in Britain has transformed dramatically in recent years. According to the Financial Conduct Authority’s latest retirement income data, over 60% of pension pots accessed for the first time are now moving into drawdown rather than being used to purchase annuities. This represents a complete reversal from just a decade ago.
This shift towards drawdown comes at a challenging time. Market volatility has reached levels not seen since the 2008 financial crisis, with the FTSE 100 experiencing significant swings. Meanwhile, UK inflation has hit multi-decade highs, forcing many retirees to increase their withdrawals just to maintain their standard of living.
Adding to these challenges, the Office for National Statistics reports that life expectancy continues to inch upward. A 65-year-old today needs to plan for potentially 20-30 years of retirement, making the impact of sequencing risk even more significant.
Understanding Your Personal Exposure to Sequencing Risk
The degree to which sequencing risk might affect your retirement depends on several key factors. Let’s explore each one:
Withdrawal Strategy Flexibility
Think of your withdrawal strategy like a tap that can be adjusted. Some retirees, like Robert, maintain flexibility by reducing withdrawals during market downturns. “I keep two years of essential spending in cash,” he explains. “This gives me breathing room when markets are challenging.” Others, with fixed commitments like mortgages or care fees, may have less flexibility.
Your Retirement Timeline
The length of your retirement significantly impacts your exposure to sequencing risk. Consider Margaret’s situation: retiring at 58 rather than 65 meant she needed her money to last potentially seven years longer. This extended timeline increased her exposure to sequencing risk, requiring careful consideration of how to structure her retirement income.
Income Source Diversity
Having multiple income sources can help manage sequencing risk. James, for instance, receives:
- A defined benefit pension providing guaranteed income
- State Pension as a foundation
- Rental income from a small property
- His drawdown pension for additional flexibility
This diversity gives him options when market conditions are unfavorable, reducing his need to sell investments at inopportune times.
Essential vs Discretionary Spending
Understanding the difference between ‘must-have’ and ‘nice-to-have’ spending provides valuable flexibility. Sarah and David mapped out their spending into these categories:
Essential Spending:
- Utilities and council tax
- Food and healthcare
- Insurance and property maintenance
- Basic transportation
Discretionary Spending:
- Travel and holidays
- Dining out and entertainment
- Hobbies and gifts
- Home improvements
This clarity helps them adjust their withdrawals when needed, reducing the impact of sequencing risk during market downturns.
The Role of Financial Coaching
As your financial coach, I can help you:
- Understand how sequencing risk might affect your situation
- Explore different retirement income scenarios
- Learn about various risk management approaches
- Prepare for discussions with regulated financial advisers
- Build confidence in your retirement planning decisions
Education Leads to Better Decisions
Knowledge about sequencing risk can help you:
- Ask better questions of financial professionals
- Understand the importance of retirement income planning
- Make more informed decisions about your retirement strategy
- Better appreciate why certain retirement approaches are recommended
Moving Forward With Confidence
Understanding sequencing risk is crucial for anyone approaching or in retirement. This knowledge helps you:
- Have more informed discussions about retirement planning
- Better understand the challenges you might face
- Appreciate the importance of professional guidance
- Make more confident decisions about your retirement approach
Take Action Today
As your financial coach, drawing on 35 years of experience as a Chartered Financial Planner, I can help you understand these complex concepts and prepare for important retirement decisions.
Contact me today for an initial discussion about how financial coaching can help you better understand and prepare for retirement planning challenges like sequencing risk. Email [contact details] or call [phone number] to begin your journey toward better retirement understanding.
Book Your Free Consultation Click here Now
About the Author
Paul Mitchell is a dedicated Financial and Retirement Coach (Qualified To Chartered Financial Planner status) with over 35 years of experience in financial services. Through Your Smart Retirement Coach, he helps clients build confidence in their financial future and create fulfilling retirement lifestyles. Book a free 15-minute consultation to start your journey toward financial clarity.
This blog post is for educational purposes only and does not constitute financial advice. For regulated financial advice, please consult an Independent Financial Adviser.
Keywords: sequencing risk, retirement planning, pension drawdown, retirement income, investment risk, financial coaching, retirement strategy, pension planning, retirement education, financial guidance
*Important Notes:
- This article provides general information about sequencing risk and retirement planning. It does not constitute financial advice.
- All decisions about retirement should be made based on your individual circumstances and with appropriate regulated financial advice where needed.
- Financial coaching services provide educational guidance only and do not include regulated financial advice.
- Examples are for illustrative purposes only.*
