A Market Downturn in Retirement: Sequencing Risk

01 Why retirees feel crashes differently

While you are working and contributing, a market fall is close to good news. Your regular contributions buy more units at lower prices, you are not selling anything, and you have decades for the recovery to arrive.

In retirement the dynamic reverses completely. You are withdrawing, so a fall means selling units cheaply to fund this year's spending, and those units are permanently gone. The portfolio has fewer of them left to participate in the recovery when it comes, so the loss is not merely paper — part of it is crystallised by the act of living.

That is why the same market, the same portfolio and the same average return produce very different outcomes depending on when the bad years fall. A retiree who meets a 25% drop in year two and a retiree who meets it in year eighteen have had identical investment experiences on paper and materially different retirements.

It also explains why "just don't look at it" — reasonable advice during accumulation — stops working. You cannot decline to withdraw. The spending happens whether or not you look, and the question is only which assets fund it.

The advice given to accumulators — ignore the noise, do not look, markets recover — is repeated to retirees, and for them it is wrong. An accumulator can genuinely ignore a fall because they are not selling anything. A retiree cannot decline to withdraw, so the units funding this year's spending are sold at the low whether or not anyone looks. The same sentence that protects one group misleads the other.

Source: ASIC Moneysmart — Retirement income

02 Worked example: the timing asymmetry

The calculator shows the heart of sequencing risk: a crash in the first year of retirement versus the same crash never happening. A big early fall can cut years off how long savings last, because it strikes the largest balance while you're drawing from it. The identical fall ten or fifteen years later does far less damage. This is why two retirees with the same average return over 30 years can have wildly different outcomes — the order of the returns, not just the average, decides it.

On the defaults above, the worked example returns —. A 25% fall in year one costs about 36 years of savings — the same fall in year 15 would do far less. That asymmetry is sequencing risk.

03 The cash buffer (bucket) defence

The most practical defence is unglamorous: hold one to three years of spending in cash or stable assets, kept deliberately separate from the growth investments.

When markets fall you spend from that bucket instead of selling shares at the bottom, which gives the growth assets time to recover before you draw on them again. In good years you refill it from gains. The mechanism is simple enough to follow under stress, which is most of its value — a defence you will not execute during a crash is not a defence.

Sizing it is a genuine trade-off rather than a free lunch. Cash earns less than growth assets over time, so a large bucket costs real long-run return. One year of spending is thin cover for a serious downturn; five years is a substantial drag on a thirty-year retirement. Two to three years is the common landing point because most significant market falls have recovered within that window, though not all of them have.

The refill rule matters as much as the size. Without one, the bucket is spent down over several average years and is empty precisely when the bad year arrives. Deciding in advance — top it back up whenever the portfolio is above where it started the year — removes the judgement call at the moment judgement is worst.

Holding cash is often described as a drag on a retirement portfolio, and over the first years of drawdown that gets the trade-off backwards. The forgone return is real but small; what the buffer prevents is selling growth assets at the bottom to fund groceries, which is the mechanism that turns a temporary fall into a permanent loss.

Source: ASIC Moneysmart — Account-based pensions

04 Flexibility and the Age Pension cushion

Two further cushions help. Spending flexibility: trimming discretionary spending during a downturn reduces how much you need to withdraw, preserving capital when it's most fragile. And the Age Pension: it's indexed and paid for life, and because it's means-tested on assets, a market fall that reduces your assessable assets can actually increase your pension — a partial automatic stabiliser. Together these mean a downturn early in retirement, while serious, rarely spells ruin for an Australian retiree who's prepared.

Source: Services Australia — Assets test for Age Pension

05 Asset allocation near retirement

The years immediately before and after you stop working are sometimes called the retirement risk zone, and the name is accurate: it is when sequencing risk is at its maximum, because the balance is the largest it will ever be and withdrawals are beginning.

That argues for moderating risk around that point — but not for abandoning growth assets. A retirement may run thirty years, and inflation over thirty years is the other risk in the room. A portfolio held entirely in cash is protected from sequencing risk and guaranteed to lose purchasing power, which is a slower failure rather than no failure.

The usual shape is a glide: reduce growth exposure moderately in the five or so years before retirement, hold the lowest growth allocation across the first few years of drawdown, then let it drift back up as the sequencing risk recedes. That last part is counterintuitive and often skipped — risk capacity actually rises once the early years are safely past, because a fall at 80 has far less time to compound against you than the same fall at 66.

The practical version for most people is not a bespoke glide path but a sensible default: a diversified option with a moderate growth weighting, plus the cash bucket, reviewed once rather than tinkered with.

Source: ASIC Moneysmart — Choose your investments

06 What not to do: panic-sell

The worst response is also the most common: watching the balance fall, deciding it will keep falling, and selling everything to cash at the bottom. That converts a temporary paper loss into a permanent real one and then locks you out of the recovery, because the decision to return is even harder than the decision to leave.

Cass's uncle did exactly that in 2008, moved to cash near the low, and waited for things to feel safe before going back. They never did feel safe, and by the time he returned the market had recovered most of the fall without him.

The defences above exist precisely so that this decision never has to be made under stress. A cash bucket means the next two years of spending are already funded and the falling balance is not an emergency. A pre-agreed spending rule means the discretionary trim is a plan being executed rather than a panic. Neither requires you to predict anything.

If you take one thing from this: decide now, while calm, what you will do if the portfolio falls 30% in your first year of retirement. Write it down. The decision made in advance is almost always better than the one made in March of a bad year, and the whole of sequencing-risk management is really about ensuring the second kind of decision never needs to be made.

The prior question — whether you are at the point of retiring at all, and what the years either side of that decision look like — is worked through in When Can I Retire in Australia.

The full decision is in Longevity Risk: Will Your Money Last as Long as You Do.

Source: ASIC Moneysmart — Retirement income

07 The same fall, at four different times

Sequencing risk is easiest to see by holding everything constant except when the bad year lands.

Only the third row is sequencing risk proper, and it occupies a window of perhaps five years. Everything in this post is about getting through that window without being forced to sell.

Source: ASIC Moneysmart — Retirement income