Sequence Risk: A Market Crash Just Before You Retire

01 What sequence risk actually is

Sequence-of-returns risk is the risk that the order of your returns, not just their average, decides whether the money lasts. While you're saving, order barely matters — a crash early just means you buy cheaply for years afterwards, and the final figure depends mostly on the average. The moment you start drawing an income, that symmetry breaks. Now a fall early on forces you to sell more units to fund the same spending, and those units are gone before the recovery arrives. The same average return, delivered worst-years-first instead of best-years-first, can be the difference between dying rich and running dry.

The standard advice to ignore market falls is repeated to retirees, and for them it is wrong. An accumulator can genuinely ignore a drop because nothing is being sold; a retiree cannot decline to withdraw, so the units funding this year's income are sold at the low whether or not anyone looks at the statement.

Source: MoneyHelper — Income drawdown

02 Why withdrawing changes everything

The mechanism is simple and unforgiving. Suppose your pot falls 30%.

If you are still working you do nothing. You keep contributing, buying at the lower price, and you have years for the rebound — the fall is an opportunity you are automatically taking advantage of every payday.

If you are retired and need £25,000 this year, you must sell assets that are 30% cheaper to raise it. You crystallise part of the loss, and you sell about 43% more units than you would have needed at the old price. Those units are permanently gone from the pot, so when the market recovers, it recovers on a smaller base.

That is the whole of sequence risk in one sentence: withdrawing converts a temporary paper loss into a permanent capital loss, and the deeper the fall, the more units each pound of income costs you.

It also explains why the effect is asymmetric in time. The same 30% fall in the final years of a retirement hits a smaller pot with fewer years left to fund, so the number of units permanently lost is much lower. Identical markets, identical portfolio, radically different outcome — decided by nothing more than when it happened.

03 Same average, two outcomes

The tool below makes the point concrete. It runs two identical retirees over ten years — same starting pot, same £25,000 income, same set of returns — and changes only when the crash lands: in year one, or in year ten. The average return is identical; only the order differs. Watch the early-crash pot fall behind and never catch up.

Source: GOV.UK — Plan your retirement income

04 The retirement risk zone

Sequence risk is not spread evenly across a retirement. It is concentrated in the decade either side of the day you stop earning — the retirement risk zone.

Before that decade, a fall is recoverable because you are still adding money and buying at lower prices. After it, the pot is smaller and there are fewer years left to fund, so a fall does proportionally less damage. In the middle, the pot is at its largest it will ever be and you have just started drawing on it, which is the worst possible combination.

That concentration is useful, because it means the defences only have to be strongest for a bounded period rather than for thirty years. Holding a larger cash buffer and a slightly lower equity weighting from about five years before retirement to five years after covers most of the exposure, and both can be relaxed afterwards.

Do not de-risk to zero, though. Going all-cash at retirement to dodge sequence risk hands you directly to inflation and longevity risk, which destroy a thirty-year retirement just as reliably and far more predictably. A pot earning nothing real while funding thirty years of rising costs is not a conservative plan; it is a different failure with a longer fuse.

The fix is a buffer plus growth assets held through the zone — not the elimination of equities from a portfolio that still has decades of work to do.

05 Defusing it: the cash buffer and guaranteed income

The most effective defence is to stop being a forced seller in a downturn, and two tools do most of that work.

A cash buffer of one to three years of essential spending, held in cash or short-dated bonds, means that after a crash you spend the buffer and leave the equities alone to recover rather than selling them cheap. The cost is the return forgone on that cash, which is real but small against what it protects.

Guaranteed income does the same job structurally rather than tactically. Every pound of essential spending covered by the State Pension, a defined-benefit pension or an annuity is a pound you never have to raise by selling anything — so a retiree whose essentials are fully covered by guaranteed income has, in effect, no sequence risk on their essential spending at all. Only the discretionary layer is exposed.

The two combine well. Guaranteed income sets a floor that markets cannot remove; the buffer handles the discretionary spending above that floor through the years the floor does not cover. Someone retiring at 60 with a State Pension at 67 has a seven-year window where the buffer is doing all of the work, which is exactly the window where sequence risk is highest.

Both need to be in place before the downturn. A buffer built after a crash is funded by selling at the bottom, which is the thing it existed to prevent.

06 A flexible withdrawal rule

The final layer is how you withdraw, and it is the cheapest of the three because it costs nothing to set up.

Taking a rigid fixed sum come what may is what turns a bad sequence into a disaster: you keep selling the same number of pounds' worth of units no matter how cheap they have become, and you do it every year the market is down.

A flexible rule breaks that. The simplest version is skipping the inflation increase after a year in which the portfolio fell — you keep the same cash income, which is a real-terms trim of two or three percent, and the pot notices immediately. A stronger version uses guardrails: if the withdrawal rate rises above a set level because the pot has fallen, the withdrawal is cut by a fixed percentage until it comes back inside the band.

The evidence on this is consistent: modest flexibility, applied early, does more for the survival of a portfolio than a materially lower starting withdrawal rate. A retiree willing to trim 10% of spending in bad years can start meaningfully higher than one who is not.

The condition is that the rule must be agreed in advance. Deciding to cut spending during a crash, while watching the balance fall, is a decision almost nobody makes well — which is why writing it down at 60 is worth more than any amount of resolve at 63.

07 Three defences, and what each one costs

They address the same risk at different points and are worth stacking rather than choosing between.

The last row is included because it is the most common instinctive response and the only one that makes things worse. Over thirty years, inflation is not a smaller risk than a crash; it is a larger one, and it arrives with certainty.

Source: MoneyHelper — Options for using your pension pot