Sequence of returns risk: why the first years of retirement matter most

While you are saving, the order in which good and bad years arrive makes little difference to where you end up. Once you start withdrawing, it matters a great deal. Sequence of returns risk is the danger that poor returns arrive early in retirement, when your pot is largest and your withdrawals have the longest to compound against you.

A worked example

Take two retirees, each with £500,000, each withdrawing £25,000 a year. Over 20 years both experience exactly the same set of annual returns, with the same average. The only difference is the order. The first meets the bad years at the start and the good years at the end. The second gets the reverse.

The first retiree is forced to sell investments at low prices to fund spending. Those units are gone and cannot take part in the recovery. Their pot can run dry years before the second retiree’s, who may finish with more than they started. Same returns, same average, very different retirements.

Why averages hide the problem

A projection that applies a steady 5% a year treats every sequence as identical. It will never show a plan failing because of bad timing. This is the main reason a single growth-rate forecast can look comfortable while the underlying plan is fragile.

Four ways to reduce the risk

• Hold a spending reserve: keep the next few years of spending in cash or short-dated gilts so you are not a forced seller of shares after a fall.
• Build a gilt ladder: secure a run of early retirement years with bonds that mature when the money is needed.
• Spend flexibly: skipping an inflation rise, or trimming discretionary spending after a poor year, materially improves how long a pot lasts.
• Reduce risk around retirement, not only before it: the years just before and just after you stop work are when a fall does the most damage.

How to see it in your own plan

Two tools make sequence risk visible. A Monte Carlo simulation runs your plan through many different orderings of returns and reports how often it survives. A stress test asks a blunter question: what if a fall like 2008 arrives in your first year of retirement? If the plan still works, you have a margin of safety. If it does not, you know what to change while there is still time.

This article is general information, not financial advice. Projections are illustrative and capital is at risk.