Sequencing risk explained (and how to avoid it)

There are ways to soften the blow. Keeping a few years’ spending in cash can buy you time to ride out downturns, though it means missing out on gains when markets roar. A 60/40 mix of shares and bonds can smooth the bumps but usually grows more slowly overall. Cutting your spending after a crash can make your pot last longer, and an annuity can turn part of your savings into a guaranteed income — at the cost of flexibility.

In this guide, we’ll look at how each of these strategies plays out in practice – running simple simulations to show what happens when the market crashes early or late in retirement.

The question is: can any of them really protect you from bad luck with timing, or just make the fall a little softer?

What is sequencing risk?

Professional Paraplanner defines it as "the risk posed by an unfavourable sequence of returns... it reflects the idea that, even where average returns over the period may be identical, a poor run of returns early on followed by a good run will produce a worse outcome than the reverse".

Sequencing risk is sometimes dubbed "pound-cost ravaging," because it forces you to sell at rock-bottom prices, eating away at the very base your future growth depends on.

Take a simple example.

Two retirees start with £1 million. Each takes £50,000 a year, rising by three percent to match inflation. Retiree A hits a 25% market crash in year one. Retiree B enjoys 15 smooth years of seven percent annual gains before facing the same 25% slump.

The results couldn't be more different.

Year	Retiree A	Retiree B
1	£712,500	£1,016,500
2	£707,270	£1,032,550
3	£700,021	£1,048,070
4	£690,561	£1,062,974
5	£678,686	£1,077,168
6	£664,173	£1,090,548
7	£646,783	£1,103,005
8	£626,260	£1,114,417
9	£602,326	£1,124,654
10	£574,683	£1,133,575
11	£543,011	£1,141,025
12	£506,966	£1,146,841
13	£466,175	£1,150,841
14	£420,241	£1,152,833
15	£368,734	£1,152,608
16	£311,194	£806,032
17	£247,126	£776,603
18	£175,997	£742,538
19	£97,237	£703,435
20	£10,231	£658,863
21	£0	£608,357
22	£0	£551,416
23	£0	£487,503
24	£0	£416,042
25	£0	£336,410

Retiree A is broke in year 21. Retiree B still has £608,357 left. And remember: both saw exactly the same average returns overall. The difference was timing.

Early losses bite harder because you're forced to sell more when prices are low, shrinking the pot that drives future growth.

Strategies to mitigate sequencing risk

It's a grim thought: two people save just as diligently, yet one ends up comfortable while the other is strapped for cash, all because of market crashes landing at the wrong moment.

There are practical levers you can pull to wrest some control back from the market's indifferent hand, although each one has its own drawbacks.

Keep a cash buffer

Here's the idea: split your retirement pot into two jobs:

• Cash bucket: five years of spending in cash or short-term bonds.
• Long bucket: growth assets left to compound for later.

The good bit is obvious: if markets tank, you don't have to sell shares at knock-down prices just to pay the heating bill. You live off the cash while waiting for the rebound.

But there is (of course) a cost. Cash and short bonds don't grow much.

If markets roar during your early retirement, your buffer sits idle while Retiree B (from our example above) enjoys a compounding bonanza.

In effect, the bucket strategy places you somewhere between Retiree A (crash early, broke fast) and Retiree B (boom early, comfortable later). You blunt the worst outcomes, but you also dull the best.

Let's run a simple simulation.

Retirees A and B are back, with the same ground rules: £50,000 a year in spending, rising three percent with inflation. Markets grow seven percent a year, except for one brutal 25% crash (think Covid). For Retiree A, the crash comes in year one. For Retiree B, it lands in year 16.

Now meet Retiree C. He faces the same year-one crash as A, but uses the cash-bucket strategy. He sets aside five years of living costs in cash at the start. That money earns nothing, but it means he doesn't have to sell shares in the middle of a crash. His investments get time to recover before he starts drawing them down.

The result is not massively encouraging: Retiree A is broke by year 21, while Retiree C, cushioned by his cash buffer during the market crash, holds on for about one year longer.

Year	Retiree A (crash early, no strategy)	Retiree B (crash late, no strategy)	Retiree C (crash early, cash buffer)	Retiree D (crash late, cash buffer)
1	£712,500	£1,016,500	£550,907	£785,961
2	£707,270	£1,032,550	£589,471	£840,979
3	£700,021	£1,048,070	£630,734	£899,847
4	£690,561	£1,062,974	£674,885	£962,836
5	£678,686	£1,077,168	£722,127	£1,030,235
6	£664,173	£1,090,548	£710,655	£1,040,330
7	£646,783	£1,103,005	£696,519	£1,049,271
8	£626,260	£1,114,417	£679,477	£1,056,922
9	£602,326	£1,124,654	£659,268	£1,063,135
10	£574,683	£1,133,575	£635,612	£1,067,749
11	£543,011	£1,141,025	£608,205	£1,070,591
12	£506,966	£1,146,841	£576,723	£1,071,476
13	£466,175	£1,150,841	£540,815	£1,070,201
14	£420,241	£1,152,833	£500,106	£1,066,549
15	£368,734	£1,152,608	£454,190	£1,060,284
16	£311,194	£806,032	£402,632	£736,789
17	£247,126	£776,603	£344,964	£702,513
18	£175,997	£742,538	£280,684	£663,261
19	£97,237	£703,435	£209,252	£618,609
20	£10,231	£658,863	£130,087	£568,099
21	£0	£608,357	£42,566	£511,239
22	£0	£551,416	£0	£447,500
23	£0	£487,503	£0	£376,314
24	£0	£416,042	£0	£297,069
25	£0	£336,410	£0	£209,109

We've also added Retiree D to the analysis. Like Retiree C, he set aside five years of spending in cash at the start, but his market crash didn't come until year 16.

That meant his investments grew steadily for the first decade and a half, then took the same 25% hit as Retiree B. By year 25, Retiree D still has about £209,000 left, compared with Retiree B's £336,000.

The difference shows the cost of keeping money out of the market: the cash buffer smooths the ride but trims down what's left at the end.

(For C and D, the figures shown in years one to five are the invested pot only. The separate five-year cash bucket is spent down at zero interest and is not included in those entries.)

Diversify across asset classes

When markets tumble, it's nice if at least something in your portfolio isn't plummeting in sympathy; it's even better if you can find something that will buck the Eeyore energy altogether and manage to rally.

Diversification is basically the art of not having all your money screaming at once. Shares might be throwing themselves off a cliff, but bonds and cash are often the quiet, sensible types – sitting having a quiet brew while everything goes to hell in a handbag.

Let's test how much difference that really makes.

We'll keep the same retiree setup: £1 million pot, £50,000 a year in spending rising three percent with inflation, and withdrawals at the start of each year. Markets grow an average of seven percent, except for one bruising crash.

Two portfolios enter the ring:

• 100% equities, which soar seven percent in good years but plunge 25% in a crash.
• 60/40 split (shares and bonds), earning 5.2% in normal years (a blend of seven percent for equities and 2.5% for bonds) and losing 17% in the crash, because bonds tend to rally a little when investors flee shares.

The crash hits in year one for the unlucky retiree and in year 16 for the lucky one.

Year	A (100% shares, crash early)	B (100% shares, crash late)	E (60/40, crash early)	F (60/40, crash late)
1	£712,500	£1,016,500	£788,500	£999,400
5	£678,686	£1,077,168	£721,247	£979,556
10	£574,683	£1,133,576	£571,184	£904,011
15	£368,734	£1,152,608	£320,789	£749,631
20	£10,231	£658,863	£0	£301,941
21	£0	£608,357	£0	£222,641
25	£0	£336,410	£0	£0

Running the numbers, we find that Retiree E (the cautious 60/40 investor) takes a softer hit when markets tank straight out of the gate.

In year one, his pot slides from £1 million to £788,500, compared with £712,500 for poor Retiree A, who went all-in on shares. Bonds give E a bit of padding, saving him from the full whiplash of a market crash.

But over time, that padding starts to feel heavy. Because E's portfolio grows more slowly in the good years, the gap between the two narrows until, by year 21, both have spent down to zero.

The safety net helped Retiree E early on, but in the end E actually runs out in year 20 and A in year 21.

Meanwhile, our luckier pair, Retiree F (60/40) and Retiree B (100% shares), don't face a crash until year 16. Here, the all-equity investor finishes with over £330,000, while F's more cautious mix is drained by year 25. The bonds that were meant to protect him act like a speed limiter.

None of this should be surprising. After all, that's exactly what diversification is supposed to do: it dampens the bad years, but it also dulls the good ones.

Use dynamic withdrawal strategies

If you can't boss the market around, you can at least fiddle with the tap.

Dynamic withdrawal rules are about turning that tap down after rough years and letting it gush a little more when things go well. It's a way of avoiding the classic mistake of selling too much when prices are at their ugliest.

Let's test a simple version.

• Baseline spending: £50,000 in year one, rising three percent with inflation.
• After a crash: cut spending to £40,000 (inflation-linked) for the remainder of their retirement.

Same set-up as before: seven percent growth most years, one ugly -25% year.

• Retiree A: crash in year one, fixed £50,000 rule.
• Retiree B: crash in year 16, fixed £50,000 rule.
• Retiree G: crash in year one, follows the dynamic rule.
• Retiree H: crash in year 16, follows the dynamic rule.

Year	Retiree A (fixed, early crash)	Retiree B (fixed, late crash)	Retiree G (dynamic, early crash)	Retiree H (dynamic, late crash)
1	£712,500	£1,016,500	£720,000	£1,016,500
5	£678,686	£1,077,168	£739,568	£1,077,168
10	£574,683	£1,133,575	£735,515	£1,133,575
15	£368,734	£1,152,608	£681,767	£1,152,608
16	£311,194	£806,032	£662,810	£817,717
20	£10,231	£658,863	£550,664	£753,716
21	£0	£608,357	£511,909	£729,174
25	£0	£336,410	£302,191	£586,982

Early crash (A vs G): When markets collapse straight out of the gate, Retiree G's strategy (cutting spending from £50,000 to £40,000 after the crash) makes a world of difference.

His pot drops to £720,000 in the first year, but then it steadies, growing gradually over time. By year 25, he still has £302,000 left. Retiree A, who kept spending the same as before, runs out of money by year 21.

Late crash (B vs H): Retiree H doesn't face trouble until year 16, after enjoying years of good returns. Once the crash hits, he also drops to £40,000 spending. Retiree H still has nearly £600,000 by year 25, compared with Retiree B's £336,000 under a fixed withdrawal plan.

If you think of a strategy as something you carefully plan, weighing every move like a chess grandmaster, the dynamic withdrawal approach doesn't quite fit the mould.

It's not strategy so much as instinct – the financial equivalent of slamming the brakes when you see the edge of the cliff looming.

And under the simple assumptions we've used here, it turns out to be remarkably effective at preventing your golden years from being described as such only because of the glow from the burning wreckage of an early pension meltdown.

Consider annuities or guaranteed income

There comes a point where even the most battle-hardened investor wants someone else to do the worrying.

Fortunately, there is an escape button: buying an annuity.

That's when you hand an insurer part of your pot and, in exchange, they promise a paycheque for life.

You might very well end up withdrawing less overall from the annuity than if you'd kept the lump sum (that's what the insurer's banking on... no toasts to your long life from them), but it gives you peace of mind: you'll never run out of money, whatever the markets or your lifespan throw at you.

Let's simulate this scenario.

Retiree I buys a £250,000 inflation-adjusted lifetime annuity paying £13,000 a year, then invests the remaining £750,000, withdrawing £37,000 a year (rising three percent with inflation). Retiree J does the same but hits their crash later in retirement.

As before, Retiree A and B keep the full £1 million invested and withdraw £50,000 a year rising with inflation. Markets grow seven percent annually with the exception of the crash year when they tank 25%.

Year	Retiree A (fixed, early crash)	Retiree B (fixed, late crash)	Retiree I (annuity, early crash)	Retiree J (annuity, late crash)
1	£712,500	£1,016,500	£534,750	£762,910
5	£678,686	£1,077,168	£512,059	£811,130
10	£574,683	£1,133,575	£439,054	£858,517
15	£368,734	£1,152,608	£292,202	£880,520
16	£311,194	£806,032	£250,976	£617,157
20	£10,231	£658,863	£34,695	£514,683
21	£0	£608,357	£0	£479,207

Early crash (A vs I): Retiree I starts with less invested, but the trade-off works in his favour. The annuity reduces how much he needs to draw from the market each year (£37k instead of £50k) and the guaranteed £13k fills the gap.

When the crash hits in year one, his invested pot falls just like A's, yet his income never wobbles. Even when the investment side eventually runs dry, the annuity keeps paying for the very basics.

Late crash (B vs J): Retiree J enjoys a long run of growth before his crash in year 16. By splitting his pot, he gives up some upside but gains calm. He finishes with around £479,000 invested plus the £13,000 lifetime income, while B ends up with £608,000 but no guaranteed payments if markets turn again.

Note for sticklers: It's worth mentioning that £250,000 for an inflation-linked annuity paying £13,000 a year is probably on the optimistic side. Retiree I's outcome would have been significantly weaker under the same assumptions if the annuity payout had been smaller. The annuity rate you get in reality depends on your age, health, options (single/joint, guarantee periods), and market yields.

Bottom line

All of these examples are just that – examples. The numbers shift dramatically depending on the assumptions: the size of the crash, inflation, growth rates, and how long you live. But the principles they highlight are real and worth keeping in mind.

Every strategy that reduces sequencing risk does so by giving something up.

A cash buffer buys peace of mind but leaves money on the sidelines. A 60/40 portfolio trades upside for stability. An annuity swaps flexibility for certainty. And dynamic withdrawal rules protect you from disaster, but only if you can stomach tightening your belt when markets fall.

The right balance between risk, return, and security depends on your goals, health, and of course your tolerance for seeing your pot shrink on paper. Professional advice is your best move if you want to find the ideal mix that keeps you steady (financially and emotionally) if markets decide to take a tumble just as you're hanging up your worksuit and preparing for a well-earned retirement.

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