Sequencing risk: what is it and how to safeguard against it

Many retirees and soon-to-be retirees share a familiar concern: the risk that investment markets might take a tumble. The good news is that with the right strategies in place, investors can lessen the impact of market downturns, while still taking advantage of market growth. We explain how to best protect and grow your superannuation savings.

If you’ve lived through investment history’s “greatest hits”—the COVID-19 crash in 2020, the 2008 Global Financial Crisis, the 2000 Dot com crash and 1987’s Black Monday—you’ve seen markets fall. And you’ve seen them bounce back again.

However, when a market downturn strikes close to, or in, early retirement, investment losses can have an outsized impact. This is because, when you withdraw money to cover living expenses, losses get locked in, reducing your capital base. With less capital, there is less scope for recovery. In contrast to younger investors who can wait for markets to recover, at this stage of life a deep loss can be consequential.

Sequencing risk is about timing. If the market falls later in retirement, you’ve likely already benefited from years of market growth and there are fewer years of spending ahead, so the effects are less damaging.

So what’s the answer? When we can’t anticipate the future, it can be tempting to switch into cash or term deposits. The risk here is that switching too much of a portfolio too early can lead to regret. A typical retirement could span two or more decades—and that’s a lot of investment market upside to miss out on.

Four strategies that may help manage sequencing risk

The good news is that by putting the right strategies in place, you may cushion the effects of market volatility without missing out on market returns. Here are four alternatives for participating in market growth while also defending against market downturns.

Set a bucket strategy

Set aside the income you’ll need to live on in the first two to five years of retirement in a low-risk investment “bucket”. With your short-term spending needs secured, the remainder of your portfolio can stay invested in investment markets.

That way, if you experience a market downturn early in your retirement, your portfolio may have more time to recover, taking into account your broader retirement strategy and the performance of investment markets.
Maintain a cash reserve throughout retirement

Keeping aside six to 24 months of living expenses in cash or term deposits means you won’t need to sell investments if the market drops. This approach puts aside what you need for short-term spending while allowing long-term investments to grow over time.
Adopt a more conservative pre- and early-retirement investment mix

As retirement approaches, one option is to gradually reduce your exposure to higher-risk assets, thereby softening the impact of market swings and creating a smoother transition into the drawdown phase.

You may have seen lifecycle or age-based superannuation investment options that automate this shift by progressively moving members into more defensive investments as they near retirement. Note that a more conservative investment mix may reduce volatility but can also reduce long-term growth potential.
Consider annuities, deferred annuities and other options that offer downside protection

Products such as annuities, deferred annuities and other income solutions can provide a stable income regardless of market conditions. By locking in a portion of your retirement income, you may be able to reduce your exposure to market downturns.

Some of these products even allow you to access investment market growth. Because features vary by product and provider, always read the relevant disclosure documents. And if you’re concerned about running out of money, deferred annuities allow you to secure an income stream for later in life.

These protective products can be particularly helpful when used strategically alongside market-linked investments, such as an allocated pension. That way a retiree’s portfolio can provide income certainty as well as flexibility and growth exposure.

How your Count Financial adviser can help

As always, you should seek personal advice before acting on articles such as this one. Talk to your Count Financial adviser about how a personalised retirement plan can best protect your retirement savings against sequencing risk. Your adviser will be able to discuss your options and recommend an investment approach that’s right for your situation.