Sequencing risk: why the first years of retirement decide whether your money lasts

WORDS: Ocean Road Editorial Staff PHOTOGRAPHY Pexels

You spent thirty years buying shares. You reinvested dividends, topped up on dips, and watched the number climb. Now you want that pile to pay you a wage for the rest of your life, and it turns out that job is harder than the one you just finished.

Accumulating is forgiving. If the market falls the year you turn 45, you keep buying and the recovery does the work for you. Drawing an income is not forgiving. Sell shares into a slump to cover your living costs and you crystallise the loss, then you own fewer units when prices come back. The order in which your returns arrive starts to matter as much as the average return itself. That is sequencing risk, and it is the single biggest threat to a self-funded retirement.

Why the first few years decide everything

Run two retirees with identical portfolios, identical average returns over 25 years, and identical withdrawals. Give one a rough first five years and a strong finish. Give the other a strong start and a rough finish. Same average, wildly different outcomes. The one who hit poor returns early can run out of money a decade before the one who got the good years first.

Once you see the mechanism it is obvious. When you take a fixed dollar amount out of a falling portfolio, that withdrawal is a bigger percentage of what is left. You are selling more units to raise the same cash, and those units are gone. They cannot participate in the recovery. A 30% drop in year two of retirement does damage that a 30% drop in year 20 simply does not, because in year two you are still drawing on that capital for another two decades.

You cannot control when the bad years come. You can control whether you are forced to sell into them.

The cash buffer, and how it actually works

The defence most self-directed retirees settle on is a cash buffer, sometimes called a bucket approach. You hold two to three years of spending money in cash and short-term term deposits, separate from your equity portfolio. When markets are up, you refill the buffer from portfolio gains and dividends. When markets fall, you stop selling shares and live off the cash instead, so your growth assets get time to recover before you touch them again.

Two years of buffer covers most ordinary corrections. Three years covers a proper bear market, which historically has taken roughly that long to claw back. It is not free: cash sitting on the sidelines earns less than shares over time, so a buffer that is too big is a drag on your long-run returns. That is the trade-off. You are paying a small amount of growth for the ability to never sell at the bottom. For a retiree, that insurance is usually worth the premium.

The buffer only works if you actually use it as designed. That means deciding, in advance and in writing, the rules: how many years of cash you hold, what triggers a pause on equity sales, and which assets you sell first when you do sell. Left to instinct, most people do the opposite of what the plan requires, selling shares in a panic and hoarding cash at the top.

How the drawdown gets built in a real system

The mechanics differ by country. The underlying problem does not. Once you stop contributing and start withdrawing, a bad first few years can lock in losses you never recover from, because you are selling units to fund income at exactly the wrong time. A cash buffer of two to three years of spending lets you pause withdrawals from equities during a downturn and live off cash instead, so the growth assets have room to recover. The Australian system shows one concrete version of this: retirees move super into a tax-free “pension phase” and draw from an account-based pension with legislated minimum withdrawal rates, and Solace Financial’s guide to managing the drawdown phase of retirement walks through how those minimums, the Age Pension asset and income tests and a cash buffer fit together. The specifics are local, but the principle travels: decide in advance which assets you sell first, and never let a falling market dictate the order.

A few features of that system are worth understanding even if you invest elsewhere, because they show the kind of constraints a drawdown plan has to absorb.

Once superannuation moves into pension phase, the earnings inside it are untaxed, which changes the maths on which account you draw from first. But you are not free to leave the money untouched. An account-based pension carries a legislated minimum you must withdraw each year, starting at 4% of the balance for someone in their sixties and stepping up with age. In a down market, that forced minimum can push you to sell shares at exactly the moment your buffer exists to prevent. The fix is to hold that minimum withdrawal as cash inside the pension account, so the mandatory draw comes out of cash rather than equities.

Then there is the means-tested state pension. Eligibility for Australia’s Age Pension is governed by both an assets test and an income test, with thresholds that shift each year. Drawing down your own capital can, over time, lift your entitlement to the government payment, which becomes part of the income plan rather than an afterthought. A retiree who ignores those tests can leave real money on the table, or trip a threshold they did not know was there.

You do not need to memorise another country’s rules. The point is that a working drawdown plan is more than “hold some cash.” It has to reconcile mandatory withdrawals, the tax treatment of different accounts, any means-tested benefits, and the timing of every sale, all while protecting you from selling into a downturn.

Building your own order of sale

Whatever system you retire under, write down the sequence before you need it.

Decide which assets you sell first in a normal year and which you sell in a bad one. Then decide which holdings you never sell unless everything else is exhausted. A common structure draws cash first, income-producing assets and bonds next, and your core equity holdings only as a last resort. The buffer sits at the front so that a market fall never reaches the shares.

Set the withdrawal rate honestly. The old 4% rule of thumb was built on specific historical returns and a 30-year horizon, and plenty of researchers now argue it is too high for a longer retirement or a lower-return decade. Treat it as a starting point to stress-test, not a guarantee. If a couple of bad early years would blow up your plan at 4.5%, that tells you the rate is too aggressive.

Review the buffer once a year, not once a week. Refill it in good years. Let it run down in bad ones. The whole design assumes you will sit still when markets fall, which is the hardest part, because every instinct you built as an accumulator told you to act.

The portfolio that got you here was built to grow. The one that carries you through retirement is built to be drawn on without forcing your hand. Get the order of sale right and the market can do what it likes early on, because you are not selling into it.