← Back to WDA Insights

One of the most common questions I hear from clients approaching retirement is deceptively simple: "How much do I need?" The answer, of course, depends on a range of factors — lifestyle expectations, health, Age Pension eligibility, housing costs, and how long your money needs to last. But there is one factor that is often overlooked and yet can be the single greatest determinant of whether your money outlasts you or runs out too early: the order in which investment returns occur.

This is sequencing risk. It is the risk that poor investment returns in the early years of retirement — precisely when you are drawing down on your portfolio — will permanently impair your retirement income, even if long-term average returns are perfectly acceptable. Understanding this risk, and building a strategy to manage it, is one of the most important things you can do before you retire.

What Is Sequencing Risk?

During the accumulation phase — your working years — the order of investment returns does not materially affect your final balance. If you invest $100,000 and earn returns of +20%, -15%, and +10% over three years, you end up with the same result regardless of the order those returns occur, provided you are not making withdrawals.

In retirement, this changes fundamentally. When you are drawing a regular income from your portfolio, negative returns in the early years force you to sell more units or assets at depressed prices to fund your withdrawals. Those units are gone permanently. When markets recover, you have fewer units to benefit from the rebound. The damage compounds over time.

The Mathematics of Sequencing Risk

Consider two retirees who both start with $800,000 and draw $50,000 per year. Retiree A experiences strong returns in years 1-5 and poor returns in years 6-10. Retiree B experiences the same returns but in reverse order. After 10 years, Retiree A has $620,000 remaining. Retiree B has just $410,000 — despite both experiencing identical average returns over the decade. That $210,000 difference is entirely due to the sequence of returns.

Why the First Five Years Matter Most

Research consistently shows that the first five to seven years of retirement are the period of greatest vulnerability to sequencing risk. This is when your portfolio is at its largest in absolute dollar terms, and withdrawals as a percentage of the declining balance have the greatest erosive effect.

A 20% market decline in year one of retirement, combined with a $50,000 withdrawal, reduces an $800,000 portfolio to $590,000 — a 26% reduction in real terms. To recover to $800,000, the portfolio now needs to generate a 35.6% return (after the next year's withdrawal). That is an enormous hurdle.

By contrast, the same 20% decline in year fifteen of retirement — when the portfolio has already been drawn down to, say, $400,000 — reduces the balance to $270,000. While still painful, the absolute dollar impact is smaller, and the retiree has already enjoyed fourteen years of income.

"You cannot control market returns. But you can control how your portfolio is structured to withstand poor returns at the worst possible time. That is what a drawdown strategy is for."

Sustainable Withdrawal Rates: The 4% Rule and Its Limitations

The "4% rule" — derived from William Bengen's 1994 research in the United States — suggests that a retiree can withdraw 4% of their initial portfolio balance annually (adjusted for inflation) with a high probability of the portfolio lasting 30 years. This rule has become a widely cited benchmark, but it has important limitations in an Australian context.

Why 4% may not be the right number for you

Key Point

Rather than relying on a single withdrawal rate, a well-structured drawdown strategy should be dynamic — adjusting withdrawals based on portfolio performance, Age Pension entitlements, and changing lifestyle needs over time. A rigid percentage applied indefinitely does not account for the reality of how retirement actually unfolds.

The Bucket Strategy: A Practical Framework

One of the most effective approaches to managing sequencing risk is the bucket strategy. This framework divides your retirement portfolio into separate "buckets" based on the time horizon for when the money will be needed.

Bucket 1: Cash and near-cash (Years 1-2)

This bucket holds 18 to 24 months of living expenses in cash or cash equivalents — high-interest savings accounts, term deposits, or short-term money market instruments. This is the bucket you draw your income from. Its purpose is to provide certainty: regardless of what markets do, you know your next two years of income is secure and will not be affected by market volatility.

Bucket 2: Defensive assets (Years 3-5)

This bucket holds three to five years of living expenses in defensive assets — high-quality fixed interest, government bonds, and other income-generating investments with relatively low volatility. As Bucket 1 is depleted, assets from Bucket 2 are periodically moved across to replenish it. This bucket provides a buffer that allows you to avoid selling growth assets during a downturn.

Bucket 3: Growth assets (Years 6+)

This bucket holds the remainder of the portfolio in growth assets — Australian and international equities, property, infrastructure, and other assets with higher expected long-term returns. Because this bucket will not be drawn upon for at least five to seven years, it has time to recover from market downturns before being called upon. The longer time horizon justifies the higher volatility.

Bucket Strategy in Practice

For a retiree with $900,000 drawing $55,000 per year: Bucket 1 holds $110,000 (2 years of income) in cash. Bucket 2 holds $165,000 (3 years of income) in bonds and fixed interest. Bucket 3 holds $625,000 in a diversified growth portfolio. Even if Bucket 3 experiences a 30% decline, the retiree has five years of secured income to wait for recovery.

Asset Allocation in Retirement: Getting the Balance Right

A common mistake retirees make is shifting their entire portfolio to conservative assets at the point of retirement. While this feels intuitively safe, it introduces a different risk: the risk that your portfolio does not generate sufficient returns to sustain withdrawals over a 25 to 30-year retirement.

At current rates, a portfolio invested entirely in cash and term deposits might generate 4% to 5% per annum before tax. After drawing an income and accounting for inflation, the real return is negligible or negative. Over 25 years, this means your purchasing power steadily erodes.

The solution is not to avoid growth assets entirely, but to manage the timing of when you rely on them. This is precisely what the bucket strategy achieves. By quarantining near-term income needs in defensive assets, you give your growth assets the time they need to deliver the returns that will sustain your portfolio over the long term.

A typical retirement asset allocation might look like:

These are indicative ranges only. The right allocation depends on your total balance, income needs, Age Pension eligibility, risk tolerance, and health circumstances.

Protecting Against Early Losses: Practical Steps

Beyond the bucket strategy, there are several additional measures that can help protect against sequencing risk:

  1. Flexible spending: Building some discretionary spending into your budget allows you to reduce withdrawals in years of poor market performance. Even a 10-15% reduction in spending for one or two years can significantly improve long-term portfolio sustainability
  2. Part-time work: Earning even a modest income in the first two to three years of retirement reduces the drawdown on your portfolio during its most vulnerable period. $20,000 per year in part-time earnings is $20,000 less you need to withdraw
  3. Age Pension planning: Understanding when and how the Age Pension will supplement your income allows you to plan withdrawals more strategically. Many retirees become eligible for a partial pension as their assets draw down, which provides a natural floor under their income
  4. Annuity allocation: For clients who want guaranteed income regardless of market performance, allocating a portion of the portfolio to a lifetime annuity can provide certainty for essential expenses while allowing the remainder to be invested for growth
  5. Regular rebalancing: Systematically rebalancing between buckets — moving gains from growth assets into defensive assets when markets are strong — ensures the defensive buffer is maintained without the need to sell during downturns

The Bottom Line

Sequencing risk is not theoretical. It is the reason some retirees with identical starting balances and identical average returns end up with vastly different outcomes. The difference is not luck — it is whether they had a structured drawdown strategy in place to manage the order in which those returns occurred.

The transition from accumulating wealth to drawing it down is the most significant financial shift most people will experience. It requires a fundamentally different approach to investment, risk, and income planning. A well-designed drawdown strategy does not guarantee perfect outcomes, but it does provide resilience against the scenarios that cause the greatest harm.

If you are within five years of retirement, or have recently retired without a formal drawdown strategy in place, this is something that warrants careful attention. The structure you put in place today will determine how well your portfolio serves you for the next two to three decades.

General Advice Disclaimer

This article contains general information only and does not take into account your personal financial situation, objectives, or needs. Before acting on any information, you should consider its appropriateness having regard to your own circumstances and seek professional financial advice. Wealth Designers Advisory Pty Ltd (ABN 65 652 475 886, AFSL 562647).