Can the sequence of investment returns ruin retirement?

Not a fan of the bucket approach as Super is a long term asset even at the point of retirement (hopefully over 7 years to go!). Dividends should generally provide cash for the relevant % drawdowns and sure in bad market times a conservative bucket will shield a portion of the capital but then the opportunity costs on that conservative bucket will be a lot greater than those losses when investing over the long haul. IMO.

Check any chart over more than 7 years and growth risk investment will win regardless of the start date. Then at the end of the day if your assets go down too much then the pension will be the "reward"! Once in that pension range, if you can't get a return of over 7.2% then you may as well spend enough of it and get the indexed pension in full.

You didn’t go back far enough. Look from the the end of the 60’s to the early 80’s

Thanks for your comments Mark. The question on whether bucketing is a useful way of managing sequencing risk is an interesting one. It generally reduce your overall allocation to growth assets which means you are typically less impacted by market ups and downs and the sequence of returns, it also means you may give up the potential of stronger long-term returns. Like everything in investing - no free lunches and there are trade-offs to accept! However, bucketing does a good job of managing many investors' behavioural biases (mainly loss aversion). I plan to write a follow-up article exploring this exact issue.

"a string of negative returns early on in retirement can significantly impact how long your money will last"
Sequence of returns makes NO difference IF withdrawals are a constant PROPORTION of returns.
Sequence of returns DOES make a difference IF withdrawals are NOT a constant PROPORTION of returns.

You beat me to it Dudley. I sometimes despair at the academic twaddle sometimes presented. Of course drawing $200k from a fund with just over $700k has a bigger negative impact than the same $200k from a fund with just over $1m. Further using a simple balanced fund means funds are being withdrawn from both the cash/FI component and the growth component. Using a "bucket" strategy and trying to withdraw pension payments from the cash portion leaves the "growth" component intact to recover. So, if you can, try to withdraw primarily from a cash fund (send all dividends/interest into this fund) and further, try to keep withdrawls at a percentage of the overall balance - if the balance falls, spend less. Small business owners, farmers and self-employed people do this as a matter of course. Retirees need to adopt as well. No-one can develop a spreadsheet that will say how much money you will have for the rest of your life as future returns are never certain, just worry about the next 12-36 months, and then revisit and adjust if needed. A simple 60/40 balance can still provide around 4-5% cashflow, worse places to start, particularly when markets seem stretched.

You are both right to some extent but for most people they need their income from super to live on and the government (rightly) mandates minimum withdrawals so simply saying live on a fixed percentage of your returns is not possible for many people. I concede the government did reduce the minimum drawdowns during the GFC and COVID but even withdrawing 2% a year along with a few years of negative returns is not great when you first retire.

I agree a bucket strategy mitigates sequencing risk significantly and I favour 3 years income in cash to draw down for my income stream. This is topped up from the returns from growth assets in the good years.

I accept the authors point that sequencing risk is real for a great many people who perhaps aren’t always as financially literate as Firstlinks readers.

I have read about the buckets strategy and in principal makes sense. However, when you get to the details on how and when to refill the buckets, it looks very similar to market timing. I also recall articles telling that the difference in performance with straight withdrawals was either neutral or even negative. It would be good though, if the government would allow in general to reduce mandatory withdrawals during very large downturns.

I find it amazing how universally agreed market timing is bad is accepted (its time in the market not timing the market), and yet the same people will argue that active fund managers produce better returns.

What do active fund managers do? They select stocks that are undervalued AT A PARTICULAR TIME. In other words active fund managers are MARKET TIMERS, and yet at the same time will preach against market timing

No-one raises this inconsistency

"live on a fixed percentage of your returns is not possible for many people":

and when returns are negative, have to make negative withdrawals (aka deposits).

The bucket strategy doesn’t necessarily require a large portion in Cash. I’m retired with a SMSF and have a 70/30 split of growth EFT’S and private mortgage investments (PMI) in individual first mortgage loans. The private mortgages are returning over 8.7% per year on average and fund my drawings along with dividends and where needed a small top up selling partial ETF’S. In the event of a market crash or correction, I’ll draw the same but slowly sell down my PMI to protect my growth investments. I have 19 individual PMI that mature every 2-3 months on average so I keep a small amount in cash, toping up as needed and reinvesting the excess back into PMI. Having a large portion in cash when their are other opportunities is madness.

"government (rightly) mandates minimum withdrawals so simply saying live on a fixed percentage of your returns is not possible for many people.":

Government does not, yet, enforce spending of withdrawals.
It comes close with taxes and benefits, such as Age Pension, which incentivise spending / investment.

The minimum cashflow for home owner retiree couple 67+ is Age Pension = 26 * 1777 = $46,202 / y.
For some that might come from a combination of Age Pension, returns and capital drawdown.

'Impossible' for sequence of returns / cash expenditure combination to result in 'running out of cash' if expenditure is always less than Age Pension - except where debt is involved.

No debt, spend less than Age Pension; no sequence of returns concerns.

Dudley, you are right.

Ok, so if you withdraw in proportion to the returns, that is just like being taxed on a fixed percentage of your returns by the Government. So you are basically imposing a self-imposed tax on your returns by withdrawing the same percentage of those returns every year.

In negative years, you would have to add money back into your retirement fund to make it in proportion to your returns.

That makes sense. The sequence of returns makes NO difference in this case because multiplication is commutative.

So with Unlucky Lucy and Lucky Ursula: 1.1 x 1.02 x 0.95 = 0.95 x 1.02 x 1.1 = 1.02 x 1.1 x0.95 x = 1.0659

A simple way to beat SOR is to invest the money during bad markets. Off source it requires that you have separate assets away from your retirement account to feed yourself while the markets recover.

Commenters skilled re advantage/disadvantage/looking at sequence & timing lump-sum withdrawals but one thing not obvious in article is another Timing... payment of required %age other than as a monthly payment per example. I view it as part of sequencing. Payments can be any time to 30/6 so it's another tool. I consider regularly as year progresses to delay as long as possible, to re- invest returns if prices down and/or if to be 1 payment or 2. Two banks each with different Div dates assist sequencing, known as my Get Out of Jail card. I Minute workings/observations/outcome, all there when random audit by Institute of C.A. of Fund Auditors. If personal investments, may not be crucial for monthly super payment. Usually find %age payment goes on personal small investment. Strategy increased super portfolio (over the years),delayed payment viewed as 'enforced' saving with which to increase personal portfolio making each work for the other. Not original but it is a sequence that can be managed for better outcome to smooth out those that can't be.

Off-piste a bit to younger readers re retirees 'no tax', my strategy sorted long ago when like you, worked & pay tax, saved for shares as could so 2 roughies on my track not 1 thoroughbred. Saving becomes habit with later thrill attached and yes tax to be paid. Many said how about tax in retirement? Reply still the same, would rather pay tax than none as other way round would worry me more as if not adequate income to be taxable I'd consider myself poor. You can start as low as $3000 for only $5 fee, it works and you'll find you will be happy to pay tax on in retirement. Hope that gives hope.

Thanks Annika.

I think the article clearly demonstrates the effect of Sequencing Risk and as stated by the author is simplified to illustrate the potentially large impact.

Where it becomes more tricky is for those that are retired with a mandatory draw down from income accounts and no ability to recontribute back to super so must maintain any excess funds in cash or seek investments outside super with more complexity.

I use a bucket strategy suited to my risk profile and take draw downs from the most conservative bucket and then rebalance periodically. Psychologically this is of comfort when markets have a down turn. My overall returns are a targeted weighted average so I’m unconcerned about maximising returns.

Errol you don’t need to worry about not being able to contribute. Unless you are mega wealthy simply run part of your portfolio in individual/joint names outside and adopt a whole portfolio approach including asset allocation.

You can put your longer dated assets in super (riskier ones) due to timing and better tax treatment and shorter dated assets outside for maximum liquidity options.

To other points of consternation above draw down rates don’t matter in this methodology it’s your spending rates that matter (another point raised above).

Outside super for most people (unless they get very large) will be tax free or almost tax free. Secondly you’ll save your heirs death benefits tax on your super portfolio unless you’ve already washed out your taxable components.

If you do have a non super tax problem along side your super you still don’t have a problem as you are quite wealthy. :-).

Totally academic... Clint Eastwood ish "do you feel lucky?" The real issue is Asset Allocation - "what is" exposed to market gyrations and "what isn't". Get that right + have the courage to hold through the downturns and you will be ok

I dont really understand sequencing. My Super is in Aware super. I will in January roll over my super so I can have a fortnightly payments. I understand that when I roll over my super I can choose balanced, growth, cash options etc. As far as i knew i couldn't pick where the fortnightly payment comes from. Am I wrong?

In Hostplus I can choose what percentage I have in balanced, growth, cash etc and I can choose where my pension payments are taken from.

Good article on an important topic Annika - thoughtful discussion as well!