From nuisance to nightmare: Sequencing risk in retirement

Sequencing risk is the danger that the order of market returns, rather than the average return alone, materially changes investment outcomes. Our recent analysis reveals that if two portfolios share the same 25‑year average (e.g. 10%), yet one suffers a string of poor returns early and the other experiences them later, they can end with vastly different results. Losses at the outset reduce the capital base from which future gains compound.

This timing effect is critical once withdrawals begin.

Sequencing risk is muted during accumulation

With no withdrawals, compounding remains uninterrupted and any ongoing contributions buy assets at lower prices in poor return years. The final value is relatively insensitive to the order of returns during the investment period.

Chart 1: Accumulation paths (no withdrawals)

Favourable, stable and unfavourable sequences all converge to essentially the same maturity value over 25 years, despite their very different year‑by‑year paths, as illustrated in Chart 2.

Chart 2: Return arrays (favourable, stable, unfavourable)

Decumulation is different

In retirement, income is withdrawn from the portfolio each year, which materially alters the impact of variable returns. Let’s consider an example where income drawdown is 5% of the initial capital (R50,000) per year and rises by 6% annually. Early losses permanently impair the capital base. Even when strong returns arrive later, the depleted portfolio has less capacity to recover.

In the unfavourable sequence (negative early, positive later), balances decline faster and may risk shortfalls far sooner than favourable or stable sequences, despite the identical average return. This is the essence of sequencing risk as illustrated in Chart 3: timing matters most when you are spending from volatile assets.

Chart 3: Decumulation paths (before blending)

Chart 3 shows that decumulation outcomes after 25 years vary greatly based on return patterns, demonstrating that return sequence is crucial when investors start to draw an income for retirement.

How blending annuities helps

Blending a guaranteed life annuity with a living annuity helps on two fronts. First, only the liquid (living annuity) portion remains fully exposed to market volatility and sequencing effects. The illiquid (life annuity) portion is insulated and pays a dependable income into the portfolio no matter what markets do.

Second, the life annuity income lowers the effective withdrawals required from the liquid portfolio. Because less needs to be drawn from market‑linked assets, the liquid balance experiences shallower drawdowns in bad years and preserves more capital for later recovery.

Chart 4: Decumulation paths (incl. blended living balance)

In our simplified example, 50% of retirement capital is converted to life‑long income at a 7% annuity rate, increasing at 6% p.a.

The results bear this out. The blended scenario’s portfolio line (green) sits above the pure living annuity line under unfavourable sequencing (orange) and retains a positive balance after 25 years – despite the liquid portfolio value starting out at 50% of the full value due to the transfer to the life annuity component. Effectively, blending transfers longevity and inflation risk to the insurer, while leaving growth potential in the market‑linked portion.

Building a more resilient retirement income strategy

Sequencing risk is a minor nuisance while you are saving but a major threat when you start drawing an income. A practical defence is to blend annuities: to lock in a portion of guaranteed, lifetime income and draw the remainder, more modestly, from a diversified liquid portfolio. This approach reduces the sensitivity of retirement outcomes to short‑term market timing, supports sustainable income paths, and gives retirees greater resilience when the sequence of returns turns against them.

This article appeared in the January 2026 edition of FA NEWS