Execution · Risk
Sequence-of-Returns Risk for Australian Retirees
The same 30 per cent decline does different damage depending on whether it arrives in year one of retirement or year five. Withdrawals make the order matter more than the average.
Why order matters once you are spending
In accumulation, a decline is mostly an opportunity to buy more units if you keep contributing. In drawdown, a decline plus a withdrawal removes units at low prices. Those units never participate in the recovery. The portfolio has to earn more than it lost just to get back, while spending continues.
Simple arithmetic makes the point. Start with $1,000,000. A 30 per cent decline leaves $700,000. Withdraw $50,000 and you are at $650,000. Getting back to $1,000,000 from $650,000 requires a gain of about 54 per cent, before any further withdrawals. The same 30 per cent decline in year five, after several years of positive returns and reinvestment, lands on a larger base and hurts less. Same investor, same portfolio, same market event, different sequence, different outcome.
What actually helps
No single tool erases the risk. A cash or short-term buffer covering one to three years of spending reduces the chance you are a forced seller of equities in the first bad year. Spending flexibility (the ability to trim withdrawals after a decline) helps. So does an allocation that is not 100 per cent equity if a large early decline would be catastrophic for you. Replenishment rules for the buffer, written in advance, stop the buffer from becoming a permanent cash drag or an empty promise.
Franking and dividend income can fund part of spending and reduce unit sales. They do not remove market risk. A dividend cut, as Australian bank shareholders saw in 2020 in varying degrees, hits income and price together. Treat dividends as a contribution to the plan, not as the plan.
The passive myth that fails here
“Just hold” is incomplete advice once withdrawals have started. Passive investing removes stock selection. It does not remove the need for a drawdown policy. The investors who carry an accumulation mindset into retirement without a buffer or a spending rule are taking a sequence risk they have not priced.
What to do with this
If you are within five years of drawing on the portfolio, or already drawing, write down essential annual spending, other income, and how many years of spending you could fund without selling growth assets. If the answer is under one year, the sequence risk is already the binding constraint.