23 May 2025
In the world of investments, the goal is often to achieve long-term growth. Investors typically look to mitigate risk by selecting asset classes that diversify their portfolios, to provide consistent returns over time. However, there is an element of risk that many investors may not fully appreciate; sequencing risk. Sequencing risk, which is very relevant once investors reach retirement, is the risk that the order of returns will negatively impact a portfolio’s overall performance. It can play a significant role in determining whether an investor achieves their financial goals, particularly when withdrawals or contributions are involved. In this article Stefan Cloete, Junior Research & Investment Analyst, at Glacier explores the concept of sequencing risk, its implications for investment strategies, and how investors might consider managing this risk to help protect their wealth.
What is sequencing risk?
Sequencing risk refers to the risk that the timing of investment returns will have a significant impact on the portfolio’s overall value. It is most relevant for investors who are making regular withdrawals from their portfolio, such as retirees. The order in which returns are experienced can drastically affect the portfolio’s longevity and its ability to support long-term financial goals.
For example, consider two retirees who each have a R5 million portfolio and are withdrawing R200,000 per year. If one portfolio experiences a series of positive returns in the early years of retirement, followed by a few negative returns later, the portfolio may sustain itself for a longer period. On the other hand, if the sequence of returns starts with a major market downturn, followed by steady or positive returns, the portfolio may deplete faster despite receiving the same average returns over the same period.
The following graph illustrates this perfectly.
The graph above illustrates a scenario involving three investors, each making an initial 6% withdrawal, which escalates by inflation +1% every year. The first investor experienced a strong initial period of returns, the second investor saw consistent performance with no volatility, and the third investor had a poor start to the period. It is important to note that all three investors achieved the same average annual return over the 10-year period. If the investors made no withdrawals, their outcomes would have been identical. However, due to the income being drawn from the portfolios, the outcomes differ significantly. To put it another way, if the clients withdrew R60,000 per year from these portfolios, the R60,000 represents a much larger proportion of the portfolio that had the poor start compared to the one with the strong start. The only factor responsible for Investor 3 depleting their portfolio faster than Investor 1 is the sequence in which their portfolio experienced performance.
This highlights the importance of not only focusing on the average annual returns of an investment portfolio but also considering the timing and sequence of those returns. For many investors, especially those in retirement or nearing it, sequencing risk is a crucial factor that should not be overlooked.
Why does sequencing risk matter?
Sequencing risk is particularly impactful for those who rely on their investments to generate an income. Retirees need to withdraw funds periodically to cover living expenses. When markets experience volatility, the timing of those withdrawals becomes crucial. If a large market drop occurs early in retirement, the portfolio may not have sufficient time to recover before the investor exhausts their funds. This could lead to a situation where the investor outlives their savings, which is a risk that cannot be easily mitigated.
The potential for sequencing risk is increased during periods of heightened market volatility. In these periods, markets may swing wildly, leading to inconsistent returns. For investors making withdrawals, these swings can have outsized consequences, especially if a downturn coincides with the need for income.
How to mitigate sequencing risk?
To mitigate sequencing risk, investors must manage volatility within their portfolio. This approach helps to create a smoother return profile over time, reducing the impact of adverse market conditions during retirement.
At Glacier, we offer the ideal solution for this: the Glacier Real Income Solutions. These solutions focus on enhancing the predictability and consistency of income, while protecting capital during market downturns. Our solutions are highly diversified, incorporating asset manager strategies that, although distinct, complement one another to achieve a smoother return profile.
The range of the Real Income Solutions are as follows:
Each of these solutions are designed to accommodate different drawdown levels during retirement. They are diversified, utilising a variety of instruments to provide investors with a smoother return profile. These solutions incorporate private market products, traditional CIS funds, smoothing funds, and listed alternatives such as hedge funds.
Let's consider a scenario involving the Glacier 2.5% Real Income and Glacier 6% Real Income Solutions, with a client we'll refer to as Person A. Person A has retired with a portfolio of R3 million. Each year, they withdraw an initial income equivalent to 6% of their portfolio, with the withdrawals increasing annually to keep pace with inflation. Under these conditions, the Real Income Solutions ensure that Person A will not deplete their capital over a ten-year period. In fact, their portfolio would have grown during this time. By offering a combination of steady income and capital protection, the Real Income Solutions enable Person A to maintain a secure financial position throughout retirement, easing any concerns about their financial stability.
(D) - Drawdown
Conclusion
Sequencing risk is often overlooked, but remains a significant factor in investment planning, particularly for retirees. It’s not just about achieving the highest returns; the order in which those returns occur can make a significant difference in a portfolio’s success. Understanding sequencing risk allows investors to take steps to mitigate it, whether through diversification, a cash buffer, adjusting withdrawal strategies, or purchasing annuities. It can help ensure that an investor’s portfolio lasts throughout their retirement years. With thoughtful planning, investors can navigate the market volatility and reduce the potential impact of sequencing risk on their long-term financial well-being.
