| Alice | Mark | |
|---|---|---|
| Year 1 | +25% return | -15% loss |
| Year 2 | +15% return | -5% loss |
| Year 3 | +5% return | +5% return |
| Year 4 | -5% loss | +15% return |
| Year 5 | -15% loss | +25% return |
| Total average | +5% return | +5% return |
Article
How market timing could make or break your retirement
5 min read 4 Mar 25
Imagine this: you've spent your entire life building your pension pot. Then just as retirement approaches, and you're ready to start accessing your money, your pension investments experience a significant drop. This is a real possibility and part-and-parcel of investing. While your money has the potential to generate returns, there’s always a risk that you could suffer losses.
When investing for the long term – usually 10 to 15 years or more – you have a better chance of weathering periods of poor performance. But if you experience a downturn at the same time as withdrawing money, it can considerably reduce your investments. This makes it harder for your money to recover, even if your funds perform better in the future.
This is known as sequencing risk
It’s especially important for those in (or nearing) retirement, as this is when most people start taking an income from their pension or other investments. Get dealt a bad hand, and it could affect the longevity of your money. This could spell trouble if you need your investments to last a long time.
Here’s the important part – even if two people achieve the same average returns over a given period, the person who experiences stronger returns early on will be better off compared to the person who sees the same returns later. This can be a little difficult to wrap your head around, so let’s take a look at a simplified example to illustrate how it works.
An example
Picture two retirees, Alice and Mark – both with a pension pot of £500,000, and who plan to withdraw £40,000 each year. After a five year period, both experience an average return of 5%, but the order of how they got there is different. Alice performed better early on, while Mark performed better later on:
Now let's see how this affects the value of their £500,000 pension pots after they withdraw £40,000 each year.
Alice
| Starting amount | Return/Loss | Becomes… | Minus income | End of year amount | |
|---|---|---|---|---|---|
| Year 1 | £500,000 | +25% return | £625,000 | -£40,000 | £585,000 |
| Year 2 | £585,000 | +15% return | £672,750 | -£40,000 | £632,750 |
| Year 3 | £632,750 | +5% return | £664,388 | -£40,000 | £624,388 |
| Year 4 | £624,388 | -5% loss | £593,169 | -£40,000 | £553,169 |
| Year 5 | £553,169 | -15% loss | £470,194 | -£40,000 | £430,194 |
Mark
| Starting amount | Return/Loss | Becomes… | Minus income | End of year amount | |
|---|---|---|---|---|---|
| Year 1 | £500,000 | -15% loss | £425,000 | -£40,000 | £385,000 |
| Year 2 | £385,000 | -5% loss | £365,750 | -£40,000 | £325,750 |
| Year 3 | £325,750 | +5% return | £342,038 | -£40,000 | £302,038 |
| Year 4 | £302,038 | +15% return | £347,344 | -£40,000 | £307,344 |
| Year 5 | £307,344 | +25% return | £384,180 | -£40,000 | £344,180 |
Despite having the same average return, Alice ends up with £430,194, while Mark ends up with £344,180 – that’s a staggering difference. Mark's early losses forced him to withdraw from a reduced pot, making it harder for his money to recover – even when his investments picked up later on.
This isn't a real life example, but it highlights how early poor returns can significantly impact how long your retirement funds could last.
Mitigating the impact of sequencing risk
There’s no 100% fail-proof solution to tackling sequencing risk, but there are a few measures you can take which could minimise it’s impact. Here are just a few:
- Delay retirement – this could give your investments breathing space to recover if they suffer a period of bad performance. There’s no promise of this, though– they could continue to perform badly.
- Diversify your investments – don’t put all your eggs in one basket, a mix of stocks and shares, bonds, and other types of investment can help spread risk. This means if one type of investment performs badly, but the others don't, it won't hit you as hard.
- Be flexible with your withdrawals – if you can afford to, withdrawing a lower income during periods of poor performance can help better preserve your investments.
- Build a buffer – keeping an amount of money as cash or in low-risk investments gives you other options to turn to if your riskier investments start performing badly.
Financial advice can help
Sequencing risk can feel complicated and scary – even seasoned investors find it challenging to prepare for. Although the steps above could help, they’re no substitute for expert financial advice. That’s where we can help. We'll work you to understand your circumstances, needs, and appetite for risk. Only then will we develop a personalised strategy aimed to help you reach your goals.
Book a no-obligation chat today to find out how we can help you.
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