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#83 “Sequence Of Returns” Risk In Decumulation

The “glide path” in accumulation applies only when you’re saving money, not when you’re making withdrawals. Here’s an important decumulation angle.


A couple of recent conversations reminded me that, although I’ve written about the investment glide path in the accumulation stage (Posts #78 and #81 – the sensible path being a decline in equity exposure as you approach retirement –  I haven’t said anything about the corresponding glide path in the decumulation stage; and it’s clear (I hope) that the glide path that’s appropriate when you’re putting money in isn’t necessarily going to be equally appropriate to continue when you’re taking money out.

It’s true that I have written once (Post #33 about decumulation, explaining the four approaches that can be applied consistently, involving a choice between (or of course some combination of) an invested pension pot, and some form of deferred or immediate annuity. But that post focused on creating a consistent overall process, rather than on how you might invest the non-annuitized portion of your pension pot.

In fact there isn’t any decumulation approach that has been widely accepted. There are approaches that suggest an increasing equity exposure as you age, others that keep the exposure constant, and yet others that suggest a declining equity exposure. This is, as you can therefore guess, a difficult and contentious subject.

In the soon-to-be-uploaded book Freedom, Time, Happiness I’ll include a couple of pieces on the subject, one explaining the bases cited by experts for each of the increasing, constant and declining glide paths in decumulation, and the other a case study on how one particular couple thought about their goals and how their attitudes might change as they aged.

Meanwhile, in this post I’ll explain, as simply as I can, a particular financial risk that can arise in decumulation, commonly called “sequence-of-returns risk.”


Yes, I’m going to over-simplify. But the over-simplified example will still make the point clearly. Bear with me while I construct a very artificial example, because I’ll draw some useful conclusions from it.

Suppose (in this over-simplified example) you have $1,000 and want to withdraw $100 at the end of each of 10 years. Let’s assume you earn a 0% investment return each year. Then obviously you’ll be able to withdraw your desired $100 a year for the 10 years.

OK, now the first of two variations.

Suppose you invest the money and earn 20% in the first year, 0% in years 2 through 9, and -20% (that is, you lose 20%) in the 10th year. Focusing only on the returns, your average return over the period is still 0%. But look what happens to your withdrawals.

At the end of the first year your initial $1,000 has increased to $1,200 because of your 20% return. If you withdraw $100 a year for the first 9 years, you’ll still have $300 left at the start of the 10th year. Because of the -20% return in the 10th year, that $300 will be reduced to $240 at the end of the 10th year, and that’s what you’ll be able to withdraw – much more than the $100 you wanted.

OK, now the second of the two variations. This time let’s suppose you earn -20% in the first year, 0% in years 2 though 9, and 20% in the 10th year. Again, focusing only on the returns, your average return over the period is again 0%. But again, let’s see what happens to your withdrawals.

At the end of the first year your initial $1,000 has decreased to $800. So you can’t withdraw $100 a year for 10 years! It doesn’t matter that you’ll prospectively earn 20% on your start-of-year-10 balance, because there isn’t a balance.


You can probably see where this is headed.

If all you focus on is returns, the base case and the two variations all come out with the same average 0% return. But the amounts of money on which those returns are earned are different, in the three cases.

In the second case the high return is earned on a large amount of money and the low return on a small amount of money. That leaves money to spare, at the end.

In the third case the low return is earned on a large amount of money and the high return on a small amount (in fact, on no money left at all). That exhausts the money before the end of the 10-year time horizon.

So, even though a focus on the average return fails to distinguish between the three cases, in practice the sequence of returns is important, because the amounts of money at various times are different.

In fact, to generalize from this simple case, here’s what happens. If you earn low or negative returns early in decumulation and high returns later on, that’s bad news. Earning high returns early and low returns later is much more favorable.

Earning lower-than-average returns early is called sequence-of-returns risk.

And so, here’s the lesson. Even though financial professionals may assume some average return over your decumulation time horizon, it’s potentially dangerous if that’s all they do. Because of sequence-of-returns risk, they should also explicitly create a way to insulate you from, or mitigate the effects of, that risk.

One possible way is to have a few years of spending held in short-term deposits that aren’t subject to market volatility. Another is to have a lower equity exposure in the early years than in later years. And there are others. All are aimed at reducing the impact of sequence-of-returns risk. And all therefore reduce the pot’s overall growth potential, since safety and growth are at opposite ends of the risk spectrum. So there’s no perfect solution.


As you will have guessed, my point today is not to suggest there’s a perfect solution. It’s to explain this particular decumulation risk.

You may not have been aware of it. Perhaps your professional didn’t discuss it with you. Perhaps you do your own thing, and never thought about it.

Perhaps you think (or your professional thinks) that your life expectancy gives you a potentially long investment horizon at the start of your Life Two and you can therefore ride out early negative investment fluctuations. But in fact in decumulation you potentially have multiple time horizons. Each withdrawal has a horizon equal to the time when you want to make that withdrawal. For example, if you want to make a withdrawal at the end of the first year, that amount has a horizon of one year – not typically consistent with the risk of equity exposure. It’s only subsequent withdrawals that have longer horizons.

Of course, if your pot puts you in the “endowed zone” (see Post #51, then you do indeed have a long (theoretically infinite) investment horizon because you never have to sell any part of your pot to finance your lifestyle. But in any of the other wealth zones, sequence-of-returns risk is something you should consider, whether you do your own investing or you rely on a financial professional.



In decumulation, an invested pension pot carries risks. One is sequence-of-returns risk. Regardless of the average long-term investment return, it’s bad news, in decumulation, if low or negative returns occur early.



I have written about retirement planning before and some of that material also relates to topics or issues that are being discussed here. Where relevant I draw on material from three sources: The Retirement Plan Solution (co-authored with Bob Collie and Matt Smith, published by John Wiley & Sons, Inc., 2009), my foreword to Someday Rich (by Timothy Noonan and Matt Smith, also published by Wiley, 2012), and my occasional column The Art of Investment in the FT Money supplement of The Financial Times, published in the UK. I am grateful to the other authors and to The Financial Times for permission to use the material here.

12 Responses to “#83 “Sequence Of Returns” Risk In Decumulation”

  1. Richard Austin says:

    This is a very helpful post. Your examples illustrate well the sequence-of-returns risk. Also, your comments at the end of the piece that each withdrawal has a time horizon equal to when you want to make the withdrawal is illuminating. Because there are multiple time horizons, a “one-size-fits-all” investment strategy may well not be the best solution to managing the retirement pool of money. Thank you.

    • Don Ezra says:

      Thanks, I’m glad you found it useful. While there isn’t a one-size-fits-all solution, I’m hoping we’ll eventually find that there are a few patterns that fit most most situations — but if so, then those patterns haven’t yet been identified, I think.

  2. David Hartley says:

    Your explanation of sequencing risk is really good and easy to understand. You also make a great point about those who are in the “endowed zone”.

    For those who are not in the endowed zone there is, by definition, a need to draw on capital. There is a choice then as to whether to control this drawdown phase; as opposed to simply spending until the money runs out at some indeterminate future date.

    I have seen a large number of methods to control the drawdown phase and my conclusion is that most, and probably all, can be characterised as a variation on the “bucketing” approach. The differences revolve around how the buckets are defined, the method by which the money is kept safe in one of the buckets, what strategy is followed outside of the safe bucket, how periodic transfers into the safe bucket are managed and the certainty with which the drawdown is controlled.

    • Don Ezra says:

      Thanks — yes, I think your comment captures the situation beautifully. And your final paragraph identifies all the issues involved in making those choices. A few examples of the variations used would be extremely valuable! I think you have a terrific blog post in the making here …

  3. Ted Harris says:

    For those who are able, that bucket of up to two years income can alleviate having to draw down on depreciated capital. In subsequent years of excess returns it is important to work at replenishing the bucket.

    • Don Ezra says:

      Thanks — both aspects are really important, and the second one isn’t often mentioned: that, just as you try not to draw down too much after a bad year, you ought to consider filling up the safety bucket to more than its usual height after a good year. For myself, I’m more cautious than I suspect you are: my neutral position is 5 years in the safety bucket. Which suggests a subject for the next blog post: how long have low returns persisted, in the past?

      • Cindy Deere says:

        I really like the idea of a post on persistence of low returns. I also would value something around bucket strategies (i know you’ve done some on this before but it’s so important!). I’m in the middle of you two with my safety bucket planning at 3 years. Is it really just individual risk tolerance or is there best practice or something else to inform?

        • Don Ezra says:

          Thanks, will do a post on persistent low returns. As regards the safety bucket, yes, I do believe it’s just risk tolerance, in the sense that the bigger (longer) the safety bucket, the lower the sustainable drawdown, so there’s then the inevitable tradeoff between upside potential (higher drawdown) and higher risk (more chance that the equity market won’t have recovered by the time the safety bucket is exhausted).

  4. Thanks Don. One of my conundrums has been fixing my financial industry training, which led to my misunderstanding the reliability of statistics as drawn from random walk data in the capital markets. Here’s what I mean, as stated by two different experts on math and markets, contrary to what Is often sold:
    “Investing for many periods does not itself introduce extra tolerance for riskiness” – Paul Samuelson
    “Probability distributions… gradually widen as the time period lengthens. Rather than going away, risk to wealth actually accumulates over time.” – Barton Waring

    • Don Ezra says:

      Thanks for raising this angle. The range of dollar values possible expands as the time horizon expands. That’s what Barton emphasizes, and (quite rightly) he considers this increasing risk. The problem arises from those who are obsessed with annualized returns, because the same spread of dollar outcomes is reflected in a narrower spread of annualized returns as the time horizon expands. It’s that translation into annualized returns that suggests (wrongly) that risk shrinks over time.

  5. Kathleen Clark says:

    Most interesting! Over-simplified example? Perhaps. But clear, understandable, and highly useful information? Definitely!

    • Don Ezra says:

      Thanks. Apologies for the over-simplification, but I simply wanted to construct an example (no matter how artificial) that didn’t require advanced arithmetic but still made the point.

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