The Sequence of Returns: Why Timing Your Retirement Matters More Than You Think

1. Why accumulation and drawdown are structurally different

During accumulation, you are adding capital regularly. Poor markets mean you buy more units at lower prices — rand-cost averaging works in your favour. The sequence of annual returns over 30 working years has very little impact on your final accumulated capital, assuming identical average returns.

During drawdown, the opposite dynamic applies. You are selling units to fund living expenses. Poor markets mean you sell more units to generate the same income. Once sold, those units are gone — they cannot benefit from the subsequent recovery. This is sometimes called “reverse rand-cost averaging” or the drawdown spiral.

“The same average return over 30 years produces very different outcomes depending on whether the bad years come at the beginning or the end of your retirement.”

2. The early retirement scenario

Consider what happens when a portfolio experiences a significant drawdown in the first year of retirement, while drawing an income at the same time:

• Market falls 30% in year one of retirement
• You draw 6% of your portfolio to fund living expenses
• Your portfolio is now down 36% from its opening value
• When the market recovers, it recovers on a much smaller base
• Future drawdowns take an even greater proportional toll
• The portfolio depletes years earlier than projected

3. The living annuity problem

Most South African retirees who accumulated through a Retirement Annuity or pension fund will purchase a living annuity with a portion of their retirement capital. A living annuity is an investment-linked income drawdown — you own the underlying portfolio, you set the drawdown rate, and the income you receive depends on investment performance.

This structure is flexible and can be highly effective. It also concentrates sequence-of-returns risk entirely on the investor:

• No income floor — if the portfolio depletes, income stops
• Drawdown rate is self-selected and often set too high
• Investment decisions remain the investor's responsibility
• Sequence of returns risk is borne entirely by the investor
• Longevity risk — living longer than the portfolio lasts

The Regulation 28 drawdown band for living annuities is 2.5% to 17.5% per annum. Most financial planners recommend staying below 6% — ideally closer to 4–5% in early retirement — to reduce the probability of depleting the portfolio before death. Many retirees draw above 7%, which materially increases sequence-of-returns exposure.

4. Mitigation strategies

Sequence-of-returns risk cannot be eliminated — markets are not predictable. But it can be managed structurally before it materialises. The key is reducing the likelihood that you are forced to sell growth assets during a drawdown. Approaches include:

• Hold 12–24 months of income in cash or near-cash on retirement
• Set an initial drawdown rate of 4–5% rather than 6–7%
• Build a bond/stable allocation ladder to fund the first 5–7 years
• Review drawdown rate annually relative to portfolio performance
• Avoid rigid fixed-rand withdrawals — move to percentage-based as capital fluctuates
• Consider a guaranteed annuity for a portion of retirement income

A hybrid structure — where a guaranteed annuity covers essential baseline income and a living annuity handles the discretionary layer — is often the most resilient approach. The guaranteed annuity removes sequence risk from essential expenses entirely. The living annuity retains flexibility and upside potential for non-critical income.

5. What to do before retirement

The most effective mitigation happens in the 3–5 years before retirement. This period — sometimes called the “retirement red zone” — is where de-risking decisions have the greatest impact. A sharp decline at this stage can reduce the capital base from which you retire and cannot be fully recovered through future contributions.

Gradually shifting the portfolio toward more defensive allocations in the years approaching retirement, building cash reserves, and stress-testing the drawdown plan against adverse sequences is not conservative thinking — it is structurally sound planning.

“The most important financial decisions of your life are not made during your accumulation years. They are made in the five years before and after retirement.”