How to plan for sequence of returns risk

Also known as sequencing risk, it applies to clients who may be forced to consolidate any investment losses in order to take the income they need.

According to Fiona Tait, technical director at Intelligent Pensions, the key to addressing this is to put them as far as possible into a position where they are not required to do this. 

She explains: “One way of achieving this is to ensure that a proportion of the portfolio is invested in a secure asset such as cash or deposits, so that even if the remainder of the portfolio performs badly the income may be paid without having to access the poorly performing assets. 

“The client may still have to adjust their future withdrawals, but they have more scope to allow the higher risk assets to recover over time.”

Planning for sequencing risk is a difficult exercise, because during periods of poor investment returns people typically stop or reduce their withdrawals, Mark Ormston, director of propositions and corporate partnerships at Retirement Line, notes. However, this is not always a viable option. 

He adds: “This scenario can be one of the reasons why using a mix of products/solutions in retirement might be a good approach for many. 

“During periods of poor investment performance, people could lean more heavily on annuity income or cash rather than withdrawing while their funds are not growing.”

Those individuals who are in drawdown and taking regular income from their plan will naturally be feeling the bite of inflation. 

While income can be increased to keep pace or even outstrip the rate of inflation, Craig Muir, senior intermediary development manager at Royal London, says this can have a detrimental impact on income sustainability.

There is then the added complication around markets swinging on a day-to-day basis and the subsequent impact of sequencing risk and volatility drag. 

Muir adds: “This can have a significant impact, not only on the capital generated to date, but also on an individual’s ability to generate further income. 

“It also highlights that when individuals transition to taking money out of their pension, it’s not just a question about how their investments perform, it’s also a question about when their investments perform. There’s no magic number when it comes to income withdrawal rates. 

“Income sustainability depends upon a number of factors such as term, investment, charges and the level of income required – all factors that need taking into consideration over the long term.”