Protecting against sequencing risk
Poor market returns or falling values shortly after retirement can be devastating. Called ‘sequencing risk’, assets sold in this environment to provide income have a substantial impact on the value of a pension pot.
There are different ways to help to mitigate sequencing risk:
- Asset allocation - A diversified strategy can help. Bonds are usually used as a counterpoint to equities, but there are periods where both have fallen.
- Cash buffer - Many advisers keep part of the pension pot in cash to provide income. Given the rarity of stock market falls, performance will suffer.
- Natural yield - This relies only on the natural yield to provide an income. The key drawback with this approach is that the income will vary from year to year.
- Substitution - If clients have other assets it can make sense to use these to generate income temporarily in the event of a significant stock market fall.
- Probability driven approach - If key expenditure is covered by a guaranteed income for life, the balance can be invested in riskier assets. If markets fall, discretionary expenditure can be reined in or other assets used to provide income.
Mitigating sequencing risk is a critical piece of the retirement jigsaw.