You will be able to explain sequence of returns risk with your own drawdown numbers.
Two people can earn exactly the same average return over thirty-five years of retirement and finish in completely different places. One reaches 95 with money to spare. The other runs out at 89. Nothing about their plans differs except the year the bad market arrived.
Financial independence: planning the number and the path, lesson 2.3, Sequence risk: why the first years matter most, explains this with two friends and a ten-year example. This lesson puts the same idea through Jasmine's own drawdown map, so you can see what it does to a full retirement plan with CPF LIFE, SRS and part-time work in it.
Jasmine's central map from lesson 3.4, Map your drawdown year by year, assumes her investments earn 5% every year. She reaches 95 with about S$710,000 left, and at 80 her savings stand at about S$1,246,000.
Now give her one bad year: a 30% fall in her investment account, with 5% in every other year. The average return across her retirement barely changes, and it is exactly the same whichever year takes the fall.
With the fall in the year she turns 60, her first year without a salary, her savings at 80 are about S$503,000 instead of S$1,246,000. Her money runs out at 89.
With the same fall at 75 instead, her savings at 80 are about S$719,000, and her money runs out at 92.
The fall at 75 actually removes more dollars on the day it happens. By then her investments are worth about S$1,230,000, so a 30% drop takes about S$370,000. At 60 they are worth S$800,000, so the drop takes S$240,000. Yet the early fall does more damage to her plan: her money runs out three years sooner.
Three things make a fall at the start more expensive.
The first is the years left to compound. Every dollar lost at 60 is a dollar that would have grown for thirty-five years. At 5% a year, a dollar grows to more than five dollars over that span. Lose S$240,000 at 60 and you have lost what it would have become by your eighties, which is far larger than the S$240,000 itself. A dollar lost at 75 only misses twenty years of growth.
The second is selling at low prices. Once the safe money runs low, you sell investments to pay for spending, and after a fall each sale needs more units to raise the same amount. Those units are gone for good. When prices recover, they aren't there to recover with you. That is what people mean when they say selling locks in the loss, and in the first years of drawdown, when the withdrawals are largest relative to what is left, it bites hardest.
The third is the bridge. In Jasmine's plan, the years from 60 to 64 carry nearly her whole spending, because CPF LIFE hasn't started. A fall in those years hits the portfolio when it is doing the most work. By 75, CPF LIFE pays part of every bill, and her portfolio has had fifteen years of growth to build a cushion.
So the years just before and just after you stop work carry the most sequence risk. Some planners call this stretch the retirement red zone. Whatever the name, it is where your defences need to be strongest.
You can't choose when the bad years come. You can change how much a bad year early on costs you.
A cash bucket is the first defence. Jasmine's first two years of spending sit in cash, so a fall in her first year doesn't force her to sell anything. Lesson 4.2, The bucket approach: cash, bonds and growth, sized hers. In her map, her cash pays for 60 and 61, which is why the early fall's damage comes mostly through lost growth rather than forced sales.
Flexible spending is the second. When Jasmine reran the early fall with her flexible spending cut by 20% for the rest of her life, her money lasted to 92 instead of 89. A temporary cut, just in her first five years, barely moved the result. That told her something useful. When a deep early fall never fully recovers, she would have to change her spending for good, and a pause of a few years would do little.
Paid work is the third. Her central plan includes three years of part-time consulting. In the early-fall case, her money runs out at 86 instead of 89 if she drops that work. Three years of modest income at the start were worth three years at the end.
A fourth defence comes from the floor. The more of your essentials CPF LIFE and other guaranteed income cover, the less of your spending depends on markets in any year, early or late.
Look at the first five to ten years of your drawdown map with suspicion. If your plan only works when those years are average or better, it is relying on luck. Lesson 5.2, Three scenarios: crash, inflation and flat returns, builds harder tests, and lesson 5.4, Run your plan through three scenarios, runs them.
For now, the test is simple. Take your own map, put a fall in the first year, and read your balance at 80 against the central case.
Rerun your drawdown map with a fall in the first year and write how much it changes the balance at 80.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).