Retirement Life
28 April 2025
How volatility affects investment withdrawals
It’s been a wild ride in investment markets thanks to the tariff war. While this needn’t concern long-term investors, it’s every new retiree’s nightmare. Just as you get to the point of giving up work and setting off to travel the world, investment markets crash. Taking the plunge into retirement can be scary enough without markets collapsing at just the wrong time.
Dollar cost averaging: Turning bumpy markets into opportunities
Leading up to retirement, the focus is on saving and accumulating wealth. During that stage, market volatility is more opportunity than threat, since there’s still time for markets to recover.
Regular contributions into KiwiSaver and other investments when markets are moving up and down produce an effect called ‘dollar cost averaging’. This simply means that when you’re contributing a regular fixed dollar amount, you’ll buy more units when prices are low and fewer units when prices are high. Over time, the price paid per unit is as close to average as possible. A market crash is favourable for long term regular contributors, as it allows investors to buy more units for the same amount of money. Over time, the value of these units will rise again, so the investor achieves a good return in the long run.
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Sequencing risk: The nemesis of retirement withdrawals
However, a market crash has the opposite effect when it comes to retirees making regular withdrawals. When you withdraw income from your investment portfolio, you’re selling units regularly, not buying. You need a plan in place to make sure you aren’t forced to sell investment units when prices are down. This type of investment risk is called ‘sequencing risk’. Here’s how it works.
Investment returns go up and down from one year to the next. Over a ten-year period, a portfolio left intact with no withdrawals might produce a return of, say, 7% a year on average. However, in any one year the returns might vary between losses and gains – for example, between a loss of 12% and a gain of 18%. If withdrawals are made from the portfolio at the start of the ten-year period and there are losses at that time, it’s much harder for the portfolio to recover and the return will be much lower than 7% over ten years.
Retirees are much more exposed to sequencing risk in the early years of retirement, when large withdrawals will have a lasting effect on the performance of an investment portfolio. Typically, new retirees have a bucket list of things they want to do after leaving work, and travel is high on the list. Other ‘big ticket’ items for early retirement might be replacing the car and renovating the house. It is therefore not unusual for spending and portfolio withdrawals to be higher in the early years of retirement.
However, there are steps that can be taken to protect yourself from sequencing risk.
Shielding yourself from sequencing risk
Plan for a lower return. When you’re making plans for how much you can withdraw from your investment portfolio over your retirement, use a conservative estimate for the rate of return. It’s preferable to have money unspent than to run out before you die.
Use a laddered portfolio of bonds or term deposits. In the last few years before retirement, build up a stash in stable assets such as cash and bonds. Have enough on hand at retirement to cover your spending needs for at least the first five years. Set these investments up so they mature at regular intervals – say every six months. That way, you’ll have cash on hand when you need it. The rest of your investments can be left untouched in a diversified portfolio to recover from any fall in share prices. When your bonds and term deposits are used up at the end of five years or so, make a withdrawal from your diversified portfolio and set up a new portfolio of bonds and term deposits to last the next five years.
Get advice on a ‘safe’ withdrawal rate for your portfolio. The big fear for anyone over the age of sixty is whether they’ll outlive the money they’ve saved for retirement and end life in poverty. Working out how much to safely withdraw from your portfolio on a regular basis is not easy as there are so many unknowns and a multitude of theories on the best approach. The challenge is to withdraw neither too much nor too little while also being aware of sequencing risk.
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Written by:
Liz Koh
Liz Koh is a money expert who specialises in retirement planning. The advice given here is general and does not constitute specific advice to any person.
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