Managing Pension Drawdown in Volatile Markets

Volatility in a retirement drawdown portfolio is not the same as volatility in an accumulation portfolio. During the working years, market falls are an opportunity — the investor continues to contribute and buys more units at lower prices (pound-cost averaging). In drawdown, the opposite applies: falling markets require selling more units to generate the same cash income, permanently reducing the number of units available to recover when markets recover.

This mechanism — commonly called "pound-cost ravaging" — is the central challenge of pension drawdown. Understanding it mathematically, and deploying strategies to manage it, is the difference between a drawdown plan that sustains income for 30 years and one that runs dry in 15.

Pound-Cost Ravaging: The Mathematics

Consider two retirees, both starting with £400,000 in drawdown, both withdrawing £16,000 per year. Their portfolios achieve identical long-run average returns of 6 per cent per year over 25 years. The only difference is the sequence of those returns.

Retiree A (favourable early sequence): Markets perform well in years 1 to 5, generating above-average returns before declining in later years. The portfolio sustains withdrawals comfortably for 30+ years.

Retiree B (unfavourable early sequence): Markets fall 30 per cent in year 1 and 25 per cent in year 2 before recovering strongly. Despite an identical long-run average return to Retiree A, Retiree B's portfolio is exhausted by year 18 or 19.

The mechanism is as follows: after a 30 per cent market fall, Retiree B's portfolio is worth £280,000 (£400,000 × 0.70). But Retiree B has also withdrawn £16,000 during the year, so the portfolio is worth approximately £264,000. The number of units in the portfolio is now substantially smaller. When markets recover, the smaller unit count generates less absolute growth — the portfolio is climbing from a lower base with fewer units. The deficit is never fully recovered.

This is not a hypothetical risk. UK equity markets fell approximately 35 per cent in the 2008 to 2009 financial crisis, approximately 30 per cent in the 2020 COVID crash, and experienced significant volatility in 2022. Anyone who began drawdown in 2007 and maintained standard withdrawal rates through 2008 to 2009 experienced severe pound-cost ravaging that materially affected their retirement trajectory.

Quantifying Sequence of Returns Risk

The FCA's work on retirement income, including its Retirement Outcomes Review (final report 2018) and subsequent thematic reviews, has highlighted the impact of adverse return sequences on drawdown portfolios. Widely accepted findings in this area include:

• A retiree who begins drawdown in a year of significant market decline may need to reduce withdrawals materially — often by 20 to 30 per cent from the original level — to maintain portfolio sustainability, even if long-run market returns are consistent with projections.
• Portfolios heavily invested in equities (80 per cent+) experience greater sequence risk than balanced portfolios (50/50 or 60/40), but the balanced portfolio's lower average return means it requires a lower sustainable withdrawal rate in the first place.
• Cash buffers reduce sequence risk significantly — see strategy below.

Independent academic research on safe withdrawal rates has estimated that the impact of an adverse early sequence can reduce the "safe" initial withdrawal rate by around one to one-and-a-half percentage points compared to what a favourable early sequence would support.

Strategy 1: The Cash Buffer

The cash buffer is the most straightforward and effective protection against short-term market volatility:

• Maintain one to two years of planned withdrawals in cash or near-cash (money market funds) within the portfolio.
• In market downturns, draw withdrawals from the cash buffer rather than selling investment units.
• When markets recover, replenish the cash buffer by selling growth assets at higher prices.

A two-year cash buffer means a retiree can withstand two consecutive years of market decline without being forced to sell at depressed prices. Most significant market downturns, while traumatic, are followed by partial or full recovery within two to three years. The cash buffer provides the necessary time horizon.

The cost of a cash buffer is the opportunity cost of holding cash, which earns less than equities over time. At current cash rates (3 to 4.5 per cent in 2025/26), this cost is lower than in the 2010s when cash rates were near zero. The insurance value — preventing even one year of forced equity sales at a 25 per cent discount — typically outweighs the opportunity cost.

Strategy 2: Natural Income Withdrawal

In volatile markets, limiting withdrawals to the portfolio's natural income — dividends from equities and coupons from bonds — avoids selling any units regardless of market conditions. The portfolio's capital base is preserved intact.

In practice, the natural income approach requires either:

• Constructing a portfolio specifically to generate sufficient natural income (typically 3 to 4 per cent yield from dividend-paying equities and investment-grade bonds), or
• Accepting reduced withdrawals in years when market income is lower than the target (e.g., when companies cut dividends in a recession).

The 2020 COVID crisis illustrates the limitation: many UK listed companies cut or eliminated dividends in 2020, reducing the natural income from UK equity portfolios dramatically. A retiree relying entirely on natural income would have seen withdrawal capacity fall sharply in 2020 regardless of portfolio capital value.

A hybrid approach — natural income as the primary source, supplemented by modest capital sales when natural income falls short — addresses this limitation while retaining most of the benefit of avoiding large capital unit sales at depressed prices.

Strategy 3: CAPE Ratio-Based Withdrawal Adjustment

The Cyclically Adjusted Price-to-Earnings ratio (CAPE, or Shiller P/E) is a measure of market valuation that compares current equity prices to average inflation-adjusted earnings over the previous ten years. A high CAPE ratio suggests markets are expensive relative to historical norms; a low CAPE suggests markets are cheap.

Research by Michael Kitces and others has shown that the CAPE ratio at the start of retirement is a significant predictor of safe withdrawal rates. When CAPE is high (markets expensive), reducing withdrawals is prudent; when CAPE is low (markets cheap), higher withdrawals are sustainable.

A practical application: if the UK or global equity CAPE is above its long-run average by 30 per cent or more at the point of retirement, consider starting at a more conservative withdrawal rate (e.g., 3 per cent rather than 3.5 per cent). If CAPE is below average, the standard withdrawal rate is more supportable.

This approach requires ongoing attention to market valuations — it is not a passive strategy. However, for engaged retirees or those with advisers who monitor portfolio sustainability metrics, CAPE-adjusted withdrawals can meaningfully extend portfolio longevity.

Strategy 4: Pausing Withdrawals in Bear Markets

Where a retiree has sufficient flexibility — alternative income sources, a cash reserve, or the ability to reduce spending temporarily — pausing drawdown withdrawals during a significant market downturn can preserve portfolio capital dramatically.

The compound effect of pausing withdrawals for twelve months during a 30 per cent market fall is substantial: not only are no units sold at the lower price, but the portfolio is larger when markets recover because no units were redeemed at the trough. Even a three to six month pause during the most acute phase of a downturn can materially improve long-term outcomes.

This strategy requires the retiree to have either cash savings outside the pension, a guaranteed income floor (State Pension, annuity, or DB pension), or the willingness to reduce spending temporarily. For retirees with guaranteed income covering essential expenses, pausing discretionary drawdown during a bear market is highly rational.

Strategy 5: Asset Allocation De-Risking on a Schedule

Portfolio de-risking — gradually reducing equity exposure as the retiree ages — reduces the impact of severe equity market falls later in retirement, when the portfolio has fewer years to recover. This is sometimes called the "age in bonds" rule (holding a bond percentage equal to your age), though modern research suggests somewhat higher equity allocations than this simplistic rule implies.

A practical approach:

• At drawdown entry (age 65): 60 to 70 per cent equities, 30 to 40 per cent bonds/cash.
• At age 75: 50 to 60 per cent equities, 40 to 50 per cent bonds/cash.
• At age 80+: 40 to 50 per cent equities, 50 to 60 per cent bonds/cash, with a cash buffer.

This schedule reduces the severity of pound-cost ravaging if a major market fall occurs later in retirement, when the portfolio is smaller and the remaining lifespan is shorter. However, it also reduces the long-run growth potential — a trade-off that must be explicitly evaluated.

For internationally diversified portfolios, currency risk must also be considered: significant drawdown from a US-equity-heavy portfolio during a period of sterling strength creates an additional valuation headwind independent of underlying market performance.

The CAPE, Volatility, and UK Equities

UK equity markets have historically exhibited higher volatility relative to their dividend yield than US markets, and UK listed companies have demonstrated a tendency to cut dividends more aggressively than US companies in downturns (2020 being a clear example). This means that UK-equity-heavy drawdown portfolios are at greater risk of both capital volatility and income volatility compared to globally diversified portfolios.

Global diversification — including significant US equity exposure — has historically reduced portfolio volatility and improved sustainable withdrawal rates for UK-based investors, at the cost of sterling currency risk. Hedging currency risk on equity positions is possible but costly; many advisers accept unhedged international equity exposure as a risk worth taking given the diversification benefit.

Annuitisation as a Volatility Management Tool

Purchasing a lifetime annuity with a portion of the drawdown pot eliminates the investment risk attached to that portion permanently. For a retiree who is anxious about market volatility's impact on their essential income, partial annuitisation — converting enough to cover essential expenses — removes the volatility risk for the income floor, leaving only the discretionary drawdown portfolio exposed to market fluctuations.

The annuity decision is irreversible. It should be made only after careful analysis of the income floor requirement, available enhanced annuity rates (which may be significantly above standard rates for those with health conditions), and the amount that should remain in drawdown for growth and flexibility.

Compliance Notes

Drawdown portfolios are subject to investment risk. Returns can fall as well as rise. Past market performance does not predict future performance. Withdrawal rate guidance is based on historical data and involves inherent uncertainty about future market conditions, longevity, and inflation.

The strategies described in this guide are general in nature and should not be construed as personal financial advice. Individual circumstances — including income from other sources, essential expense levels, health, and risk tolerance — must be assessed before implementing any drawdown strategy. Regulated financial advice is strongly recommended.

Taking flexible income from a drawdown plan triggers the Money Purchase Annual Allowance (£10,000 per year). Pausing or reducing withdrawals does not affect the MPAA once triggered.

How Global Investments Can Help

Global Investments advises clients on drawdown portfolio construction and sustainability modelling, including stress tests against adverse market scenarios and sequence-of-returns risk analysis. We do not rely on optimistic "straight line" return projections — we model realistic downside scenarios and ensure clients understand the implications before entering drawdown.

For internationally mobile clients, we additionally model the currency risk components of globally diversified drawdown portfolios and advise on the interaction between UK pension drawdown and overseas income sources, property rental yields, and tax treaty positions.

Investments can fall as well as rise. Please seek regulated advice before making any pension investment or drawdown decision.