Most individuals must now decide for themselves how they should withdraw money from their defined contribution retirement funds — or decumulate — each year to maximize their income during their post-retirement lives.

One important, but often poorly understood, factor that can complicate this decision is sequence risk — the risk of experiencing bad investment outcomes at the wrong time. In other words, it is not just long-term average investment returns but when those returns are earned that determines a decumulating investor’s wealth. Numerous studies have shown that poor returns in the early phases of decumulation have a more damaging effect on retirement income than poor returns that come later.

The authors deploy the concept of a perfect withdrawal rate (PWR)—that is, the proportion of an investor’s retirement fund that he or she would need to withdraw per year to entirely exhaust the fund at death, assuming perfect foresight of investment returns. The authors use this concept to consider the historical decumulation experience over a 20-year period of someone wholly invested in an S&P 500 Index portfolio, which they acknowledge may be an unlikely investment choice in practice but which, nevertheless, illustrates their key points.

The hypothesis was that applying a simple monthly trend-following rule to any series of returns would reduce volatility, either maintain or increase returns over the long term, and ultimately reduce sequence risk. Using real returns from the S&P 500 between 1872 and 2014, the authors first calculated (by a Monte Carlo approach) a probability distribution of the PWR for an investor who had followed a buy-and-hold strategy.

To test their hypothesis, the authors then replaced the buy-and-hold investment strategy with an equity strategy that incorporated a trend-following filter. Under this approach, the hypothetical investor switched between holding equities and holding cash depending on whether the S&P 500 was above or below its 10-month moving average. Trend following is subtly different from momentum investing, which relies on price behavior based on technical rules. Trend following relies on price behavior but also orders the past performance of the assets of interest.

The study found that investors, depending on their birth date, who used a buy-and-hold strategy with US equities would have encountered a huge variation in the amount they could withdraw from their retirement pot. Depending on birth date, the PWR generally varied between 8% and 12% but reached as low as 4% and as high as 15%.

As the authors suspected, the 10-month trend-following strategy markedly improved investor outcomes. Around 90% of the time, it produced PWRs greater than the equivalent buy-and-hold equity strategy, and at low levels on the probability distribution, PWRs were almost double.

One clue to explaining these results can be found in annual real return data: The trend-following strategy produced an average real return of 8.84%, compared with 6.82% from the buy-and-hold strategy. But perhaps even more importantly, the trend-following filter reduced volatility by a third and halved the maximum drawdown. These effects, in turn, reduced sequence risk and produced higher PWRs in the clear majority of cases. While the transaction costs of switching between equities and cash would have an impact, the authors found these costs were unlikely to have been high enough to eliminate the benefits of the trend-following approach in the past.

This study confirms that the sequence of investment returns can dramatically affect retirement income, for better or for worse. But although asset returns are unpredictable, it suggests that decumulating investors do not have to resign themselves to the accident of their retirement date.