Defining Risk – Volatility vs Loss of Capital
When people think about investment risk, it’s usually the immediate and dramatic kind — red numbers flashing across screens, alarming headlines, and sudden drops in portfolio value. It’s understandable. These moments feel urgent and emotional.
But not all risks are created equal. In fact, the greatest risk to long-term investors often isn’t the one grabbing the headlines. To invest with confidence, it’s important to understand the difference between volatility, permanent capital loss, and sequencing risk.
Volatility: The Bumps in the Road
Volatility refers to the short-term ups and downs in the value of your investments. It’s how markets react — sometimes sharply — to things like economic data, global events, and investor sentiment.
While it can feel unsettling to see your investments decline in value, volatility is a normal and necessary part of investing. It’s the price we pay for the opportunity to earn higher long-term returns.
Consider recent history:
The Global Financial Crisis (2008), the COVID-19 crash (2020), and other downturns all caused temporary pain.
Yet markets rebounded strongly — rewarding those who stayed invested and remained disciplined.
In contrast, those who panicked and sold during market lows often turned a temporary decline into a permanent loss. That’s the difference mindset makes.
Permanent Capital Loss: The Real Danger
Permanent capital loss occurs when an investment loses value and does not recover — often because the underlying asset is no longer viable.
This can happen due to:
Investing in a company that fails or becomes obsolete.
Being overexposed to a single stock, asset class, or sector.
Selling quality investments during downturns and never re-entering the market.
Structuring mistakes — such as using excessive leverage or having inadequate liquidity.
Unlike volatility, which can bruise your confidence, permanent loss damages your wealth — and that’s why thoughtful portfolio construction, diversification, and long-term discipline are essential.
Sequencing Risk: Timing Matters in Retirement
While volatility affects all investors, sequencing risk is particularly critical for those in or approaching retirement.
Sequencing risk refers to the order in which returns occur — and when you're drawing down your portfolio to fund your lifestyle, this order can have a lasting impact.
Here’s the challenge:
If markets fall early in retirement and you’re withdrawing income at the same time, you may be forced to sell assets at depressed prices.
This leaves your portfolio with less capital to recover, which can amplify losses over time, even if markets eventually bounce back.
An extreme example but let’s consider Rachel and Stan who are retiring in different years, 1992 and 2006 respectively. It should be noted that for Rachel, the year 1992 was before a bullish period whereas for Stan, 2006 was before the GFC.
From the below, you can see that although the set of returns are the same for Rachel and Stan, the order of returns is different. Rachel experiences positive returns at the beginning of her retirement and can successfully draw an inflation-linked income for 38 years. Conversely, the impact of negative returns at the start of Stan’s retirement means his account is depleted after only 20 years. A difference of 18 years. By not protecting their capital during a market downturn, investors risk exhausting their savings much earlier than planned.
*Source – Allianz Retire Plus
To manage sequencing risk, investors should:
Maintain a cash buffer or defensive "bucket" to meet short-term income needs.
Avoid selling growth assets in a downturn by aligning investments to timeframes.
Implement a structured drawdown strategy to support sustainable income.
A well designed investment strategy and prudent ongoing portfolio management should aid in mitigating sequencing risk over time.
Our Role: Managing Risk, Not Eliminating It
As advisers, we can’t eliminate market volatility—nor should we try. Our role is to help clients navigate risk with clarity and confidence. This means constructing well-diversified portfolios to reduce the chance of permanent capital loss, aligning assets with investment timeframes to avoid selling long-term holdings to meet short-term needs, and preparing for market drawdowns with thoughtful retirement income strategies that help guard against sequencing risk. Just as importantly, we support our clients in staying calm and focused when markets become noisy and emotions run high.
By understanding these risks and planning with intention, investors are better equipped to stay the course and build long-term wealth with resilience and purpose.
General Advice Warning:
Any general advice on this page does not take account of your personal objectives, financial situation and needs, and because of that, you should, before acting on the advice, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. Information contained on this page was correct at the time of posting.