The First Five Years of Retirement Matter More Than You Think

Many things can and will go wrong in retirement, but the timing of when they happen matters almost as much as what actually happens.

A bad stock market when you’re 85 isn’t fun, but a bad market six months after you retire can be a much bigger problem. That’s one of the reasons I believe the first five years of retirement deserve more attention than they usually get.

The major difference is that you’ve lost one of the best weapons you had to combat a market downturn while you were working: your income.

Prior to retirement, if the market declines, it stinks, but it’s OK. You’re still living off your working income, contributing to your 401(k)—and actually purchasing more shares because of the decline, which we all know is not a bad thing—and you’re not forced to sell investments into the downturn because you don’t need the money yet.

That all changes in retirement.

You’re withdrawing money every month to meet your income needs, relying on your portfolio more, and having to sell stocks when they are down is a bad recipe.

There is a name for this problem: sequence-of-returns risk.

Basically, it says that two people could retire with the same balance, spend the same amount every year, and even earn the same average return over their entire retirement. But if one experiences a significant downturn in the early years and the other doesn’t, their outcomes can be very different.

The reason is pretty simple.

If the market is down substantially and you still need $60,000 to live on, that money has to come from somewhere. If you’re forced to sell investments when they’re down, those investments are no longer there to help you recover when the stock market bounces back.

Do that enough times early in retirement and you can dig a hole that’s difficult to get out of. But the stock market is not the only reason those early years are so important.

That’s also when you figure out what retirement actually costs.

We can run projections all day long prior to retirement, but when every day becomes Saturday, maybe you travel more, take on some projects at home, eat out more, etc. None of those are bad things, but they could lead you to spending more money than you planned on.

The earlier we figure that out, the better off we are because we can adjust the plan accordingly.

Those first few years can also be important from a tax standpoint.

If you’re retiring in your 50s or early 60s, Social Security may not have entered the picture yet and, in theory, those could be some of your lowest taxable-income years. This creates a great opportunity to be proactive about tax planning and potentially get money out of your retirement accounts at a lower tax rate than you would have otherwise.

Maybe it means converting some IRA money to a Roth or taking funds out of the IRA before you’re required to. The right answer is different for everyone, but those low-income years can be valuable—and once they’re gone, they’re gone.

The last part I’ll mention comes down to behavior and how we “feel” when the market pulls back. A 20% decline feels a lot different at 65 when you’re withdrawing money from your accounts than it did at 45 when you were still putting money in.

That’s important because bad decisions tend to happen when people are scared. If you live long enough, you will almost certainly experience a prolonged downturn at some point during your retirement.

That’s why I want people entering retirement prepared for exactly that. If it doesn’t come for a long time, great. But we know market declines are part of investing, so we’ve got to be ready for them.

So what does being ready actually look like?

I believe in keeping enough money to support up to five years’ worth of planned portfolio withdrawals separate from the stock market. This separate fund belongs in a mix of cash and high-quality that have historically been much more stable than stocks.

The purpose isn’t to predict when the next downturn will happen or how long it will last. It’s to give us options when it does.

If the stock market pulls back significantly, we can use those more conservative assets to fund your income rather than being forced to sell stocks at depressed prices. Ideally, that gives the stock portion of the portfolio time to recover before we need to start selling from it again.

Five years won’t guarantee that every bear market will be over by the time we need to touch stocks again. Nothing can guarantee that. But it gives us something incredibly valuable in retirement: time.

And time gives us choices.

The first five years of retirement deserve a lot of focus and planning. We don’t know what the stock market will do during those years, and we don’t need to.

We just need to know what we’re going to do when the market declines, not if.

Be ready.

Investment advice offered through 55 Wealth, LLC, an Indiana-registered investment advisor. See our full disclosure at www.go55wealth.com/disclosure.