Why do the first few years of retirement matter so much for your savings?
While you’re saving for retirement, a bad year in the market is unpleasant, but time is on your side. Once you start withdrawing, the same bad year can do lasting damage. Two retirees can experience the very same returns, in a different order, and end up in very different places. Understanding why helps you plan for the years when it matters most.
Same returns, different order
Imagine two people who each retire with $600,000 and withdraw $36,000 at the start of each year, 6% of their starting savings. To keep the example clear, their withdrawals stay the same each year.
Over their first ten years, they experience exactly the same yearly returns: −15%, −10%, 5%, 8%, 12%, 10%, 8%, 12%, 10% and 15%. The only difference is the order. The first retiree gets them in that order, with the losses at the start. The second gets them in reverse, with the losses at the end.
Without withdrawals, the order wouldn’t matter at all. Multiplication works the same in any order, and both would end with the same balance.
With withdrawals, it matters a great deal. After ten years, the first retiree has about $381,347. The second has about $591,322, nearly $210,000 more, from the same returns and the same withdrawals.
Why order matters once you withdraw
When losses come early, you’re withdrawing from a portfolio that has just shrunk. Selling investments after they’ve fallen locks in those losses, and the money you sold isn’t there to benefit when markets recover.
For the first retiree, two losing years combined with withdrawals took the balance from $600,000 to about $399,060. The later strong years produced good returns, but on a much smaller base.
For the second retiree, strong early years built the balance up before withdrawals had worn it down, so the losses at the end hit a larger cushion.
This is called sequence of returns risk. It’s greatest in the years just before and after retirement, when your savings are at their largest and you’re beginning to draw on them.
Why the average hides it
Both retirees’ returns averaged 5.5% a year. A plan built on that average would show them both doing equally well. That’s the limitation of projections that assume a steady return every year: they can’t show what happens when a downturn arrives at the worst moment.
How people plan for it
There’s no way to choose the order of returns, but there are ways to reduce how much it can hurt.
Some retirees keep a few years of planned withdrawals in cash or short-term bonds, so they don’t have to sell stocks after a fall. Others adjust spending, taking a little less in years when markets are down. Starting with a more conservative withdrawal rate leaves more room for a bad sequence. Guaranteed income, such as Social Security or a pension, covers some spending regardless of markets, which reduces how much has to come from investments. Some people also delay retirement or work part-time in the early years to reduce withdrawals during the riskiest period.
Each of these has trade-offs, such as lower expected growth, less spending or more years of work. The right mix depends on how much flexibility your spending has and how much other income you have.
What you can explore
The retirement withdrawal calculator shows how long savings could last at a given withdrawal rate. It uses a steady return, so it’s a useful starting point rather than a stress test; try a lower return to see how much margin you have. The retirement calculator projects savings before retirement.
The takeaway
Once you begin withdrawing, when returns happen matters as much as what they average. Early losses can leave a lasting mark, which is why the years around retirement deserve the most careful planning, and why having flexibility in those years is valuable.
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This article is general education about US personal finance, based on the assumptions and sources described in it. It isn’t financial, tax or legal advice, and examples use hypothetical people and figures.