Why do the first five years of retirement matter so much?
A market drop in the first few years of retirement does more damage than the same drop later. That’s called sequence of returns risk. Planning ahead for what you sell first, and keeping a few years of spending out of the market, can make or break your retirement.
The short answer
Early in retirement you’re selling investments to pay the bills, so a market drop in those years can do more lasting damage than the same drop later. Planning what you sell first, and keeping a few years of spending out of the market, can take the pressure off.
Your savings become your paycheck
While you’re working, your paycheck pays the bills and your savings can grow untouched. When you retire, the paycheck stops and your savings take its place. That often means selling some investments every month to cover your spending.
Why an early market drop hurts more
Most retirement savings hold two kinds of investments: stocks and bonds. When the market drops, stocks usually fall the hardest and bonds tend to hold up better.
If you have to sell stocks while they’re down, each share you sell is worth less, so it takes more shares to raise the same cash. Once those shares are sold, they can’t grow back when the market recovers. That’s why a drop in your second year of retirement can matter more than the same drop fifteen years in.
The timing of the bad years can matter as much as your average return. This has a name: sequence of returns risk.
How to plan around it
You can’t control the order of your returns, but you can plan for it:
- Keep a few years of spending out of the market, so you aren’t forced to sell stocks during a drop.
- Decide ahead of time what you’ll sell first, so a down year doesn’t make the choice for you.
How we handle it
At Sansone CPA & Financial, we coordinate your tax, investment, and retirement decisions so an early down market doesn’t have to decide the next twenty years.
This article is general education, not tax, legal, or investment advice for your situation. Tax rules change, so talk with us before acting on it.
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