Why the First Five Years of Retirement Matter Most

My first week of my first job out of college, HR sat me down in a conference room with a stack of forms to be completed. Taxes, benefits, and this thing called a 401(k). They told me that if I maxed out the 401K, I would never have to worry about retirement.

I was in my mid-20s and could not comprehend retirement. Then, in the blink of an eye, 32 years went by, and I found things had changed. But HR never came back to tell me about those changes.

Here's one of the things that changes when you retire, and almost nobody talks about it.

Saving and spending play by different rules

While you're working, a financial market drop isn't a disaster. You keep contributing every paycheck, your employer may match it, and you're buying shares at lower prices. When the market comes back, those share values increase.

Retirement flips that around. You're no longer adding to your savings. You're taking money out to live. And when you withdraw during a downturn, you're selling at low prices, and those dollars aren't there for the recovery.

That's why the order of your returns matters as much as the returns themselves. The industry calls this sequence of returns. It isn't just about what the market does, but when.

Same returns, opposite order

Here's a hypothetical example. Two people retire at 65 with $1,000,000 each. Both withdraw $40,000 in their first year and increase it 3% a year for inflation. Over 25 years, both earn exactly the same annual returns, averaging 6.3% a year.

The only difference is the order. Retiree A gets the three bad years at the start of retirement. Retiree B gets the same three bad years at the end.

	Retiree A (bad years first)	Retiree B (bad years last)
Starting balance	$1,000,000	$1,000,000
Average annual return	6.3%	6.3%
Balance after 5 years	$470,000	$1,772,000
Balance after 10 years	$345,000	$2,412,000
Balance after 15 years	$136,000	$3,063,000
After 25 years	Ran out in year 18	$2,263,000

Same savings. Same spending. Same average return. One retiree runs out of money at 82. The other still has more than $2 million at 90.

Nobody has a crystal ball. I can't tell you what or when the markets will do. What I can tell you is that the years right around retirement are when a downturn does the most damage. Many planners call the last five years before retirement and the first five years after it the most important stretch of your financial life.

It has happened before

After peaking in September 1929, the Dow Jones Industrial Average fell for almost three years. By July 1932, it was 89% below its peak, and it did not return to that level until November 1954. That price index alone took 25 years to recover, which is an entire retirement.

Investors who reinvested dividends recovered sooner than the index suggests. But a retiree selling shares every year to pay the bills doesn't get the full benefit of a recovery. That's the problem in a sentence.

Downturns since then have been shorter, but they keep coming: 1987, the dot-com crash, 2008, 2020. The question isn't whether you'll retire into a rough market. It's whether your plan can sustain if you do.

Ways to reduce the risk

There's no single answer, and each approach has trade-offs:

• A cash reserve. Keeping one to three years of withdrawals in cash or short-term holdings means you don't have to sell investments during a downturn. The trade-off is that money in reserve grows more slowly.
• Flexible withdrawals. Taking a little less in down years and more in good ones can stretch savings significantly. It requires a budget with some room to give.
• Income that doesn't depend on the market. Social Security, pensions, and annuities can cover essential expenses regardless of what markets do. Annuities come with costs, surrender periods, and less access to your money, so they need to be understood before you buy.
• Real diversification. Owning several mutual funds that all move together isn't real diversification. Holding assets that respond differently to the same conditions can soften the blow when one area falls.

If you work with an advisor, ask one question: what happens to my plan if the market drops 20% in my first year of retirement? You deserve a clear answer before that year arrives.

Let's talk

If you're within five years of retirement, or just past it, this is the time to look at it. Call or text me at 770-598-8063 or email Kyle@PeaceOMFS.com. The first conversation is at no charge.

Plan today, so you never look back wishing you had.

Sources

• Federal Reserve History: Stock Market Crash of 1929

This article is for educational purposes only and is not individualized financial, tax, or legal advice. All investing involves risk, including possible loss of principal. Past performance does not guarantee future results. Securities offered through Simplicity Investments, Member FINRA/SIPC, 475 Springfield Ave, Summit, NJ 07901 (303) 797-9080. Peace of Mind Financial Strategies is not affiliated with Simplicity Investments.