Retiring Into the Wrong Year

Investing

A hypothetical woman (invented for this piece, not a real client) is 63, planning to retire next spring, and she cannot stop thinking about 2008.

She watched her parents' portfolio get cut nearly in half the year her father retired. They recovered, eventually. But she remembers the two years he went back to consulting, the trip they never took, the way her mother watched CNBC like weather.

Her fear has a name in the planning world, and unlike most retirement fears, this one deserves the respect she's giving it. It's called sequence of returns risk, and it's the reason "average returns" is one of the most dangerous phrases in retirement.

Same average, opposite outcomes

Take two hypothetical retirees. Each retires with $1M and withdraws $45,000 a year, adjusted for inflation. Each earns EXACTLY the same average return over 25 years, about 7%.

The only difference: the order the returns arrive in.

Retiree A gets a bad first three years (say, down 20%, down 15%, flat) followed by two decades of strong markets. Retiree B gets the strong markets first and the same bad three years at the very end.

Retiree B dies with well over a million dollars. Retiree A runs out of money in her early 80s.

Same money. Same withdrawals. Same average return. One of them broke, one of them left an inheritance. Nothing about the market was different. Only the sequence.

Why the early years are so heavy

While you're saving, a crash is a discount. Your contributions buy more shares, and everything recovers together. A 2008 at age 40 is one of the best things that can happen to your 401k.

While you're withdrawing, a crash is a wound that keeps bleeding. You sell shares at the bottom to fund living expenses, which means fewer shares are left to recover when the market turns. The portfolio can't "just wait it out" because you're eating it during the wait.

Do that in year fifteen of retirement, when the portfolio has already grown and your remaining horizon is shorter, and it stings. Do it in year one, and it changes the trajectory of every year that follows. The first five to ten years of retirement carry more of the risk than the other twenty combined. Researchers call it the "retirement red zone" for a reason.

What history actually says

The real numbers, for our 63-year-old's peace of mind:

Someone who retired in January 2000 with a stock-heavy portfolio and a 4% withdrawal rate faced two major crashes in their first nine years. Their portfolio survived, but barely, and only because the 4% rule was built on scenarios exactly like that one.

Someone who retired in 2008 saw a 37% drop in year one. But the recovery that followed was so strong that a disciplined 4% withdrawer was ahead of the January 2000 retiree within a decade.

Someone who retired in 2010 or 2013 never faced an early crash at all and is now sitting on far more than they started with, and probably underspending because of stories like the ones above.

The lesson isn't that crashes don't hurt. It's that WHEN they hit is largely luck, and the entire craft of retirement income planning is about making sure luck doesn't get a vote.

Taking away luck's vote

The moves that defang the sequence, in rough order of importance:

A cash and bond buffer for the red zone. Two to three years of the portfolio's required withdrawals sitting in something that doesn't crash. If 2008 arrives in year one, you spend the buffer and leave the stocks alone to recover. This is the single most important idea in this newsletter: never be a forced seller of stocks in a down year.

Flexible spending guardrails. A plan that says "we withdraw $45K no matter what" is fragile. A plan that says "we withdraw $45K, and trim to $40K if the portfolio drops below X, and get a raise if it grows past Y" survives almost everything history has thrown at it. Small cuts early beat catastrophic cuts late.

A Social Security floor. Delaying the bigger benefit toward 70 means more of your essential spending is covered by a check that cannot crash. The larger the guaranteed floor, the less the portfolio has to produce during the exact years a crash would hurt most.

Realistic starting rates. Retiring the year after a huge run-up? Some planners start at 3.5% instead of 4%. Not forever. Just through the red zone.

For her, specifically

She should retire next spring. The fear isn't a reason to keep working; it's a reason to build the buffer, set the guardrails, and park the Social Security. Done right, a 2008 in her first year becomes a bad year, not a bad retirement.

Her parents didn't fail because 2008 happened. They struggled because nobody had built the plan for it. She has a year to build hers.