When it comes to retirement, timing is everything. And for retirees, the good times aren’t just on Social Security start dates to thread the needle or start taking required minimum distributions (RMDs). It also has to do with understanding the markets. That’s because retiring during a down market can have long-term effects on the health and longevity of retirement savings.
It is related to what is known as sequence risk. This usually refers to the dangers posed by early retirement withdrawals during down markets. Retirees who retire during a bear market, for example, may see their long-term savings take a big hit from starting to drawdown in a bad investment climate.
After a massive 2022 decline in which the S&P 500 fell nearly 20%, SmartAsset crunched the numbers to see how starting retirement in a fall year could affect long-term investment savings. Here we have found it.
To uncover the long-term effects of early down-market retirement withdrawals, SmartAsset looked at two past bear markets: 2001 and 2008. We examined what would have happened to the long-term savings of a retiree who kept $1 million in an investment account. at the start of a year in which the value of stocks plummeted — and whether waiting until the market retired improved the health of their long-term savings.
Here’s a breakdown of the profiles for these aspiring retirees:
retirement dates. The first two retirees in our analysis plan to retire in 2000. The other two plan to retire in 2008, the year of the Great Recession.
drawdown rate. Every saver plans for a 4% drawdown rate, which will increase with the historical rate of inflation. We believe that these accounts do not have required minimum distributions (RMDs) or mandatory withdrawals.
investment mix. The pre-retirees each maintain a portfolio of investments that is weighted 50% to the S&P 500 and 50% to the performance of a popular bond index mutual fund.
Various retirement dates. This is where our aspiring retirees make a difference. In every bear market, a retiree barrels forward with retirements, starting account withdrawals in a down year and locking in losses early. The second investor waits until the year the market begins to recover, retiring during the period when the market is on the upswing.
2001 Bear Market
Pre-retirees A and B both have $1 million saved at the start of the early 2000s bear market. Since he is retiring soon, his portfolio tracks a half-and-half mix of stocks and bonds.
But as the market begins to decline, Retire B decides to delay retirement account withdrawals, choosing to work longer or perhaps living on cash savings for an additional three years. His account still takes a beating throughout the bear market, but he doesn’t close at a loss by making withdrawals. Today, his account is worth $1,332,513.
Retiree A, on the other hand, goes ahead as per the plan. She retires. Despite experiencing similar annual returns, inflation rates, and subsequent withdrawals, the difference is huge. His account value is $833,934.
Retiree B, who waited to begin withdrawing until the market had recovered, has $498,579 more saved in his retirement account than Retiree A today. That’s the difference of a few years.
2008 Bear Market
The same two scenarios apply here. Retiree A does not wait to begin withdrawing from his accounts, choosing to begin withdrawing during the down market in 2008. His balance today: $1,163,628.
Retired B just waits one extra year – when the market recovers. His balance today is $1,262,926. The total difference between the two is $99,297 after just one extra year of delayed withdrawals.
importance of sequence risk
For retirees staring down the barrel of a bear market, it may make sense to wait an additional year or two to start drawing on retirement accounts.
Of course, hindsight is 20-20, and an extended down market and recovery is impossible — and not advised — for most retirees. Still, if the wheels are already in motion on retirement, and the markets are starting to tank, novices may be able to pivot quickly to minimize or avoid the retirement drawdown. This can help them reduce the impact of poor early retirement returns on their savings.
Four general strategies for doing this may include:
- Continuing to work even on a part-time or consultancy basis.
- Tapping short-term cash savings or other funding sources before withdrawing the investment.
- Option to reduce withdrawals – perhaps taking 2% in the initial decline year instead of the full 4%.
- Delaying big expenses like vacations for a year or two to reduce or eliminate withdrawals.
No matter what strategy retirees use, weathering a bear market downturn, especially early in retirement, can have a substantial impact on retirement longevity.
Another example of sequence risk
Here is another chart that can show how important sequence risk is.
These numbers are examples only. Both the accounts return 5% over 30 years. And both have the same annual return. It’s just that they are inverted. A retiree retires in one year. The other one retires in a down year. See the difference in their account sizes at the end of 30 years.
Sequence risk matters. New or soon-to-be retirees considering downsizing should have a plan in place to prevent early market losses from doing long-term damage to their portfolios. Consider strategies to stave off or minimize withdrawals, such as continuing to work or consult instead of retiring in a down market.
Retirement Planning Tips
- Planning for retirement can feel like solving a complicated puzzle, but you don’t have to do it alone. A financial advisor can help you put the right pieces together by assessing your needs and connecting you with the right services for you. SmartAsset’s free tool matches you with up to three vetted financial advisors serving your area, and you can interview your advisor matches for free to decide which is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Social Security plays an important role in many people’s retirement plans. By delaying Social Security beyond your full retirement age, you can increase your benefit by up to 8% per year until age 70. SmartAsset’s Social Security calculator can help you determine the best time to claim your benefits.
Questions about our study? Contact [email protected]
Photo credit: © iStock.com/kupicoo
Susanna Snyder, CFP® Susanna Snyder is the Managing Editor of Financial Education at SmartAsset, where she oversees the strategy and production of all expert-driven personal finance content, including commentary and columns from CFPs and other financial professionals. In addition, Susanna writes articles, newsletters, columns and commentary found on SmartAsset.com and syndication partner sites. She also serves as a spokesperson and cited expert on a wide range of personal finance and financial planning topics, including retirement, investing, estate planning, mortgages, and more. Susannah earned her CFP designation in 2019 and leverages her expertise to easily explain complex financial topics. Prior to SmartAsset, Susannah was Senior Editor of Financial Advisors at US News & World Report. He also previously covered personal finance, career and college financing for US News and served as a staff writer for Kiplinger’s Personal Finance magazine. She is the recipient of the McGraw Fellowship for Business Journalism Program and won the 2018 RTDNA/NEFE Excellence in Personal Finance Reporting Award in the Digital category. Susannah holds a bachelor’s degree from the University of Rochester and a master’s degree in journalism from the University of Southern California. Susanna Cheddar has appeared as a personal finance expert on Fox & Friends, The Tavis Smiley Show, Your Money on Wharton Business Radio, Fox Business News and more.