Two retirees, same returns, one runs out of money first

Quick answer: A market drop in your first five years of retirement does far more damage than the same drop in year twenty, because you're selling shares while prices are down to pay your bills. You can't predict the market. You can build a cushion and stay flexible.

Same returns, different order

Take two neighbors, both retiring with $1,000,000. Both withdraw $50,000 at the start of each year. Both see exactly the same five annual returns: -20%, -10%, +10%, +15% and +20%. The average is the same for each of them.

One neighbor gets the bad years first. The other gets them last.

This is a simplified worked example, not a forecast. The withdrawals are flat, with no inflation raise, and there are no taxes or fees.

• Retiree A (bad years first): After year one, $760,000. After year two, $639,000. After year five, about $765,000.
• Retiree B (bad years last): After year one, $1,140,000. After year two, about $1,253,500. After year five, about $877,000.

Same returns and same withdrawals. Retiree B ends the five years about $112,000 ahead.

Now the part that should bother you. Take away the withdrawals and both neighbors finish with the same $1,092,960. The order doesn't matter when you're not spending. It only matters when money is leaving the account.

Why the early years carry the weight

Retiree A sold shares at a 20 percent discount, then sold more after another 10 percent drop. Those shares are gone. When the market recovers, A owns fewer of them to ride it back up.

Run both neighbors forward at a steady 4 percent a year with the same $50,000 withdrawals. In this simplified example, A's money lasts roughly six years less than B's. Neither one did anything wrong. One just drew the unlucky order.

The usual retirement advice about averages misses this, because averages describe the long run. You live through the sequence one year at a time.

This is also why the five years on either side of your retirement date get called the red zone. Your balance is at its biggest, so a drop costs the most dollars, and you've just started drawing it down. A drop at 52 is an annoyance. A drop at 63, the year after you stopped working, is a different animal.

What you can do about it

None of this requires a crystal ball. It requires a few decisions made before the market gives you a bad year.

Build a spending cushion. Many planners suggest holding one to three years of spending in cash or short-term bonds, separate from your stocks. In a down year you spend from the cushion and leave the shares alone to recover. The trade-off is real. Money in the cushion earns less over time, and a big cushion can drag on growth. Where you land is a personal call, and a fee-only fiduciary adviser can help you size it.

Make the raise optional. Most retirement math assumes you bump your withdrawal by inflation every year, automatically. You don't have to. If the portfolio is down 15 percent, skipping the raise for a year, or trimming spending by a few percent, takes real pressure off those early years. Know in advance which expenses are fixed (mortgage, insurance, property tax) and which can bend (travel, a new truck, the lake trip). The bendable list is your shock absorber. Write it down now, while nobody's panicking.

Look at when you claim Social Security. Waiting to claim raises your monthly check, and that check is guaranteed income that doesn't care what the market did. Some retirees spend a bit more from savings in their early sixties precisely so the larger benefit kicks in later. That only works if you can afford the bridge years, and the right claiming age depends on your health, your spouse's benefits and your other income. The rules and the exact numbers live at SSA.gov, and they change.

Consider earning something early. Part-time or consulting income in the first few years, even $15,000 or $20,000 a year, means you sell fewer shares into a weak market. It doesn't have to be forever. A couple of years can be enough to get past a rough stretch. If you're wondering what else to do with your weekday hours, see What to do with Tuesday morning when you retire.

Mind the order you spend accounts. Which account you tap first affects both taxes and how long the money lasts. We walk through the logic in Which Retirement Account To Spend From First. And if a mortgage payment is eating a big slice of your early-year spending, When To Pay Off The Mortgage Before You Retire covers the trade-offs.

What not to do

Don't try to time the market. Selling before a drop and buying back before the rebound sounds smart. It takes two correct guesses in a row, and most people who try it sell low and buy back after the recovery is underway. A written plan beats a hunch.

Don't let a bad year push you into a product you don't understand. When the news is ugly, people arrive with solutions that come with commissions. Some products have a place for some people, but read the fine print first. What to Ask Before You Sign an Annuity Contract is a good list to have in your pocket before any meeting.

And don't skip the boring step. Pick your withdrawal rate, your cushion size and a clear rule for what you'll do if the market drops 20 percent, and put it on paper. Show it to your spouse. A plan you made calmly is much easier to follow than one you invent during a bad week.

Check the rules before you act

Withdrawal rules, required minimum distribution ages, Social Security claiming math and Medicare premiums are all set by law and they change. Check IRS.gov, SSA.gov and Medicare.gov for the current numbers. Every dollar figure in this piece is an illustrative example, not a forecast or a promise.

This is general education, not individual financial, legal or tax advice. Before you change how you draw down your savings, sit down with a fee-only fiduciary adviser, a CPA, and an estate attorney if your situation calls for one.

The market will have its say in your first five years. Make sure you've already had yours.