Why the First Five Years of Early Retirement Matter
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Retiring early with $5 million may sound like complete financial security. However, the amount you have accumulated is only one part of determining whether your wealth can support a long retirement.
The market’s performance during the first several years after you retire may have a significant effect on how long your portfolio lasts. This is known as sequence-of-returns risk.
Understanding this risk can be especially important for early retirees, whose assets may need to provide income for several decades.
What is sequence-of-returns risk?
Sequence-of-returns risk is the possibility that investment losses occurring near the beginning of retirement could have a lasting effect on a portfolio.
When someone is still working and regularly contributing to investments, a market decline may provide time to continue investing and wait for a potential recovery.
Retirement changes that dynamic. Once withdrawals begin, an investor may need to sell assets to fund living expenses, even when those investments have declined in value.
Those withdrawals leave less capital invested and available to participate in a future market recovery.
Why does the order of investment returns matter?
Two retirees could begin with the same portfolio, withdraw the same amount, and earn the same average return over time, yet experience very different outcomes.
The difference may be the order in which those returns occur.
A portfolio that experiences positive returns early in retirement may be better positioned to support future withdrawals. A portfolio that experiences substantial losses during the first several years may face greater pressure because money is being withdrawn while asset values are lower.
This means an average return alone does not tell the complete story.
Why can early retirees be particularly vulnerable?
Someone who retires early may need their assets to support 40 years or longer.
A longer retirement can create greater exposure to:
- Market volatility
- Inflation
- Healthcare expenses
- Changing tax rates
- Unexpected family needs
- Lifestyle changes
- Longevity
- Multiple economic cycles
Early retirees may also have fewer options for replacing portfolio losses through additional employment income. If withdrawals begin during an extended market decline, the effects could continue influencing the plan years later.
Is having $5 million enough to retire early?
The answer depends on much more than the portfolio balance.
Five million dollars may be sufficient for one person and inadequate for another. Important considerations include:
- Annual lifestyle expenses
- Retirement age
- Taxes
- Healthcare and insurance costs
- Other income sources
- Portfolio allocation
- Family responsibilities
- Debt
- Inflation
- Desired legacy
- The flexibility to reduce spending
The important question is not simply, “How much have I saved?” It is whether those assets are coordinated with a realistic spending and withdrawal strategy.
How can retirees prepare for difficult markets?
Managing sequence-of-returns risk does not mean attempting to predict when the next market decline will occur.
Instead, it involves creating a plan for where spending may come from when markets are not cooperating.
A retirement-income strategy may consider:
1. Maintaining appropriate liquidity
Cash reserves or other liquid assets may help cover near-term expenses without requiring certain investments to be sold during unfavorable market conditions.
2. Coordinating different income sources
Social Security, pensions, business income, rental income, and investment withdrawals may all play different roles within a retirement plan.
3. Creating a flexible spending strategy
Separating essential expenses from discretionary spending may help identify which costs could be adjusted temporarily during a prolonged market decline.
4. Reviewing the investment allocation
The portfolio should reflect the retiree’s time horizon, spending needs, risk tolerance, and capacity to experience market losses.
5. Monitoring withdrawals
Retirement withdrawals should be reviewed regularly rather than placed on autopilot. Market performance, inflation, taxes, and lifestyle changes may require adjustments.
Why is a withdrawal rate only one part of the plan?
A withdrawal rate can provide a useful starting point, but it does not account for every situation an early retiree may experience.
A complete strategy should also consider which accounts will fund spending, how withdrawals may affect taxes, how much liquidity is available, and what adjustments may be made during difficult markets.
Aventura Private Wealth helps individuals, families, business owners, and executives coordinate their investments, retirement income, liquidity, taxes, and long-term goals. Preparing for retirement is not only about reaching a target number. It is about creating a strategy for how your wealth may support you through changing markets and every stage of retirement.
Aventura Private Wealth, LLC (“APW”) is a Registered Investment Adviser ("RIA"). Registration as an investment adviser does not imply a certain level of skill or training, and the content of this communication has not been approved or verified by the United States Securities and Exchange Commission or by any state securities authority. APW renders individualized investment advice to persons in a particular state only after complying with the state's regulatory requirements, or pursuant to an applicable state exemption or exclusion. All investments carry risk, and no investment strategy can guarantee a profit or protect from loss of capital. Past performance is not indicative of future results.
