James Conole analyzed a retirement case study that highlights a critical consideration for those planning to retire before their Social Security benefits begin. Through examining Becky’s situation, a 62-year-old retiree with a $1 million portfolio, he uncovered essential insights about portfolio adjustments during the pre-Social Security period.
Understanding the Pre-Social Security Gap
Becky’s case presents a common scenario: she wants to retire at 62 but won’t start collecting Social Security until age 67. This five-year gap creates unique challenges for portfolio management. With monthly expenses of $5,000 ($60,000 annually), she needs to carefully structure her investments to bridge this period safely.
During these five years, Becky will need approximately $380,000 from her portfolio to cover expenses, accounting for inflation and taxes. This creates a withdrawal rate between 6.5% and 8% of her portfolio – significantly higher than what’s typically recommended for sustainable retirement.
The Risk of Market Downturns
The main challenge lies in protecting against market downturns during this critical period. Historical data shows that bear markets typically take about two and a half years to recover, with some lasting up to five years. A significant market decline during the pre-Social Security period could severely impact retirement sustainability.
Consider this scenario: If the market drops 20% while withdrawing 6.5% annually, the effective withdrawal rate increases substantially as the portfolio value decreases. This combination of high withdrawals and market losses can permanently damage retirement savings.
Creating a Protected Income Strategy
To address this risk, I recommend implementing a two-part strategy:
- Set aside approximately $300,000 in stable, high-quality short-term bonds
- Account for dividend income (estimated at $80,000 over five years)
This approach creates a safety net for the critical pre-Social Security period. The remaining portion of the portfolio can stay invested in growth-oriented investments, leading to a roughly 70/30 stock-to-bond allocation.
The higher your withdrawal rate, the more money you need set aside in stable investments because during market downturns, you need access to those reserves.
Portfolio Evolution After Social Security
Once Social Security begins, the required withdrawal rate drops dramatically – in Becky’s case, from 8% to 3.2%. This reduction in portfolio dependence creates flexibility to adjust the investment strategy. The portfolio can potentially become more growth-oriented since the lower withdrawal rate reduces the need for stable assets.
This dynamic approach to portfolio management – adjusting based on changing income sources and withdrawal needs – proves more effective than maintaining a static allocation throughout retirement. While it might show lower potential returns in straight-line projections, it significantly increases the probability of retirement success by protecting against sequence-of-returns risk during the critical early years.
Frequently Asked Questions
Q: Why is the pre-Social Security period so critical for retirement planning?
This period is crucial because retirees must rely entirely on their portfolio for income, resulting in higher withdrawal rates. Without proper planning, market downturns during this time can permanently damage retirement savings.
Q: How much should I set aside in stable investments before Social Security begins?
Calculate your total expenses until Social Security starts, including inflation and taxes. Subtract expected dividend income to determine the amount needed in stable investments like high-quality short-term bonds.
Q: Can I return to a more aggressive portfolio after Social Security begins?
Yes, once Social Security starts, your portfolio withdrawal rate typically decreases significantly. This lower dependence on your portfolio may allow for a more growth-oriented investment approach.
Q: What types of stable investments are recommended for the pre-Social Security period?
Short-term, high-quality bonds are recommended as they offer stability while maintaining some yield. These investments help protect against market volatility during the critical early retirement years.
Q: Should I delay retirement until Social Security begins to avoid this risk?
Not necessarily. With proper portfolio structuring and adequate savings, early retirement can be feasible. The key is creating a protected income strategy that shields essential expenses from market volatility.
