Can one bad week ruin your retirement savings? How about 3 bad years?

By Beth Pinsker

It's not so much what's happening in the market as what you do about it

If there are storms at the start of your retirement, it can be hard to recover.

Getting off on the right financial foot early in your retirement is essential for long-term success. The research on this is clear: If you spend too much right away, you can permanently shrink your nest egg. If you have the bad luck of experiencing a market downturn at the outset, your slope of growth will forever be lower.

What's less apparent to new retirees is how big the spending dent needs to be and how long the market setbacks need to last to really harm your long-term retirement success. It's easy for panic to set in during times of volatility. Since we are now in near-permanent chaos, that can be confusing.

Is one bad week enough to ruin things? If this summer's trips now cost 10% more than you were expecting because of rising energy costs, should you think about canceling? Is your portfolio mix too aggressive in this atmosphere?

"There's obviously a lot of anxiety out there, especially early in retirement," said Mari Adam, a financial educator. "It's very disconcerting when you spend, spend, spend and then there's no money coming in."

For a reality check, you have to look at what's happening at ground level. Adam walked plenty of clients who suffered most from heavy spending in early retirement when she was a full-time financial planner. She warned them: "If money goes out, it's out. But on the other hand, market losses can recover and eventually go back up."

The impact depends on some key factors: how much you have, how long the trouble lasts and how you react to it. To see how this plays out, MarketWatch turned to Nancy Gates, lead educator and financial wellness coach at Boldin, which provides professional-level retirement-planning software to individuals for a subscription fee.

Gates looked at a hypothetical couple, Ben and Elaine, who were newly retired and had a combined $1.5 million in retirement assets, mostly in 401(k) accounts. She used Boldin's baseline assumptions for monthly spending of $8,000, plus average inflation and portfolio growth. Without any major shocks, the couple had a 90% chance of their money lasting through retirement. Their total net worth actually grew to $4 million in future dollar terms.

But what if bad things started to chip away at their retirement savings just as they were starting? This is what the models saw coming:

If spending increases

We tested what would happen if the couple had to spend $500 more per month, and then $1,000 more per month over three years, and then resumed spending $8,000 as they had originally planned.

How much you have: That rate amounts to 6% and 12% more spending - much higher than the current official rate of inflation - but it felt like a realistic amount for a couple that might have to spend more for planned vacations and incrementally more for goods and services. Even an extra $10 per trip to the gas pump adds up. With $1.5 million in the bank, Ben and Elaine could easily absorb $6,000 in additional spending per year for three years. It only dented their success chances by 1%. Even an extra $1,000 per month didn't have much of an effect. But cut that nest egg in half, or to $200,000, which is about the average 401(k) balance of older Americans according to Fidelity, and the impact is much greater.

How long the trouble lasts: Three years of extended spending is a long time in financial terms. Inflation is currently substantially lower than its 2022 peak of over 9%, yet people remain concerned about high prices.

How you react to it: Couples like Ben and Elaine have to consider their budget expectations at some point. If you can't sustain higher spending, then you have to cut back. "It becomes essential vs. nonessential spending," said Kate Beattie, a senior retirement income strategist at Capital Group, who has studied sequence of returns risk. "There will be times when inflation and gas prices are coming at you and you're not going to be able to cut back as much as you need to. But you have to put guardrails in place, like here's my bare minimum floor."

Flat or down market

We tested whether a flat market for three years made an impact - and then what happened if the market was down 5% cumulatively in those years. In both scenarios, the market returned to a moderate historical average for the rest of the timespan.

How much you have: A flat market made a noticeable dent in Ben and Elaine's plan, taking their success chances down to 86%. Their portfolio rebounded with the market, but by the end of their lives, they were forecast to have $750,000 less. With a healthy starting balance, they still had excess at the end of their lives, just less. A market that was down 5% over those three years, cumulatively, pushed their success rate to 68%, and into worrisome territory.

How long the trouble lasts: A flat market or down market over three years is rare, but possible. All stock-market analysis is based on past performance, and it can't be said enough that this does not predict future results.

How you react to it: If you move your portfolio to a less risky stance because you're scared, you might permanently lock in losses. "Behavior plays a big role in it," said Beattie. "As we age, risk tolerance goes down. Having that equity component and maintaining it is important." In this sense, the flat or down market might not have to occur in the world out of your control - you could create this storm in your own portfolio by being more conservative than you need to be.

"You spent all this time climbing the mountain, and you think it will be so great, but then you see other people coming down, and they're saying, Oh it's so hard," said Gates. "What are you downshifting to? You need to position it against this sequence of return risk."

Both negative effects together

We looked at what would happen if you experienced both increased spending and a flat market at the same time over three years at the start of retirement to see if the double-whammy effect was bigger than the troubles separately.

How much you have: For Ben and Elaine, the effects added up, but did not explode their plans. With three years of flat market returns and $500 extra spending per month, their success chances went down to 85% and their end portfolio estimate lost another $80,000.

How long the trouble lasts: In her experience, downturns tend to last three to five years, said certified financial planner Valerie Rivera, who has worked with many clients through these scenarios. "We can look at research, but what's important to think about is that this is a real person's life here," she said. One of her clients is in the same position in real life now as the hypothetical Ben and Elaine. Her best advice for them is to position cash for the short term. "We don't know the future, but I do know we want to protect your mental health. So we maintain two years of cash and from what I have seen in times like this, this allows them freedom."

How you react to it: When it comes time to replenish cash, if the downturn isn't over, Rivera's plan is to liquidate some of the investments that are set up in the "intermediate" bucket. "The intermediate is where we're seeing the ups and downs, but we can pick and choose what comes out of it," she said.

This is the real danger zone, said Beattie. "Market volatility isn't going to ruin you. It's that, plus inflexible spending, that is the problem," she said. That's why one of her strategies is to shift withdrawal amounts each year according to market returns.

"If you keep up the spending, the market volatility will magnify that, but if you focus on the withdrawal aspect of it, you can mitigate some of that risk," she said. "You don't want to be drawing down more than earnings if you can help it."

She called that "dollar-cost ravaging," a play on the investing term "dollar-cost averaging," where you put money into the market in regular increments, like a 401(k) contribution from your paycheck. In that way, it's a positive. You're steadily adding to your nest egg without being dependent on market timing to find an up day to invest. Dollar-cost ravaging, on the other hand, is taking from your portfolio all the time, probably at the worst possible moments all along.

"You want to start to free up some assets into something short-term so you aren't ravaging your portfolio all along, saying 'Oh shoot, the market just tanked, but I need money now,'" she said. "I think it's just forward thinking."

Got a question about investing, how it fits into your overall financial plan and what strategies can help you make the most out of your money? You can write to me at beth.pinsker@marketwatch.com. Please put "Fix My Portfolio" in the subject line.

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