Retiring before claiming Social Security presents a unique financial challenge—one that many retirees overlook until it’s too late. If you’re planning to retire before your Social Security benefits begin, your portfolio needs to be structured strategically to bridge the income gap. Otherwise, you risk running out of money too soon or being forced to sell investments at a loss during market downturns.
In this article, we’ll walk through a real-world case study to illustrate how you can adjust your portfolio to maintain financial security in early retirement. Whether you’re in your late 50s or early 60s, making this adjustment now can make a significant difference in your long-term financial success.
The Challenge of Retiring Before Social Security Begins
Let’s take a look at Becky’s situation. Becky is 62 years old and wants to retire now. She has a $1 million portfolio, entirely in a 401(k), and plans to spend $5,000 per month ($60,000 per year) in retirement.
So far, everything seems straightforward—until we consider one critical factor: Becky won’t start collecting Social Security until age 67. That means she has a five-year gap where her only income source is her investment portfolio.
This gap is where most retirees make a major mistake. They fail to adjust their portfolio to account for the withdrawals they’ll need to cover expenses before Social Security kicks in. This mistake can lead to financial instability, especially if the stock market performs poorly in the first few years of retirement.
Let’s break down the key risks Becky faces and how she can mitigate them with a better portfolio strategy.
Understanding the Impact of Withdrawals in Early Retirement
To properly plan for early retirement, the first step is to analyze cash flow needs year by year. Becky’s Social Security benefits won’t start until age 67, so for the next five years, she’ll need to withdraw funds from her 401(k) to cover living expenses.
However, withdrawals come with two significant risks:
1. Market Timing Risk
If Becky’s portfolio is invested 100% in stocks and the market experiences a downturn, she may be forced to sell investments at a loss to generate income. For example, if the market drops 20% in the first year of her retirement and she still withdraws $60,000, that withdrawal represents a much higher percentage of her portfolio than she initially planned.
Over time, this can have a compounding negative effect, making it harder for her portfolio to recover.
2. High Initial Withdrawal Rates
Becky’s initial withdrawal rate is around 6.5% to 8% per year for the first five years of retirement. Historically, financial planners recommend a safe withdrawal rate closer to 4%. A high withdrawal rate, combined with market downturns, increases the risk of running out of money too soon.
Once Becky’s Social Security kicks in, her withdrawal rate will drop to around 3.2%, which is much more sustainable. But the key challenge is making sure she can weather those first five years without depleting her portfolio too quickly.
The Portfolio Adjustment Becky (and You) Should Make
To reduce risk and ensure financial security, Becky needs to adjust her portfolio allocation before retirement. Here’s what she should do:
1. Set Aside Five Years of Withdrawals in Low-Risk Investments
Becky needs approximately $380,000 to cover her first five years of withdrawals. Instead of keeping this money in stocks, she should shift a portion of her portfolio into safer, more stable assets.
A good approach is to allocate this $380,000 as follows:
- $80,000 in dividends from stocks – Even in a market downturn, many companies continue paying dividends. Assuming a 2% dividend yield, Becky’s portfolio could generate about $16,000 per year, or $80,000 over five years.
- $300,000 in short-term, high-quality bonds – This ensures that a significant portion of Becky’s portfolio is protected from market volatility, allowing her to withdraw money without selling stocks at a loss.
2. Shift to a More Balanced Portfolio (Not 100% Stocks!)
Instead of keeping 100% of her portfolio in stocks, Becky should adjust to a 70/30 allocation (70% stocks, 30% bonds). This allows for continued long-term growth while reducing short-term risk.
3. Revisit Allocation After Social Security Begins
Once Becky turns 67 and starts collecting Social Security, her withdrawal rate will drop significantly. At that point, she could consider shifting her portfolio back to a more aggressive allocation if she wants to maximize long-term growth.
The Real Impact of This Strategy
Some retirees hesitate to shift money into bonds, fearing they’ll sacrifice long-term growth. However, adjusting Becky’s portfolio actually increases her probability of success.
With a 100% stock portfolio, Becky’s retirement plan has a 73% probability of success (meaning she has a 27% chance of running out of money too soon).
By shifting to a 70/30 portfolio, her probability of success jumps significantly, reducing her overall risk while still allowing for strong long-term growth.
Even better, once her Social Security begins, Becky can increase her stock allocation again, ensuring her portfolio keeps up with inflation while providing financial security.
Key Takeaways for Retirees
- Retiring before claiming Social Security requires careful portfolio adjustments.
- Set aside five years of expenses in safer investments to avoid selling stocks in a downturn.
- Avoid high withdrawal rates in the early years of retirement to prevent depleting your savings too quickly.
- A balanced portfolio (e.g., 70/30 stocks to bonds) improves financial security while still allowing for long-term growth.
- You can adjust your allocation over time—early retirement requires a more conservative approach, but you may shift back to more stocks once Social Security starts.
If you’re planning to retire before claiming Social Security, now is the time to adjust your portfolio. Don’t let market downturns or high withdrawal rates derail your retirement.