A lasting market downturn can be big risk early in your retirement

For investors whose retirement is decades away, the stock market’s pullback should be of little concern — there’s plenty of time for your portfolio to recover before you need the money.

Yet if you are a new retiree or on the verge of retiring, it’s worth considering what a prolonged dip would mean for your portfolio over the long-term.

Basically, down markets can pose significant “sequence of returns” risk in the early years of retirement. That risk basically is about how the order, or sequence, of stock returns over time — combined with your portfolio withdrawals — can impact your balance down the road.

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“If there’s a downturn early on, it can derail a whole retirement plan,” said Wade Pfau, a professor of retirement income at the American College of Financial Services.

The major indexes have had a rough week. Through Thursday’s close, the S&P 500 index has shed 3.9%, the Dow Jones industrial average is off roughly 3.4% and the Nasdaq composite index has slid 4.9%. Year to date, the S&P has lost 5.9%, and the Dow and Nasdaq have dropped 4.4% and 9.5%, respectively.

Generally, down markets can present a buying opportunity for investors because they’re purchasing stock at a lower price than they would have otherwise.

However, it also means that if you sell, you’re doing so at depressed prices. And for retirees especially, that can be problematic.

“If there’s a big loss in the market and you’re taking withdrawals, you could be taking more from your portfolio than what it can make up for,” said certified financial planner Avani Ramnani, managing director at Francis Financial in New York.

“If that happens early in retirement … the recovery may be very weak and put you in danger of not recovering at all or being lower than where you would have been and therefore jeopardizing your retirement lifestyle,” Ramnani said.

Here’s how a sequence of returns risk can impact your savings: Say a person had retired at the turn of the century with $1 million invested in the S&P and withdrew $40,000 each year, with withdrawals after the first year adjusted 2% for inflation.

In 2020, the remaining balance would have been about $470,000, according to Ben Carlson, director of institutional asset management for Ritholtz Wealth Management, who crunched the numbers for a blog post.

In the above scenario, the portfolio would have been subject to a bear market at the outset of the person’s retirement, when the S&P lost 37% over three years during 2000-2002, but enjoyed a long-running bull market that began in 2009.

However, if the order of yearly returns were flipped — the gains posted by the S&P at the end…