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Can a Year of Low Earnings Reduce My Social Security Benefit?

A reader writes in, asking:

“I’m in the not-quite-retired-but-probably-could-afford-to-if-I-wanted-to stage of my career. I am pondering many options, including cold-turkey retirement, switching to fewer days per week, or retiring but starting a new type of work that I hope would be more fun on a daily basis. One concern I have about the last two options is that they will result in one or more years of lower earnings at the end of my career, and I have heard that could reduce my social security retirement amount. Is that true?”

Short answer: no, that’s not true.

Many pensions are based on things like “average of last 5 years of earnings.” For pensions like that, yes, a year of low earnings at the end of one’s career could result in a smaller pension.

But that’s not how Social Security works. Your Social Security retirement benefit is based on your 35 highest years of earnings (after adjusting years prior to age 60 for wage inflation). If you have a new year of low earnings, worst-case scenario is that it isn’t one of your 35 highest and it therefore is simply not included in the calculation. In other words, that year of earnings wouldn’t reduce your benefit — it just wouldn’t increase it, as an additional year of high earnings might.

However, a year of low earnings could cause the benefit estimates on your Social Security statement to go down. Similarly, a year of low earnings could cause your actual benefit to be lower than the benefit estimate that you are seeing on your statement.

The key point here is that the benefit figures that appear on your statement are estimates. And those estimates include a projection about future earnings. Specifically, the estimates assume that you continue earning — at the same earnings level as your most recent earnings year for which the SSA has data — until you retire and file for benefits (the estimated figures on the statement assume that those two things will happen simultaneously*).


  1. If you have a year of earnings that was lower than your prior year, once your benefit estimate reflects the new lower year of earnings (and therefore projects that lower earnings level forward) it could result in a lower estimate, and
  2. If your actual earnings turn out to be lower than the assumed/projected earnings baked into the estimated benefit figures, your actual benefit could turn out to be lower than the estimated benefit.

But again, an additional year of low earnings will not reduce your actual benefit. Worst-case scenario is that a year of low earnings will have no effect on your actual benefit (i.e., will not increase it).

*This article explains how to use the SSA’s calculators to calculate what your benefit would be if you retire at a different age than the age at which you file for benefits.

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Dividend Reinvestment FAQs

I thought I’d do something different with today’s article. Below are a few questions — from different readers — about various aspects of reinvesting dividends. None of them required a long enough answer to constitute its own article, but the topics in question are likely to be of interest to other readers.

“I’ve read that from 1960 until now, 82% of the stock market’s overall return is from reinvesting dividends. But I’ve also seen that dividends are usually only 2-3% in a given year, whereas the market’s overall return might be something closer to 8%. I guess what I’m asking is why are dividends so much more important than the increasing price, even though they are a small part of the return?”

It’s not that the dividends are more important than the price appreciation. It’s simply that they are a significant part of the return, and leaving off a significant part of the return dramatically reduces the overall accumulation over an extended period. (This is the same reason that mutual fund expense ratios are super important.)

The longer the period in question, the more pronounced this effect. For example, a $1 initial investment that grows at 8% per year for 75 years will come out to about $321. Reduce the return to 7% instead, and the final result is just $160. In other words, reducing the return by one eighth cut the final value by half. If you instead reduce the return from 8% to 6%, you end up with just $79 — a one-quarter reduction in return reduced the final value by more than three quarters.

That’s why when you read about statistics regarding the importance of dividends over several decades, you see very pronounced effects. Any change to the rate of return will have a magnified impact on the ending value. The effect is smaller if we look at periods that are shorter but still significant over a person’s lifetime (e.g., 20 years).

To reiterate, dividends are important, because they are a significant part of the overall return. But the idea that they are far more important than the price appreciation is simply a misunderstanding of the math involved.

“Why does the price of a mutual fund fall when it pays a dividend?”

In short, the price falls because the fund has less assets, which means it’s less valuable. (The same thing happens with individual stocks, by the way.)

For example, imagine that a fund has a net asset value (NAV) of $25 per share on a given day, made up of $24 worth of various stocks holdings and $1 of cash. Then the fund declares a $1 cash dividend.

Anybody who buys the fund before the ex-dividend date will essentially be getting $24 worth of stocks and $1 of cash. Anybody who buys after the ex-dividend date will be getting just the $24 worth of stocks. Point being: the price should fall by $1 on the ex-dividend date. (Of course in the real world it’s messier than that, because the prices of the various underlying stocks would also be moving around from one day to the next.)

To be clear, the fact that the price falls on the ex-dividend date doesn’t mean that you lose something when your fund declares a dividend. The price falls, but you now have an equivalent amount of cash in your brokerage account. (Or, if you reinvest the dividend, you’re in exactly the same place as before, tax considerations notwithstanding.)

“Should I set my mutual fund to automatically reinvest dividends?”


Having dividends automatically reinvested means that your money begins to earn a return sooner, which is a good thing.

But, if the account in question is a taxable account, it also means that there’s more tracking to be done, because you’ll have a greater number of dates and prices at which you purchased shares. But if you aren’t tracking your cost basis yourself anyway (e.g., you’re using the “average cost” method, and you are relying on your brokerage firm to calculate such for you), then the additional complexity doesn’t much matter. (To be clear though, I would encourage you to keep your own cost basis records, rather than completely relying on another party.)

You should also be aware that automatic reinvesting of dividends could result in a wash sale if you sell the investment in question at what would otherwise be a loss. Generally, this would not be a major reason not to reinvest dividends, as the effect would usually be small. But it’s something to be aware of so that you can report your taxes appropriately.

“How do I calculate the gain or loss on a sale of a mutual fund when I have had dividends and capital gains reinvested? Last year I invested $40,000 in a mutual fund, and it was worth about $40,500 at the end of the year. My dividends and taxable gains for that year, all of which were reinvested, were about $1,700 according to my online statements. Let’s say my fund’s value is $40,500 when I sell it this year. What would be my gain or loss?”

Because you have the account set to reinvest dividends and capital gains, you actually purchased $1,700 worth of shares over the course of last year. So your total basis at the end of the year was $41,700.

So if at the beginning of this year (i.e., before any new money gets invested or distributions get reinvested) you had sold all of the shares for a total of $40,500, then you would have a capital loss of $1,200 (i.e., $40,500 realized on the sale, minus $41,700 cost basis).

If further dividends/capital gains had been reinvested this year before the sale, those would be added to your cost basis as well.

Whether or not you could actually claim this loss would depend on whether or not it’s a wash sale — which it could be, if you own other shares of this same investment (or something else that is “substantially identical”) in another account.

Risk Adjusted Returns: What’s the Point?

A reader writes in, asking:

“I don’t understand the point of ‘risk adjusted’ returns. All I’m concerned with is actual returns. If a change to my portfolio ‘improves’ my risk adjusted return but does not improve the actual return, it doesn’t seem like I actually benefit from it.”

I’m sure you would agree that any change to your portfolio that results in an increase to expected return without an increase in risk is an obvious “win.”

Similarly, any change to your portfolio that reduces risk without decreasing expected return is also a “win.” What may not be obvious is that, in such a case, you have the option of happily accepting that lower level of risk, or, if you prefer, you could do something else that brings your risk level back up to what it was before (e.g., shift your stock allocation slightly upward), but now with a higher level of expected return.

In other words, those two things — an increase in expected return without an increase in risk, or a decrease in risk without a decrease in expected return — are somewhat interchangeable. A decrease in risk can easily be exchanged for an increase in expected return.

More broadly, the concept of risk-adjusted return is asking: once we have determined approximately how much risk is acceptable for this portfolio, how can we get the highest expected return for that level of risk?

Everybody Has a Risk Limit

Over the years I have come across several young, risk tolerant investors who have told me that they do not care about risk at all. All they are concerned with is return (or expected return).

That’s nonsense.

Every investor has a limit to the risk they can accept.

Even if your portfolio is 100% stocks right now, you are still forgoing higher-risk, higher-expected return options. For instance, instead of just 100% stocks, why not 100% small-cap value stocks? And why stop at 100%? You could borrow money to invest (i.e., invest on margin). You could short a bond ETF (e.g., have an effective allocation of 110% stocks, -10% bonds). If you haven’t done such things and choose not to do such things, you too have a limit to the risk you will accept.

Sometimes the limit is a financial limit (you cannot afford to take on more risk), and sometimes the limit is a psychological limit (you cannot tolerate more risk). But you definitely have a limit.


While the concept of risk-adjusted return is useful for understanding portfolio construction discussions, applying it in real life comes with important caveats.

Firstly, there are many ways to measure risk. Standard deviation of returns is the most popular measure historically. But looking only at the standard deviation of a distribution gives you an incomplete picture. For instance, as Larry Swedroe often mentions, it is helpful to also consider skewness (i.e., how asymmetrical is the distribution of returns) and kurtosis (i.e., how far is the distribution from a normal distribution — how fat are the tails).

And for a retirement stage portfolio (as opposed to an accumulation stage portfolio), we’re concerned with an entirely different set of risk metrics (e.g., probability of portfolio depletion, size of portfolio shortfall, etc.).

Secondly, portfolio changes that clearly achieve either of the goals that we’re discussing here (that is, a reduction in risk without a reduction in expected return or an increase in expected return without an increase in risk) are rare. And you want to have a high degree of skepticism when somebody suggests that they have a way for you to do so, other than simply “diversify” and “reduce costs.”

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