What if the stock market (your nest egg) drops by 50% and stays there a while?

[Jadambomb]

Hello,

I have a general question for Mr. Money Moustache or any of the Moustachians out there. I wasn't sure if this was discussed specifically or in detail...

 Let's say you think you can retire because you've run the 4% rule, and 4% of your current investment assets cover your already bare bones spending.  So, for example, you've cut your spending to $20,000 per year, and you finally hit $500,000 in your investment account.  Now it looks like you can retire because 4% of $500,000 is $20,000, so you retire. 

What would happen (or how would a Moustachian deal with the situation where) if the stock market crashed by 50%.  So now your investment assets are only worth $250,000.  So now 4% of THAT is only $10,000.  Now you can't cut back further because you already live an extremely bare bones lifestyle.  Now typically, stock market crashes like that don't last THAT long, but what happens if it is protracted?  Like 5 years or more?  Would we just start withdrawing 8% and hope for the best? 

I guess I am just confused about that ONE thing.  That you get where you think you need to be, you retire, and then, BOOM, your assets, (and therefore your 4% income) crash, and you can't live on that. 

Any advice on how us Moustachians might deal with a situation like this?

[odput]

A.  Dividend payouts won't get cut by 50%, even if the value of the stock does.

B.  Most people here don't intend to retire on "bare-bones" budgets.  I see all over the place FIRE budgets that include travel, entertainment, and the like.  Even if not, almost every budget has some fat to trim. 

C.  A part-time job can easily fill $10k a year if you get that scared about it.

http://www.mrmoneymustache.com/2011/10/17/its-all-about-the-safety-margin/

ETA link

[Timmmy]

I think I could figure out a way to earn the $200 per week to cover the dip.

I'd actually be really tempted to go back to work for a while.  If stocks are on sale that much I'd like to be a buyer and not a seller.  An extended 50% dip sounds like a great way to set myself up real nicely for the rebound. 

[Tyler]

Classic Trinity study followers will say that even if things crash, at 4% of the pre-crash amount you'll still most likely be fine in the longrun. Those past assurances won't necessarily ease the pain of the ride, though, if you lack confidence in your financial plan and skills.

You could choose to focus on dividends where face value is less important, a more diverse portfolio (with more than just stocks) where a huge drop is less likely, or real estate rentals where income is generally more stable if you know what you're doing. One should be aware, however, that RE and other investments don't necessarily play by the 4% rule. So educate yourself first.

You can also build a bit of buffer into your spending projections. IMHO, if there's absolutely no breathing room in your budget you're probably better off working a little longer anyway.

The ERE types would argue that you can focus on learning how to do more things yourself rather than assume you must pay for them. Start a garden. Maintain your own transportation and home. Barter more. Who cares if the stock market drops if you're mostly self-sufficient?

You can get a job if you need to. Granted, if the stock market crashes 50% that's exactly when steady jobs will be more difficult to come by. But an entrepreneurial mindset can always find opportunity where others see roadblocks.

So there are definitely ways to mitigate that risk. How you personally do it is up to you, but I do think it's a good mental exercise to go through.

[Jadambomb]

A.  Dividend payouts won't get cut by 50%, even if the value of the stock does.

B.  Most people here don't intend to retire on "bare-bones" budgets.  I see all over the place FIRE budgets that include travel, entertainment, and the like.  Even if not, almost every budget has some fat to trim. 

C.  A part-time job can easily fill $10k a year if you get that scared about it.

http://www.mrmoneymustache.com/2011/10/17/its-all-about-the-safety-margin/

ETA link

Thanks so much!  Great reply.  By the way, what is a FIRE budget?  (Sorry, I'm pretty new here)

[Louisville]

Keep a couple years' cash on hand. Live on it, and also buy some more stock market while it's down 50%.

[DecD]

A.  Dividend payouts won't get cut by 50%, even if the value of the stock does.

B.  Most people here don't intend to retire on "bare-bones" budgets.  I see all over the place FIRE budgets that include travel, entertainment, and the like.  Even if not, almost every budget has some fat to trim. 

C.  A part-time job can easily fill $10k a year if you get that scared about it.

http://www.mrmoneymustache.com/2011/10/17/its-all-about-the-safety-margin/

ETA link

Thanks so much!  Great reply.  By the way, what is a FIRE budget?  (Sorry, I'm pretty new here)

FIRE = Financially Independent, Retired Early

[SunshineGirl]

It's easy to confidently theorize how wonderfully we'd handle it, but the truth is, that would be a very unsettling period of time. I try to think in terms of having "buckets" of income or ways to make money -- i.e. rental property will cover some of our expenses, dividends or 4% withdrawal, pension. If circumstances require it, we'd rent out our guesthouse. I'd certainly be fine getting a $10/hour PT job if needed.

I'd also start the whole retirement journey with a lot of cash in the bank, like 1-2 years' worth of expenses.

[waltworks]

Play with some simulators/spreadsheets like Cfiresim and you can test your portfolio/spending against all of the history of the (US) market. Yes, obviously, the entire market could lose 90% of it's value and stay there forever. You could also be killed by lightning 5 minutes from now. Do you stay inside at all times to avoid lightning? Or work indefinitely to get more and more portfolio/security? Then you're doing it wrong.

-W

[briandougherty]

I doubt I'll ever be 50% down. What I have in unrealized value today may decrease by 50% a few months later but that's not me being 50% down. Thinking about my lifetime value changes will dampen some of the blow.

[Eric]

Lots of good advice already, but no one has mentioned that there's a reason it's not recommended to hold 100% stocks.  If the market drops by 50%, your stash should not drop by that much as you'll also own bonds, which tend to move the opposite of stocks, especially during a large downturn.

[ioseftavi]

Lots of good advice already, but no one has mentioned that there's a reason it's not recommended to hold 100% stocks.  If the market drops by 50%, your stash should not drop by that much as you'll also own bonds, which tend to move the opposite of stocks, especially during a large downturn.

Was coming here to say this.  Almost nobody would own 100% stocks - very aggressive FIRE folks might own 70%+ in stocks, but 100% is nearly unheard of. 

As other people have mentioned, FI types also keep emergency funds available, separate from their long-term stash.  If your portfolio shrank by 50% or whatever, most people might dip into their e-fund instead of "kicking their portfolio while it's down" by selling 4% for yearly living expenses while it's in the middle of a big downturn.  You can also, as people mentioned, take your budget down to bare-bones and try to pickup a little part time work.  Anything will help in a year where your P/F drops 30% or so.

EDIT:  I meant "almost nobody retired would own 100% stocks."  Some mustachians in the accumulation phase are 100% equity, however.

[frugalnacho]

I own 100% stocks.  I'm also not planning to FIRE for like 10 more years, so i'm assuming I have plenty of time to recover from any dips.  I would not be 100% stocks if I was planning to retire because a scenario like the OP mentioned would devastate me.

[The Money Monk]

You could always have a long term hedge position be a part of your plan too, if you are heavily in stocks and really worried about it.

If I'm not mistaken billionaire George soros has a 'legacy' hedge position like this that he rolls over every quarter

[Beric01]

I own 100% stocks.  I'm also not planning to FIRE for like 10 more years, so i'm assuming I have plenty of time to recover from any dips.  I would not be 100% stocks if I was planning to retire because a scenario like the OP mentioned would devastate me.

100% stocks may be too risky if you're planning to FIRE in 10 years. My horizon is around the same, and I'm 80/20. 100% stocks is more of a 25 years+ strategy, and there's very little additional benefit (and a lot more volatility) compared to something even a little less risky, such as a 90/10 ratio.

[surfhb]

It seems a lot folks on this site consider 500k-700k to be a FIRE stash in their30s or 40s...... That's dangerously low to just say:  "yep!   In retired now.....no more working"

[Beric01]

It seems a lot folks on this site consider 500k-700k to be a FIRE stash in their30s or 40s...... That's dangerously low to just say:  "yep!   In retired now.....no more working"

If your expenses are 20K/year, how is this "dangerously low"? Run Cfiresim - this should be more than enough in most cases.

[4alpacas]

Lots of good advice already, but no one has mentioned that there's a reason it's not recommended to hold 100% stocks. If the market drops by 50%, your stash should not drop by that much as you'll also own bonds, which tend to move the opposite of stocks, especially during a large downturn.

+1 to Eric's comment

If there was a huge drop in the market, I would probably be tempted to go back to work (at least part-time) and shovel money into index fund. 

[Bateaux]

Like others here have said.  Take a job, any job that pays day to day expenses till the market rebounds.  Think how much better off you are with a 50 percent drop in the market than those with debt and no savings.  You only sacrifice a year or so.  They will slave till death.

[FIreDrill]

Lots of good advice already, but no one has mentioned that there's a reason it's not recommended to hold 100% stocks. If the market drops by 50%, your stash should not drop by that much as you'll also own bonds, which tend to move the opposite of stocks, especially during a large downturn.

+1 to Eric's comment

If there was a huge drop in the market, I would probably be tempted to go back to work (at least part-time) and shovel money into index fund.

Yep, I would plan on trimming as much fat off the budget as possible and create some income to put towards investments if there was a 50% decline.  I would see it as a rare opportunity to add some awesome padding to the stache but that's just me.  Also,  I will most likely be keeping about 5 years expenses in bonds to hedge against a big drop like that and then take from stock dividends and bonds in the event a big drop happens.   Assuming a 1 million dollar portfolio and 4% safe withdrawal rate that would put me at about 200k in bonds or 20% of my total portfolio.  Still pretty stock heavy but it provides a lot more flexibility than a 100% stock portfolio.  Especially when you can cut back on spending.

[Beric01]

And while it's not a bad idea to take a part-time job in an awful downturn, you don't really need to. Run Cfiresim - you can see that even maintaining your 4% withdrawal rate on your original balance, you'd still be fine in historical scenarios. 4% withdrawal is actually quite conservative.

[4alpacas]

And while it's not a bad idea to take a part-time job in an awful downturn, you don't really need to. Run Cfiresim - you can see that even maintaining your 4% withdrawal rate on your original balance, you'd still be fine in historical scenarios. 4% withdrawal is actually quite conservative.

Buuuuuuuuut...stocks at a discount!  Who can pass that offer up?!

[Dee18]

This is why you need think about the amount of risk you are comfortable with.  I am choosing to create a bigger stash and keep some of it guaranteed because I do not want to have to go back to work after retirement if there is such a crash. 

[dude]

Like others here have said.  Take a job, any job that pays day to day expenses till the market rebounds.  Think how much better off you are with a 50 percent drop in the market than those with debt and no savings.  You only sacrifice a year or so.  They will slave till death.

I would be careful in relying on this strategy, as a 50% market drop would also likely be accompanied by double-digit unemployment, making jobs scarce and highly competitive (even the shitty ones).  I'd prefer to keep a 2-3 year cash equivalent cushion on hand for just such a scenario (which, we all know, is generally only potentially catastrophic if it occurs within the first 1-3 years of retirement).

[Kansas Beachbum]

My plan is to keep 1 year of living expenses...plus a slush fund...in cash (money market checking), keep a second year also in cash in the form of CD's, keep an additional three years in bonds (not bond funds) structured such that another year's worth of expenses matures at the end of each year, with the balance of our portfolio in a moderate stock/bond mix focusing on blue chips, dividend payers, etc.  I'm thinking that will provide plenty of short to medium term liquidity while keeping at least some of the stash working in the stock market.  Thoughts?

[frugalnacho]

I own 100% stocks.  I'm also not planning to FIRE for like 10 more years, so i'm assuming I have plenty of time to recover from any dips.  I would not be 100% stocks if I was planning to retire because a scenario like the OP mentioned would devastate me.

100% stocks may be too risky if you're planning to FIRE in 10 years. My horizon is around the same, and I'm 80/20. 100% stocks is more of a 25 years+ strategy, and there's very little additional benefit (and a lot more volatility) compared to something even a little less risky, such as a 90/10 ratio.

Why is it too risky?  I have steady income and a high savings rate, for probably another 10 years.  What will bonds do for me besides smooth out the volatility at the cost of lower returns?  When I get closer to FIRE I will have bonds added into the portfolio to reduce volatility since I will be living on that portfolio

[Beric01]

And while it's not a bad idea to take a part-time job in an awful downturn, you don't really need to. Run Cfiresim - you can see that even maintaining your 4% withdrawal rate on your original balance, you'd still be fine in historical scenarios. 4% withdrawal is actually quite conservative.

Buuuuuuuuut...stocks at a discount!  Who can pass that offer up?!

No I completely agree, and would most likely do the same. I'm just saying that it isn't mandatory.

I own 100% stocks.  I'm also not planning to FIRE for like 10 more years, so i'm assuming I have plenty of time to recover from any dips.  I would not be 100% stocks if I was planning to retire because a scenario like the OP mentioned would devastate me.

100% stocks may be too risky if you're planning to FIRE in 10 years. My horizon is around the same, and I'm 80/20. 100% stocks is more of a 25 years+ strategy, and there's very little additional benefit (and a lot more volatility) compared to something even a little less risky, such as a 90/10 ratio.

Why is it too risky?  I have steady income and a high savings rate, for probably another 10 years.  What will bonds do for me besides smooth out the volatility at the cost of lower returns?  When I get closer to FIRE I will have bonds added into the portfolio to reduce volatility since I will be living on that portfolio

I agree with the concept, but you need to be careful about your implementation. I want to FIRE in 10 years (or less), and I don't want to take as much risk that I might be waiting until 15 years due to an awful market. At it is, 80/20 is pretty risky 10 years from FIRE.

Of course, if you plan to continue working as normal after your FIRE date, then this is moot point. But I most likely would stop working, at least in my current field, upon reaching FIRE, and move to a lower-paying one (assuming I do take a paying job at all and don't just volunteer somewhere).

[LennStar]

What would happen (or how would a Moustachian deal with the situation where) if the stock market crashed by 50%.  So now your investment assets are only worth $250,000.  So now 4% of THAT is only $10,000.  Now you can't cut back further because you already live an extremely bare bones lifestyle.  Now typically, stock market crashes like that don't last THAT long, but what happens if it is protracted?  Like 5 years or more?  Would we just start withdrawing 8% and hope for the best? 

You mean like what happened in 2007/08?
stocks were down 50% for more then 3 years, then slowly started to go up.
Not they are up about 1/3 including inflation, thats about 5% a year - AFTER the biggest (world wide) crash after WW2.
So even if you would have slopped out 7% (saved 1% or got some money for the 1%), you would now nearly at plan.


Back to question: If I retired at the 2007 high of the stock market, I could first use "emergency money" (the real emergency stack and another one of stable bonds) to buffer the drop. 6+6 month expenses would buy me 2 years. (If something really happens, I can always sell the stocks)
Also I would have planted a walnut and a haselnut tree by now. If you are like MMM in the paleo diet, that saves a lot of money in the long run ;) If not, you can sell them. Just put a dign up at season like "500g walnuts, 5$, guaranteed organic from own garden" - that would be 20% cheaper as I have seen them in the supermarket last year. People should buy. Or trade it with other tree-havers ;)
I would also try to cash in my hobby(s) that I have worked on since FIRE.
Since a lot of people will need to cash in what they have bought earlier in such a down, you could promote yourself as a seller - help them sell their stuff, get a % of it. You will have it easier then them because it is not your stuff and the money is not pressing you and you have basically all the time you need. Even if you only net out 2$ a hour, you learn how to sell better and have an additional buffer.
(In reality I would not going to sell, because I deeply hate selling, but most people can get used to this after a week or two.)

[opnfld]

100% stocks may be too risky if you're planning to FIRE in 10 years. My horizon is around the same, and I'm 80/20. 100% stocks is more of a 25 years+ strategy, and there's very little additional benefit (and a lot more volatility) compared to something even a little less risky, such as a 90/10 ratio.

Paul Merriman has a table showing historic average annualized return, standard deviation, worst drawdown, and worst 12-month performance of stock/bond allocations in 10% increments at http://paulmerriman.com/fine-tuning-your-asset-allocation-2014/.  His data assumes 50/50 US/International.   A 90/10 ratio has averaged 11.5%, worst 12-months 47.1%.  100% equities has averaged 12%, worst 12-months 51.1%.

It's a helpful tool to choose a long-term asset allocation that balances return versus risk.  I'm a year from FIRE, 80/20, and trying to get to 70/30 over the next year...and ideally add some rental income.
 

[DarinC]

Inflation adjusted recovery, including invested dividends, can take up to 15 years in certain markets (eg the S&P 500 from 1965-1980).

If you're living off the dividends then your real investments could take up to ~20+ years before you break even (S&P from 1965 to ~1985).

Anyone should be financially prepared for their real investments and dividends to drop simultaneously and take decades to recover, because that has happened and will likely happen again (although who knows when).

I'm curious how a well diversified investment would behave, but I imagine it's similar to a market w/o as much in the way of highs/lows.

[Hotstreak]

Someone pointed out that 4% is already a conservative number, historically.  This is from MMM's 4% rule post:

[MsRichLife]

I'm considering setting up a 'Fixed Income Security ladder' to cover at least my bare bones expenses when I RE. That should see me through 5 years of stock market pain if it happened.

http://www.rbcwm-usa.com/resources/file-687481.pdf