Hi Nords, good to see you here. I have some fears about a market crash that would derail early retirement. If I retire now in late late 40s, it would be near impossible to get my job back in my line of work. It's almost easier to retire early, early... Because then one would not be too old to re-enter the workplace.
How to you see surviving market crashes?
Thx!
Thanks for asking the question, Joanie-- as I drafted my answer I realized that I've written a blog post.
You're right about that early-early retirement concept. I know several ERs in their 30s (and a couple in their 20s) who are confident that they'll be able to freelance their way to more income if they need to. But if you can accumulate the assets to retire that early then you'll never go hungry again, and you'll always be producing income through some entrepreneurial side hustle. I'm lookin' at you, Jim Wang (
http://microblogger.com/) and Pat Flynn (SmartPassiveIncome.com).
My spouse and I have been through two market crashes during our ER: the tech wreck and the Great Recession. We've been investing since the late 1970s but the retirement recessions felt more painful without a paycheck. Today, though, we have the experience and confidence born of the crucible. Another recession wouldn't bother us much, but we might find some great bargains.
Your biggest challenge is dealing with emotions, particularly fear. The first step is to pick an asset allocation that lets you sleep at night. Then you can lie in bed reciting the Bogleheads mantra "Stay the course!" until you doze off. But seriously, watching your portfolio through a recession is a test of mental toughness and stamina. If you have an asset allocation plan then you can feel as if you're in control (even though you're not), and you can also buy more bargains at the bottom (rebalancing). The confidence is what keeps you from panicking and selling out at the bottom.
Another defense is reading about asset allocation and investing during recessions. I started with Dimson & Marsh's "Triumph of the Optimists" and William Bernstein's most excellent "The Four Pillars of Investing". It probably doesn't matter exactly what books you read about asset allocation as long as you read about recessions and investing until your reaction becomes "Ho-hum, another swing of the pendulum." Then turn off CNBC, step away from the computer, and go for a long walk. If you need to pick a book for inspiration then start with the blog's "Recommended Reading" list from the "investing" or "retirement" categories:
http://the-military-guide.com/recommended-reading-books-research-papers-and-articles/It also helps to post to forums like this one. You'll see plenty of people buying gold bullion and shotgun shells, but the experienced investors will be watching for their rebalancing criteria to trigger. You'll also find plenty of reassurance. Other people hire financial advisors just to have someone to hold their hand and tell them that everything's going to work out fine.
The next challenge is financial: having the assets to survive a recession. Most recessions bottom out during the first year and start to recover during the second, so we keep two years' expenses in cash. We start out in January with 8% of our portfolio in CDs and a money market fund and begin spending it for the expenses that aren't already covered by my pension. At the end of the first year, if the market is up then we replenish the cash stash from dividends/interest or by selling a few appreciated shares. If the market is down at the end of the first year then we start cashing in the CDs. By the end of the second year you might have to contemplate selling equity shares, and they might be off their peak value, but we've never had to sell at a loss. This post covers the month-by-month excruciating details:
http://the-military-guide.com/2014/02/20/how-should-i-invest-during-retirement/Every portfolio should include some annuitized income, even if it's "just" Social Security. When you ER, if you do not have a pension then I strongly recommend putting 20%-25% of your asset allocation in a single-premium index annuity. If you're reluctant to trust an insurance company (and pay the fees for the longevity insurance) then I'd recommend a low-expense index dividend equity fund. (We have a portion of our portfolio in the iShares Select Divident ETF DVY.) During the Great Recession this fund lost a huge chunk of its value, but its dividend payouts only lost about 10%. Today it's back at its 2007 levels but the dividends have grown faster than inflation (and a lot faster than our personal inflation!). Other disciplined and diversified dividend investors who held on during recessions (only selling if a company froze or cut its dividend) saw minimal reductions in income.
The 4% SWR assumes withdrawing 4% during your first year and then boosting withdrawals for inflation every year afterward, but that's just "easy" for a computer to simulate. No human actually robotically follows that system. Investor behavioral psychology says that we tend to spend more during bull markets (wealth effect) and cut back during recessions. If you find yourself tempted to boost your spending during a bull market, then at the end of the year you could try to raise your cash asset allocation to 9-10% to give you a little more buffer during the next contraction. You will also spend less during a recession, so your two years' cash will probably stretch to 2.5 years or even longer.
In "Work Less, Live More", Bob Clyatt pioneered the 4%/95% SWR. (You can probably find WLLM at a library.) Bob's system withdraws 4% of your portfolio value every year, no matter what that value may be. No inflation adjustments, and this 4%-every-year works great during bull markets. However if the portfolio drops during a recession, you'd end up taking a huge spending cut. That's where the 95% comes in-- if the market is down at the end of the year and next year's withdrawal would be less than 95% of last year's withdrawal, then just limit your cutback to 95% of the previous year's withdrawal. That means you might end up withdrawing 5%-6% of your portfolio for a couple years, but eventually the market will recover and your portfolio will rebuild. Bob paid a financial analyst firm quite a bit of money to run the simulations, and he treats his own portfolio this way.
Bob's "Armageddon" solution is to find a temporary job-- even if it's greeting Wal-Mart shoppers or running errands on TaskRabbit. However since writing WLLM he's rekindled his passion for sculpture and he's now one of NYC's leading artists: ClyattSculpture.com. When you're in ER you'll probably find your own passion or at least a paying hobby, and that will also help you feel more productive and confident during recessions. Mine is writing & blogging, and I could pull in at least $25K/year by working 3-5 mornings a week. My cousin has confirmed my estimate with her blog, and FinCon is filled with hundreds of entrepreneurs doing at least that well.
Statistically, your fears of a market crash may be baseless. Here's the crux of the 4% SWR: 19 times out of 20, you end up with way more money than you need. Since we're all (mostly) human, everybody immediately zooms in on the 1 out of 20 with laser-keen focus and starts trying to reduce that to "0 out of 20" by various schemes like "just one more year" or the 3% SWR or living off only their dividends. However the fastest way to plug that 1 out of 20 failure is with some annuitized income from a SPIA or dividends, and then the other 19 situations will take care of themselves.
