Hard and fast recession vs long term stagflation

[blue_green_sparks]

Which is better for us retired folks? It's not like we are worried about losing a job. I almost prefer if the fed raised rates higher and faster so we can reset all the imbalances quickly and move on. In fact, I wouldn't mind grabbing a 5 or 6% 10 yr bond while they are available. The last thing I want is a 'lost decade'. Thoughts?

[Blackeagle]

Historically, periods of stagflation have been the worst for trying to survive on returns from an investment portfolio.  Give me a recession any day.

[reeshau]

In fact, it's the 70's stagflation that defines the 4% rule.

In Bengen's original study, it was the late 60's that had the lowest "SAFEMAX," or maximum withdrawal without going below $0.  The 60's themselves weren't bad, but they were followed by the 70's, which killed portfolio value vs. inflation-adjusted spending.

Note that this is worse (by a little bit) than the 1929 crash, followed by the Great Depression.

[ChpBstrd]

In the stagflation scenario, higher interest rates would cause your unhedged stock positions to lose value due to PE contraction, but on the other hand you'd have the opportunity to buy investments on sale. If you have $1M in cash, then the middle of a stagflation episode is not a bad place to be. You'd get to ask yourself "Shall I buy treasuries yielding 7% or shall I buy the S&P500 at a PE ratio of 12 and dividend yield of 3%?" However, if you already lost half or more of your portfolio's cash value during the stagflation episode because you started with high-priced stocks and bonds, you wouldn't be able to fully capitalize on the opportunity. Chances are you'd have to go back to work while agonizing over the knowledge that the 30-year safe withdraw rate is probably 5-7%, but that's a lot harder to prove than the 4% rule.

In the severe recession scenario, expect stocks to drop another 20-40%. This is a similar setup as the stagflation scenario, except in the recession scenario bond yields will likely fall. As in the stagflation episode, this would be a great time to buy if you haven't already lost much of the value of your portfolio! Also, recessions are the perfect time to FIRE with a higher-than-advised withdraw rate.

To summarize these ideas, if you think either stagflation or a recession is probably on the way, capital preservation should be your first concern. In either scenario, a big stock sale and much higher SWRs are right around the corner. The right things to do in either case are to (1) raise your allocation of cash, and (2) aggressively hedge or otherwise reduce your exposure to stock beta.

It's not that the recession or stagflation are bad for you in and of themselves. Your ability to capitalize on these future conditions depends completely on whether you lose a large chunk of your portfolio prior to the big investment sale.

Also, in the stagflation scenario, it is important to take steps to reduce your personal exposure to inflation. A home with a long mortgage, solar panels, insulation, a highly fuel efficient and durable car, the ability to fix things instead of replacing them, a low "electronics" footprint, preferences for free entertainment, a lack of booze/cigs/drugs habits, getting plenty of exercise, a preference for low-processed or no-processed foods, a preference for quality furniture and household items, and cheap hobbies go a long way toward preventing your spending growth from directly tracking CPI. These behaviors break a key assumption of most FIRE models which limits the SWR.

[blue_green_sparks]

To summarize these ideas, if you think either stagflation or a recession is probably on the way, capital preservation should be your first concern. In either scenario, a big stock sale and much higher SWRs are right around the corner. The right things to do in either case are to (1) raise your allocation of cash, and (2) aggressively hedge or otherwise reduce your exposure to stock beta.

My strategy might be considered by many in the FIRE community to be market timing. Personally, besides leaning (maybe too far) towards wealth preservation because I am in my 60s (and I do expect healthy defined benefits later on,) I make what I would call "major bull/bear adjustments" to my allocations. Macro-economic trends develop slowly and are obvious, so the exact timing is relatively unimportant. I am only down around 3% as of today but even that bothers me.

When the skies clear and we learn interest rates will be lowered, I will start shifting back to stocks. I may miss some gains, sure, but I am OK with that. I am only down 3% today but even that bothers me.

I should create an automatic GTC order like this.....
if (News == Fed rate increase)
 sell (TREASURY6M, on the bid);
 buy (SPY, on the ask,1000 shares);

[bmjohnson35]

No question that a recession is better than stagflation.

I'm not sure about other early retiree's, but we don't have much traditional income and we do try to keep our AGI in check for the ACA.  We rebalance from time to time, but we don't have "new" money to take advantage of drops in the market.  You go into FIRE with a strategy and although we may tweak it over time, we won't be trying to "time" the market or make radical changes in our portfolio.  Between years of easy money, covid and the war in Ukraine, it will take a while for the dust to settle. Hopefully we can avoid extended stagflation......a lost decade or more would be a bummer.

[HawkeyeNFO]

If I had to choose, I'll take the recession.  Stagflation is a disaster for anyone interested in RE.
That said, if you have a COLA'd pension and the annual changes are realistic, then you do have some mitigation.  In my case the USN retirement pay makes up about nearly 40% of what I need to meet expenses, which still leaves a great deal of vulnerability to market conditions.