When retirement finally rolls around

[kathryn1029]

Hi all,

Long time reader, but recently registered. I've gotten totally down with the mustachian way of life, and am excited to have already made, and to continue making, changes that will allow me to retire early (I'm 26, and I think I'll be able to do it by 42). Boyfriend is almost all the way on board too. I definitely connect with all of the principles here, but I do have one issue I haven't wrapped my head around...

What if the stock market crashes right before I retire? I'm comfortable basing my lifetime projections off a 7% return, but am I wrong in thinking that if there's a crash right before I retire I'll be screwed? I know there's an answer to this, I just haven't been able to think of it/find it. Can't wait to hear from some of you mustachian geniuses how this is compensated for.

Thanks!

[Random Hangers]

I'm no expert, but I would guess that it has to do with expenses: if you keep them low, you would have time to wait out the market until a (hopefully) rebound. If you were nervous, you could also pick up a side hustle. The difference would be that you could pick something that you enjoy doing, instead of working for "the man," lol.

Our plan is to make sure we could pay for our base expenses (the needs) off our 'stash, but if we wanted to take vacations or otherwise bump up our expenses in the short-term (the wants), we would pick up side gigs. For me, that would be writing somehow, or perhaps working part-time somewhere that I actually enjoy. Retirement for me is just being financially independent, so I can choose when and if I work, and what I do with that time.

I'm sure others will chime in too, but hope that helps in the interim...

[nawhite]

There is a technical answer which involves how the 4% rule is impacted more by the performance of the stock market in the year after you retire than any other year (a crash the year you retire decreases your safe withdrawal rate more than any other year). If you'd like that explanation, let us know.

There is also a non-technical answer which is, you have lots of options if your stache is cut by a crash. You can reduce your expenses, you can go back to work, you can work harder at an income producing hobby. You have options. You may lose the option of "continue with plan to retire and spend X amount per year" but there are lots of other options and almost always will be.

[2527]

If you don't sell the stocks, the value will return.  The best years follow the worst years.   If your income is based on dividends, they remain pretty steady.

[matchewed]

In general retiring right before a crash or during (assuming you had the right funds prior to the crash and those funds are lower than anticipated in the "during") is one of the few things which can derail a FIRE attempt (inflation is much more dangerous IMO).

That being said there are a couple of strategies.
As you near FIRE you can adjust your AA to be more conservative and as the first few years pass move it to a more aggressive AA. The downside to this that I can see is it all depends on what is crashing at that time or what market is tanking.

If it crashes right before you pull the trigger then maybe don't pull the trigger? Wait and ride it out.

Do it anyway and be flexible, adjust your spending or pick up some side income.

In any investment plan and FIRE plan I would strongly suggest running scenarios based on how you plan on liquidating your assets, what the market would do, and how you could react. Use cfiresim and evaluate if you'll have good odds of success.

[rubybeth]

The 7% is an average, so in some years, investments might go up, for example, 10-20% while some years it may drop 5% overall, but eventually, it kind of evens out.

[Nords]

What if the stock market crashes right before I retire? I'm comfortable basing my lifetime projections off a 7% return, but am I wrong in thinking that if there's a crash right before I retire I'll be screwed? I know there's an answer to this, I just haven't been able to think of it/find it. Can't wait to hear from some of you mustachian geniuses how this is compensated for.

You're referring to "sequence of returns" risk.

First, having the stock market crash before you retire is a fantastic opportunity.  I retired in June 2002, and on 17 Sep 2001 (after the FAA reopened American skies and the stock markets resumed trading) I watched our portfolio value melt like an ice cube on a hot sidewalk.  At the end of the day we took a deep breath, ran our portfolio through FIRECalc and Financial Engines again, and... we still had enough.  It was a nice "worst case" stress test.  The stock market even helpfully ran that test several more times on us before finally bottoming out on 9 Oct 2002.  Not, of course, that any of these events are seared into my cerebral cortex.

If our portfolio had not been "enough" then I would have continued working for another year or two.  Frankly, most ERs could do the same for even the first decade after retirement... but it's nice to have the stress test before you retire.

Second, "sequence of returns" risk is built into FIRECalc, cFIRESim, and Monte Carlo calculators.  It's the failure part of the success rate.  The risk is greatest during the first 5-10 years of a 30-year ER, and that may be the case for a 50-year ER too.  If the portfolio can survive the first decade then it's big enough to survive almost anything after that. 

Your challenge is to gather enough assets to be reasonably sure of success, whether that's 80% or 90% or 95%.  Your other challenge is to have enough assets to avoid failure (20%, 10%, 5%, or 0.00001%).  The best way to do that is through a combination of annuity income (whether that's "just" Social Security or a SPIA or a pension) and a variable spending plan.  A few ERs do it through a dividend equity portfolio, although living off your dividends takes more assets than a 4% SWR which consumes principal.  You'll have a "normal life" budget, but you'll also have a "severe recession" barebones budget that you can revert to if necessary.  (Note that very few retirement calculators can simulate a variable-spending plan, but hopefully it'll be mainstream in the next  5-10 years.)  You can work the 4% SWR to about a 90% success rate (or whatever helps you sleep at night) and hope that the barebones contingency plan will cover you if the Great Recession returns for an encore five years after you ER.

If it's any consolation, Bob Clyatt of "Work Less, Live More" has paid for the computer simulations that show his 4%/95% variable spending plan will survive.

[foobar]

If you look at the failure cases in those simulation, most of them are when you have a bad crash early in your retirement.  You either need to adjust (slash expenses or pick up income) to survive. Most people also have a lot of slop in their numbers. It is cool to ignore social security, but picking up 1-2k/month of inflation adjusted dollars pays for a heck of a lot of the cost of living for someone looking to live on 20-40k/yr. On most of the charts if you make it 15 years, your account balances tend to soar up. There is a bit of margin (to handle low return years early) in the 4% number.

What if the stock market crashes right before I retire? I'm comfortable basing my lifetime projections off a 7% return, but am I wrong in thinking that if there's a crash right before I retire I'll be screwed? I know there's an answer to this, I just haven't been able to think of it/find it. Can't wait to hear from some of you mustachian geniuses how this is compensated for.

You're referring to "sequence of returns" risk.

First, having the stock market crash before you retire is a fantastic opportunity.  I retired in June 2002, and on 17 Sep 2001 (after the FAA reopened American skies and the stock markets resumed trading) I watched our portfolio value melt like an ice cube on a hot sidewalk.  At the end of the day we took a deep breath, ran our portfolio through FIRECalc and Financial Engines again, and... we still had enough.  It was a nice "worst case" stress test.  The stock market even helpfully ran that test several more times on us before finally bottoming out on 9 Oct 2002.  Not, of course, that any of these events are seared into my cerebral cortex.

If our portfolio had not been "enough" then I would have continued working for another year or two.  Frankly, most ERs could do the same for even the first decade after retirement... but it's nice to have the stress test before you retire.

Second, "sequence of returns" risk is built into FIRECalc, cFIRESim, and Monte Carlo calculators.  It's the failure part of the success rate.  The risk is greatest during the first 5-10 years of a 30-year ER, and that may be the case for a 50-year ER too.  If the portfolio can survive the first decade then it's big enough to survive almost anything after that. 

Your challenge is to gather enough assets to be reasonably sure of success, whether that's 80% or 90% or 95%.  Your other challenge is to have enough assets to avoid failure (20%, 10%, 5%, or 0.00001%).  The best way to do that is through a combination of annuity income (whether that's "just" Social Security or a SPIA or a pension) and a variable spending plan.  A few ERs do it through a dividend equity portfolio, although living off your dividends takes more assets than a 4% SWR which consumes principal.  You'll have a "normal life" budget, but you'll also have a "severe recession" barebones budget that you can revert to if necessary.  (Note that very few retirement calculators can simulate a variable-spending plan, but hopefully it'll be mainstream in the next  5-10 years.)  You can work the 4% SWR to about a 90% success rate (or whatever helps you sleep at night) and hope that the barebones contingency plan will cover you if the Great Recession returns for an encore five years after you ER.

If it's any consolation, Bob Clyatt of "Work Less, Live More" has paid for the computer simulations that show his 4%/95% variable spending plan will survive.

[Baylor3217]

Firecalc existed in 2002?

What if the stock market crashes right before I retire? I'm comfortable basing my lifetime projections off a 7% return, but am I wrong in thinking that if there's a crash right before I retire I'll be screwed? I know there's an answer to this, I just haven't been able to think of it/find it. Can't wait to hear from some of you mustachian geniuses how this is compensated for.

You're referring to "sequence of returns" risk.

First, having the stock market crash before you retire is a fantastic opportunity.  I retired in June 2002, and on 17 Sep 2001 (after the FAA reopened American skies and the stock markets resumed trading) I watched our portfolio value melt like an ice cube on a hot sidewalk.  At the end of the day we took a deep breath, ran our portfolio through FIRECalc and Financial Engines again, and... we still had enough.  It was a nice "worst case" stress test.  The stock market even helpfully ran that test several more times on us before finally bottoming out on 9 Oct 2002.  Not, of course, that any of these events are seared into my cerebral cortex.

If our portfolio had not been "enough" then I would have continued working for another year or two.  Frankly, most ERs could do the same for even the first decade after retirement... but it's nice to have the stress test before you retire.

Second, "sequence of returns" risk is built into FIRECalc, cFIRESim, and Monte Carlo calculators.  It's the failure part of the success rate.  The risk is greatest during the first 5-10 years of a 30-year ER, and that may be the case for a 50-year ER too.  If the portfolio can survive the first decade then it's big enough to survive almost anything after that. 

Your challenge is to gather enough assets to be reasonably sure of success, whether that's 80% or 90% or 95%.  Your other challenge is to have enough assets to avoid failure (20%, 10%, 5%, or 0.00001%).  The best way to do that is through a combination of annuity income (whether that's "just" Social Security or a SPIA or a pension) and a variable spending plan.  A few ERs do it through a dividend equity portfolio, although living off your dividends takes more assets than a 4% SWR which consumes principal.  You'll have a "normal life" budget, but you'll also have a "severe recession" barebones budget that you can revert to if necessary.  (Note that very few retirement calculators can simulate a variable-spending plan, but hopefully it'll be mainstream in the next  5-10 years.)  You can work the 4% SWR to about a 90% success rate (or whatever helps you sleep at night) and hope that the barebones contingency plan will cover you if the Great Recession returns for an encore five years after you ER.

If it's any consolation, Bob Clyatt of "Work Less, Live More" has paid for the computer simulations that show his 4%/95% variable spending plan will survive.

[dude]

There's also a school of thought out there that counsels having 2-3 years of living expenses in savings, so that when a down market year hits, you can live off of those savings until the market rebounds -- as it has pretty quickly in pretty much every downturn since the Great Depression.

[nicknageli]

There's also a school of thought out there that counsels having 2-3 years of living expenses in savings, so that when a down market year hits, you can live off of those savings until the market rebounds -- as it has pretty quickly in pretty much every downturn since the Great Depression.

I've been kind of thinking the same.  If the market dies just prior to retirement, I'll want to have enough straight cash to live off of for a few years to wait for it to recover some.

Right now I'm 75.5% in stocks and dividend paying stocks (through index funds) and 24.5% cash.

[Nords]

Firecalc existed in 2002?

It also existed in 2001 when I was using it after 9/11. 

Bill Sholar (Dory36, the founder of Early-Retirement.org) started coding the first version from a spreadsheet in 1999:
http://firecalc.com/resources.php

It's been through an upgrade or two since then.

I was also one of the gazillions of beta-testers for FinancialEngines.com, and apparently still have free access. 

There's also a school of thought out there that counsels having 2-3 years of living expenses in savings, so that when a down market year hits, you can live off of those savings until the market rebounds -- as it has pretty quickly in pretty much every downturn since the Great Depression.

"Pretty quickly" is a relative term when you're watching that two years of cash trickle away through month #23... but it's worked for us through two recessions now.  It certainly does nothing to reduce portfolio volatility, but it allows investors to wait it out.  It's similar (for a limited time) to living off dividends without selling the dividend-generating shares.

[ShortInSeattle]

I'd recommend you assume the stock market *will* crash during your ER, and if you can't survive that then you are probably not ready.

We're working on our plan, and part of it is keeping about 2-3 years worth of expenses in cash or a cash-like instrument like I Bonds.  This is part of our overall asset allocation, but it also means that if the market goes to hell we can draw down our cash without having to eat into our depleted equities portfolio.

Your question  isn't a bad one, the key is to find  your answer. :)

SIS

[Nords]

By coincidence, Wade Pfau and Jonathon Guyton weigh in on the same subject:
http://wpfau.blogspot.com/2014/02/jonathan-guyton-tames-gorilla.html

These rules may be more practical and easy to understand, and therefore will be more usable in the real world, even if they are not fully optimal at a theoretical level. Any approach which reduces spending after market drops does also help to alleviate sequence risk.

Guyton says "Don't worry about sequence of returns risk."

[kathryn1029]

Thanks everyone. I think the 2-3 years expenses in cash is the answer I was looking for. That's definitely something I'll plan to have, just wanted to see if there was an inherent cushion somehow built-in to the 4% rule that I wasn't seeing.

[foobar]

Yes there is a cushion in there but it is only enough for a 95% success rate. Save 10% more money (pretty much what save 3 years of salary does) and you up your chances to closer to 99%.  For example the 2008 crash was no big deal.  Use the s&p 500 (I have it handy), you lost 38% but then bounced back the following years.  Compare that to 2000-2002 where you lost 9%,11%, and 22%.  That sustained loss means that you spent 3 years taking money out versus 1 year.  When you run the calculations the people that retired in 2000, have ~50% of making their money last another 15 years. Before last year it was closer 25%.

Thanks everyone. I think the 2-3 years expenses in cash is the answer I was looking for. That's definitely something I'll plan to have, just wanted to see if there was an inherent cushion somehow built-in to the 4% rule that I wasn't seeing.

[bacchi]

When you run the calculations the people that retired in 2000, have ~50% of making their money last another 15 years. Before last year it was closer 25%.

http://raddr-pages.com/forums/viewtopic.php?f=2&t=1208&hilit=Y2K+ER&sid=7ea44c2d7aae8ad61f801b22a9f74d2d&start=390

The good news is that the 2000 retiree is 14 years closer to SS. That helps out any Hypothetical Y2K older than 47.

[Bateaux]

My plan is to use 2 or 3 % withdrawal rate.   My wife and I have good salaries and have two boys in college.   Our expenses are nose diving in about 2 years.  Planning for a $50,000 dollar budget in retirement.  Hope to simulate a $50,000 annual budget by 2016 by saving the rest. Hope to FIRE 2018 at 49 years old.

[nicknageli]

My plan is to use 2 or 3 % withdrawal rate.   My wife and I have good salaries and have two boys in college.   Our expenses are nose diving in about 2 years.  Planning for a $50,000 dollar budget in retirement.  Hope to simulate a $50,000 annual budget by 2016 by saving the rest. Hope to FIRE 2018 at 49 years old.

2-3% seems very safe.  Very cool.  Sounds like you're close and have a great plan in place.

[PeteD01]

I think having three to five years in cash or similar is a sensible insurance against sequence of returns risk. Otherwise, in the long run, I think there are diminishing returns in padding the investments - there are political and other risks around which cannot be controlled by spending discipline or portfolio size. Maybe diversification into tangible assets is of more value in managing these risks - but who knows...

Peter

[SugarMountain]

You could also diversify by having non-stock income producing investments (rental real estate for example).  After the crash/meltdown in 2008/2009, while everyone and their brother was getting foreclosed on, rental property actually got tight because people still need to live somewhere.