In my post last week, I looked at how the 2020 Bear Market will impact folks saving for (early) retirement. But I deferred my recommendations on how current retirees will optimally adjust to the new realities. So, here we go, a new installment of the Safe Withdrawal Series, now 37 posts strong!
Nothing I write here today should be shocking news to people who have read the other 36 parts, but having it all summarized in one place plus some new simulations and perspectives is certainly a worthwhile exercise. In a nutshell, I argue that if you’ve done your homework before you retired, not even a bear market, not even this bear market will derail your retirement. Depending on what approach people chose, some retirees might even increase their spending target now.
Well, it is a Bear Market as of this week! We dipped well below the -20% line on March 12 due to the awful 10% meltdown that day. But we also recovered very nicely on Friday the 13th, of all days!!! I’m putting together some notes about my thoughts. To be published on Wednesday, March 18. Stay tuned! Good luck everybody! Stay invested! 🙂
Original Post (3/4/2020)
Volatility is back! Did it feel a little bit like a bear market last week? Actually, that wasn’t even a bear market, only a correction so far. Hence the title picture with the Koala “Bear,” which is not a bear at all but a marsupial. But it still felt like a mini-bear-market, didn’t it?
So, I thought it’s a good time to write a response to some of the questions I’ve been getting over the last few days:
How bad is this event compared to other corrections? How long will this last?
Should I sell my stocks now?
Is this a good buying opportunity?
How did some of the “exotic” investment styles fare during this volatile time (Yield Shield, Merriman’s Small-Cap Value)?
What does this all mean for my retirement plans?
Did your leveraged option writing strategy blow up already?
What? A new case study? I know, I had promised myself to wind down the Case Study Series I ran in 2017/18 after “only” 10 installments. It was a lot of work and a lot of back and forth via email. It takes forever! I mean F-O-R-E-V-E-R! But then again, there’s always a reason to make an exception to the rule! Jonathan and Brad from the ChooseFI Podcast had a very interesting guest on their show this week (episode 152). Becky talked about her experience of a late start in getting her and her husband’s finances in order. They started at around age 50 and became Financially Independent (FI) in their early 60s and retired a year ago. I should also mention that Becky recently started her own blog, appropriately labeled Started At 50, writing about her path to FI and RE so make sure you check that out, too.
In any case, Jonathan and Brad asked me to look at Becky’s numbers because I must be some sort of an expert on Safe Withdrawal Strategies in the FIRE community. I chatted with Jonathan and Brad about my case study results the other day and this conversation should come out as this week’s Friday Roundup episode. Because there’s only so much time we had on the podcast and I didn’t get to talk about everything I had prepared, I thought I should write up my notes and share them here. Heck, with all of that effort already spent, I might as well make a blog post out of it, right? That’s what we have on the menu for today… Continue reading “A Safe Withdrawal Rate Case Study for Becky and Stephen”→
Before we get to the business part of today’s post, again, let me thank everybody who nominated my blog for this year’s Plutus Awards! We got into the final five in two categories: “Best Financial Independence/Early Retirement Blog” and “Best Series: Blog, Podcast, or Video.” We’ll find out at FinCon next week on Friday who will win! But let’s not forget that there’s also the People’s Choice Award. I never even actively encouraged anyone to vote for me yet – I never thought I’d have a chance anyway. But it looks like the ERN blog is among the top 10 contenders as of August 28, see screenshot below! How awesome is that? If you haven’t cast a vote yet, please consider heading over to the Plutus Award page…
… to nominate the ERN blog for that category. All you need is to enter your name and email address. The blog URL is already pre-filled! 🙂
But let’s get to the really important business. Safe Withdrawal Strategy business! The other day I was browsing on Amazon to look for the book “The Simple Path to Running a Pension Fund” and couldn’t find anything. Maybe Jim Collins is working on that right now? Or Mr. Money Mustache might have a blog post on the “simple math” or wait, I mean the “shockingly simple math” of running a pension fund? Duh’uh! Of course, there is no such simple path/simple math! Because it’s no simple task. Lots of people are involved in running a pension fund. And we’re not just talking about the operational people; customer service reps, lawyers, etc. There would also be a bunch of highly-trained investment professionals taking care of the portfolio. When I worked in the asset management industry I talked to them frequently because a lot of our clients were indeed pension funds.
And I realize that – strictly speaking – I’m actually running a pension fund right now. For a married couple like us, it has only two beneficiaries, my wife and myself. I could count our daughter as beneficiary #3 because she’ll get some money for the first two decades or her life, but strictly speaking, she’s more of a “residual claimant” who’s going to get most of the “leftovers” when Mrs. ERN and I are gone. All of us in the FIRE community are running our own little one-person or two-person pension funds. And of course, in a lot of ways, running these small-potato pension funds is a lot easier than what the big guys (and gals) are doing. We don’t need fancy buildings, lawyers, customer reps, etc. But that’s the bureaucracy side. How about the mathematical and financial aspects? I’ve obviously written about how decumulating assets in retirement is clearly more complicated than accumulating assets while working (see Part 27 of this series – Why is Retirement Harder than Saving for Retirement?) but I was surprised how my DIY pension fund faces math/finance challenges greater than even a large pension fund. So, here are seven reasons why I think my personal pension fund is a heck of a lot more challenging than a corporate or public pension fund…
“Do not trust any statistic you did not fake yourself” (Winston Churchill)
There is a classic book called “How to lie with Statistics” that I read many, many years ago (actually decades ago!) as a college student. If you’re ever looking for an inexpensive but fun and impactful present for a young student/graduate with the hidden agenda of getting that person interested in math and statistics, this is the one! The book taught me to take with a grain of salt pretty much anything and everything number-related. Anywhere! Whether it’s in the news or in the Personal Finance blogging world and even (particularly?!) in academia. I’m not sure if I was already a severely suspicious (paranoid?) person before reading this or the book turned me into the person I’m today. So, inspired by that book, I thought it would be a nice idea to write a blog post about the different ways numbers are misrepresented in the FIRE/Personal Finance arena. And just to be sure, this post is not to be understood as a manual for fudging numbers, but – in the spirit of the “How to Lie With Statistics” classic – serves as a manual on how to spot the personal finance “lies” out there!
And there’s a lot of material! Probably enough for at least one more followup post, so for today’s post, I look at just four different way of how quantitative financial issues are frequently fudged in the personal finance world. And a side note about the slightly attention-grabbing title I used here: Well, I put the word “Lie” in quotation marks to show to the faint-hearted that this is a bit tongue-in-cheek. I could have written, “fudge the numbers” or “Enron-accounting” or “How we delude ourselves in personal finance,” or something like that. Also, Hanlon’s Razor (“don’t attribute to malice what can be explained by incompetence”) comes to mind here, but I’m not sure if those faint-hearted folks feel that incompetence is a significantly more benign explanation than malice.
So, let’s look at some of my favorite examples of how people lie to themselves (and others) in the realm of personal finance…
I hope everybody checked out the ChooseFI Roundup episode in early January, where I talked with Jonathan and Brad about the recent stock market volatility. They invited me for a short appearance on their Friday show after reading my piece from two weeks ago. That post was on how the recent stock market volatility will probably not obliterate the FIRE community. One issue that came up is the potential for people on their FIRE path to actually benefit (!) from the drop in the stock market. How can one possibly benefit from a drop in the stock market? It’s certainly not a guarantee. It depends on the personal circumstances and on the nature of the stock market drop! Generally speaking:
How permanent or how transitory is the drop in the market? If your portfolio dropped because one of the equity or bond holdings went bankrupt (or you were a victim of the OptionSellers meltdown) then that’s not something to cheer about. It’s about as permanent as it gets. Not good for the investor! But frequently, the market drops without much of a change in fundamentals. Be it a “flash crash” that reverses within a few hours or even minutes or the (likely) overreaction of the stock market drop in December, one could argue that since nothing (or not much) changed in the fundamentals (GDP growth, earnings growth, etc.) the drop may be only temporary and will eventually revert to the mean. Or even during a recession (the definition of weaker fundamentals!) stocks often overreact on the downside and then stage a strong comeback, i.e., return expectations going forward could be higher than long-term average returns. In other words, that paper loss you see now could be at least cushioned by higher returns on your additional savings going forward. And if this admittedly uncertain advantage of higher expected returns is large enough and over time more than offsets the paper loss then we could be looking at a net gain.
How far along are you on your path to FIRE? The further along you are the more damage a bear market will cause even if you can expect a bounce in future expected returns from a transitory shock to the market. On the other hand, if you’re just starting out saving for retirement and all you lost is a few hundred or thousand bucks in your 401k/IRA and you still got 10-15 years ahead of you then you might benefit from the drop!
So, in other words, if the loss in your existing portfolio is offset by enough of a rise in future expected returns, then a drop in the stock market can be a net positive. Seems pretty obvious from a qualitative point of view. But quantitatively? How early is early along the FIRE journey? How much of a rise in expected returns do we need to make this work? Even if there isn’t a net benefit, how much of the paper loss is at least cushioned by higher future returns? These are all inherently quantitative questions. This blog post is an attempt to shine some light on the math behind the tradeoffs…
Wow, did you see the big stock market move in October? The worst monthly S&P 500 performance since 2011! When you’re still working and contributing to your retirement savings it’s easy to lean back and relax: you can buy equities at discount prices and you buy more shares for the same amount of savings when prices are down, a.k.a. dollar-cost-averaging. Now that we’re retired things are different. Sequence Risk creates the opposite effect of dollar-cost-averaging: you deplete your money faster while the portfolio is down. I have been writing about this theme for almost two years now and now it looks like I might become my very own poster child of Sequence Risk.
So, are we worried having retired at (or close to) the peak of the market? Well, take a look at the title image: an ERN family selfie while vacationing in Angkor Wat (Siem Reap, Cambodia) in October. It doesn’t look like we’re too concerned about the stock market! And here are a few reasons why…
Talk to anyone in the FIRE community and ask how folks will deal with market volatility (especially downside volatility) during the withdrawal phase and everyone will mention “flexibility.” Of course, we’re all going to be flexible. Nobody will see their million dollar portfolio drop to $700k, $600k, $500k, $400k and so on and then keep withdrawing $40k every year no matter what. Rational and reasonable retirees would adjust their behavior along the way and nobody will really run out of money in retirement in the real world, as I noted in my ChooseFI podcast appearance. In other words, we’ll all be flexible. But is flexibility some magic wand we can swing to make all the worries about running out of money go away? Or is it BS? It’s a bit of both, of course. For example, I would put the following into the BS category:
I’ll do “something” with my asset allocation and recover the losses. Good luck with that!
I will skip the Starbucks Lattes for two months until the market recovers! Ohhhh-Kaaayyy….?!
I will sit out one or two years of inflation adjustments. Qualitatively, a good idea, but it won’t work quantitatively.
I will rely on Social Security. That may work for middle-aged early retirees but not for 30-year-old early retirees!
But flexibility will work through significantly reducing spending. And again, let’s be realistic, foregoing a 2% inflation adjustment for a year is not enough. Flexibility would involve being prepared to cut spending by probably around 20-25%, maybe more. A different route and maybe a better solution might be the side hustle. Specifically, one reader, Jacob, emailed me with this proposal:
Your series is quickly covering a lot of financial acrobatics to discover and maximize safe withdrawal rates while working to reduce the risk of running out of money. However, so far the most tried-and-true solution to the “not enough money” problem has not been considered: Get-A-Job. I acknowledge that for most job-hating FIRE-aspiring people this is the nuclear option, but it’s still an option.
Great idea! Get a side hustle and solve the safe withdrawal rate worries and (hopefully) salvage the 4% Rule! But there are two very important limitations:
The side hustle might last for longer than a few months or years. Withdrawals plus the market drop equals Sequence of Return Risk and might imply that the side hustle will last much longer than the S&P 500 equity index drawdown. How long? Try a decade or two, so if you want to go that route better make sure you pick a side hustle that’s fun!
For some historical cohorts where the 4% Rule would have worked even without a side hustle, flexibility would have backfired; you would have gone back to work for years, maybe even a whole decade and afterward it turned out it wasn’t even necessary!
This post has been on my mind from day one and it’s also been a topic that was requested by readers in response to previous installments in the Safe Withdrawal Rate Series (click here for Part 1):
Is the FIRE (Financial Independence Retire Early) community setting itself up for failure by making retirement conditional on having reached a certain savings target?
If we specify a certain savings target, say 25x annual expenditures, as in Mr. Money Mustache’s legendary “Simple Math” post, we are more likely to retire after an extended equity bull run. And potentially right before the next bear market. Very few savers would have reached that goal at the bottom of a bear market! Don’t believe me? Let’s look at some of the calculations from my post from a few weeks ago: The Shockingly Simple/Complicated/Random Math Behind Saving For Early Retirement. Specifically, let’s assume that every month, starting in 1871, we had sent off a new hypothetical generation on their path to FIRE. They start with zero savings, then save 50% of their income (adjusted for CPI-inflation), invest in a 100% equity portfolio and retire when they reach 25-times annual spending. Even though the starting dates are perfectly spread out, one each month, the retirement dates are not. They follow the big bull markets with extended gaps in between, see the chart below. The endogenous retirement dates are in red. Using the Mr. Money Mustache Simple Math method, you’ll mostly retire during a bull market, and often during the last part of the bull market, right before the peak and the next bear market!