Market Volatility isn't the only road to portfolio depletion

[walkinwood]

Another great post by Dirk Cotton:

The Retirement Café: Positive Feedback Loops: The Other Road to Ruin

This post addresses issues that arise when you cannot reduce your spending in response to a portfolio drop. I think this is especially pertinent to members here who are thinking of retiring with a withdrawal rate that leaves little headroom above their spending floor. Or even those who are relying on some other non-guaranteed income stream for a significant portion of their income.

[Turn_the_Page]

Nice article. Thanks for sharing.

[audreyh1]

I agree having spending headroom is really important for early retirees, but I found the article too contrived.

Quote:

I readily admit I don't have data to back that up, so take it for what it is.

OK

[Earl E Retyre]

I also enjoyed reading the article. Thanks for posting.

[bingybear]

Quote:

Originally Posted by audreyh1 I agree having spending headroom is really important for early retirees, but I found the article too contrived. OK

+1

Late last night I typed a couple responses, but posted neither. This story really was about market volatility, leveraged assets, and the inability to reduce expenses.
I could not grasp the "positive feedback" as they would typically cause an oscillation, but looks more like an open loop system. Sorry, I've designed too many over the years.
It uses the 1970's recession (table near the end) as an example which is a classic example that is used in many examples about retirement timing and spending flexibility.
Dirk's attempt to explain retirement finances to the "unweathly" is a good passion, but I suspect that many would just see this as too far over the top and write it off for that reason. A more realistic story for typical retirees might be more useful. It might not be quite as entertaining. Retirees need to monitor how there assets are depleting early in the game so they can adjust. This can be harder to catch than the firestorm in the blog.

[Earl E Retyre]

Quote:

Originally Posted by audreyh1 I agree having spending headroom is really important for early retirees, but I found the article too contrived. OK

I agree the article was contrived but I did find the writing style entertaining. I also agree that a primary point of the article was having spending headroom.

Hopefully I am not hijacking the thread, but something I do in order to try and ensure spending headroom is that I track and plan my spending in 3 buckets. I was curious if others do anything similar.
- Bucket 1 is the amount "I expect to spend" each year. It contains what I have been tracking for all my costs (e.g., utilities, taxes, cell phone, insurance, groceries, entertainment, etc., etc. - all the usual expenses).
- Bucket 2 contains variable amounts that I will likely not spend next year but I may. It includes both "pad" like additional entertainment or additional clothing but also includes "accruals" for things like medical, house and car maintenance. We are healthy and typically our medical expenses are very low but I accrue a medical bucket assuming that at sometime, one of us will visit the hospital and we have a high deductible HSA. Although we have a home warranty, home insurance and a relatively new house, at some point we will have a house maintenance expense not covered. Some years we spend some of bucket 2 and many years we do not.
- Bucket 3 is travel budget

So, my goal is to have enough ROI to cover all 3 buckets. I consider all 3 buckets to be my "annual expenses" for planning purposes. However, if something happens (such as a severe market downturn taking many years to rebound) then I know I could always completely cut out bucket 3 (travel) and at least some of bucket 2 is pad which could easily be cut out (e.g., additional entertainment) and the accruals will likely not hit at the same time as the extended downturn (e.g., additional house and medical expenses) - although they could.

So in down years I could probably live on bucket 1 alone. Ideally I have relatively conservative investments to cover bucket 1.

Let me know if anyone has any comments or does anything similar.

[W2R]

Quote:

Originally Posted by walkinwood Another great post by Dirk Cotton: The Retirement Café: Positive Feedback Loops: The Other Road to Ruin This post addresses issues that arise when you cannot reduce your spending in response to a portfolio drop. I think this is especially pertinent to members here who are thinking of retiring with a withdrawal rate that leaves little headroom above their spending floor. Or even those who are relying on some other non-guaranteed income stream for a significant portion of their income.

I can't imagine retiring without a feasible plan for surviving a severe market crash.

Why would anyone assume that the market would always go up, up, up, and never down? So mystifying to me.

[Fedup]

Depressing. It makes people keep guessing whether they ever have enough to really retire if there is one of these spells.


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[nun]

If the folks in the article had been more diversified and less leveraged they would have been ok.

Also there was a time when the average investor would never have used stocks to fund retirement, they were seen as too risky. Pensions, annuities and conservative bonds were the core of retirement income. IMHO people rely far too much on stocks and their historic growth to fund retirement

[W2R]

Quote:

Originally Posted by Fedup Depressing. It makes people keep guessing whether they ever have enough to really retire if there is one of these spells.

Or, they can PLAN, assuming that "one of these spells" is going to happen eventually and that they had better be ready for it.

If they are inclined to be cautious, they could even plan that "one of these spells" is going to happen right after they retire.

[nun]

Quote:

Originally Posted by W2R Or, they can PLAN, assuming that "one of these spells" is going to happen eventually and that they had better be ready for it. If they are inclined to be cautious, they could even plan that "one of these spells" is going to happen right after they retire.

What if there are multiple "spells"?

[W2R]

Quote:

Originally Posted by nun What if there are multiple "spells"?

Plan for a very, very LONG spell, and consider the time in between to be just gravy.

I just can't even imagine someone not planning for market drops, anywhere from a bad Friday like yesterday, to a drop that outlives us. Surely our members are brighter than to just assume everything will be ducky from here on out.

[nun]

Quote:

Originally Posted by W2R Plan for a very, very LONG spell, and consider the time in between to be just gravy. I just can't even imagine someone not planning for market drops, anywhere from a bad Friday like yesterday, to a drop that outlives us. Surely our members are brighter than to just assume everything will be ducky from here on out.

I expect ERers to be pretty savvy about all this within the current retirement dogma of a 60/40 portfolio. However, there are lots of people who won't be as sensible and I feel that the 60/40 dogma will prove a disaster for many.

[bingybear]

Quote:

Originally Posted by nun What if there are multiple "spells"?

Isn't this what firecalc helps us understand. Look at those who retired in 2000, they had the tech bust and the 2008-9 little drop. So two major drops in a decade.
So for a 40 year retirement one should assume 8 drops based on this logic? One may be able to come up with a better number using more data than that hand wave.
The harder one would be a Japan style downturn where their market is still down 50% 25 years later.

[W2R]

Quote:

Originally Posted by nun I expect ERers to be pretty savvy about all this within the current retirement dogma of a 60/40 portfolio. However, there are lots of people who won't be as sensible and I feel that the 60/40 dogma will prove a disaster for many.

From what I read a lot fewer Americans can depend mainly on pensions for retirement income, than might have been the case 20 years ago. Now, I suppose, they must depend on 401K investments to make up the difference. And yet many never learned to plan or invest (as opposed to our members, who I think are pretty savvy about retirement planning and investing, overall).

In fact, my understanding is that a surprisingly high percentage of the general public are not even capable of doing the simplest math. You're right; this type of person may endure disastrous financial circumstances in retirement if they don't have a pension and don't take some steps to get help in their planning.

The rest of us can PLAN...

[daylatedollarshort]

Quote:

Originally Posted by nun If the folks in the article had been more diversified and less leveraged they would have been ok. Also there was a time when the average investor would never have used stocks to fund retirement, they were seen as too risky. Pensions, annuities and conservative bonds were the core of retirement income. IMHO people rely far too much on stocks and their historic growth to fund retirement

Good list. I think my grandfather also had utility stocks with dividends. That is pretty close to our plan these days. We remembered the sick feeling we had in 2008 and we are willing to give up the potential for future stock market growth to not have to ever experience that again or have to worry about running out of money when we are 90+ if future returns are less than historical returns.

We each have our own risk tolerances. I see some here saying they have a 90% chance of not running out of money under Firecalc at age 90. Personally, I would never want those odds. That means a 10% chance of running out of money if I don't live past 90 and historic returns are the same or better. So add in the chance of living past 90, historic returns being lower and there is a 30%+ chance or something along those lines of running out of money when I'm too old to get a job. Personally I don't want even a .5% chance of ever running out of money.

[Theseus]

Quote:

Originally Posted by W2R From what I read a lot fewer Americans can depend mainly on pensions for retirement income, than might have been the case 20 years ago. Now, I suppose, they must depend on 401K investments to make up the difference. And yet many never learned to plan or invest (as opposed to our members, who I think are pretty savvy about retirement planning and investing, overall). In fact, my understanding is that a surprisingly high percentage of the general public are not even capable of doing the simplest math. You're right; this type of person may endure disastrous financial circumstances in retirement if they don't have a pension and don't take some steps to get help in their planning. The rest of us can PLAN...

I'd agree that many are here on this forum because we understand the inherent 'calculated risk' involved with ER, and choose to understand and manage it the best we can by employing diversification, mix of annuity income, AA, SS optimization, Roth/IRA strategies, etc. My belief is that as fewer and fewer retirees have the relative security of a defined benefit employment-based retirement plan, overall risk of retirement financial failure will increase, and will have become a very difficult social problem just about the time when the SS program itself will be reaching the long forewarned problem in making payments without a change.

Whether that change becomes a reduction in benefits, 'need' based distribution of benefits, or increasing funding to maintain benefits is anybody's guess. Of course the 'need' will be debated in any case, and my nagging thought is whether those who spend freely and do not save adequately for the their retirement will be deemed 'needier' than those who had the foresight to do so. In any case, I predict the future may be very tough for those who rely heavily on defined contribution based plans.

[walkinwood]

Quote:

Originally Posted by W2R I can't imagine retiring without a feasible plan for surviving a severe market crash. Why would anyone assume that the market would always go up, up, up, and never down? So mystifying to me.

He's saying that in addition to being prepared for a severe market drop, there must be a plan to survive a sudden reduction in other, non-portfolio based, income sources - be they rental income or pensions.

We've seen examples where retiree health benefits have been cut and also some where pensions were reduced (United airlines), so these aren't theoretical worries.

[Fedup]

Does Firecalc take into account of 2008-2009 downturn? I run these calculators but being extremely conservative, I don't put everything in, put in very low return on purpose.


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[Theseus]

Yes. Inflation adjusted return '07 of 0%, '08 of -26%, '09 of +25%. Based on FIRECalc spreadsheet results from investigate tab using a very hypothetical $0 spend per year 1 year plan with a beginning stash of $100.