Sequence of returns risk & fear of retiring into a bear market

[jjonas]

Hello,
I'm brand new to these forums and have just recently started started researching my early retirement strategy. My wife and I are getting serious about leaving our jobs at the end of 2017 so I've been quietly lurking these forums and reading as much information as I can about early retirement.

I think my question is more of a case study, investing question and general advice all wrapped in one.
Perhaps my questions and/or fears have been already been addressed in this forum so please link me to them if that's the case. There's a lot of content on here and I haven't had time to read it all.

Case Study Part:

Age: I'm 43 years old, the Mrs is 39, no kids.
Location: New Hampshire

Investments: Total net worth is roughly 950k but should be about 1 million at the end of 2017 (without any market growth) unless there's a market correction then who knows.
Roughly 600k will be in my 401k and 400k in a non-retirement brokerage account. Asset allocation is about 75% stock, 20% bonds, 5% cash.

Debt: 165k mortgage, 4% 30 year fixed, paying $400 more per month to pay down in 15 years. No other debt. We have one credit card and charge as much as we can for the points but pay off in full every month.

Credit score: average of 815 (I don't think this is too relevant but maybe someone will find it useful)

Expenses: I've completed a detailed budget and determined we can live pretty easily on $3300 per month. This includes our mortgage payment. Paying off the mortgage would reduce our expenses to $2500 per month but would take 160k from our brokerage account.

Income during retirement: possible part time work doing something we really enjoy but likely nothing for a year or two. We would prefer not to rely on any part time income as part of our planning but it's certainly an option down the road.

Investing question/fears:


1. We're in the 2nd longest bull market in history. We're concerned about retiring into a bear market and withdrawing 4% of our investments at the same time. If you look at hypothetical portfolios of starting withdrawals in an extended bear market vs withdrawals in a bull market, the principal erosion is significant. Here's an example below. Look at page 11 of this .pdf from Fidelity:

https://www.fidelity.com/bin-public/060_www_fidelity_com/documents/income-diversification.pdf

I know the Fidelity example assumes a 5% withdrawal rate but I think you'd see a similar fate with a 4% withdrawal rate.

I'd like to know what your thoughts are about the importance of sequence of returns. Please help to alleviate our fears of early retirement in a nasty bear market. It's been pretty nice for since early 2009 but we want to be prepared for the worst.

2. If the markets do drop, do I adjust my 4% withdrawal with the market value of my investments? Lets say I take out a monthly withdrawal of $3300 per month which is about 4% annually but our portfolio drops by 5% in a few months down the road. Would I then only withdraw $3166 that month? How do people manage withdrawal rate? We have some wiggle room in the budget but if we see a 20% drop or higher, we couldn't adjust our withdrawals that much. We would be forced to work some kind of job.

3. If anyone has a similar financial situation as ours (source of income exclusively from market investments), I'd like to hear your thoughts on early retirement. How are you managing your withdrawals?

I know this is long winded so I appreciate your time reading and look forward to your answers.

Jjonas

 

[rodi]

Welcome jjonas -

I, personally, would not be comfortable with a 4% WR at your age. The trinity study which established the 4% wr assumed a 30 year retirement... and at your age that only takes you to age 73, and your wife 69... Too big a chance of running out of money before you die.

Your options are to reduce spending or increase the nest egg. Much as I want to encourage your to retire young/early... I don't think it's 'safe' to retire in your early 40's with a 4% WR.

For me - when faced with similar numbers/analysis I worked hard on my spending... first targeting recurring monthly charges (cable, cell phone, etc) and figuring out where I could negotiate cheaper programs or do without. At the same time I diverted even more money than I was saving prior to a) my 401k (maxed out plus catchup since I was 50) and b) paying extra on the mortgage. By diverting this money every payday I learned to live on less... so my nest egg grew from the contribution and my needed nest egg shrunk from my new slimmed down budget.

As far as WR strategies - the trinity study talks about taking a snapshot of your nest egg and figuring your percentage - then taking the same amount out - adjusted for inflation - forever... so the market ups/downs don't change the way you spend. There are other methods - variable withdrawal methods. And several members here use a percentage of remaining portfolio method. So if you nest egg is $1M on 1/1/xx, and you're using a 4% wr - you would take 40k... if the market goes up and your nest egg goes to 1.1M the next year, you take out 44k. If the market goes down and your nest egg sits at 900k, you'd take out 36k.

I would run your figures through firecalc (linked at the bottom). Make sure you fill out all the tabs - including asset allocation and expected SS.

 

[rodi]

Also - since you're familiar with the fidelity.com site - have you run your numbers through the fidelity retirement calculator. What's nice about that calculator is you can choose different inflation for different items... I use that to backcheck my plan with a higher inflation on medical costs.

 

[rodi]

Oh - and one last thing... to address the question in the title of your post... We *all* have sequence of returns fears early on. For me, I handled it by reducing my withdrawal rate to less <3%. I'm coming up on 3 years retired and still feel nervous about sequence of returns risk.

 

[OldShooter]

Wow. I have hesitated to comment because it's gonna mostly be cold water:

$3300/month will have the purchasing power of $1500/month in 30 years, assuming historical inflation.

$3300/month pretax doesn't leave much for living expenses after maybe $800-1000/month for health insurance and it leaves nothing IMO for major purchases like a few good used cars along the way.

Are you successfully living on $3300/month pretax now? If not, start doing this immediately and see how it goes.

As @rodi said more politely, 4% withdrawal rate is hopelessly optimistic given your ages IMO.

Re serious bear markets, stand far away from the graphs and it looks like bear markets occur (very roughly) about every ten years. So it isn't just the first bear market that you should be worried about. It's all of them. Ref: https://cdn2.hubspot.net/hubfs/295024/Brad_Images_IMO_Blog/Charts/jp-littlebook_15.pdf and http://ritholtz.com/wp-content/uploads/2016/01/sp-index-at-inflection.png

If/when you begin to run out of money, you will be pretty much unemployable for any kind of decent jobs due to age and lack of recent work history. "Would you like fries with that?"

I admire your optimism but I would not even consider making the bet that you are proposing. Sorry, but hopefully YMMV considerably.

 

[Al18]

Sounds like you're in the ER home stretch, but based on a $1,000,000 net worth and a 2.5% withdrawal rate (typically mentioned on this forum for a 40 year old), that's $25,000 per year. That seems on the low side for New Hampshire, where the typical median family income is $70,000. What have you budgeted for healthcare and large expenditures such as car replacement, roof replacement? If you have a preexisting health condition, it's not inconceivable for your entire budget to be consumed by health costs once you're in your 50's. Have you determined how much your SS benefit will be reduced, since you have less than 35 years of payments into the system?

Please consider your options before retiring. Based on your post, you're able to save $100,000 per year. So for each year you continue working, you're annual retirement budget will grow by 10%. You have a well paying job now, and I think it would be difficult to achieve this level of earnings once you're retired a few years and rejoin the workforce.

 

[Golden sunsets]

Sequence of returns risk &amp; fear of retiring into a bear market

Sorry-I have to agree with Rodi and Shooter. Folks on this board are pretty conservative. There aren't many who use a SWR as high as 4% even though they are considerably older. Given your ages, I would start with 3%. Regarding the sequence of returns risk, many hold 3 or more years worth of expenses in Cash, CD's or other maturing instruments so that they can ride out a down market without having to sell equities. They then refill that bucket when equities rebound. You haven't indicated whether retiring now is a must or just a desire. If the latter, I would tack on several years, continue to increase the investments so that you can utilize a smaller SWR. If you absolutely have to leave your current jobs, then I would downshift to jobs with incomes that support your current expenses for several years while your investments remain untouched and grow.


Sent from my iPad using Early Retirement Forum

 

[ERD50]

I agree with the others, 4% at a young age is risky.

Also, rather than pay down your 30 year 4% mortgage to 15 years, why not re-fi? I've seen 15 year rates ~ 3%.

-ERD50

 

[jjonas]

Thank you Rodi & OldShooter and everyone else for your replies. I appreciate the honesty and candid feedback.

The one thing that I left out of the equation is future income. My wife will have a $1100 per month pension starting at age 60 with a 100% survivor benefit for me. I also looked at ssa.gov and factored in zeros for the number of years out of 35 we would not work and calculated our projected social security benefits based on that AIME. If i started social security early at age 62, my benefit would be $1400 and my wife $1100. I subtracted 25% from those amounts in case social security takes a haircut by the time we turn 62 - $1050 & $825. So in our 60's and going forward we would have almost $3000 per month in income. By that time, our mortgage would be paid off as well thus reducing expenses by $800 per month. In reality, my 4% withdrawal rate would only need to get us to about 20 years. This is also assuming that we bring in zero income during that time which is not likely. Do you think the 4% withdrawal rate is more doable if we're able to reduce withdrawals in a down market and have the income to look forward to in our 60's?

I really wanted to see if I could make this work by removing all future income out of the planning and just look at my assets. I'll have to check out the firecalc. Thanks for pointing that out.

I did run my plan through Fidelity's Planning & Guidance retirement analysis and it was successful through age 95 for both of us at a 90% confidence level but only assuming we both continue to bring in $1100 per month in income (or one of us bring in $2200) through age 55. That's $275 per week each. I'm a Justice of the Peace in NH so I can make much of that doing weddings and I wouldn't even mind bartending or landscaping a few days a week. My wife is a school teacher so she could substitute 3 days a week or tutor for some rich parents and charge them way too much.

Based on the responses here and the Fidelity planning tool, I think we'll really have to consider "partial" FIRE where we both work 2-3 days a week at jobs with lower pay but are much less stressful and feels less like an actual job. This would bring our withdrawal rate down about 2.5% annually.

We would also leave about 30k in cash/CD's for large purchases or emergencies.


I feel the need to address what OldShooter said about being "unemployable" if you have a lack of recent work history. In the early 2000's I went 2 years without working at a regular job (long term travel) and I managed to get my current job that is now allowing me to potentially retire in my 40's or at least partially retire. My father went a solid 8 years due to an illness and still managed to find work in his prior field before he was sick. I think employers look for much more than recent work history. If you're intelligent, well presented, reliable and trainable, you can get a job in a number of fields regardless of work history.

 

[OldShooter]

... Based on the responses here and the Fidelity planning tool, I think we'll really have to consider "partial" FIRE where we both work 2-3 days a week at jobs with lower pay but are much less stressful and feels less like an actual job. This would bring our withdrawal rate down about 2.5% annually. ...

Much better plan. This also has the benefit of letting you test how it works to live on this $3,300 figure. It still feels low to me considering health insurance costs, income taxes, and the inevitable capital expenses for cars, home repair, etc. Over 40 years or so you'll probably have to buy at least 3 or 4 used cars, for example. Our last two roofs (home and lake home) were $10K each and guaranteed for 20 years. .... It goes on and on.

... I feel the need to address what OldShooter said about being "unemployable" if you have a lack of recent work history. In the early 2000's I went 2 years without working at a regular job (long term travel) and I managed to get my current job that is now allowing me to potentially retire in my 40's or at least partially retire. My father went a solid 8 years due to an illness and still managed to find work in his prior field before he was sick. I think employers look for much more than recent work history. If you're intelligent, well presented, reliable and trainable, you can get a job in a number of fields regardless of work history.

Well ... er .... I think you're misquoting me a little bit. What I said was that age and lack of recent work history will probably make you unemployable. Talk to a few people in their late 50s who are looking for work, even with recent work history, and I think you'll get my point. I'm assuming that your plan doesn't fall apart immediately, ergo you will be relatively old before you need the jobs. From the demographics and the economic analyses, too, it appears that there will be a lot of oldsters competing in the job market. So just don't assume that going back to work is an easily available option.

To your point about what employers look for, I am a retired CEO so I do have a perspective. Trust me, it's not enough to be "intelligent, well presented, reliable and trainable." There is and will be lots of competition with those attributes. Think of it this way: Would I prefer to buy a machine that will work in my factory for 20 years or one at the same price that will probably only work for 5 or 10? The age discrimination valkyries will want to strike me down for saying this but it is the real world. If I invest in someone younger, I will probably get a longer payback.

 

[pb4uski]

I think you should be good to go.... but only if you are real sure on your expenses and I am skeptical of $30k a year. However, if it is truly $30k a year then that is a 3.6% WR [$30k living expenses/($1,000k nestegg - $160k mortgage)] about the high end of the range of WRs that would be prudent for someone retiring at your young age. And that WR would go down later in life when your wife's pension starts and SS starts.

$30k a year excluding mortgage is pretty low. You'll need to occasionally replace cars, the roof, the furnace, etc and these can add up quickly. I'm probably 20 miles from NH as the crow flies and we could never live on $30k a year... heck, our property taxes alone are about $7k. Also, what about healh insurance, co-pays and deductibles?

On the other hand, you have not included anything for SS and there will likely be some benefits there for you. The other issue to consider is access to your money since it doesn't look like you have enough taxable account money to last you to 59 1/2 when you can access tax-deferred funds penalty free.

 

[Blue Collar Guy]

Seems like the herd of knowledgeable posters all gave you the same advice. I learned a few things in here, one of them is if the majority of posters are saying xyz, its a sure bet xyz is the best path. once in a while someone with an outlandish suggestion to do abc with good back up evidence is also correct. Then you get the odd ball that should start their post with "once upon a time", i find them entertaining but terribly misleading. That being said i thing you got dynamite answers to you question, good luck i think you have almost arrived. Work a few more years but not too many.

 

[OldShooter]

... if the majority of posters are saying xyz, its a sure bet xyz is the best path. ...

There are no sure bets.

Really, we all tend to forget that we are making judgments based on past history. Inductive reasoning: "The sun has come up every day this year, so it will come up tomorrow as well." Black swans, fat tails, and Taleb's turkey are generally not considered. I am as guilty as the next guy.

And there are many proofs that this type of reasoning doesn't always lead to correct conclusion. For example, it seems obvious that an active manager with two or three years of success is a good bet, yet all the statistical studies say he's not. He's just a lucky monkey and that history doesn't predict anything.

So, not to argue, but I did smile a little when I saw your statement.

 

[bmcgonig]

Take a look at this guy's work. Not only is the SWR important but the AA is equally important for a 50 yr outlook, much more so than a 30 yr one.


https://earlyretirementnow.com/2016/12/07/the-ultimate-guide-to-safe-withdrawal-rates-part-1-intro/

 

[Blue Collar Guy]

i never saw people that say an active manager with 2-3 years is a better bet

There are no sure bets.

Really, we all tend to forget that we are making judgments based on past history. Inductive reasoning: "The sun has come up every day this year, so it will come up tomorrow as well." Black swans, fat tails, and Taleb's turkey are generally not considered. I am as guilty as the next guy.

And there are many proofs that this type of reasoning doesn't always lead to correct conclusion. For example, it seems obvious that an active manager with two or three years of success is a good bet, yet all the statistical studies say he's not. He's just a lucky monkey and that history doesn't predict anything.

So, not to argue, but I did smile a little when I saw your statement.

as a matter of fact they are bad bets, so im thinking the herd would be split on this choice, but im glad i made you smile. I had a boss once say "always leave em smilin"

 

[daylatedollarshort]

We're in the 2nd longest bull market in history. We're concerned about retiring into a bear market and withdrawing 4% of our investments at the same time.

Matching strategy portfolios may help to mitigate sequence of returns risk, but at your age you'd need a bigger nest egg and/or part-time work to go that route.

 

[Al18]

Looks like your plan is complete and you have all angles covered.

If it was me, I would continue to work an additional 2 years for a bit more cushion - rather than 5-6 years part time. But it's your life - enjoy.

Best of luck.

 

[jjonas]

Again, thank you to everyone for taking the time to reply. This is all really helpful. I posted here at the recommendation of someone from the Mr. Money Mustache forums. He or she said that I may get more realistic responses. The responses here are either more realistic or pessimistic, only time will tell. I could be wrong but I have a feeling that "early retirement" on this forum is more likely in your 50's and not 30's or 40's like other FIRE blogs. Either way, it's good to get different opinions and perspectives.

There's been some doubts about our monthly spending. Maybe some people are looking at their personal life style or expenses or perhaps looking at spending averages for the northeast, i don't know but i'm confident our spending is roughly 40k annually. This includes our mortgage, interest and taxes and projected health insurance premiums. We live in a 1100 sq foot house and drive Subarus that I can maintain myself (other than major work). We've never had an electric bill more than $55 in a month and our natural gas bill ranges from $40 in the summer and $175 in the winter. We eat out once a month because quite frankly, our cooking is better than most restaurants in the city where we live. Our internet bill is $80 (way too much) and netflix is $13. We spend less than $1000 per year on auto insurance for both cars (no tickets/accidents in over 10 years...knock on wood) and about $150 per month in gas. Of course I know there's other expenses but just want to give you a general idea of how much we spend and how we can arrive at $3300 per month. I even get a massage once a month and my wife shops at WholeFoods out side of the farmers market season.

There was a time when we would spend 5-6k per month. We never budgeted, ate out once a week, bought coffee every morning and lunch out every day (well at lease I did. The wife is a school teacher so she was forced to bring lunch). I would hire out every project around the house but now I try to do most work myself. We never really shoped around for anything. We now live well below our means. This is why we've been able to save so much in a short period of time. We still don't go with out anything and enjoy our life style.

I'm concerned about sequence of returns because I feel this is the biggest threat to my early retirement. With out growth in my investments, I am concerned about not being able to afford the big expenses that come up as many have pointed out like a new roof or cars. I don't think we'll need a new roof for 20 years or furnace for 25-30 or a car for 10 years because they are all relatively new but retiring into a bear market might seriously have an impact on longevity of my plan.

I'm thinking that the "partial FIRE" approach were we work 2-3 days a week would provide more peace of mind and put less pressure on our investments. We would still be very happy with having 4-5 days off per week coming from 2 days off a week now.

 

[REWahoo]

I'm thinking that the "partial FIRE" approach were we work 2-3 days a week would provide more peace of mind and put less pressure on our investments.

This ^

 

[Ready]

I hope it all works out for you. Given your young ages, I'm curious as to what is motivating you to retire, and what you will be doing with your free time once you do.

 

[rodi]

MrMoneyMustache is definitely a different group... and yes - this group is much more financially conservative and skews older.

Sequence of returns is definitely a concern for anyone retiring without a pension and SS a ways off... There is a "Percentage of remaining portfolio" option on firecalc where you can set how much of the previous years withdrawals you'd be willing to do without in a down market. That's human nature and for those retirees who survived the great recession - many posted that they pulled in their spending instinctively.... But a quick test shows that you'd be edging pretty close to the poverty line with some of the sequences. But... you could always go back to w*rk....

 

[daylatedollarshort]

The responses here are either more realistic or pessimistic, only time will tell. I could be wrong but I have a feeling that "early retirement" on this forum is more likely in your 50's and not 30's or 40's like other FIRE blogs. Either way, it's good to get different opinions and perspectives.

We have low overhead, too, relative to our retirement income. However, these is only so much a pre-Medicare retiree household in the U.S. can do about health care costs, and the continuation of subsidies at current levels is far from certain. Even with subsidies the out of pocket family maximum for a Bronze plan is over $14K, possibly a lot more with out of network charges that are sometimes impossible to avoid even at in network hospitals. And no matter how well you plan your own finances, there may be family members you care about needing financial assistance from time to time, and it is nice to have the extra funds to help them out.

 

[evilanne]

JJonas,

I really admire your optimism. I'm curious, what led you and your wife to considering retiring later this year? Is she as energized in pursuing retirement it as you are? Are you just burned out at your current jobs, looking at a change of pace? Would a sabbatical or new job change your perspective?

You indicate some fear of retiring in a down market. It doesn't matter what anyone here thinks, what matters is how your your wife really feels with all available information. What amount of savings & level income would she be comfortable with?

Imoldnu's thread is an interesting read on Frugal Retirement http://www.early-retirement.org/forums/f27/sharing-23-years-of-frugal-retirement-62251.html

 

[Fedup]

My question is why do people want to retire too early, like in 30s and 40s. I might be considered old here, I retired at 55, but in real life, nobody I know or met retire that young. Except for one guy who graduated from UCLA in engineering and has not found a job since. He is mooching off his mom and rich brother.

 

[razztazz]

My question is why do people want to retire too early, like in 30s and 40s. I might be considered old here, I retired at 55, but in real life, nobody I know or met retire that young. Except for one guy who graduated from UCLA in engineering and has not found a job since. He is mooching off his mom and rich brother.

If work sucks and you don't have to work what's the alternative?

I know.: "Well then why don't you find a job you like doing?" HA! Good luck with that one. Talk about a roll of the dice. If that was even a useful concept and not a fairy tale everybody would be doing it. But you can see how how easy it is. Besides, if I don't have to work why look for a job? It's like worrying about where to go on vacation. I'm always on vacation. I don't worry about it.