Family of Four Taking Flight to Financial Independence

The Stock Market This Century: Would The 4% Rule Be Safe?

As you know by now, I’m always running our numbers in planning for our (very quickly approaching) ER (early retirement).  While I was doing some research on historic market returns, I came across this great website that lists the yearly returns of the stock market from 1928 to current day.  

While scrolling through the numbers, I thought it would be a great idea to see how well a person would have done if they had retired at the beginning of this century and applied the 4% rule.  

New York City's Financial District is home to the New York Stock Exchange

I did this for two reasons: 

One: After looking at the data, it doesn’t take a rocket scientist to see that retiring in the year 2000 was really bad timing, so therefore a good way to test the 4% rule.

Two: I wanted to compare a portfolio withdrawing 4% no matter what the market is doing with one that will apply safety margins via a smaller withdrawal rate and / or tapping into a cash cushion (this would be similar to our future strategy). 

Lets take a look at the results.  

The above table illustrates what a 4% withdrawal rate would look like from 2000 - Present.  

As shown, after retiring right when the dot com bubble was bursting, and Enron was imploding, along with September 11th, two major wars (Afghanistan and Iraq), and with the housing bubble looming, this person would have an overall loss of ($108,443.40) to their portfolio.  This certainly isn’t a good outcome, but this is also a scenario in which a person literally retired at one of the worst times in history and with that said, it's not a terrible outcome (they still have almost $900k invested!)  They have clearly been able to weather the storm, and my guess would be over the next 20 years their account value will go up even while withdrawing their 4%.  

Also note, this person didn’t apply any safety margins during this time frame, which IMO (in my opinion) is a reckless way to go about early retirement.  But, to each their own.

This table illustrates what would be much closer to the way our withdrawal strategy would have worked had we retired in the year 2000.  In this scenario the person / family lives on 3.5% of their investments in the good years (Safety Margin 1: 3.5% withdrawal), and they lowered that down to 2.5% in the bad years by tapping into their cash cushion as needed (Safety Margin 2: 2.5% withdrawal).  

Also remember, in this plan, each year’s withdrawal rate is based on the previous year's market performance.  For example, even though in the year 2000 the market was down over 10%, they still withdrew their 3.5% because in 1999, the market was up 19.53%. 

As we can see (and hopefully this is obvious) the results in table 2 are better, but still not really great.  After dealing with such volatility, I expect a better return than this, and again my guess would be the next 20 years are set to provide that.

Note, table 2 isn’t even a true representation of our plan because it does not factor in any extra income coming in, which we absolutely intend to have in some shape or form at some point.  This income would be used to lower our withdrawal rate even more (potentially to zero for at least some of the time).

What this exercise shows us is that despite the historic bull run that the market has been on the last 10 years, this century overall has been extremely volatile.  While we expect and even embrace the volatility that the market brings, this leaves me feeling (dare I say) optimistic with what the next 20 years has in store for market returns ...?!

Also, it is important to keep in mind that it is very rare (though possible) to retire at a historically bad time like this post illustrates.  For example, if the person from the first table would have decided to work just one more year and retired in 2001, their account balance in 2019 would have been positive by over $38k.  Work a few more years and retire in let’s say 2003 ... and withdrawal their 4% as shown in table 1, their current account balance in 2019 would be over $1.7 million!  Had they adopted the withdrawal strategy shown in table 2 (and retired in 2003), their account balance in 2019 would be over $2 million.

Key Takeaways

  • Stay flexible in retirement (and really in life in general) because there will be stretches of years where returns aren’t great. 
  • Plan to have safety margins, and implement them as needed. 
  • Don’t be scared to earn some income in ER (early retirement).  This doesn’t mean your ER has failed, this just means you are a relatively young, healthy, educated, and productive human being (pat yourself on the back).

Lastly, I leave you with a quote from Mr. Money Mustache:

What do you think?  What withdrawal rate feels safe to you?  Would you apply safety margins?  What might yours be?


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