What do you do when you’ve been planning for early retirement (or traditional retirement) and everything is going along great ... until it isn't?
Your investments are doing great... you’re getting stuff wrapped up at your job, and your life overall is slowing down because in the ER process you have also decided to downsize / minimize your life. Then the bottom falls out of the stock market, and it has one of the worst (if not the worst) weeks in its history.
To top it off, there is a decent chance that your investments could continue to fall over the coming days / weeks. Now you start running calculations in your head. What if the market drops another 10% before it bounces back? Anything seems possible at this point. What if instead of dropping another 10% the market drops another 20% or 30%? When does it end?
This all seems so crazy when just a week ago you were enjoying all time highs and your investments were actually ahead of schedule. You knew that there would be some pull back eventually because your rate of return was greater than the historic 7% inflation adjusted rate of return that the market produces (and that you base all of your investment calculations on). But you never thought such a drastic and historic downturn would happen so quickly!
Let’s come up with an example. Your (hypothetical) planned retirement date is 3/15/2020. We will also assume that your goal is to have $1,000,000 ($900,000 is investments and $100,000 is cash). Now let’s assume that last week just happened where the market went from all time highs to dropping over 12% ... and that the market goes on to lose another 20% (hypothetical) (for a total of 32%) before it stabilizes and starts an upwards march again. Assuming things play out this way, your account has gone from over $1,000,000 to around $610,000 (900,000 * .32 (estimated decrease for this example)) within a month or so. That means that your spending power has gone from $36,000 per year ($900,000 * .04) to $24,400 per year ($610,000 * .04).
So what do you do? Do you go on and retire and base your withdrawal strategy on the current account value of $610,000? Or do you decide to put off retirement and continue working until the market recovers and your account gets back closer to where it should be? Honestly, neither sounds all that appealing.
This is a choice that we are currently facing and decisions need to be made. But I would like to present a different way to look at this. To do this, let’s go over some facts. Based on history, the stock market WILL produce a rate of return of around 7% (after adjusting down 3% for inflation). We also know that when the account was up over $1,000,000 the rate of return was over 7% (and so slightly inflated). Lastly, we know that over the last month the account has dropped over 30% (just a hypothetical estimate for this example) and now has a ROR (rate of return) below 7%.
This is a perfect example of why it is important to plan your retirement goals around a realistic ROR, and if you invest similar to us (using VTSAX Total Stock Market Index Fund) you can’t get more realistic than a 7% inflation adjusted ROR. This way, no matter what happens in the stock market leading up to your retirement date (and this is for traditional retirees as well as FIRE individuals) you are going to base your withdrawals on an account value that has been calculated using a 7% ROR. So in the example above, it’s not accurate to use the $610,000 because the ROR is below the historic 7% return. That said, it works both ways. Say that you retire when the market is at all time highs, and you end up with more than you planned. You still need to base your withdrawals on the value that uses the 7% ROR because it will eventually regress to the mean (again, assuming you invest similar to us).
What are we doing?
First of all, we aren’t panicking. We were actually pretty excited to pick up some shares of VTSAX last Friday while they were on sale. If the market continues to crater and doesn’t recover by our target retirement date of 7/31/2020 we will more than likely continue with our plan to move to Spain. However, we will absolutely implement our safety margins of tapping our cash cushion to lower our withdrawals to 3% or less. We will also take part-time income a little more seriously in year 1. We may have to postpone a fancy Paris trip and turn it into some more camping / hiking / beach bumming around Spain (however will we manage?!). In other words, we will implement the greatest safety margin of all which is to remain flexible.
While it certainly isn’t pleasant to see investment accounts tank by over 12% in a week, it’s not the end of the world. And remember, you only lose money if you panic and sell (DON’T).
So what do you think? What was your reaction to the market this past week? What is your strategy?
-Erik
So what do you think? What was your reaction to the market this past week? What is your strategy?
-Erik
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