Executive Summary
The modern form of retirement – a period of non-work that you can and must enter because you’re no longer able to work – is itself a rather modern phenomenon, and one that ironically became both more feasible and more necessary as life expectancies increased over the past 100 years. Because when coupled to the industrial revolution and the shift from farms to factories, rising longevity became both a business and societal necessity to figure out what to do with the “obsolescent” human beings who couldn’t productively work anymore, but still needed to support themselves!
Yet as life expectancies and medical science continued to advance, we reached the point where retirement wasn’t just a stage of being unable to work, but instead a stage of being able to enjoy a period of non-work leisure. The only requirement was to save and invest enough to be able to afford to not work. Which in turn led to those who tried to reach the threshold earlier and earlier, younger and younger, until the “Financial Independence, Retire Early” (FIRE) movement was born.
But the challenge of trying to “FIRE” out of work as quickly as possible – sometimes as early as one’s 40s or even 30s – is that it leaves a very long time to be in “retirement.” So long, in fact, that the classic “4% rule” of retirement should probably be more like a 3.5% rule (given the extended time horizon). But also so long that most human beings will struggle to be idle for so long… which often leads back to productive engagement that even ends out producing post-retirement employment income. Which ironically means that if many of those accumulating towards FIRE considered this likely income, they might even transition sooner instead! (Because even earning “just” $20,000/year of side income in retirement can reduce nearly $500,000 from the required retirement savings!)
And ironically, despite the focus on accumulating enough assets to FIRE (often as quickly as possible), the real challenge is that while sequence of return is a real risk, it is more often a great boon. In fact, while a 3.5% initial withdrawal rate is necessary for the one worst sequence… 50% of the time, a FIRE retiree at a 3.5% initial withdrawal rate finishes with more than 9X their starting principal left over!
Which suggests the real key, especially for the kinds of extended time horizons that FIRE retirees face, is to develop more flexible spending rules that can adapt to whatever markets (or post-retirement income) may bring. Because while 30-year retirement time horizons have both some upside and downside risk, 40-50+ year time horizons end out with extraordinary upside potential… if only the retiree can weather any potential initial storm. Creating options to ratchet spending higher over time, to create spending “guardrails” to remain in a safe zone, or to segment expenses to ensure the essentials are covered but allow more adaptive lifestyle expenses to creep higher over time (as it will likely be feasible to do!).
In the end, though, the key point is simply to understand that, with extended retirement time horizons under FIRE, it becomes necessary to be more conservative against the potential worst-case scenario, but flexible to the overwhelming number of more positive scenarios likely to occur. Especially when considering that most retirees will struggle to remain “idle” for 40-50+ years (especially when retiring in their early still-productive years). The good news is that more flexible spending rules create many options to still adjust spending dynamically along the way. The problem is simply that they’re arguably the area that most needs to be studied further, to determine spending rules that are both comfortable to manage lifestyle and spending expectations, and really can weather the adverse-returns storm should it happen to come!
The Problem With FIRE: Human Beings Aren’t Meant To Be Idle For Life
For most of our history as human beings, a safe “retirement” simply meant having enough children to farm the land when you were no longer able to. It was only over the past century or two – with the industrial revolution and the move from farm to factory – that the more modern concept of retirement began to emerge. A world where humans were workers who earned wages to buy the necessities of life… right up until they couldn’t work anymore, and as “obsolescent factory equipment” had to be “retired” from the factory.
Which meant, in essence, that saving for retirement was simply about being able to financially support yourself after you were retired into obsolescence. And in turn led to the creation of social safety nets – like Social Security – to help protect those who older workers were "obsolescent" and unable to work, but who hadn’t saved enough to support themselves.
It was only in the mid-1900s that the financial services industry really attached onto the concept of retirement, and began to morph it from being not just a stage of obsolescence (where you hopefully had enough to get by), but as a stage of post-work leisure that you wanted to work towards, and where you would save enough that you could not just get by, but actually enjoy retirement. (And, hopefully, save in the financial services industry’s investment and annuity products in order to get there!)
Of course, once retirement is about saving enough to retire – instead of simply retiring when you have to because you can’t work anymore – a natural opportunity emerges: to save more, faster, and retire even earlier. In other words, once achieving retirement and a life of leisure was simply about saving enough in order to do so, it was only a matter of time before at least some people would make it a goal to reach that financial threshold as quickly as possible. And thus was born the Financial Independence/Retire Early (or FIRE) movement.
The problem, however, is that even as the FIRE movement develops strategies to reach financial independence earlier and earlier, to have a longer time window for that life of leisure… retirement research is finding that even "normal" retirees often aren’t nearly as happy in that retired life of than they expected!
Instead, retirement is associated with everything from the rise of Gray Divorce (divorce rates amongst those ages 65 or older has tripled in the past 25 years), to increased isolation that can lead to depression and other health complications, along with the birth of “encore careers” and the numerous ways that retirees are figuring out to (re-)engage themselves in retirement to avoid these adverse outcomes… which, ironically, often includes an income component, as retirees take new/different jobs, start new careers, or even start new businesses altogether. In fact, recent research suggests “retirees” in their 60s actually have the highest rates of entrepreneurship and business ownership in America, and those who retire (FIRE) earlier may have even more entrepreneurial potential (as entrepreneurial success rates peak for founders that start around age 40).
In other words, FIRE is arguably less about “Retire Early,” and more about simply achieving “Financial Independence”… which doesn’t mean a world of not working, but simply a world where the choice of what to do with your time happens to be independent of the need to generate financial income. Because retiring early implies a life of indefinite leisure vacation... even though, as Anna Rappaport recently put it, “You can’t be on vacation all the time. Vacation is a break from what you normally do. People who retire with the idea of an endless vacation are likely to be disappointed or bored within a year or two, if not sooner.”
All of which is incredibly important, because even just modest levels of income can drastically change how much is needed to “FIRE” in the first place!
For instance, the common rule of thumb is to use the 4% rule to FIRE (i.e., that it’s safe to retire early when you have 25X your expenses saved up). Thus, for someone that spends $40,000/year, they’ll need $1M to FIRE (retire early); those spending $80,000/year need $2M.
Except what happens if that early retiree realizes he/she will earn “just” an average of $10,000/year in “retirement” for the next 40 years after all? It cuts down the net spending need by $10,000/year, which reduces the required savings to FIRE by $250,000! And what if the part-time income after financial independence is $20,000/year? It cuts $500,000 – a half million dollars – off the required savings, just by recognizing some post-Financial-Independence income will likely still be there!
(Of course, the retiree may still need to make this up after he/she really can’t work anymore in their later years of retirement, but that’s often a point where discretionary spending is declining… which means the income may no longer be necessary to support the lifestyle at that point anyway!)
How Longer Time Horizons Amplify Sequence Risk – To The Downside And The Upside
On the other hand, while the failure to recognize the potential for post-Financial-Independence income causes many people to save more than they need and wait longer than necessary to FIRE, the caveat is that, for those retiring extremely early – who may have 40-50+ year time horizons – the “safe withdrawal rate” isn’t actually 4% in the first place.
Because the original “4% rule” safe withdrawal rate, first published by Bill Bengen in 1994, was specifically based on a 30-year time horizon. In fact, in a 1996 follow-up to him seminal study entitled “Asset Allocation for a Lifetime”, Bengen himself recognized that the safe withdrawal rate is actually 5% for those with a 20-year time horizon, but only 3.5% for those with a 45-year time horizon.
Notably, decreasing the time horizon by “just” 10 years increases the safe withdrawal rate by 1% (to 5%), but increasing the time horizon by 15 years decreases the safe withdrawal rate by only 0.5% (to 3.5%). Which would turn the classic 25X post-retirement spending target (a 4% rule on your accumulated retirement savings) should perhaps be a 28X rule instead (or 30X for those who prefer to be a little more conservative?).
Notably, though, the reason that the withdrawal rate only decreases slightly, even for a much longer time horizon, is that markets themselves tend to move in 10-20 year secular cycles, with extended periods of substantial growth, followed by substantial periods of largely-sideways markets. Which are the cycles that create “sequence of return” risk and necessitate the 4% (or 5%, or 3.5%) rule in the first place. Because even if market returns average out in the long run, if you get there with a bad sequence – 15 years of mediocre returns followed by 15 years of great returns – you can literally run out of money in the bad sequence, before the good returns finally show up to average out in the long run.
Except, given that secular bear markets typically run in roughly 15 year cycles, if a withdrawal rate is low enough to “survive” until the recovery and last for another 15 years (30 total), it doesn’t take much more to survive the same difficult period and then last for another 30 years (45 total). Because the secular bull market cycles are typically so good that they create more than enough wealth at a modest withdrawal rate to weather the next storm that may follow!
In fact, ironically, the real challenge of 45+ year time horizons is that a longer time period increases the upside potential if returns go well, far more than the downside risk if returns are poor! As in scenarios where the sequence is not horrific and doesn’t necessitate needing an initial withdrawal rate of 4% for 30 years (or 3.5% for 45 years), the excess returns above that amount, compounding for 40-50 years, can create absolutely extraordinary upside!
Accordingly, the chart below shows the trajectories of wealth for 50-year retirement time horizons for those FIRE very early with a $1M account balance, at a 3.5% initial withdrawal rate, for a 60/40 annual rebalanced portfolio, through various rolling return periods in history.
As the chart reveals, it is “necessary” to take a 3.5% withdrawal rate for the one scenario that is depleting after 50 years at that rate. Yet with “just” a $1,000,000 starting balance, there is a 90% chance of finishing with over $3,000,000 (or 3X the starting wealth) at the end (i.e., only a 10% chance that wealth is anywhere below $3,000,000, from a $1,000,000 starting point!), and a 50% chance of finishing with more than $9.3M (i.e., 9.3X the starting wealth) left over after 50 years (which would still be more than 2X starting wealth on an inflation-adjusted basis)! In fact, the wealth accumulations are so extreme, it’s impossible to see the one failing scenario that necessitated a 3.5% initial withdrawal rate!
To highlight just how wide the range of outcomes actually are, the chart below shows equally-probable percentile outcomes with both a 4% withdrawal rate for 30 years and a 3.5% withdrawal rate for 50 years.
In fact, the upside potential is so significant after weathering the “initial” speed bump of a mediocre first 15 years of returns, that the results are even better using an 80% equity portfolio instead of “just” 60% in equities. Again, one scenario just barely falls short of the 50-year mark (in this case, a 1966 retiree who had to suffer through the challenging 1970s until the bull market finally arrived)… but 50% of the time, the retiree finishes with almost 15X their original wealth on top!
Why FIRE Necessitates Spending Rules For Adaptive Flexibility
The fact that 40-50 year retirement time horizons create such a wide range of outcomes – with a $1M portfolio equally likely to be depleted, or finish with over $150M(!) in wealth left over – suggests that it’s really not enough to just set a safe withdrawal rate spending target and then cruise forward from there. As at best, doing so creates an overwhelming likelihood of simply leaving “extreme” wealth accumulations left over. Which, in turn, also means that those pursuing Financial Independence might have even been able to retire sooner, or at least lift up their lifestyle sooner, especially when also considering the “unexpected” introduction of post-Financial-Independence income streams from voluntary work.
Of course, the caveat is that there’s still “that one scenario” where financial disaster may occur – or more realistically, a very-extended period of poor returns, such as those during the Great Depression or the 1970s – that can cause even a 3.5% initial withdrawal rate to fail after 50 years. Which means any increase in spending, initially or in subsequent years after retirement, must be accompanied by some means to adapt, in case that one disastrous scenario appears to be playing out.
In other words, the longer the retirement time horizon, the more conducive it is to rules-based spending strategies that change and adapt over time, rather than simply a fixed “anchor” spending level that can become extremely de-coupled from the wealth accumulation reality over time.
Using Ratcheting Rules To Adjust Up When Times Are Good
The first option is to consider adopting a “ratcheting rule.” The idea of a ratcheting rule is to set a spending “floor” that is intended to be relatively impermeable (e.g., a baseline 3.5% initial withdrawal rate for a 50-year time horizon), but with a concrete target for how spending will be increased if/when a disastrous scenario does not unfold and returns are even merely “decent” (not to mention when returns are very good, or additional post-Financial-Independence income comes into the picture). In other words, like a ratchet itself, spending is only meant to turn one direction (increased when safe), but is locked in the other direction (not to be cut), in acknowledgment that most people find it very distressful to cut something out of their lifestyle once accustomed to it. (Thus starting spending more conservatively in the first place.)
In terms of implementing the ratcheting rule itself, one approach is a version previously discussed on this blog: simply track ongoing wealth, increase spending by 10% if the portfolio has accumulated at least a 50% buffer over its original value, and re-check every 3 years. Another option might simply be to re-calculate a 3.5% “initial” withdrawal rate any year the portfolio grows above its high water mark (under the auspices that if it was “safe” at 3.5% in the first place, it should still be safe to reset to 3.5% of a new higher amount, especially as the years go by and the time horizon gets shorter anyway).
Using Guardrails To Keep FIRE Spending In A Safe Range
A second approach would be a “Guardrail” strategy, such as the rules-based spending approach delineated by Jon Guyton in his prior research. The idea of a Guardrail strategy is to set thresholds on either side of the intended withdrawal rate and make spending adjustments any time withdrawals deviate outside that range.
For instance, rather than spending a “fixed” 3.5% initial withdrawal rate (only adjusting for subsequent inflation), the retiree might start spending at 4% instead, but set guardrails at 3% and 5%. Then in each subsequent year, inflation-adjusted spending is compared to the value of the portfolio. As long as the then-current withdrawal rate remains in the 3% to 5% range, spending remains on track. If the portfolio rises more quickly and outpaces spending – such that the withdrawal rate falls below 3% - then the retiree gets a 10% raise to their real-dollar spending. Conversely, if the portfolio falls (or simply lags spending increases) and the withdrawal rate drifts above 5%, the retiree must take a 10% real-dollar cut. Notably, in Guyton’s original methodology, an additional “tweak” is not to take the annual inflation increase any year that the portfolio’s returns aren’t positive –a small-but-permanent cut to baseline spending, which also has a surprisingly large positive impact on helping portfolio spending to adapt to unexpected adverse market sequences.
In essence, the goal of the Guardrail approach is to get spending in a protected channel – at least for the next 20-30 years, until the time horizon is shorter (and withdrawal rates can naturally drift higher).
Of course, the caveat to the Guardrail approach – unlike following a Ratcheting Rule – is that it assumes that spending cuts will occur when the portfolio veers off track from its original withdrawal rate course. Which, unless the guardrails are set extremely wide, is almost a certainty to happen at least temporarily at some point, given market volatility.
And in a sustained period of poor market returns, it’s possible that multiple cuts could occur sequentially/repeatedly over time, which can take the retiree’s standard of living even lower than just having started at a more conservative withdrawal rate. But that’s also the point – for those willing to take cuts along the way, it’s feasible to spend more, and “often” works out… except sometimes it doesn’t, and the guardrails will do what they need to do ensure the retirement accounts aren’t depleted (at the cost of downgrading lifestyle along the way).
Segmenting Retirement Spending To Maintain An Essentials Floor With Upside
A third approach to manage the FIRE path more dynamically is to segment the spending itself, effectively combining a ratcheting strategy for a spending “floor” with more dynamic guardrails for the more adaptive components of spending along the way.
For instance, a prospective FIRE saver might decide to make the Financial Independence transition when a 3.5% spending rate against their assets is enough to cover the pure essentials – the food, clothing, and shelter kinds of expenses that you cannot afford to outlive, along with the “basic” niceties of life (some form of transportation, simple entertainment, and travel expenses, etc.) – and then allow any portfolio upside, plus any post-Financial-Independence work and the income it generates, to cover and enrich the lifestyle along the way.
The key distinction of this approach is simply to recognize that these more adaptive expenses – eating out more often, at nicer and fancier (and more expensive) restaurants, taking longer and more exotic vacations, buying designer clothes, etc. – are by definition more flexible. They’re the “nice-to-haves” that we may hope for… and in all likelihood, will be able to afford in the overwhelming majority of scenarios where there is not a catastrophic return sequence and/or there is a non-trivial amount of post-Financial-Independence employment income.
In fact, if/when better (or at least non-catastrophic) market returns do arrive, and/or there is additional income, the FIRE retiree would actually have a choice, to increase the adaptive expenses, or to ratchet higher the core lifestyle to a higher standard of living in the first place (e.g., moving to a larger house or a more expensive location, buy a fancier car, etc.).
Nonetheless, expenses are still segmented in a way that ensures the core lifestyle is feasible to afford and sustain even if the upside doesn’t come.
In the end, arguably the biggest challenge in the FIRE movement – and ultra-long-term retirement planning in general – is that we haven’t done enough to develop “rules”, and a framework for rules-based spending adjustments, to know not just what is a safe point to retire, but what is a safe spending path as the subsequent future unfolds. Recognizing that, with 40-50+ years to compound, the range of future outcomes is actually much much wider than more retirees realize (or can even comprehend, with “equal” likelihood of a $1M retirement account running out, or turning into $150M, at a 3.5% initial withdrawal rate!).
Either way, though, a deeper look at the retirement research suggests that, with the 40-50+ year time horizon of FIRE retirees, that the “4% rule” is really more of a 3.5% rule (or to round down a little further for "safety," 30X post-retirement spending may be a better target than 25X as implied by the 4% rule). Though at the same time, it’s equally crucial to remember that the 3.5% withdrawal rate should reflect the intended spending after giving some consideration to whether any post-Financial Independence income will eventually arrive (and that, simply given human nature, it is very likely to come at least for a material subset of FIRE retirees).
Yet again, even with a more accurate initial withdrawal rate, and a better reflection of the likelihood and potential amount of post-FIRE income, the reality remains that even most FIRE retirees will not need to stick with that spending floor indefinitely, most will have some (or a lot) of upside, and that those who are willing and able to be more flexible in their spending actually have the latitude to start with a higher withdrawal rate and spending amount in the first place (as long as they really have the flexibility to make the adjustments if/when/as necessary). Which, ironically, means, that in the end, perhaps the problem isn’t that the 4% rule is too aggressive for an unusually long time horizon, but that it’s too conservative – at least for those who have any comfort and ability to make mid-course adjustments along the way? (But to each their own about their individual tolerance for spending changes!)
Have we really had contracting P/E ratios for 20 years? Has earnings growth really been that good?
This graph is pretty much meaningless. Fact is P/E ratios went through insane heights in the late 90s (due to speculation on Price, the Internet bubble). Therefore, it is true that P/E ratios have been ‘contracting’ since then, but this doesn’t tell us anything else that showing how wild speculation was in the late 90s… It certainly does NOT illustrate economic cycles.
A challenge for any historical analysis today is the intermediate term real returns on core fixed income are 0% to negative after fees. Withdrawal rules are useful IMHO for establishing an “initial” withdrawal parameter, nothing more. Based upon the individual capacity and situation, guard rails and risk mitigation techniques are the most important success factor. After all, WR in any given year below annual ROR grows the portfolio. Hence, we need a strategy that eliminates or greatly reduces liquidation of depressed assets. Modeling behavioral response to market conditions over a 30 much less 40 or 45 year time horizon approaches the impossible with current technologies. However, the “fuse” approach with the remainder invested to capture the equity risk premium along the efficient frontier with rebalancing seems to logically provide the best outcomes coupled with behavioral compliance. Level withdrawals in down markets taken from “fuse” portfolio representing ~ 3 years of spending plus a healthy contingency fund for coinsurance requirements.
It should be called the “4% rule of thumb.” I don’t think Bill Begen thought in 1992 there would be such a large amount of people in 2019 talking about 40-50+ year retirement timelines. But, I still think it’s a great place to start and gives younger people a clear objective on what they are trying to accomplish. Yes, there’s risk. But, there are a lot more riskier things people could be doing to jeopardize their financial future. If you’re someone trying to decide between a 3.5% or 5% withdrawal rate it means you’ve made some smart financial decisions and probably had to take some risk. The worst thing that could happen is going back to work.
Well strictly speaking, Bengen himself came to the 4% “rule” based on a 30-year time horizon. He wrote himself just 2 years later that if the time horizon goes to 45+ years, the same withdrawal rate drops to 3.5%. It was his follow-up study to the original. (After people started asking him “What about retirees who don’t have 30-year time horizons?)
– Michael
While I admire and respect the extreme savings discipline of FIRE disciples, I believe the concept is seriously flawed for all those except perhaps the “Financial Samurai” types who are able to cash out early from lucrative tech careers with several million banked from 7-figure salaries, stock options, IPO proceeds and the like.
A MISAPPLICATION OF THE 4% RULE
In many of the articles I have read, the basic FIRE concept is to apply extreme savings to accumulate a $1 million nest egg to which the so-called “4% Rule” would be applied. As Michael has noted, Bill Bengen’s original conclusion was that a 4% inflation adjusted withdrawal would be sustainable when using a 60:40 allocation applied to a normal 30-year retirement horizon. It was not based upon a 40-50 year time horizon. Further, the paper was written at a time (1992) when the interest rate one could earn on bonds was north of 7%. Today, allocating 40% of one’s portfolio to a bond portfolio that may be generating only 2-3% interest may intuitively be expected to have a much higher likelihood of running out of money over a 30-year time frame (even more so for a 40-50 year time frame!) In fact, a 2013 Journal of Financial Planning paper authored by Michael Finke, Wade Pfau, and David Blanchett, entitled “The 4% Rule Is Not Safe in a Low Yield World”suggested that the safe withdrawal rate in today’s economic environment might actually be as low as 2.5% for a 30-year time horizon!
On the other hand, as Michael also noted, the 4% rule is by definition, inefficient. It represents the maximum amount one could withdraw from a portfolio without running out of money in even the most extreme adverse market conditions. In the more likely event that returns are closer to historically normal, the 4% rule may cause adherents to live too far below their means and die with a pile going to heirs.
In sum, the 4% rule was never intended to represent an optimal withdrawal amount, it was not intended to be applied to 40-50 year time horizons, and the internal return assumptions of Bengen’s original two-asset model may no longer be applicable. From a financial planning perspective, the heavy foundational reliance on the 4% Rule is misguided and makes the FIRE concept a dangerous and potentially irreversible decision.
DON’T OVERLOOK SOCIAL SECURITY RETIREMENT BENEFITS
One other important point that is absent from this and most other FIRE discussions I have read is that the decision to stop working early may seriously limit your ability to claim social security as a source of income upon reaching normal retirement age. Since social security benefits are based on an indexed average of your 35 highest earning years, if there a many zeros in your earnings history, your benefits may be dramatically lower than if you (and/or your spouse) remained in the work force. Put another way, it takes an awful lot of extra savings to generate the $30,000-40,000 (as much as 50-100% higher still if you have a spouse who also qualifies for social security benefits) of annual income that a worker with a full earnings history may receive by staying in the workforce . Prospective FIRE disciples should carefully consider that they are giving up this valuable safety net by exiting the work force long before logging 35 years of earnings.
Once you’re past the second “bend point” in lifetime earnings there’s very little added to your monthly SS check.
https://www.fool.com/retirement/social-securitys-bend-points-what-are-they.aspx
High wage earners could hit that point probably in their 40s.
While you are correct in noting that early retirees may receive some social security, the impact of 15-20 “zero earnings” in the 35 year index earnings average can be substantial. Michael addressed this specific issue in an excellent 2017 post entitled, “How early retirement reduces projected social security benefits.” [https://www.kitces.com/blog/calculating-how-much-projected-social-security-benefits-statement-reduced-for-early-retirement/]An excerpt reads as follows –
While retiring one year early rarely impacts Social Security benefits by more than 0.5% to 1% of benefits (especially for those already in the 15% or 32% replacement rate tiers), retiring 5+ years early can have a more substantial impact, and “extreme” early retirement (e.g., for those who retire in their 40s or earlier) can have a very dramatic impact, with actual Social Security retirement benefits far below what is projected from Social Security.
As I mentioned, FIRE can work just fine for a young execs who call it a career in their 30s or 40s with several million $ banked. My sense, however, is that the movement is attracting legions of wistful lower/middle-income workers who buy into the idea of extreme saving to bank as little as $1 million in their 30s and 40s and retire. My point is that $1 million does not buy as much as it used to and giving up as much as hundreds of thousands of $ in lifetime social security benefits on top of having insufficient savings may lead to impoverishment long before the end of the 40-50 year time horizon.
I developed a “fuse plan” which includes some variability in WR but also a second smaller porfolio of dramatically difference risk. The fuse portfolio is about 2.5-3 WR in a 15/85 Tangent portfolio which is mostly bonds, re-balanced yearly. On the way up WR money is extracted from the big more risky portfolio. Come a crash (say 30% down draft) the risky portfolio closes and the fuse portfolio opens. The value of a 15/85 would drop only 5% in a 30% down draft and would not drop at all with a few years of accrued interest. I would also decrease the WR by an amount equal to the main portfolio’s over all risk. So if the risk is 10% the WR goes down 10% in a crash. If the fuse portfolio gets spent there is no need to replenish it. It acts as a fuse to get you beyond the bad SOR and effectively re-indexes your retirement to a different more favorable cohort. If you look at the graph on the main page of FIREcalc you see what I am talking about. The 1973 cohort headed into the ground. The 74 cohort lost money but didn’t fail. 75 cohort made a mint. To get from 73 to 75 all you need is a small second portfolio to live on until things re-index. It seems a “one shot” is all that is needed to change the retirement outcome
I’d be careful about this. While there is plenty of published research to support a bucketing strategy to ameliorate sequence of returns risk, if you tested your strategy against either the great depression market returns or against the 20 year returns since 1999 (two 50%+ market declines in the first 10 years of retirement), I think the results would be far less sanguine.
I would also add that there is a fair amount of research (including some by Michael and Wade Pfau) to indicate that proportional spending from a portfolio (e.g., your 15/85 portfolio) in conjunction with annual rebalancing may be inefficient relative to a a bonds-first spending strategy with no annual rebal.
Can you suggest a clear definition or measure of what would be considered a poor sequence of returns (even a flat market for x number of years?) such that one should adjust to a reduced spending rate? How do you suggest someone knows when to ratchet down spending, or ratchet it back up?
I’m interested in this for a more traditional 30-35 year retirement, as well as for someone with a 40-50 year time horizon.
Thanks.
There are many people who believe that that retirement period beginning at the end of 1999 may serve as the poster child for sequence risk. Far from being flat for a few years, the stock market lost 50% of its value from its 1999 Peak to its 2002 trough. It then fell 54% again from its 2007 peak to its March 2009 trough. From March 2000 through March 2009, the stock market’s 10-year annualized rate of return was approximately -3%. THAT is sequence risk. Although monthly return data for different asset classes is not available for the 1930s, anyone who retired in 1929 would have likely experienced the mother of all sequence risk.
While the markets have recovered from 100% of all previous bear markets, many investors who were forced to liquidate stocks to meet their income needs during these two time periods would likely have run out of $ long before returns regressed to the mean.
I did the analysis on 20 year returns for the 1973 crash, 1981 and an 18 year retirement from a Dec 1999 crash, and graphed the changes in trajectory of the portfolio using S&P 500 data It is NOT a bucket strategy, so you apparently didn’t read what I wrote and just assumed you understood. This is a portfolio re-indexing. 1929 was caused by monster over leverage in the face of an economy pinned to the gold standard, which wasn’t removed till 1933 for domestic transactions. In addition 1929 was not a recession but a major economic deflation like Japan experienced. Given the state of the Fed it’s unlikely we will see 1929 again unless the US looses its reserve currency status. 2008 had the potential for deflation due to over leverage but was saved by moving bad paper to the Fed’s balance sheet and putting the banks in idle for 10 years and letting the bad paper mature
Awesome review of the known investment trends.
A fixed 4% rule for an early retiree is too restrictive and not necessarily sustainable.
Picking a lower SWR is certainly an option (2.5% – 3.5%) is one option.
Following a more flexible withdrawal is a more realistic approach. It is only natural to pull less out of your portfolio when times are tough. Also, the early retiree always has the option of part-time work or even returning to full-time employment.
Yes flexible rules would be safer for sure. Prefer to use the current CAPE into the equation as well
Something like 1.5 + (1/CAPE)*100 which works to about 3.1% as of now
oops that should read as 1.5 + (0.5/CAPE)*100.
Michael, this is an excellent article, further explaining your perspective on strategy and tactics. And while FIRE is a viable strategy for those who wish to embrace the lifestyle, the research you present shows that there ARE substantial risks. Working in SOME capacity to “take the edge off” those risks seems prudent. Bringing in around $25k to $30k a year would help AND bolster the potential for better Social Security Income later in life. Additionally, obtaining healthcare coverage is a real concern that can torpedo an otherwise great strategy. Hopefully, Congress can find a workable solution that assists those who want affordable coverage before age 65.
If the 60/40 asset mix is based on past bond returns, it is highly unlikely that these bond returns will be repeated over the next 30 years.
Michael, this is a fantastic article!
Given that retrospectively most portfolios would have been able to withstand a higher withdrawal rate and this becomes even more true for a longer horizon, paired with the idea that most people continue with part-time work, I wonder if there is a reason you didn’t consider starting withdrawals at an earlier date with a lower rate?
Something along the lines of a 3% WR starting at 50% of the target FI number paired with part-time work. Then use a ratcheting strategy as the portfolio likely still grows, and taper off the side-work around social security age. Logically, this seems to me to be one way of pulling likely excess future dollars into the present when to enable a more flexible work schedule.
Why do you spend so much time writing about this Rule of Thumb? Most of your readers are CFPs whose job it is to run annual financial plans so that we don’t have to rely on Rules of Thumb. I really don’t understand your rationale for devoting so many articles on a topic that at best is highly suspect as a withdrawal guidepost.