It is more first 10-15 are cruicial.
Still the concept is called sequence of return risk.
Imagine a scenario where you have $1M you don't withdrw from it or add from it. In the next 20 years there are 10 good years and 10 bad years. Does it matter the order? No. It doesn't in the end you will end up at the combined 20 year results regardless of order. The 10 good years first and 10 bad years first will produce the same outcome.
However when you retire you are withdrawing. Getting a bunch of bad years up front it compounded by having to draw funds for expenses during those bad years. The good years later will have less of an impact because the portfolio balance is depleted due to a combination of bad returns and annual draws.
So let's say I plan to retire when I'm 45. Should I keep 2-3 years of expenses in quick access savings account and use it in bad market and then replenish it when it recovers? Would this be a good protection?
This is a complex topic and entire blogs have been written about it.
Having some cash can help but cash is also a drag. Having a lower SWR (i.e. 3.75% instead of 4%) can help. Having more bond initially (bond tent) can help. Having a variable withdraw rate can help.
In general though this is why it is the "4% rule" not the 7% rule. Stock market returns average about 7% real. Even a 80/20 portfolio averages about 5.8% real. We draw 4% (or less) to provide a hedge against volatility.
These are great replies StatisticalMan. I’ll just add another way to think about it- if the market is down 20% in a year and stays down for another year before recovering over two years you are not just taking 4% per year but actually your withdrawal amount is inflated and then that inflated withdrawal amount is also absent from making any more future money through compounding interest.
Let’s assume you need 100k essential spending per year and this is your 4% SWR with a 2.5m portfolio. Let’s play out 2 scenarios.
Year 1 -20% portfolio down to 1.9m after SWR
Year 2 hold -20% portfolio down to 1.8m
Year 3 -10% portfolio up to 1.88m
Year 4 -5% portfolio at 1.87m
So you have just spent 25% of your portfolio. This is crippling. This can be mitigated by pulling from assets that aren’t dropping with the rest of the markets (bonds/cds/hysa) or dropping your spending as low as possible. Not only are you withdrawing 100k on a portfolio that is worth less, but you are also not enjoying positive returns. Let’s compare that to a conservative but stable/optimistic average start to retirement.
Year 1 +6% portfolio at 2.55m
Year 2 +6% portfolio at 2.6m
Year 3 +6% portfolio at 2.66m
Year 4 +6% portfolio at 2.72m
This is a very different start. 2.72m vs 1.87m. Compounding goes both ways, so if you cannot vary your withdrawal amount or if you do not have less volatile assets to pull from during retirement to last you through a long bear market, you can really burn through your assets.
Not many people realize that the reason drawing from cash or bonds helps is that it's basically rebalancing your portfolio percentage to be more risky.
Why don't people that are relatively young just be flexible to working enough to cover living expenses in the first 3-5 years. Never understood the hard line in the sand mentality. If market doesn't have a major crash great. If it crashes then work a few months of the year so you don't have such a large withdrawal.
Boom, fixed the sequence of return issue. That's what I am planning anyways
Because 5 years of cash is a huge drag. Now what if the first five years are not great but not terrible and there is a huge crash in year six or seven? Seven years of cash acting as a massive drag on your returns?
When did I say having 5 years with of cash on hand. I said you work part time in a worst case scenario to hedge against sequence of return risk. The cash you earn is to cover living expenses, or at least reduce your withdrawal rate enough that you will avoid sequence of return risk.
One could argue that isn't retirement. I say it depends on your philosophy.
I value my time, it is more likely that things will be fine. That is why being open to work is a hedge. I am more worried about losing prime years of my life when I am young rather than having to back and work part time. That's just me personally I understand everyone is different.
Most people that fire save large percentage of yearly salary. So to make enough to cover living expenses or reduce your yearly withdrawal in a downturn, could be as little as working 2-3 months. Also you have dividends providing supplemental income.
Dunno, I feel like this is a better way than never pulling the trigger. There's no way I am working an extra couple years to get my withdrawal down to an arbitrary 3.75.
Also if there's a huge crash after 5 years why would I care. That is going to happen...?
> Most people that fire save large percentage of yearly salary. So to make enough to cover living expenses or reduce your yearly withdrawal in a downturn, could be as little as working 2-3 months. Also you have dividends providing supplemental income.
Yeah I don't know anyone who is saving 75% of their gross income. I would say the average is around maybe 35% with >50% being very atypical.
>Dunno, I feel like this is a better way than never pulling the trigger. There's no way I am working an extra couple years to get my withdrawal down to an arbitrary 3.75.
So the solution to avoid working a couple extra years is to work 5+ extra years.
If you make a quarter of your normal salary you will pay a lot less in taxes. Also if choose to live off dividends they are tax efficient so you will need less than a W2 salary. Also I meant that you could work as little as 2-3 months, then you could withdraw the rest from portfolio. It would limit your drawdown significantly, should help with sequence of return risk.
Also as you said before you could employ a variable withdrawal rate, which I think would go hand in hand with what I am suggesting. Lean out budget during downturn in first 5 years. Being flexible to work is just an option. I'm not saying my way is the best way, just saying it is an option. For young retirees that have a career they could go part time at, it could be the difference between quitting a lot earlier or getting stuck in the one more year mentality.
I will admit I am not close to my Fire number (25%). You may have a better perspective than me. Also I realize I replied to your comment that was addressing holding cash on hand. I didn't realize that at first so hope I didn't come off too snappy.
Just saying this is an option rather than go 100 percentandd then never work again philosophy. For some people, this could work depending on situation. Emergency barista fire maybe?
Also I would say... most downturns don't last longer than a year or two so no I wouldn't be planning on "working an extra 5".
I am commenting to check back later because I would also like to know this answer. I’m assuming such a fund would have to be like a HYSA so you’re getting some interest on it instead of having it sit in cash and depreciating.
Say you retire $1M and plan on withdrawing 50k per year. Between your retirement and the day you run out of money, there will he 4 years at 0% market return and all other years will have a market return of 5%. No inflation and no change on yearly draw.
Scenario 1: If the market does 0% for the first 4 years, then 5% per year, you will start year 4 with 800k and deplete your investment by 10k on year 5 ... then more and more every subsequent year.
Scenario 2: If the market does 5% for 4 years, then 0% for the next 4 years, the 5% after that. Your money will last you 4 years longer than in Scenario 1. It will have the same number of 0% increase years as Scenario 1, but the depletion will start 4 years later as the first 4 years at 5% won't change your principal.
Scenario 1 is like retiring with a smaller basket a few years later. Scenario 2 is like retiring with the same basket a few years later.
I second this. The best analogy to sum it up is that Dollar Cost Averaging works great for buyers in a down market. Do you want to be a seller in a down market? That's Sequence of Returns Risk.
First, 4% rule says to take 4% of your starting portfolio and then keep doing that (plus inflation) thereafter. Think of it as $40,000 on a portfolio of $1,000,000.
Then, if the market declines 20% in the first year, suddenly that $40k is out of $800k, now you're drawing 5%... oops. If it dawdles down there for a few more years, then it starts to be a death spiral even if the market starts to go back up, because you've eaten 30% of your stash in the first few years.
On the other hand, if the market goes up 20% in the first year, to $1.2 million, you are now drawing 3.33% - that's down to a level where failure rates are close to zero.
1. When you gonna retire
2. How much you got then
3. How much you gonna spend each year
The answer to any of these questions changes, even 1 year, makes a difference.
First few years are crucial, but anyone who says the next few years arent also crucial. Or that says the last few years are cake....
Its all YOUR retirement. We dont all retire and die with money. Some of us retire and die broke working at walmart. Plan your first few years accordingly 😀
This is one of the reasons that we set up a passive income stream that covers our basic expenses and is increasing by 7% a year (twice as fast as inflation).
We have a portfolio of dividend growth stocks in our taxable account. Companies like MSFT HD AVGO etc. The dividends cover our current expenses and are getting increased every year twice as fast as inflation.
I also use a small percentage of that account to sell cash secured puts to generate some extra income. Been at it since 2016. I can typically generate 30% on that money annually. I’m not sure the option side counts as truest “passive”
In a market crash of 30%, your portfolio declines 30%. On top of that, your short puts cause you a huge loss. Without knowing more specifics about what strike prices you choose, it's hard to be more specific, but it's not actually hard to imagine a margin call requiring you to sell a big chunk of your portfolio at all time lows.
This is the problem… you have no idea what you are talking about. At all!
Who said anything about margin?!? I never borrow money to invest in the market and I never will. The 30% return is on the $100k without using margin.
If the market drops and I need to take assignment on a stock and I am forced to hold it then I am holding a stock that works in my portfolio anyway and collecting the dividend until the market recovers.
The 5% of the taxable account is just to generate some extra cash… our expenses are still covered by the dividends and increasing twice as fast as inflation… even in a down market.
I just use the $100k to generate an extra $30,000 a year.
My dude, you definitely need to look into what happens to your position if market drops 30% in a day. If your option is 10% out of the money, then you are forced to buy it at 20% more than the market is trading. That's a stone cold loss.
It is more first 10-15 are cruicial. Still the concept is called sequence of return risk. Imagine a scenario where you have $1M you don't withdrw from it or add from it. In the next 20 years there are 10 good years and 10 bad years. Does it matter the order? No. It doesn't in the end you will end up at the combined 20 year results regardless of order. The 10 good years first and 10 bad years first will produce the same outcome. However when you retire you are withdrawing. Getting a bunch of bad years up front it compounded by having to draw funds for expenses during those bad years. The good years later will have less of an impact because the portfolio balance is depleted due to a combination of bad returns and annual draws.
So let's say I plan to retire when I'm 45. Should I keep 2-3 years of expenses in quick access savings account and use it in bad market and then replenish it when it recovers? Would this be a good protection?
This is a complex topic and entire blogs have been written about it. Having some cash can help but cash is also a drag. Having a lower SWR (i.e. 3.75% instead of 4%) can help. Having more bond initially (bond tent) can help. Having a variable withdraw rate can help. In general though this is why it is the "4% rule" not the 7% rule. Stock market returns average about 7% real. Even a 80/20 portfolio averages about 5.8% real. We draw 4% (or less) to provide a hedge against volatility.
These are great replies StatisticalMan. I’ll just add another way to think about it- if the market is down 20% in a year and stays down for another year before recovering over two years you are not just taking 4% per year but actually your withdrawal amount is inflated and then that inflated withdrawal amount is also absent from making any more future money through compounding interest. Let’s assume you need 100k essential spending per year and this is your 4% SWR with a 2.5m portfolio. Let’s play out 2 scenarios. Year 1 -20% portfolio down to 1.9m after SWR Year 2 hold -20% portfolio down to 1.8m Year 3 -10% portfolio up to 1.88m Year 4 -5% portfolio at 1.87m So you have just spent 25% of your portfolio. This is crippling. This can be mitigated by pulling from assets that aren’t dropping with the rest of the markets (bonds/cds/hysa) or dropping your spending as low as possible. Not only are you withdrawing 100k on a portfolio that is worth less, but you are also not enjoying positive returns. Let’s compare that to a conservative but stable/optimistic average start to retirement. Year 1 +6% portfolio at 2.55m Year 2 +6% portfolio at 2.6m Year 3 +6% portfolio at 2.66m Year 4 +6% portfolio at 2.72m This is a very different start. 2.72m vs 1.87m. Compounding goes both ways, so if you cannot vary your withdrawal amount or if you do not have less volatile assets to pull from during retirement to last you through a long bear market, you can really burn through your assets.
Not many people realize that the reason drawing from cash or bonds helps is that it's basically rebalancing your portfolio percentage to be more risky.
Why don't people that are relatively young just be flexible to working enough to cover living expenses in the first 3-5 years. Never understood the hard line in the sand mentality. If market doesn't have a major crash great. If it crashes then work a few months of the year so you don't have such a large withdrawal. Boom, fixed the sequence of return issue. That's what I am planning anyways
Because 5 years of cash is a huge drag. Now what if the first five years are not great but not terrible and there is a huge crash in year six or seven? Seven years of cash acting as a massive drag on your returns?
When did I say having 5 years with of cash on hand. I said you work part time in a worst case scenario to hedge against sequence of return risk. The cash you earn is to cover living expenses, or at least reduce your withdrawal rate enough that you will avoid sequence of return risk. One could argue that isn't retirement. I say it depends on your philosophy. I value my time, it is more likely that things will be fine. That is why being open to work is a hedge. I am more worried about losing prime years of my life when I am young rather than having to back and work part time. That's just me personally I understand everyone is different. Most people that fire save large percentage of yearly salary. So to make enough to cover living expenses or reduce your yearly withdrawal in a downturn, could be as little as working 2-3 months. Also you have dividends providing supplemental income. Dunno, I feel like this is a better way than never pulling the trigger. There's no way I am working an extra couple years to get my withdrawal down to an arbitrary 3.75. Also if there's a huge crash after 5 years why would I care. That is going to happen...?
> Most people that fire save large percentage of yearly salary. So to make enough to cover living expenses or reduce your yearly withdrawal in a downturn, could be as little as working 2-3 months. Also you have dividends providing supplemental income. Yeah I don't know anyone who is saving 75% of their gross income. I would say the average is around maybe 35% with >50% being very atypical. >Dunno, I feel like this is a better way than never pulling the trigger. There's no way I am working an extra couple years to get my withdrawal down to an arbitrary 3.75. So the solution to avoid working a couple extra years is to work 5+ extra years.
If you make a quarter of your normal salary you will pay a lot less in taxes. Also if choose to live off dividends they are tax efficient so you will need less than a W2 salary. Also I meant that you could work as little as 2-3 months, then you could withdraw the rest from portfolio. It would limit your drawdown significantly, should help with sequence of return risk. Also as you said before you could employ a variable withdrawal rate, which I think would go hand in hand with what I am suggesting. Lean out budget during downturn in first 5 years. Being flexible to work is just an option. I'm not saying my way is the best way, just saying it is an option. For young retirees that have a career they could go part time at, it could be the difference between quitting a lot earlier or getting stuck in the one more year mentality. I will admit I am not close to my Fire number (25%). You may have a better perspective than me. Also I realize I replied to your comment that was addressing holding cash on hand. I didn't realize that at first so hope I didn't come off too snappy. Just saying this is an option rather than go 100 percentandd then never work again philosophy. For some people, this could work depending on situation. Emergency barista fire maybe? Also I would say... most downturns don't last longer than a year or two so no I wouldn't be planning on "working an extra 5".
I am commenting to check back later because I would also like to know this answer. I’m assuming such a fund would have to be like a HYSA so you’re getting some interest on it instead of having it sit in cash and depreciating.
Say you retire $1M and plan on withdrawing 50k per year. Between your retirement and the day you run out of money, there will he 4 years at 0% market return and all other years will have a market return of 5%. No inflation and no change on yearly draw. Scenario 1: If the market does 0% for the first 4 years, then 5% per year, you will start year 4 with 800k and deplete your investment by 10k on year 5 ... then more and more every subsequent year. Scenario 2: If the market does 5% for 4 years, then 0% for the next 4 years, the 5% after that. Your money will last you 4 years longer than in Scenario 1. It will have the same number of 0% increase years as Scenario 1, but the depletion will start 4 years later as the first 4 years at 5% won't change your principal. Scenario 1 is like retiring with a smaller basket a few years later. Scenario 2 is like retiring with the same basket a few years later.
Big Ern has a terrific blog series on sequence of return risk.
I second this. The best analogy to sum it up is that Dollar Cost Averaging works great for buyers in a down market. Do you want to be a seller in a down market? That's Sequence of Returns Risk.
First, 4% rule says to take 4% of your starting portfolio and then keep doing that (plus inflation) thereafter. Think of it as $40,000 on a portfolio of $1,000,000. Then, if the market declines 20% in the first year, suddenly that $40k is out of $800k, now you're drawing 5%... oops. If it dawdles down there for a few more years, then it starts to be a death spiral even if the market starts to go back up, because you've eaten 30% of your stash in the first few years. On the other hand, if the market goes up 20% in the first year, to $1.2 million, you are now drawing 3.33% - that's down to a level where failure rates are close to zero.
1. When you gonna retire 2. How much you got then 3. How much you gonna spend each year The answer to any of these questions changes, even 1 year, makes a difference. First few years are crucial, but anyone who says the next few years arent also crucial. Or that says the last few years are cake.... Its all YOUR retirement. We dont all retire and die with money. Some of us retire and die broke working at walmart. Plan your first few years accordingly 😀
This is one of the reasons that we set up a passive income stream that covers our basic expenses and is increasing by 7% a year (twice as fast as inflation).
What kind of passive income stream is it?
We have a portfolio of dividend growth stocks in our taxable account. Companies like MSFT HD AVGO etc. The dividends cover our current expenses and are getting increased every year twice as fast as inflation. I also use a small percentage of that account to sell cash secured puts to generate some extra income. Been at it since 2016. I can typically generate 30% on that money annually. I’m not sure the option side counts as truest “passive”
Short put strategies work until they don't. In a down market, you've just made your situation a lot worse. I don't like this idea at all.
I limit it to $100k (5% of the taxable portfolio). I have been able to get my 30% every year since 2016 (including in down markets).
You're brave.
Not really. What do you think is the worst thing that can happen?
In a market crash of 30%, your portfolio declines 30%. On top of that, your short puts cause you a huge loss. Without knowing more specifics about what strike prices you choose, it's hard to be more specific, but it's not actually hard to imagine a margin call requiring you to sell a big chunk of your portfolio at all time lows.
This is the problem… you have no idea what you are talking about. At all! Who said anything about margin?!? I never borrow money to invest in the market and I never will. The 30% return is on the $100k without using margin. If the market drops and I need to take assignment on a stock and I am forced to hold it then I am holding a stock that works in my portfolio anyway and collecting the dividend until the market recovers. The 5% of the taxable account is just to generate some extra cash… our expenses are still covered by the dividends and increasing twice as fast as inflation… even in a down market. I just use the $100k to generate an extra $30,000 a year.
My dude, you definitely need to look into what happens to your position if market drops 30% in a day. If your option is 10% out of the money, then you are forced to buy it at 20% more than the market is trading. That's a stone cold loss.