One anonymous GCC reader made an astute observation in a recent email:
“In your analysis of the 4% rule and the worst times to retire (1929, 1965, 2000) you repeatedly made a suggestion that early retirees spend less in the early years of retirement to minimize sequence of returns risk.
You also shared how you have been increasing spending every year as the stock market has grown. If the market crashed 50% tomorrow, what would you do? If you were to follow your own advice, wouldn’t you need to roll back all of your spending increases?”
Possibly, sure. Stranger things have happened.
Preparing for the Coming Recession
Recently predictions for a recession on Twitter (my main news source) have been increasing in volume and intensity “A recession is coming, a recession is coming!”
Recessions are an interesting economic and social phenomenon. Since one person’s spending is another person’s income, if enough people and businesses believe that a recession is imminent, they can actually manifest one… like wishing upon a star.
I have vague memories of my first recession… it would have been in the early 80s around the time I was in 3rd grade. Business earnings were down, dividends were cut, and unemployment was above 10%. My father was laid off and times were tough.
I’d like to avoid repeating that experience.
But there are a lot of signs if you are looking… The Fed has been reducing interest rates, there is a lot of uncertainty around business investment, trade wars maybe aren’t so easy to win, lots of people are writing news articles and blog posts about recessions, and more.
But what is the saying… economists have predicted 9 of the last 5 recessions?
If a coin toss has similar odds to the experts, maybe paying attention to all the noise won’t help.
So, based on my great and unmatched wisdom, to prepare for the coming recession, I am doing… nothing.
What would I do if the stock market crashed tomorrow?
Back to the question at hand… if the stock market crashed 50% tomorrow, what would I do?
The answer to that is also nothing.
Instead, consider that the time to prepare for a recession is before you retire.
It is better to act than to react. (I nominate this sentence for smug comment of the year award.)
Preparing for a Recession
In the grand scheme of things, there are only a few things we can actually control:
- Prepare mentally
- Choose an appropriate asset allocation
- Make a plan
Prepare mentally
Life experiences that can cause an intense and overwhelming emotional response are numerous and frequent. Watching your net worth cut in half overnight is one of them.
Preparing yourself mentally for this inevitability is an important and necessary step to early retirement readiness.
To prepare myself for this experience I did 3 things – gained first-person experience, practiced stoic visualization, and math.
Through the process of building a portfolio worth at least 25x your target annual expenses, we will all experience investment ups and downs. Watching my portfolio lose (and gain) $1,000 in a single day was challenging when I was trying to pay off my student loans. Then losing $10,000 in a day was tough. Then $100,000. Then $400,000. Over time we become accustomed to the volatility, which mutes the emotional response.
Stoic visualization is a process where we try to envision ourselves in an undesirable situation. Thinking about how it would feel to experience a devastating loss in portfolio value will, over time, make it easier to face the actual event in a more calm and rational way. Probably. The Mediations of Marcus Aurelius are helpful for this. (See other recommended books.)
And finally, one of the most powerful tools on the planet: math.
If we target spending 4% of our portfolio per year (we have accumulated 25 years’ worth of spending) and we lose 50% in a market crash, we’ve just lost 12 1/2 years worth of expenses.
Ouch!
But in the historical examples where that happened, 3 times in the last 150 years, things worked out more or less OK (see chart below.)
This is precisely why I explored these 3 scenarios:
For a detailed stoic visualization of the 1965 period, see the classic post: The Worst Retirement Ever.
For a more mathematical view of 1929, see What if it all went to hell?!
And for 2000, explore the details in the post: How are the 2000 and 2008 retirees doing?
Choose an Appropriate Asset Allocation
There isn’t a single appropriate asset allocation for an early retiree.
An individual’s mental preparation should influence which investments to buy, and how much. How long we want/need the portfolio to last, what withdrawal rate we plan to target, how much volatility impacts our personal happiness, and personal preferences all need to be considered.
For example, we own zero real estate because I hate being a landlord. (Definitely some bad experiences there.)
We can look at how various portfolios would have performed in the past, and try to find some balance.
We settled onto a roughly 90% stock / 10% bond portfolio (see the details of our portfolio.)
This gives us the long-term growth opportunities of equities for a 60+ year retirement, with a bit of diversification via bonds if we encounter an early economic downturn.
Contributing a portfion of our stock allocation to International equities historically would have given us lower volatility and greater return.
Make a Plan
“Everybody has a plan until they get punched in the mouth.” – Mike Tyson
Nice quote, Mike. We still need a plan though. Emotional reaction: Bad. Follow the plan: Good.
Our plan is simple. The simpler, the better.
- Save enough so we could spend less than 4% for our dream life in Seattle.
- Spend less than that in the early years so the portfolio can continue to grow.
- Aim to have the portfolio value in 30 years greater than or equal to starting value (inflation-adjusted.)
- Use geographic arbitrage to significantly reduce expenses (Travel the World!)
- Travel hack free flights and hotels for additional savings in the short term (1st 10 years, reduce sequence of return risk)
- Hack our taxes with the best of them to eliminate current taxes and reduce future taxes.
- If the market crashes early on, put all of our bonds into more stock.
- If the market grows early on, intentionally inflate our lifestyle.
- If everything goes to hell, plan for Social Security to help with the recovery
- Enjoy life.
This plan is about as robust as you can get. Add some accidental income and success is guaranteed.
If we do get punched in the mouth, the plan tells us what to do.
Known Risks in Our Plan
So here we are in the year 2019, 7 years into our early retirement.
We aren’t as nimble as we used to be.
We’ve pushed our expenses significantly higher, and it would be more difficult to go back to a lower cost of living.
We have a long-term lease. Jr is in a school we like. We’ve become accustomed to the finer things in life. We can’t easily uproot and camp out in Argentina during a downturn. We have become normal.
But…
We are still spending less than 4% (of current market value), which as we know is extremely robust. As long as we stay below that threshold, the need to respond sharply to a market downturn is limited.
Plus, our expenses will decrease in 1.5 years when Jr starts public elementary school, and some of the larger expenses of our last few years are non-recurring (e.g. IVF.)
I’d rather not experience a severe recession, but we’ve prepared as much as we can. Life is good.
Summary
So, is a recession coming? Sure.
When? Dunno.
How severe will it be? Don’t know that either.
What will we do when it happens? Keep on keeping on.
How can we be so calm about the whole thing? Because we prepared in advance, financially, yes. But more importantly, mentally.
Namaste.
Smug comment of the year winner, for sure ;) We are definitely in a different place, but we try to do much the same. Learn, research, and plan now so that things are actions, not reactions. Thanks for sharing your take on this topic amid all the Twitter buzz.
I think first place will go to the people screaming “The recession is coming!” It would be close though.
I’m with you. I’m not doing anything different. I’m prepared to lose 50% as I have enough cash reserves to last me around 4 years in living expenses in Seattle and I’ll exercise geographic arbitrage by going back to Kuala Lumpur for at least 4 months out of the year.
As I see it, most recessions don’t go past 2 anyway, and the market will eventually rebound. Like you, I spend less than 4%, around 2% to be exact, but my lifestyle is still pretty good as I purchased pretty much everything I ever wanted before I retired. Being single helps.
As it is I’m already down +-300K, and I am not even batting an eyelid. I have gotten used to watching my portfolio bounce around up and down 100k or more in a day. I’m sticking to a mostly 95% stock portfolio with about 5% being kept in cash to use in bargain hunting when the recession happens/expenses.
Finding your blog has been a godsend. You guys have been my heroes and inspiration to retire early.
Thanks man.
Sounds like you got the mental and financial parts down too. Congrats!
Given that you invested through the global financial crisis and didn’t seem to lose your cool, you are probably fine. I’m glad your timing for when you actually bailed on work went great (me too!). I think always mentioning your income from this blog in how you approach these matters would give these analyzes more integrity — as that income is equal to or greater than the income from a seven figure bond allocation at this point (I’m guessing). Cheers!
I had a job through the GFC, so it would probably feel a little different.
I assume blog income goes to zero if the shit really hits the fan. Ain’t nobody trying to minimize taxes when there are no capital gains, and the banks would stop affiliate programs for credit cards. Impact wise, our portfolio is worth about 10% more than it would have been without blog income (data.) Not much changes based on 10%. Losing 50% of a slightly higher number is still a punch in the face.
Fair points.
Being FI for 18 months we are definitely at risk of bad sequence risk of return if the recession hit tomorrow. Our plan is basically to keeping using geographic arbitrage but travel only part of the world (the two of us currently travel the world for $30K / year – https://www.nomadnumbers.com/year-one-nomadic-travel-spending-report/).
When the recession will hit our portfolio real bad (let’s say a 30-50% decline in value) then we will have no other options than slashing our budget until our portfolio recover. For us this mean that we will have to get stuck in South East Asia (SEA) in boring countries like Thailand, Malaysia or even Indonesia. There we will carefully track our budget and do things we can afford such as bi-weekly 1hr Thai massage (at $7 USD / hour), drinking daily freshly pressed juice + having pad Thai (at $1.5 each), getting stuck in a 1 BR apartment for about $300 a month and getting our teeth clean twice of year for about $23 / person / visit. Our yearly budget would then be well under $10K. This will be a tough life but but this is the price to pay for leaving your 9-5 in your mid-30s I guess. What do you think Jeremy?
This was our plan too. A nice tailwind at the beginning just meant we could remove some of the safety measures. Good plan!
this is not my idea of retirement, when i retire, I don’t want to worry about sequence of returns, but still want my portfolio to grow. Why should I have to change my lifestyle to accommodate ? My strategy is to take advantage of this bull run, which may never happen again, and take some money off the table. I have a 40% cash reserve, that I can use to buy opportunitys. Yes a down turn is probably on its way, but no Recession is planned… don’t count on it. And if it happens or not, I sleep at night, knowing I can still afford to travel, and drink Tequila in Zi Wattna Ne HO…
working longer to save more is also an option.
I’m calling it. A moderate recession in 2020. :)
We’re being a bit more conservative until the outlook improves. I reduced our stock holding to 70/30 for now. That will help us ride through the recession. If no recession, not a big deal. We won’t gain as much. I can live with that.
To MI’s comment above.
Investing through the great recession was easy because I had a well paid job. Life is different now. I’m more conservative.
Income from blogging probably would drop like a rock when the recession hits. You can’t count on it.
If you call it right you can start to go on all the TV shows as the guy who predicted the Great 2020 Recession!
We are at the slowest growth rate in years (2% yoy in Q3.) Still a ways to go for a contraction.
It will be interesting for everybody to see how blogging income gets impacted by a recession :).
I missed the 2nd half of your comment on the first read…
It’s interesting that we both have the same assumptions about blog income.
I understand your recession explanation, but in reality has a “wishing upon a Star” recession ever happened? I do not believe so. There were always other well definable causes, I believe. Just wondering. I was toooo conservative in my retirement. My portfolio is large enough that a 3% dividend yield provides 133% of our spending needs. SS and IRA RMD still years away. Was exceedingly lucky to retire into longest bull market EVER. Dividends don’t reduce so materially in a recession to warrant much of a change in a diversified portfolio.
I don’t think there is ever a single cause.
The Great Depression was self-sustaining. Nobody hired or invested because nobody was buying products/services, and nobody was buying products/services because there was no work. It took a war to break the cycle.
I think in may ways the 2008 recession had an element of wishing on a star. Our office cut back (and I’m in land development) but I never lost my job, still got raises, etc. Yet we cut WAY back on our spending – and I suspect that was a common reaction. If 100 of my neighbors cut back just 10%, the restaurant on the corner closes.
To retirebyforty’s comment, “Investing through the great recession was easy because I had a well paid job. Life is different now. I’m more conservative.” Absolutely! My pay wasn’t even that great then but my specialty (bankruptcy) was in high demand. I knew I had paycheck through the end of the recession and beyond. I just kept investing, and used an unexpected inheritance from my mother to convert my traditional IRA to a Roth, open a spousal Roth for my Spousall Unit, and fully fund my emergency and FU accounts. Today, none of that applies.
For us, life through 2008+ was exactly the same as before the crash. We were living in a little bubble in Seattle with a good income, as was everyone around us. The only change was the number on the computer screen when I checked our portfolio value.
Nailed it!
Always a great perspective! Thanks for keeping us all on the wise path, Jeremy.
Not sure about wise, but happy so I guess it works out :)
Deflationary recession is nice for a passive investor if real interest rates are high – money in guaranteed bank deposits, prices down, possibly including securities.
Day dream over.
https://fortune.com/2019/09/06/market-crash-how-to-be-ready/
Have cash in a crash.
Have cash in a crash by having cash on the sidelines while the market goes up. Then when you buy in you can do so at a higher price than if you had just purchased at the beginning.
“while the market goes up … at a higher price”: Correct.
Share markets are highly erratic. Volatility ~20% / y, total return ~10% / y. Put simplistically 20% / 10% = 2 years return to move 1 standard deviation – leaving direction indiscernible.
While the market goes down, with adequate cash can avoid selling at lower prices while buying at lower prices.
Everyone looks to the worst case scenario. Why not a little positivity. I work in finance and people have been calling for a massive recession since I started in 2013. No one knows and it’s irresponsible try to guess. Timing the market, even becoming more conservative makes irreparable damage to your future net worth.
Selling is never an option for me and I don’t even try to pretend I know when the recession is coming.
I may feel different if I retire but I plan to be conservative in withdrawal rate and allow myself some flexibility. Plan before retiring! Don’t react.
As you can tell I love this post!
I’m so glad to have a pension! My wife and I will be collecting approximately 11k to 13k, per month in 5 years with 3% annual cola’s And with paid for BCBS PPO healthcare, paid for by my employer.
I can leave my portfolio invested aggressively for John Bogles favorite holding period, FOREVER. Hmmmm or was that Warren Buffett?
Currently 100% VTSAX and not changing it.Investing it for my children’s lifetime.
These articles make me appreciate how fortunate we are and I just wanted to add that some posters mentioned keeping some cash on the side for the buying opportunity that recessions can provide.
I’ve tried this and in my opinion, very difficult to do. It’s market timing and I watched the market climb and climb and climb.
I finally put the cash reserves 100 % VTSAX and I’m no longer looking at the market and sleeping like an baby!
Here’s the problem I believe you will have. When the market does drop, how will you know if it’s going to drop any further?
So you’ll wait for it to do so and it might go sideways, it might go up and you’ll hold steady waiting for another drop.
Then the market will drop again, and you’ll find yourself again thinking, what if it drops even more tomorrow. You’ll end up sitting on the sidelines, and when it starts to recover, you’ll still wait thinking it’ll reverse. And you’ll still be holding that “dry powder” or what’s left of it.
This was my experience and I realized the saying “it’s time in the market” not “timing the market” which made me stick to an asset allocation.
The best time to buy equites like VTSAX, is when you have the money, PERIOD.
In theory, trying to buy during downturns sounds great but difficult to do for the reasons I mentioned above.
If Amazon ever sells a crystal ball telling me when to buy, I’ll try it again because I smashed my crystal ball because it wasn’t working.
Gino
Pensions are nice, I wouldn’t mind having one.
Vanguard agrees with you about the dry powder plan. Most of the time you’ll just miss out on the growth, and if it does plummet you will most likely wait to long to get back in. Pick an asset allocation and stick with it is the best solution.
Thanks Nate
It’s human nature, I think. If we don’t have problems to solve we create imaginary ones :)
We have been selling a little here and there to pay the bills. I’m OK with spending some principal.
Yet another very knowledgeable and worthwhile post, Jeremy. It’s always nice to have the reminder from you to ‘stay the course.’ Sending love to the three of you from Patricia and me.
And back at you, Tom. Hope all is well!
Namaste, indeed :) – may be have a 2 year cash reserve given that’s how long it’s taken on average for the economy to rebound
Maybe. We have about a 1-2 month cash supply, plus or minus.
Jeremy, I do like articles like these, and I understand your plan for a recession. I also know you don’t believe in timing the market. However, if/when you sell equities for the purpose of spending there must be a little portion of your brain that is trying to time that sell to a high point in value? Do you maintain any type of cash cushion to attempt to avoid selling when valuations are low?
In the big picture everything in your article makes sense. But when the rubber hits the road everyone will have to sell their stocks at some point, and that point will have some sort of timing associated with it, good or bad. Do you do anything to actively try to avoid selling at low points?
I don’t waste energy on the impossible.
Jeremy, I’m asking a practical question here. I’m asking how you – individually – choose to sell your equities. I know you don’t pay attention to budgets or the markets in general. But I’m asking how you choose when to sell equities. If the answer is you literally don’t pay any attention to price then that’s fine, but take this last January for example. The market dropped about 20% between Sept 2018 and January 2019.
Let’s say hypothetically you paid no attention to markets between Sept 2018 and January 2019. Jan 2019 comes up, you need cash, you open your account and realize it’s down 20%. Do you choose to sell at the low point? Or do you pull from cash reserves that you have set aside for this purpose?
If you pull from cash reserves that means you made a conscious pro-active move in the past to avoid having to sell at a low point in the future.
This is what I am asking, do you do anything, anything at all, to avoid having to sell at low points (such as having cash on hand), or would you have – in the example above- been forced to sell at a low?
Nothing
How do you know it is the low? Maybe it is the high for the next 10 years.
In which case your retirement would have a great possibility of falling apart (without changes being made).
If you don’t waste time worrying about the possibility of 1991-current Nikkei 225 then that’s fine (-0.1% CAGR with dividends, adjusted for inflation).
We probably have different definitions of “great possibility.”
An alternative would be to not retire with a portfolio of only 25x annual expenses with 100% of it invested in a single asset with a CAPE of 100 and representing 50% world market cap but only 15% of global GDP and 2% of world population.
Crash cash reserve:
Until central banks recently came repeatedly to the rescue of shareholders by repressing interest rates, banks paid interest on deposits that was competitive with yields on shares, especially when risk adjusted and over the ‘economic cycle’. More so in Aus, less so in USA.
Keeping a significant ‘all weather’ cash reserve did not significantly alter portfolio performance other than to reduce volatility.
Now low interest rates are undermining bank viability and increasing risks all around; for example savers such as home buyers or husbanders such as retirees.
Keeping a cash reserve currently seems less rational – even more so than it has previously when the share markets have out performed best bank deposits.
Perhaps, in the ‘digital age’ banks are obsolete and we are in transition to the ‘risk age’.
Good post. I like to say, “If you can’t afford to retire in a recession, you can’t afford to retire.”
Long-time reader, first-time commenter.
Jeremy,
I’m retired with a 70% stock /20% bonds/ 10% cash allocation – same allocation I had when working. I rebalance once per year. This gives me peace of mind. 70% is high enough to realize significant market gains when times are good – I don’t mind leaving some potential gains on the table. Thanks to the bull run and re-balancing 10% cash is good for 3 years worth of expenses and then there’s still the bonds.
I like your idea of moving to a higher stock allocation as the value of your portfolio grows – if you’re happy with your life at around your current level of spending this is less risky than many people believe.
Sounds solid.
re: moving to higher stock allocation
There are 2 common ways of thinking about this –
“You’ve won the game so stop playing” so take money off the table –> reduce stock allocation
“You’ve won the game, so let it ride” –> increase stock allocation
We’ll be fine either way, but taking the 2nd route might give us the option to buy a Curry Cracker charitable hospital someday.
You said, “So, based on my great and unmatched wisdom, to prepare for the coming recession, I am doing… nothing.”
I went far beyond your actions. I made my wife turn off the TV and walk downtown to the coffee shop with me. No TV allowed there, just intelligent discussion.