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
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.
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.
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.
So, is a recession coming? Sure.
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.