Some people thrive on jumping out of airplanes, climbing untamed mountains, or riding wild rapids. These same activities would stop the heart of many an avid Scrabble player and crochet aficionado. Perception of risk varies widely… as every extreme sports fan knows, more than one person has died with knitting needles in hand.
This same risk spectrum exists in finance. Even the words we use belie our assumptions. Someone whose preferred method of saving for retirement is to hoard cash under their mattress may be labeled as “conservative”, whereas an investor with 100% of their assets in equities might be called “aggressive.”
These word choices are unfortunate. Obviously if I don’t enjoy jumping out of airplanes into the rapids of a high mountain river in a kayak, then I must be conservative… I wonder how many investors have been led astray by nomenclature.
This is all vary strange, because I enjoy jumping out of airplanes and riding wild rapids. But when it comes to our retirement I’m extremely risk averse.
I’m not alone. Nobody wants to be destitute in their old age, so like bad television news we focus on the negative, the failures, the worst case.
“Is the 4% Rule unsafe?” “What does safe mean anyway?” “Should I work One… More… Year…?” “Should I go for a 3% withdrawal rate?” “Do all of the very vocal & very risk averse people in some online early retirement forums know something I don’t?”
Instead of focusing on all of the potential failures, just for fun let’s look at what happens when everything goes right. What would have happened if we had retired in 1982?
Accumulation and Preparation
As we explored previously, the decade or so before 1982 were financially challenging. High inflation, high unemployment, an oil embargo, price controls, the “death of equities”…
Stock prices moved sideways for over a decade, losing significantly to inflation. Although bond yield was at an all time high and stock dividends were at a peak, inflation was eroding purchasing power by the minute.
For somebody in the accumulation phase, this was a mixed blessing. Certainly, low prices provided incredible buying opportunities; the Shiller PE10 ratio has not been lower since. But this economic environment provided little in the way of real return, making it more difficult to accumulate 25x annual spending in total assets.
This would be an emotionally difficult environment in which to retire early. Little positive has happened in the economy for too long and many have lost faith.
Not wanting to endanger your family’s future by retiring without sufficient assets, of course you do some research. You spend many evenings simulating portfolio longevity in cFIREsim. You seek out like minded people online and get a 2nd and 3rd opinion, and discuss your concerns about health insurance, raising a child, and paying for college. You even share all of your personal financial information with a random person on the Internet for a detailed Reader Financial Review.
And of course you discuss important topics with your spouse such as personal risk tolerance, margins of safety, and contingency plans.
Willing to bet on history and your analysis, you take the plunge and start spending 4%.
Best Retirement Ever
Interestingly enough, all of the worrying and planning was a colossal waste of time. 1982 was the best time to retire ever.
Spending 4% is surprisingly easy from any asset allocation. Income on a portfolio of 80% stock / 20% bonds is over 7% of assets.
S&P500 dividend yield is over 5.5%. 10-year bond yield is an amazing 14.6%, due to inflation averaging more than 10% per year.
It is hard to say if the Volcker-led fight on inflation is having an effect. Members of both political parties are calling for his impeachment, claiming he is destroying the small businessman, destroying the American dream, and destroying Middle America. Throughout 1982 the stock market continues its decline. Everything is a mess. Was retiring early really a good idea?
As summer comes to a close, the Fed announces it is lowering interest rates and President Reagan announces the recession has bottomed. Shortly after, the stock market takes off like a rocket. It ends the year up 23%.
And thus begins one of the most powerful bull markets in history. Over the next 5.5 years the stock market rises 280%. Despite spending 4% per year, our portfolio has exploded to nearly 3x the starting value. Inflation appears to have been defeated, averaging less than 4%/year. Our target withdrawals are now just slightly more than 2% of the portfolio.
A few months later, on Black Monday, the stock market dropped 22% in a single day. Had we retired with $1 million in 2014 dollars, we would lose more than $500,000 dollars in a single day. Yet our total assets are still worth over 2.5x what they were 6 years ago, and we stay the course
2 year later, Savings & Loans Associations across the country start to fail. Thousands of these banks go out of business, costing taxpayers over $100 billion. The Doomers predict total economic collapse (again.)
And yet we would end our first decade of early retirement with nearly 4 times as much money. Income each year is much greater than spending, and we continue to accumulate assets.
Over the next 7 years, despite increasing trade and budget deficits, hurricanes/floods/earthquakes/terrorist attacks, the death of Dr. Seuss, and yours truly graduating from high school and college, the portfolio nearly triples. Income from bond interest and dividends is nearly 2.5x our target spend
Things go south from here. The Internet bubble brings the lost decade in stocks. Interest rates plunge which brings the housing and mortgage bubble. Yield chasing charlatans start selling collaterized debt obligations, laying the foundation for the stock market collapse of 2008. But with a withdrawal rate of less than 1%, we’ve long since stopped paying attention. And yet, our net worth continues upwards to unprecedented levels. Up, up, and away.
Sometime soon we’ll need to start thinking about how to benefit our fellow humans with this ridiculous pile of cash.
Investment returns were so strong over the past 33 years, that we could have spent an inflation adjusted 9.5% of the starting portfolio value, and still have the same purchasing power as when we first retired.
There isn’t much to worry about when everything goes your way, much like being born the son of Frederick Trump. That advantage is HUUUUGGGEEE.
Maybe the opportunity to spend more is an exciting prospect. Or the alternative… you could have stopped working with less than half as much savings. Wild!
Although spending 9.5% was something that worked only once in recorded history, I’m sure some aggressive souls may be willing to give it a try.
I’m not so bold. But imagining what it was like to live through the extremes… what happened in the worst case and what happened in the best… helps me feel comfortable in the middle.
And being comfortable with the plan is really what makes for the best retirement ever.
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