The Worst Retirement Ever

After years of commitment, dedication, and hard work, your early retirement plan has come together nicely

By living well below your means and investing in stocks and bonds, total assets have eclipsed $1 million, 25x your budgeted annual spending of $40k/year (all in 2014 inflation adjusted dollars, of course)

Everything you’ve read says that if you remain flexible, this should be enough to provide a relatively constant standard of living for the next 50 years, a must for somebody retiring in their mid 30s

The last few years at work have been a little stressful, so it will be nice to take time to recharge before diving into your new life’s ambitions… a little travel, learning a new language, writing a novel, communing with nature, creating music and art… all of the things that were put on hold due to the demands of career

People are a little confused on your last day of work. “But… what will you do all day?” “You are going to live off of your investments? I could never do that, the stock market is too risky” “How could you save so much, we can’t seem to save anything”

Your coworkers mean well, but their questions remind you of why you felt so compelled to gain freedom from the need to work in the first place. You walk out the door, a weight lifting off your shoulders for the first time in years



The Plan

It doesn’t take long to discover that early retirement agrees with you. Waking up without an alarm clock brings new meaning to the word luxury. With extra free time, exercising and making healthy meals at home feels natural. Riding a bicycle to the grocery store at 2 pm on a Wednesday is so much more enjoyable than the crazy after work rush, and it seems you can’t help but scratch items off your To Do list.

A few months go by, and as the stress of life melts away you start to feel like a new person. You finally feel ready to move on to bigger and better things

One of those things is a quick review of the retirement plan

With a 50+ year horizon, the portfolio is heavy on equities with 80% stock and 20% bonds, all invested in low-cost index funds. At the beginning we keep one year’s worth of spending in cash to help smooth out the inevitable bumps in the road. If there is a market crash early in retirement, we can move our bond position into stock and use the cash for spending

It seems a good time to depend on a portfolio instead of a job. The last few years, the economy has been quite robust. Inflation is low and growth is strong, and people seem optimistic about the future.

Our budgeted spending of $40,000 per year can provide for a high quality of life, more than we will probably spend (Although maybe we will spend that much someday.) Because the early years are critical to a portfolio’s long term survival, the plan is to spend a little less than 4% while we get used to our new life.

Is this plan sufficiently robust?

I hope so. We are about to retire in 1965, the worst year to retire Ever

(All numbers are 2014 Dollars. Using 1965 dollars, this fictitious retiree would have started with ~$135k and been spending ~$5.3k per year)

The First 10 Years

The first few years go by fairly smoothly. Income from dividends and interest grows and our spending grows with it. As during any time in history, bad things happen. In 1968, Martin Luther King Jr. was shot. Vietnam War protests increase in frequency and intensity, including the tragedy that took place at Kent State. But good things happen as well. In 1969, the whole nation watched as Neil Armstrong stepped foot on the Moon, and it seemed anything was possible

But then President Nixon announces that the US Dollar can no longer be redeemed for gold, along with wage and price controls. This is going to take some time for the world economy to sort out, and there is nothing worse for the economy than the unknown. Even though our spending is still ramping up, we realize things will be turbulent for some time and are ready to make short term changes

And then things get worse. In 1973 the Arab Oil Embargo causes oil prices to quadruple virtually overnight, pushing prices up on nearly everything. Price controls cause a shortage of gasoline, long lines, and fear

This hits the wallet a little, but not nearly as bad as it does for the people driving to work everyday.

Worse than gas shortages and increasing prices is the plunging stock market. In 1973, the stock market drops 19%. In 1974, it drops another 25%. While inflation is kicking you in the gut, the stock market punches you in the throat

In what is one of the hardest financial decisions we ever make, we stick to the plan… moving half of our bond position into stock during our annual asset reallocation in ’73, and the other half in ’74. We go all in… 100% stocks. When the world looks to be on the edge of collapse, we fight that clenching feeling in our gut and follow the plan.

Touring all of the National Parks in an RV was part of the plan as well, but not with a gas shortage. Instead we prioritize our budget friendly goals and spend the next two years hiking the Appalachian Trail and biking across the United States. This helps drop our spending to about 2.5% of the initial portfolio value, less than we are earning in dividends

10 Years in daily life is quite enjoyable, but economically things are not looking good. The stock market has crashed, there is no oil, the President Nixon has just resigned, inflation is out of control, and when adjusted for inflation our portfolio is worth only half of what it was when we started

Making Adjustments

We would be hard pressed to find somebody at this point in an early retirement who wasn’t willing to make some adjustments to the plan

Inflation and unemployment have been rising steadily, and it is hard to predict what will happen next. Our own personal rate of inflation is much lower than the reported figures, but it is hard to ignore President Ford’s WIN speech and resulting drama

We consider the idea of getting a job. Even a part-time minimum wage job would bring in an extra $500/month after-tax. There are so many opportunities available it is hard to choose which option to pursue.

Maybe we can finish our book. That worked out well for that Harry Browne fellow with his success with How you can Profit from the coming devaluation

We’ve also had a few offers for some of the paintings we’ve done these past few years, maybe that could bring in some reliable income. Or the band we’ve been a part of could take on some gigs or busk on street corners, maybe even just for fun

But in the end, some friends have the idea of spending a year or two in Argentina and Brazil. Learning Spanish is on the Bucket List, and Portuguese sounds interesting as well. And we should be able to spend much less than just our dividend income in those countries. Let’s do it!

Two years later we return to the US, and things worsen. The Iranian Revolution causes another doubling of oil prices.

Paul Volker takes the helm of the Federal Reserve and makes policy changes to reign in inflation, causing a depression and a spike in unemployment. Things look so bad, Business Week predicts the Death of Equities

But we take these things in stride. If anything, these past 15 years have taught us that flexibility is an incredibly powerful force for portfolio longevity. With confidence, we loosen up the purse strings. Now seems like a good time to start that RV tour

15 years into Retirement and our portfolio is still worth $500k (2014 dollars)

Maturing into Retirement

By now we’ve settled into our new life quite nicely. Some income opportunities present themselves regularly, but we always seem too busy to pursue them. Some years our investments do well, other years they don’t, but we are wiser (or perhaps just older) and the roller coaster doesn’t seem as interesting or exciting anymore

An upward surge in the stock market in the late 1990s makes us consider taking some money off the table, but we remember that market timing is a younger man’s game. Still, it is fun to see the portfolio return to its starting value on an inflation adjusted basis… even if just for a day

We start receiving Social Security income at Age 70. Income isn’t as high as it would have been had we worked an extra 30 years, but it is sufficient to cover 25% of our annual spending

Nearly 50 years later, our portfolio is still worth $500k. Our only source of income during this time was our investments. Looking back, we averaged a 3.7% withdrawal rate and lived a deeply rewarding life. The future looks equally bright

If this is the worst history has to offer, I’ll take it

Alternatives

A little flexibility goes a long way, and this retirement thought experiment has a happy ending. But what if we don’t want to be flexible? What if 4% withdrawals are a minimum?

Pure 4% withdrawals for a retirement starting in 1965 were a disaster, with the portfolio dropping to $0 in about 25 years. This occurred regardless of asset allocation. A portfolio of 50% stock / 50% bonds failed just as surely as a portfolio of 100% stock

One possible conclusion is that a 4% withdrawal rate isn’t safe enough. A 3% withdrawal rate, on the other hand, has had a 100% historical success rate. What if instead of retiring in 1965, we continued to work and built up the portfolio to $1.33 million, enough to support $40k/year with a 3% withdrawal rate?

This would only require working another 8 years, retiring in 1973 instead of 1965. Following this plan would have provided for incredible portfolio growth and opportunity for increased spending, with total assets in 2014 of over $4 million, even without taking SS income

But… if we were of the mindset that 3% was necessary, what we would have done in 1973? If in the first few months of retirement, the stock market dropped and the Oil Embargo began, would we have stayed the course? Or would we have returned to the work place? Safety first

What Made 1965 So Terrible?

In the years after 1965, the perfect storm of retirement killing conditions took place. Inflation grew rapidly over the following decade, exceeding 10% in several years in the 1970’s and averaging 6% a year from 1965 to 1985. Interest rates rose rapidly, from ~4% in 1965 to ~8% in 1970, up to 15% in 1982, causing bonds prices to plummet. The combo of fast rising high inflation and rising interest rates destroyed bonds.

Stocks also performed horribly. Adjusted for inflation, the stock market didn’t rise above its 1965 value until 1992, 27 years later. Dividends moved sideways over 2 decades

But as we saw in our hypothetical 1965 retirement above, these things are manageable

The most insidious portfolio killer was inflation. When the stock market drops, we can’t help but notice. When interest rates are rising, we see the impact. But when prices increase, humans are horrible at internalizing the change

My grandfather used to complain about how expensive certain things had become, even though on an inflation adjusted basis they were actually cheaper.

Or consider how much excitement occurred when the Nasdaq recently eclipsed its 2000 high. But when including inflation, the Nasdaq is still 40% below the lofty heights of 15 years ago. The excitement is completely arbitrary

To understand the impact of inflation during this period, I looked at the CPI over the 60 year period before and after 1965. Inflation was largely predictable before 1965 and after the early 80s. However, the transition was painful. Between 1965 and 1982 prices would triple. The main contributions are generally agreed to be the result of closing the gold window, the Oil Shock, and discredited economic policies.

Incidentally, the two trend lines in the chart show average annual inflation of ~4%. As long as inflation is predictable, normal positive economic behavior ensues

Since this was before my time, I asked the older and wiser Jim Collins to share his experience

While I lived thru them, I missed most of those sideways years, graduating from college in 1972 and starting my first professional job in 1974 I was pretty poor, especially living on 50% of my income so I’d have traveling money as I did. The point of this is that when you don’t have much, as long as you are employed, economic woes don’t much matter. While I was basically aware of the stock market, inflation and the oil embargo I didn’t have much skin in the game. Plus with inflation in play and being at the start of my career, I was able to double my income by 1978. With my low expenses I felt very comfortable. Without a car I never sat in one of those infamous gas lines. I remember there was great fear built around inflation and it seemed destined to only worsen. And, of course, then as now, the talking heads were predicting disaster. The big difference, however, is there were far fewer and thus far less noise. No cable TV or internet. Looking at stock performance during those years, you’ll notice that sideways motion started around 1965-6 and lasted until 1982. The market bumped between ~1000 and ~6-700 during those years. So the question isn’t so much why the 4% failed a couple of times, but why it held up as well as it did.

Conclusions

Reviewing all periods in the Trinity Study, the year 1965 was amongst the worst. While the future may provide even worse economic conditions, we can use this period to explore how strategies to improve portfolio longevity would have performed historically

By being flexible with spending, and being willing to adapt our goals to economic conditions, what at first appears to be a certain failure can become a long and rewarding retirement. In the worst of times, the difference between failure and success is small and largely within our control

I, for one, feel much more optimistic about our own retirement plans

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