The hottest topic in personal finance blogs these days is Early Retirement. It appears no matter where you turn you run into someone who plans to retire in a few months under the age of 40. This blog is not about early retirement. This is for good reason, I don’t expect to retire before 40 and doing so is not even one of my goals. I might retire early but for me that means 55.
Questioning the 4% Early Retirement Rule
So, why don’t I set early retirement as a goal? The main reason is that I know I’m not going to be ready. Everywhere I see blogs with people retiring with less than $1 million. I see those values and the first reaction is, “I can achieve that number”, then the second realization I have is that those numbers may not be as safe as they first appear. In 2008 we had one of the worst recessions in history, the stock market lost 50% of its value in the next 2 years.
Sequence of Returns Risk and Early Retirement
Since that time the market has largely done nothing but go up, to the point where many feel it is over inflated. This means that the assets someone might use today to retire on are also inflated. Many of these individuals with early retirement goals set their target spend within the famous 4% per year rule. This states that under most 30 years periods your money will last a full 30 year retirement if you only withdraw 4%. The problem is the low probability scenario where the 4% rule does not work. This tends to be where there is an issue with sequence of return. If a dip in the stock market happens immediately at or near retirement the impact will be outsized compared to other collapses. This will likely result in a failure of the 4% rule. Conceptually this is known as sequence of return risk.
Looking at an Example
So, say you plan on living off $30K a year. This is risky given what we don’t know about inflation, medicine, and other significant future financial impacts. However, let’s assume you can control the expense side of the equation. If you retire with $750K and in the first 6 months we see a repeat of 2008, what happens? Well, your initial $750K becomes $375K. Your 4% rule deems that you will now be living off of $15K a year. Alternately you can continue to pull out the original $30K.
However, let’s instead assume it takes 3 years for the stock market to recover to the original level. You will not only be out the $90K you spent, but also the equivalent of $180K from your original investment level. That would be the same as if you had normally pulled out 8%, after just 3 years you could be out up to 24% of your retirement account.
The Going Back to Work Arguement, Risky
Now, a lot of individuals argue they would go back to work if it was really bad. This is a good argument albeit not without risk. Job hunting during 2008 was quite difficult. It might be that when they need the job most is when they will have the most difficulty reentering the workforce. Still, with enough ingenuity I’m sure it is possible. I have read other detailed plans that allow for significant adjustments and thus success. But these plans are simply not for me. The reality is I am inherently cautious. This means I will never feel comfortable putting myself in a position where I may need to scramble somewhere down the line.
Pursuing Financial Independence, Not Retiring Early
That being said, I am working on being financially independent, which is an altogether separate scenario from extreme early retirement. I can continue to work my regular job. But if I have 15-20x my current spend then I feel much more secure to speak my mind and take risks in my career. Simply put the only risk I incur with a situation at work is to whether I retire at 50 or 55. This decreases my stress levels and even allows me to take jobs that are less stressful and more appealing to me, rather than chasing that extra dollar. Essentially, while I’m not pushing for early retirement, I am driving towards financial independence.
If you’d like to read more indepth technical analysis of the 4% rule I can strongly recommend the safe withdrawal series by early retirement now, found here.
What are your plans?
Good post. This resonates with my approach as well. As I often say, achieving FI is mandatory, but RE is optional.
Thank you, I think thats a pretty concise way to sum up my feelings.
I don’t like the word early retirement. I’d rather use financial independence. FI means to mean that my passive income is greater than expenses so I can quit my full time job if I want to. It doesn’t mean I will though. Reaching FI would allow more choices and freedom in life.
Exactly, it’s always great to have choices. What you do with them is up to you.
Thanks for sharing. I am in a similar boat. I think $1 million is too small to retire based on the reasons you stated above. While ideally $5 million would probably be my number to retire, based on the current 2% yield from the S&P 500 that would allow me to live off of $100k, but I am a long way off from that.
On top of that with a small child I am unsure of what I would even do with my time if I retired. I am not sure I want to travel around the world with a small child and enjoy being close in proximity to my family. Based on that I’ll probably continue to work for the foreseeable future unless something dramatic happens.
We are in the same boat with the small children. I’ve found that traveling with children gets easier the more you do it, but I doubt I’d want to do it full time.
You’re right, it is dangerous to assume that we can outlive our investments. I don’t see us truly fully retiring for many years until after we become financially independent (where our investment income is more than our expenses). Our approach is to invest in shares/companies that would continue to pay increasing dividends through a recession (as some companies did during 2007-2009 and onwards) so we wouldn’t even feel the pain. Also remember that the stock market did recover from 2008, so if we keep enough cash on hand (say a year or two’s worth of expenses) we can also ride out the worst of it. We also plan on continuing to invest once we’re retired as part of our budget, that way we’ll hopefully never run out of money.
I’m saying all this, we’re in our mid 20s, so we have a long way to go.
Tristan
As others have mentioned, to me its more about being FI than actually retiring. You want to have a choice about what you do. Working isnt all bad but you want to be able to get away from a bad job, long hours/ commute, excessive stress etc. Its your life. You dont want to have to always spend the best hours of your day doing something that sucks all the time. My overall plan is to keep working at my side job that I enjoy and use a 3% withdraw rate. This will give me an extra buffer and peace of mind.
I’m 26 and I’m on the fence on early retirement. The more I think about it, the more I want to financially independent. I want to have options! Right now, there’s no way I could just quit my job.
It certainly takes time, but set a goal and you should be there in no time. Thanks for stopping by.
For many early retirees, its all about luck. If you were to retire early in mid-1990s you were set. Change that to 2007 and you are screwed. As long as you can get decent stock market returns for a few years after you retire, you most likely don’t have much to worry about, assuming you are smart with your asset allocation. The problem is that no one ever knows when the next downturn will come. Like you, I’d rather play it safe and know that I am financially independent first.
Sequence of returns is the key. If only we had a crystal ball…thanks for the comment.