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?