My Birth Year = The Worst Year to Retire???
In Bill Bengen’s original 1994 study that produced the 4% rule, 1966 was the worst year to retire. This happens to be the same year I was born. I’m not sure if that’s a bad omen, good fortune for me (being born, not retiring), or just pure coincidence. Let’s go with the last two; I don’t want to be a bad omen, lol.
You might remember from 007 | FIRE Starter: Introduction to the 4% Rule, Bill Bengen’s 1994 study found that the maximum Safe Withdrawal Rate from a 50% equities / 50% bond portfolio over 30 years was 4% (withdrawing 4% the first year, then increasing that amount for inflation each subsequent year). He determined this by analyzing every 30-year period starting with 1926. While no period ran out of money before 30 years, 1966 was the worst case, running out in 33 years.
Cool Story, Bro – What’s the Point?
Well, the point is that the 30-year period starting in 1966 produced reasonable returns, albeit below average. Let’s take a look at that 1966 30-year period using Kitces’s 60/40 data. The table below summarizes inflation-adjusted returns for this period. Note that the last 15 years were actually higher than the historical average and the 30-year return rate is still nearly 4% above inflation.
| 1966 Retiree, 60/40 Portfolio, Real Returns | Per year |
|---|---|
| First 15 years | 0.64% |
| Last 15 years | 7.40%* |
| Full 30 years | 3.97%* |
| A typical 15-year stretch (140-year average) | 6.17% |
So, why is this year the worst in Bengen’s 1994 study?
Sequence of Returns Risk
The answer to the cliffhanger in the previous section is “Sequence of Returns”. Aside from catastrophic health issues or similar disasters, this Sequence of Returns Risk (SORR) is one of the largest threats to a successful retirement portfolio. Simply put, SORR states: when a market correction occurs is far more important than if a market correction occurs. That’s because during retirement, you are withdrawing from your portfolio. Selling investments early on when they are down significantly depletes the growth potential of your portfolio.
When a market correction occurs is far more important than if a market correction occurs.
History Lesson – What Happened After 1966?
1966 was the beginning of a 15+ year secular bear market. Note: “Secular bear market” is just fancy talk for “the market went nowhere”. From 1973-1974, the Dow dropped about 45% and the S&P 500 fell about 48%. That’s about 7 years into retirement for a 1966 retiree. Further, inflation ranged from 5.8% to 13.5% annually between 1973-1981 (~7 to 15 years in for our 1966 retiree). Talk about the perfect storm for disaster!
What If 1966 Ran in Reverse?
To illustrate how sequence of returns has such a profound effect on a retirement portfolio, we’ll take another look at the 1966 example using Kitces’s 60/40 data again. For simplicity, we’ll use a straight-line analysis here (i.e., we’ll assume steady rates for each 15-year period). This means our results will vary from the historical data. Let’s look at a $1-million portfolio over those 30 years with the original order of returns, then with the order flipped.
| $1M, 4% withdrawals, real dollars | Actual order (0.64% then 7.40%) | Flipped (7.40% then 0.64%) |
|---|---|---|
| Balance after 15 years | $469K | $1.80M |
| Balance after 30 years | $254K | $1.35M |
| Highest safe 30-year withdrawal rate | 4.34% | 6.92% |
| When does it run out? | ~38 years* | Never* |
Wowzers! That’s quite a difference, especially for the FIRE community, which often seeks retirement periods greater than 30 years. As you can see, a bad first decade or similar mishap early in retirement can devastate your retirement portfolio’s chance of success.
Surviving the Retirement Danger Zone
There are a number of strategies discussed in the FI/FIRE community to protect your portfolio during retirement. I’ll very briefly mention three here, the first two of which are somewhat in opposition and are often debated heavily.
Strategy One – Maximize Returns (Stocks/Equities)
This strategy is simple: historically, stocks/equities produce superior returns over longer periods of time. Therefore, you should be fully (or mostly) invested in stocks at all times. Mr. Money Mustache has said he’s essentially invested all in stocks for this reason. I’m not disagreeing, but I also can’t help but wonder if he perhaps has some of the FIRE movement’s overconfidence that I spoke of in 025 | Is “VTI and Chill” Still a Sound Strategy? (Part 1 of 2).
Strategy Two – Diversification / Cash Reserves
To be fair, this isn’t just a single strategy. The idea is to diversify your portfolio. Most experts would suggest some mix of stocks and bonds like 60/40. Others might suggest a small percentage in alternative investments like gold, bitcoin, real estate, etc.
As additional diversification and safety, others would suggest having reserves in cash equivalents like high-yield savings accounts, CDs, and/or short-term treasuries. This may be done as part of some form of a “Bucket Strategy”, which I discussed briefly in 026 | Is “VTI and Chill” Still a Sound Strategy? (Part 2 of 2).
Strategy Three – Guardrails
Guardrails can be used alongside either of the previous strategies. There are a number of different guardrail strategies floating around. Some have very exact and sophisticated guidelines while others are simpler and looser. The gist of all of them is that when markets are down you adjust your spending/withdrawals down and when markets are up you can spend/withdraw more. It is a surprisingly effective strategy for increasing your retirement portfolio’s success rate, assuming you have some flexibility in your spending. I discussed it in 026 | Is “VTI and Chill” Still a Sound Strategy? (Part 2 of 2).
Class Dismissed
Sequence of Returns Risk is, IMO, one of the biggest risks to a successful retirement. It’s what makes the early years the retirement danger zone. And the fact that you’re withdrawing funds is what makes this risk specific to your retirement phase and not so much to your accumulation phase.
I highly suggest you factor this into your retirement planning. Build a simple spreadsheet, run Monte Carlo simulations (like I did in 017 | The Decision to FIRE), or play with any number of free online FIRE calculators, including mine: FIcology 101 FIRE Calculator.
What’s your plan if the market drops 30% in the first year(s) of retirement? Drop a comment below.
I hope this helps you see the early years of retirement a little differently. I want you to have a happy and successful FIRE journey. I’m your friend and your supporter, and I love you! See you next time, FI friend. ♥️
-The Professor
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