Is your early retirement under threat from an unlucky sequence of returns?

Everyone assumes it won’t happen to them. But from history we know that not everybody is so lucky.

No, not jury service. I’m talking about sequence of returns risk. The unluckiest break that derails your financial future and throws cold water on your FIRE1.

Sequence of returns risk is the risk of earning negative portfolio returns shortly before or after you retire. It’s a dangerous situation created when you start withdrawing money from a portfolio that’s seen little to no growth, only shrinkage.

Consider the following graphics from Axa Equitable [PDF].

The first charts the fortunes of three investors over three different time periods. All start with a $1 million portfolio that grows for 25 years.

Each investor experiences a different market cycle. But – neatly for the example – all three enjoy the same 6% average annual return:

The maths means the route doesn’t change the destination. With no withdrawals and the same average annual return, everyone ends up at the same place.

But what about with withdrawals?

We assume the same investors start with $1 million each once again. They live through the same cycles as before. The average portfolio return is again 6%.

Déjà vu? Don’t worry, things are about to get interesting.

This time each investor withdraws $50,000 a year from their portfolio:

The difference is stark. The portfolio returns are the same. And Mr Green still leaves a fabulous $2.5m legacy.

But now Mr Blue goes bankrupt!

Regularly taking money out of the portfolios vastly changed the outcome.

Mr Blue’s first three years of withdrawals coincided with a crash. He never recovered.

However the same three bad years came at the end for Mr Green. It scythed his portfolio, but it had already grown substantially by then.

That is sequence of returns risk.

A different mindset

Not selling as an accumulator is fairly easy. All crashes are buying opportunities with a long enough time horizon. Why not grab a bargain?

However a de-accumulator must – by definition – be taking money from their portfolio.

And sequence of returns risk means that a few early bad years for the markets – combined with withdrawals – can torpedo your long-term prospects.

Sure, even after an early bear market a decent portfolio should eventually start growing again.

But for an unlucky few, the damage is done. You’ll be a failure case. In 20 years or so you’ll run out of money.

You’re already dead. You just don’t know it yet.

SWR versus sequence of returns

Let’s not be too gloomy. The initial sustainable withdrawal rate (SWR) research was aimed squarely at these issues. It estimated how much you could spend while being confident (if not certain) that your portfolio would outlast you.

The data that fed into the SWR research included some truly dire periods. Depressions and wars.

Yet choose a low enough withdrawal rate and the data shows that – historically – everyone made it.

Even those those who retired into a bloodbath for shares!

However most people – especially early retirees – can’t withdraw a very low 2% a year. Their portfolios are too small.

Luckily you can ratchet SWRs up a lot and still hit 95% forecast success rates.

So most people do that. We assume we’ll withdraw around 4%, say, and 19 cycles out of 20 we’ll be okay.

In the good times we forget that means 5% weren’t okay. They failed.2

The opposite is a fat streak. Your portfolio doubles, and doubles again. You spend with abandon. You leave your grandchildren a fortune. Those grandchildren tell everyone about their grandpa who retired at 50 and died rich. Someone writes an article about your investing smarts. Your portrait beams.

I hope that happens to us.

But this post is about avoiding joining the blighted failure cases – before it’s too late.

Retiring into a market that’s falling fast or an economy where high inflation threatens to savage your real returns?

Let’s consider your options.

Easy mode: watch but do nothing (yet)

Let’s say markets are down. A lot. But it’s not yet a long dream-crushing bear market.

Inflation may be stubbornly high. But it’s not yet an era of high inflation – let alone hyperinflation.

Should you act?

A good financial plan and asset allocation anticipates turbulence. Maybe you can grip the armrests tighter rather than parachuting at the first wobble.

Consider it a watching brief. Like when a suspect lump seems benign but your doctor says to keep an eye on it.

Most market upsets quickly pass and are soon forgotten. Look at Michael Batnick’s chart:

Click to enlarge the drama…

Source: The Irrelevant Investor

Not every investing herring turns out to be red – that’s the point of sequence of returns risk.

But depending on how you’d respond to a scare, it may be best to pause and ponder.

Pausing your plan

Reminder: if you’re in the saving and investing phase, keep at it. This post is not about putting everyday accumulation on hold. (Buy more shares in bear markets. You’ll end up richer.)

It’s only those drawing down their savings – or those getting close to the transition – who should consider acting if a bear market strikes, especially in the early years of retirement.

As we’ve just seen there are always worries in markets. Few threaten a solid retirement plan.

But some do. And it’s not obvious which ones in advance.

Consider 2020. It was a banner year for stock market returns. Spending fell so people saved more, too. Some people also got government assistance.

But we only know all that good stuff now. For much of the year people were frightened.

Who could fault somebody who retired in 2019 and panicked in March 2020?

Shares had cratered. A new illness was killing thousands. Governments were turning economies off. Many expected a global depression.

Personally I didn’t think it was the end of the world. But a threat to a new retiree’s long-term financial future? That was a far harder call.

So let’s be humble and pragmatic and consider some options.

Work one more year (or two)

Somebody has to say it. Maybe if a bear market is raging, keep working?

One more year is a curse in the FIRE community.

But truly bad periods for sequence of return risk are rare and damaging. Trying to avoid them is worth considering.

Stay employed longer due to a falling market and you won’t spend from a depleting portfolio. You could even add to it. Things should look better on the other side.

There are two snags.

Firstly, it may not be better on the other side. At least not anytime soon. Some bear markets last for years. What if you end up throwing several more years into the work furnace?

I’ve no idea how you’d feel. Some would-be retirees like their jobs. Some are killed by them.

But I know for sure you won’t get those years back.

Second snag: maybe it was a false alarm.

The good news is you’ll be richer when you do retire. But again you can’t get that time back.

Also you’re still exposed to sequence of return risk when you finally do retire. Albeit with more assets as a cushion after a year or two extra at work and some portfolio growth.

Go back to your old job

If you recently left work, you’ll never be more employable again.

Perhaps rewind the tape for a year or two if you’re having second thoughts.

Acquire more money

Sequence of returns risk hurts when you spend assets that have shrunk too far, too fast.

Continuing with employment avoids that. Instead of spending from the portfolio, you’ll save more.

But what if you can’t hack your job any longer?

Well there are other ways to get spending money.

Downsize your home

Many retirees plan to downsize someday. Where practical, bringing forward such plans can release cash to tide you through an early bad market.

If a stock market downturn coincides with a recession, downsize sooner rather than later if you’re going to do this.

Remember: you’re taking capital out of the property market. Not moving up the ladder. So do it when prices are buoyant to get the most cash.

Take a part-time job

Okay, so you can no longer stomach the nine to five to email before bed. But what about the ten to two? Or the Monday to Thursday?

A managed retreat from work keeps some money coming in for longer. Again, that could reduce or eliminate a fatal drawdown of your capital.

High-end information workers are blessed here. The word you’re looking for is ‘consultant’. Sweat that intellectual capital while you still have some!

Skilled tradespeople might transition to part-time pretty easily, too.

But middle-managers who owed their income to recently forfeited fiefdoms could struggle.

Enter the gig economy

The jury is out on the uber-flexible gig economy. Are today’s young workers getting a raw deal?


But for a workplace refugee in a bear market, the gig economy could be a lifeline.

Drive an Uber. Deliver for Deliveroo. Rent out a room on AirBnB. Whatever works for you.

It won’t be lucrative compared to your old salary. It probably doesn’t need to be.

I’ve explained before how just a little income is worth more than you think.

A few hours earning £100 a week equals £5,000-ish a year, ignoring taxes. You’d probably need over £100,000 in capital to generate the same income, depending on your SWR.

Spending your gig earnings to reduce your withdrawals could take the edge off a nasty sequence of returns.

Debt or other reserves

Now we get to what’s probably the least good option in the ‘mo money!’ category.

Best case: maybe you could hurry along an expected inheritance or some other bequest. There may even be taxes advantages.

Middling good/bad would be to drawdown cash from an offset mortgage. You’re taking on new debt, and increasing your monthly outgoings due to interest. Not ideal. (You’d also probably have to have arranged the offset mortgage years in advance while working. It may not be an option now.)

The benefit of releasing cash is your investment portfolio then requires less raiding for liquid spending money. Just remember to rebuild your offset mortgage pot ASAP when the markets bounce. (And acknowledge the risk that it might not bounce to your schedule.)

Beyond that are even worse options. Borrowing from family or friends. Raising cash on margin against your portfolio. (I wouldn’t, too risky). Equity release.

I’d cut my spending instead.

Tweak your investing strategy

Again, a market wobble isn’t unusual or necessarily an emergency. A good plan should be ready for rough patches.

Maybe you’ll spend a cash reserve first. Next you’ll sell your bonds. Equities last. They may even have bounced by the time you have to sell some.

Or perhaps you plan to live solely off portfolio income, and not sell your principal? Fine but this isn’t a free lunch. Inflation can outrun dividend growth for starters, and dividends can be cut. Though at least you’re not a forced seller of shares.

But however good your plan, as the German field marshal Moltke the Elder is often paraphrased: no plan survives contact with the enemy.

Or maybe you didn’t have a great plan anyway. With the market falling you see you were winging it. Or you were over-optimistic. Or maybe you’re less risk-tolerant than you thought.

Lower your sustainable withdrawal rate

What about a lower sustainable withdrawal rate? Success or failure can turn on small tweaks. Target 3.5% as your initial spend instead of 4% and you might never run out of money.

Consider a US investor spending $40,000 a year from a million dollar portfolio over 30 years. She would have have run out of money six times in 121 historical cycles, according to the FIRECalc tool:

However cut that withdrawal amount by just $3,000 to $37,000 though and only one period saw a failure.

At $35,000 a year there were no failures.

Don’t get hung up on these specifics. This is historical data. The future is unknowable. The point is lowering your SWR by whatever you can manage will boost your chances.

Note that for long-term security you don’t just reduce your SWR during the early bearish years and then ramp it back up. The maths compounds from a lower spending base over a full retirement.

You were unlucky enough to retire into a market crash. So digest it and move on.

(Perhaps if the stock market gets truly euphoric you could reduce risk and readjust. But don’t rush!)

Take more risk

This is a bit counterintuitive and won’t work for most. But selling more of your safe assets to buy equities during a downturn should see you climb faster and higher on the other side.

Assuming you make it…

It won’t be easy. You’ll be taking stuffing out of your safety cushion to buy what’s reeking havoc. And you must have enough safe assets to spend your way through, so this is only an option for the wealthy. There are no guarantees it will work either – especially not quickly.

I could imagine doing this, but that’s after a lifetime of very active investing. Most should consider other options.

Take a bit less risk

You wanted a feature-rich retirement. You also wanted to leave a chunky legacy. The sun was shining and markets were flying.

So you exited the workforce with an aggressive portfolio – 80% in equities.

The first Monday out of work shares fell. By the end of the week they’re off 10%.

You panic.

There’s no shame in learning your true risk tolerance later than is ideal. It’s better than denial. Investing when you have a regular salary is very different to shepherding a pot of worldly wealth.

You are where you are.

Now, nobody wants to sell when markets are down. You’re locking in losses.

But it’s better to take limited action when shares are 10% off than to capitulate after a 50% decline.

If you’re rich enough, consider swapping shares for cash and bonds until you feel comfortable again. Do not abandon shares completely. Nearly all of us need some equities to meet our portfolio goals. But try to immunise yourself against freaking out at further falls.

(Then maybe turn off the stock market news.)

It might also be worth looking at an annuity. Especially if you’re a not-so-early retiree.

Annuities can provide a low but very safe floor to your income drawdown strategy. That’s valuable.

What not to do

Don’t punt on cryptocurrencies or buy NFTs to make good your losses. Don’t bet at the races.

I’m also not talking about tactically selling your shares, hoping to repurchase them when the falls are done and the sequence of returns turns to your advantage.

If you could be confident of making that operation work you’d already know it. You probably can’t.

More likely you’ll lock in losses and then miss the rebound. Maybe you’ll spend years waiting for a second bite. Your entire strategy is now derailed.

Market timing will cost most people more than they ever make. It’ll also turn your hair grey.

Cut your spending

Your wealth is down. Your portfolio is shrinking. But you need income from it to get by.

So spend less money and then you’ll need less of an income.

If you’re a fancy sort, you’re adopting a tactical withdrawal strategy, dontyaknow.

If you’re a simpler soul like moi, you’ll cancel your foreign holiday, put off buying a new laptop, and rediscover your inner graduate student.

Live well but cheaply until the tough times pass. It’s not so hard. (Especially if you own your home).

There are innumerable ways to reduce your outgoings. Doing so probably got you here.

Just remember retirement spending is a thorny problem not simply due to the risk of running out of money. There’s also the ‘danger’ of leaving lots of leftover money at the cemetery gates.

Because sequence of returns risk cannot ever be known perfectly, you may be making unnecessary sacrifices. Some postponed opportunities (travel, say) will eventually recede completely.

Many retirement plans assume your pot will go to nowt. If your plan does, get used to it.

The ideas in this article aim to reduce the risk of accelerating the march to zero due to an unlucky early knock. The aim is not to abandon your plan whenever your portfolio wobbles a few percent.

Down but not out

If you’re vulnerable to sequence of return risk when a bear market strikes – newly-retired, smaller portfolio, early exit from work, few other resources – I’d consider acting to protect your future.

By pick-and-mixing a few evasive measures, you could reduce your exposure to sequence of returns risk without too much pain, even if your portfolio has been shellacked.

For example you could reduce your long-term SWR by 0.25%, work a day a week, and swap one meal out a month in your budget for an M&S Meal Deal.

Perhaps that would make all the difference?

This is not an exact science. That’s why I haven’t bothered with spurious calculations in this article.

Nobody knows the future.

A bad market can turn on a dime. Perhaps you’d have been fine, after all.

Rather it’s all about risk reduction.

If today’s crash is tomorrow’s false alarm, no harm done. You’re better-placed going forward. You can enjoy swankier remaining years than you’d originally planned for.

Conversely if it’s not a false alarm, you’ll be glad you did something early.

Better safe than sorry.

Financial Independence Retire Early.Don’t dwell on the exact details here. I’m just illustrating with round numbers for simplicity and because the future is unknowable anyway.

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You retire and the stock market crashes. What should you do?
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