Running Out Of Money In Early Retirement
Panic washes over me. The realization that I’m broke, penniless and destitute sinks in. How will I provide for myself? My family? Where will I live? I wake up in a cold sweat, heart pounding, pulse thumping in my ears. Slowly, I return to wakefulness and I realize I was only having a nightmare.
But what if it really happened? What if I woke up one day and realized my investment portfolio was depleted and I couldn’t feed my family?
Spending all the money in my investment accounts would definitely qualify as an “early retirement failure”. This kind of failure is what some early retirement naysayers claim will happen if you quit working before age 65. But is it really possible to suffer this kind of catastrophic early retirement failure?
I don’t think so. Here are five reasons why:
1. We only spend a tiny fraction of our total investment portfolio each year.
The standard rule of thumb for retirement spending is that you can spend 3% to 4% of your investments each year. Flip this rule on its head and you see why I’m not too worried about spending it all. Every year early retirees don’t spend 96% to 97% of their investment portfolios.
Put another way, since we spend only 3% of our portfolio each year, it would take us 33 years to deplete our portfolio (assuming zero investment returns for all 33 years). We have a 33 YEAR emergency fund at our disposal.
What if the unthinkable happens and our investments get cut in half overnight? We still have adequate assets to last for 16 more years! I don’t think we could live forever on a portfolio balance half its current size, but we will have plenty of time to adjust course and figure out our next steps. We could wait and see what happens with the markets for a year or two, or wave the white flag and head back to work as soon as possible.
2. Dividends and Interest.
Part of our annual expenses are funded by dividends and interest. Dividends can fluctuate year to year but are relatively stable. Interest payments are very stable. Our portfolio yields around 2.2% to 2.4% each year, which is just a little bit less than our annual spending. We don’t really need big returns in the stock market to fund our annual expenses, as dividends and interest cover most of our annual spending. In our taxable accounts alone, I expect around $8,000 per year in dividends and interest, which is enough to pay 25% of our $32,000 budgeted retirement expenses and enough to pay 33% of our “core” expenses of $24,000 per year.
3. Availability of other income sources
The core foundation of our early retirement financial plan is an adequately sized investment portfolio. But it’s not the only source of income available to early retirees. If we saw our investment balances dropping quickly, we could supplement our portfolio withdrawals with other sources of income. Part time temporary jobs, self employment income, profits from hobbies, selling your stuff on ebay or craigslist, or doing odd jobs can all provide additional income streams while the investment portfolio continues to do the heavy financial lifting.
I suppose some would demand the forfeiture of your honorary early retiree badge if you were to accept the idea of “doing work in exchange for money” as a valid pursuit during retirement. That’s a very binary view of life. I’m okay with others placing themselves within artificial constraints. Lucky for me and everyone else on the planet, we get to make our own rules in life. Like how we define “retired”. It can be pretty easy to earn money with a part time pursuit that you enjoy, just be sensitive when using the word “retired” around those that would seek revocation of your early retiree badge.
In a guest post here at Root of Good, Nick from Pretired.org laid out a case for rethinking retirement altogether. That article might help frame your conceptual take on early retirement and the role of making money even though you are “retired”.
4. Flexibility With Annual Spending
Even though our retirement budget is $32,000 per year, we don’t have to spend $32,000 every year. I intentionally added some wiggle room into our budget so that we could shrink our spending in years when our investments struggle to hold their value. Vacations, gifts, entertainment, and dining out represent over 25% of our annual budget. We could trim a few thousand dollars from these categories and still live a perfectly wonderful life.
5. Social Security
We are still three decades away from Social Security. Under the current SS rules, we will be entitled to payments that can fund two thirds of our retirement budget. Maybe Social Security will still exist when we become eligible, or maybe SS will be modified to our detriment. I’m guessing it will still exist in some form. I haven’t explicitly factored SS into our retirement budget, but knowing that there’s a good likelihood of receiving something 30 years from now provides an extra layer of financial security.
Minimizing Risk Of Early Retirement Failure
During our early retirement, we rely on our investment portfolio to generate our living expenses. We also expect the investment portfolio to grow over time to keep up with inflation (at a minimum). Even though we have a big fat investment portfolio, it doesn’t mean we can rest on our laurels and ignore our finances.
Here are some tricks anyone can use to keep early retirement finances on track:
1. Track spending.
Are your expenses trending up or down? Are some categories growing disproportionately? Do we need to trim expenses to keep within our budget? The easiest way to automate expense tracking is with Personal Capital (review of Personal Capital). Personal Capital does all the heavy lifting by automatically consolidating your purchases and bill payments from your credit cards, debit cards, and checking or savings accounts so you have a full view of your spending all in one place. Automatically. For free. You can’t beat the price and level of effort required to get a complete view of all spending.
2. Manage investments.
In general, you don’t want to look at your investments on a daily basis. The fluctuations will drive you insane and force you to make emotional (dumb) decisions. Keep your eyes away from your investments and your hands off the “buy” and “sell” button at your brokerage firm. Go out, live life, and have fun instead.
You do need to keep track of your investments and make sure you aren’t going broke. Monthly or quarterly check-ups will do the job. It’s infrequent enough that you won’t suffer much emotional pain if the portfolio value dips. The last thing you want to do is sell when your investments are down. Remember the “buy low, sell high” rule to getting rich in the stock market? Don’t do the opposite.
In addition to tracking expenses, I also use Personal Capital to gather all my brokerage accounts, 401k, 457, IRA, and HSA holdings into one screen so I can quickly determine my total investment portfolio balance. I love spreadsheets and have a number of them to do more detailed analysis, but I pull data from Personal Capital to populate my other investment management spreadsheets.
If you notice your portfolio has dropped 20%, don’t panic, but pay attention. Your investments will most likely recover over the next couple of years. But it may be time to consider a plan B to get some supplemental income flowing in order to take some pressure off your investment portfolio.
As part of your investment management, don’t forget to rebalance your portfolio. Here’s how I do it. While you are rebalancing, keep in mind tax implications from selling appreciated assets. As you are rebalancing your investments, you can also sell appreciated assets to generate cash to fund the next quarter’s budgeted expenses.
3. Generate more income.
I already touched on the possibility of other income streams. If you have adequately saved and prepared for early retirement, you don’t have to focus too much energy on earning even more money. Just be aware that the option to earn a buck is out there if your portfolio starts to get rough around the edges. Think about your hobbies or interests and how you can make some cash doing what you love.
Getting some cash flow coming in the door can also help relieve the psychological fears of running out of money due to exhausting your investment portfolio. In our situation, we plan on spending $32,000 per year which is around 3% of our investment portfolio. If Mrs. Rootofgood and I make just $8,000 per year from part time pursuits, hobbies, or odd jobs, we will have enough to fund 25% of our annual spending, and bring our withdrawal rate closer to 2%.
$8,000 per year isn’t a big number. It equates to $333 per person per month. I happen to make more than that from Root of Good right now, but I could also make that much doing a ton of different things that are interesting or challenging (in limited quantities). Fixing appliances, light handyman/construction tasks, yard work, dog walking, babysitting, tutoring, running errands, participating in focus groups, or ebay/craigslist selling could easily net $10-25 per hour. To earn $333/month at that rate of pay, you would have to work 3 to 8 hours per week. Not exactly hard work. Maybe you don’t like doing any of those jobs I mentioned, but I bet you are sufficiently creative to come up with a few things you wouldn’t mind doing a few hours per week.
The concept of working during retirement may not be to your liking. That’s okay, because you probably won’t need to work another minute if you don’t want to (assuming you’re only spending 3-4% of your investments each year). The odds are strongly in your favor that your portfolio will rise enough over your lifetime that you’ll be just fine. But if you are genuinely scared of running out of money when there’s a dip in the stock market, earning a little supplemental income is a great way to put your mind at ease and take a little stress off your hard working portfolio.
4. Adjust spending in hard times.
Getting in some supplemental income is great, but you can also keep your early retirement on track by trimming expenses when your portfolio takes a hit. You’re already following tip #1 “Track Spending” and you have Personal Capital quietly capturing all your expenditures, right?
Find areas where you can cut back temporarily. Skip the long overseas vacation this year and explore local tourist destinations in your own state or within driving distance. Skip the luxury hotel and find a good lower tier hotel that has solid reviews. Travel off season.
An even better way to cut vacation expenses is to figure out travel hacking. Sign up for some credit cards and snag some free flights and hotel stays. And get some cash back bonuses from credit cards. We flew half way across the world to Argentina and Uruguay for free using frequent flyer miles from credit card sign up bonuses. Once we arrived, we enjoyed the region’s low costs on restaurants, entertainment, local transportation, and hotels.
When you’re at home, skip some expensive restaurants and work on improving your cooking skills. You can often replicate expensive entrees at home for a fraction of the price, and tweak the salt, oil, and butter to your tastes to make the dish a bit healthier. And you save money.
There are also big expenses that can be postponed for a year or two if your investment portfolio is temporarily depressed. Major home maintenance, replacing a car, and optional medical or dental procedures all fall into this category. Eventually these big lumpy expenses will be a necessity, but there’s usually some flexibility with the timing.
Failing Early Retirement Due to Boredom
I haven’t seen any academic papers on the topic of “early retirement failure”, but I bet a common cause of returning to work isn’t financial, but rather mental. Some people aren’t cut out to provide their own entertainment all day. Think of prisoners serving a life sentence. After decades of incarceration the inmates would have an extremely hard time adjusting to life outside the walls of their cell.
Maybe the office cubicle is the perfect environment for those who can’t handle the freedom of choosing what to do all day. But that’s another topic for another day. I’ll have to address the non-financial aspects of early retirement failure in a future post.
Don’t Fear Early Retirement
In this article I have explained why the risks of running out of money aren’t as dire as some fear. We are humans, not mindless machines stuck in an endless loop of unbridled spending without any feedback from our own finances. If an early retiree’s investment portfolio hits a speed bump, that retiree has a number of options before declaring their early retirement a complete failure and heading back to work full time out of financial necessity. As outlined in the tips above, the early retiree would be wise to keep track of expenses and investments, and be ready to earn some supplemental income or trim expenses when their investment portfolio starts to wilt.
Do you fear running out of money during early retirement?