When calculating the ability in retirement to spend some of your hard earned money that you deferred for future use, we often are concerned with “market risk” labeled as Sequence of Return Risk.
Yesterday, I was talking with Becky Heptig (from Catching Up To FI and Started At 50) about the opposite SORR.
We talked about the past decade plus of Sequence of Return REWARDS. SOR REWARDS
We talked about using those rewards for life-enhancing amazement.
This is almost exactly the same conversation I had with Mark Trautman in 2021, which created our Fun Buckets for spending.
Perspective
While I read online that there are only 7 personal finance topics that everyone rehashes, I also find that sometimes inverting (thanks Aubrey Williams per Charlie Munger), either on purpose or accidentally, adds to the number of topics, or most specifically enhances the depth of the thoughts and conversations.
Important question: Did you build in, do you have some intentional freedom in the spending part of your life?
SOR Risk
Why is “Sequence of Return” so critically important?
For the Risk portion, I believe it has to do with timeline and duration. The huge impact of the length of decreased compounding. The fact that you had to sell more shares to fund early lifestyle. Those remaining shares will have a harder time getting your balance back to homeostasis, returning to the norm.
Bad Year 1
If you had to sell 1200 shares out of 30,000 in a good market, you’d have almost 29,000 shares to keep working for you.
If the market is way down and you have to sell 1500 or 1600 shares of your 30,000 shares, you have just over 28,000 or so shares (yes, I know I over-rounded, to make the exaggerated point) working for you.
The good market leaves so many more “working” shares for you than after your sale in a bad market.
Bad Year 2
If things still stay OK, and you sell 1100 shares (depending on dividend re-investment, which I turn off in retirement) you may have just under 28,000 shares left.
If the market is still way down and you have to sell 1800 shares, you only have down toward 26,000 shares.
Yes, I know my round calculations are big swags, but they show direction.
The lowering of your working assets shrinks more quickly after bad years if you decide to sell when down– take the same amount out–no matter what’s happening in the market.
SOR REWARDS
What happens (happened the past decade plus) with GREAT returns? Share price kept increasing and increasing and INCREASING, year after year.
In a generic example, maybe in year 1 you had to sell 1200, then in year 2 you sold 1000, then in year 3, you sold 800, year 4 it took 650 shares to fund your spending gap.
Not only are your share counts not shrinking, but each share is worth A LOT more, and your portfolio is growing much faster than your spend rate.
This is what Mark and I talked about in 2021 after the growth from 2008 or 2012, or so.
Nice Life of Great Life?
We were living on a safer, conservative (yet good life) spending rate. All along our accounts, investments, and net worths were growing and growing.
For us: Good Life = Much larger acct balances.
For Becky: the good market returns allowed them to live a great life now doing so much of what they dreamed, and allowed the option of many “Hell Yes” decisions. Many of these activities would not have been as (easily) possible if the market returns were lower or flatter.
This is why I changed the second R to Rewards.
There have been 9 extraordinarily good return years since 2008. There were about 2 “average” 10% years. And there were 4 down years.
If I look at VTI returns, I see a slight pattern of 2 or 3 up years, 1 down year. Hmm, that sure sounds like the “70% of the time the ‘market’ goes up” to me.
I didn’t exactly cherry-pick those years; Gemini gave me those VTI returns. Even 2003-2009 would have doubled the share price.
Why are these Rewards so significant?
So early-in-retirement down markets, especially in a row, can cause significant problems with your retirement nest egg shrinking and causing concern.
Inverted: great early-in-retirement market returns are wonderful. Why? Because at the start of retirement, you may have the highest nest egg you’ve had your entire life. This could be the most inflation-adjusted money your plan will have through your retirement. (if you spend on Rocking Retirement)
This “largest” nest egg of investments is the amount that will be multiplied by the Rewards.
Yes, saving early to allow those younger-you saved dollars to grow and compound over a long time is wonderful. But, right now, having your largest chunk of money growing nicely is even better.
As Mark said to me way back in 2021 (look at the returns since then for VTI) “we’ve had a great tailwind.” I now realize that we also had a LARGE sail to catch that wind.
SWR
So, now what is the Safe Withdrawal Rate across your retirement?
Who gives a $h!t. Who really thinks the best life in retirement is to spend the same amount inflation-adjusted every year for the next 30, 35, 40+ years based on a worst-case scenario?
Who really thinks optimal living is to spend the same at 56, 67, 79, and 88?
The 25x “rule” does give a nice BIG planning target for what to save. If gets you on the BIG target. But the 4% rule was the worst case over 30 years, with a 50/50 allocation. Who has that exact time timeline and allocation? Who wants to plan for the very worst case, when you may have the best permanent summer vacation ahead of you? A vacation you’ve work decades for and built knowledge and skills before (and during) that employment. You EARNED this time.
Expenses
Understanding one’s expenses is huge for me.
Understanding one’s base life expenses (Base Great Life), and the lower Minimum Dignity Amount floor–just in case.
I love the idea of breaking life (and the future FIRE/retirement years) into MDF and BGL. This sets two nice foundations.
I then look at the Wants to add on top of those foundations. In our case, these Wants seem to be fundable from the savings that we have in place.
How smart am I?
As I’ve been typing this and getting worked up into a rant, I realized that I don’t know what will happen for us. I don’t know the future. Geez, I barely remember some of the past (“where were we when we saw that place/thing…?”).
I sure hope that if I read this 40 years from now, that we lived a great life, true to ourselves, and helped those around us, and all worked out great.
That’s the same thing I hope for you. I’m sorry that I took a chunk of your life time away from you as you read this.
Take your deferred spending, especially the overgrowth, and live great.
*** Nothing in this article is to be construed as financial advice. I am not a financial planner, nor do I pretend to be. You should always consult your own professional when seeking advice. This post is not a piece of literary mastery, just a random thought I had.