Losing your FI status to the market

[elegant]

I'm worried about this recent pullback.

I believe it is driven by, and could get much worse as a result of, massive black swans including Russian adventurism and the manipulation of oil prices (here used as a weapon of mass financial destruction).

My risk tolerance is very low so I'm only 50% in equities (globally diversified non-distributing index funds), the rest in fixed income. I pushed a large lump sum into equities on December 5th, just before the recent downturn has started.

I consider myself FI since my portfolio currently represents over 34 years of expenses. A 50% decline in stocks will leave me with roughly 25 years saved, albeit with a 4% SWR which I consider to be extremely unsafe for my age (30).

Anything worse than that -- which cannot be ruled out given the current environment -- and I'm going to lose my FI status earned after years of aggressive saving.

What is the best way to cope with something like that? And by coping I mean not only in practical terms, but psychologically. I wanted to become FI in order to stop worrying about money, but here I am, ostensibly free but worried more than ever, since I don't have any serious income other than my withdrawals.

And, what's more, it is hard for me to accept the fact that the market can simply evaporate everything I've saved so I'll be forced to work again.

For those of you who are FI, what are your strategies for this scenario?

[stand@desk]

Good thread topic, elegant, I am in a similar position to yourself (although I am currently working). I'm looking forward to other Forum Member's comments..

For myself, I tend to take a more "Permanent Portfolio" approach to the markets which provides diversification, safety, growth etc.

I would say with the downturn it shows how important it is to have some dry powder to buy at the lows. And since ERErs are FI minded we will never stop worrying about money in my opinion, even when we have very small SWRs and the markets are steady we will still worry, it's part of us being us.

The market is a risk/reward system and it gets harder to comprehend by the day it seems like. The people who had powder dry in 2009 and invested that recovered very well. Those that held and waited it out recovered moderately well, those who sold lost much of what they had. And yea, it seems like there could be more road to run SE on the stock graphs..

My strategy is to keep some powder on hand, keep working, buy small amounts of equities on weakness and stay the course..

[Tyler9000]

IMHO, you've already done a great job, Elegant. You have a 3% WR in a diversified stock/bond portfolio at age 30. I'm not worried about you 1% as much as you are about yourself. Give yourself some credit!

I originally planned to recommend the Permanent Portfolio, as that's how I invest my money and it performs well in the situations that worry you. Then I remembered from your journal that you already tried it and gave up after three months. So part of the issue is investing experience and confidence -- whatever you choose (you've tried two very solid methods so far, IMHO), you need to adjust to the idea that you will experience portfolio drops no matter what you choose. It's normal and temporary. You definitely should not be distracted by a 4% drop in stocks over 10 days.

However, I personally think you're over-thinking it and the core issue may not be the investments. The moment I really became comfortable with my investments was when I gained the confidence to stop believing I am beholden solely to money for my future happiness and security. That's a hard bridge to cross for a proficient saver and I don't know exactly when it happened, but at some point my withdrawal rate became just one leg of a larger system I believe in. Even if it deviates from my early plans, I do not believe my house will crumble.

You are intelligent and self-aware enough to be financially independent at a very young age, yet you're not over-confident at all. You're going to be fine. Focus on non-financial security, and the investments won't stress you out so much.

[bad_LNIP]

My risk tolerance is very low so I'm only 50% in equities (globally diversified non-distributing index funds), the rest in fixed income

Don't take this the wrong way, but I don't think you have a low risk tolerance, but poor understanding of risk. I would NOT be in fixed income (thinking bonds in particular, but fixed income as a whole isn't paying squat) and global stocks have been getting hammered as of late.


What is the best way to cope with something like that?

Hedging/risk reducing strategies. Sell puts, sell covered calls, buy puts for protection, short a correlated ETF like SPY perhaps.

And by coping I mean not only in practical terms, but psychologically.

Hedging helps a lot.

For those of you who are FI, what are your strategies for this scenario?

Learn about hedging. Do it before you need to just like insurance. When the market drops by 20%, its too late.

[Sclass]

Here is my darkest plan b. I'm FI (right, just mentioning it for the new reader). I live on about 3% SWR. If things go bad and I lose half of my money I'll cut back to 1.5% the previous asset level.

It's actually pretty simple. I'm spending about 2x of what I could comfortably live on. Why? I dunno, I'm too lazy to change as long as the SWR is reasonable. Everyone can step it down a notch and still survive. I actually don't know how my expenses ballooned up on me over the decades. I thought I lived ok as a grad student. Maybe that's why I'm attracted to this forum.

So that's the plan. Hunker down if things get tough.

[Fuzzy]

There's no way to guarantee not having to work again. Annuities are only as stable as the company selling them. Real estate can be wiped out without insurance paying you anything (for example, an act of war). Gold goes through bubbles and stagnation, and doesn't generate returns other than principal. Cash can evaporate if people loose confidence in it.

You can't control everything, and worrying doesn't help. It's not good for you physically or mentally, and leads to a panicky "buy high, sell low" investing strategy. Chill out. Go on a investing sabbatical: Put several months of cash in a bank account, then go do other stuff for a while. Don't check your account or think about investing. When you come back around to investing you should think about a general plan instead of what Putin is doing this week.

[bibacula]

Stop checking the news. All news. For a long time, like weeks or months. You'll get by fine without. Instead, do something active and interesting (hiking, biking, skiing, exotic travel).

These are merely unfounded fears that you need to confront and dismiss. There are always things that you can worry about, whether you're FI or not. You'll need to decide whether you want to live in fear of the unknown or enjoy your time on Earth. You determine your attitude toward the vicissitudes of life.

Ultimately, trust yourself to do what needs to be done. If everything goes wrong, you can cut your expenses and get a part-time job. Is that really so terrible? Your worst-case scenario is pretty damn good.

Best wishes.

[A Life of FI]

"I consider myself FI since my portfolio currently represents over 34 years of expenses. A 50% decline in stocks will leave me with roughly 25 years saved, albeit with a 4% SWR which I consider to be extremely unsafe for my age (30)."

When looking at withdrawal rates all the research/analysis that has been done on the original WR rate. So if are looking at the safety of your WR rate against historical market performance you should not be assuming equities decline by 50% after you begin FI and then re-computing your withdrawal rate based on this 50% decline. Equities have declined by 50% in the past and the thus the research in determining what an original safe withdrawal rate when you reach FI is takes into account possible 50% decline in equities in determining the safety of a given original withdrawal rate.

In your case your original WR it is 3% (1/34 years of expenses) which (based on historical market performance since 1870) for most portfolios compositions never fails, even over very long periods of time (50+ years).

If you want to make yourself feel better go over to http://www.cfiresim.com and run your numbers. I put in your situation, a 50% fixed/50% equity portfolio with a 3% withdrawal rate over 70 years (until your 100), and the result was that this situation never failed. And in almost every case the ending portfolio was more that the starting.

If you will receive social security, a pension, an inheritance, can generate some type of small regular income each year (something like cash incentives from opening brokerage, credit cards) this situation will only improve further. I would guess if you are 30 years old and have amassed enough wealth to live on for the rest of your life (based on every possible market scenario over the last 150 years) it is somewhat unavoidable that you will not make more - even if you don't want to.

[teresajs]

Speaking as someone who weathered the dot com crash and the housing market crash relatively well, I feel confident in saying that a downturn of 4 or 5% is really nothing. Oh, sure, it might become something, but a 4 or 5% downturn is more of a market correction (which should be expected given the how hot the market has been lately).

I agree with the others who say that you need to stop watching the news and looking at the current value of your equities. Watch those things when the market is going up. It'll make you feel good. When the market is going down, ignore them and send in more money to buy more equities. (Remember the whole "buy low, sell high" thing? When the market goes in the dumper, that's the time to scrape together whatever change you have laying around and buy more shares... not the time to start panic-selling.)

Here's how I see it: I really need a couple new pairs of jeans. So, I go to the mall (which I hate doing) and the jeans that fit me best are all a little more than I want to spend but I really need some jeans. So, I buy one pair of jeans instead of the two I really need. The jeans really fit well and I end up happy with the purchase. Well, I happen to be back at the mall a few weeks later (seriously, that's like hell for me) and I see the same jeans being sold for 25% less. Do I get upset that I overpayed for my jeans? No, they were a good purchase at the time. What I do? I buy another pair of jeans.

So, what am I doing today, with the market down? I am online, sending an order to buy more mutual funds for my investment accounts. Because the market is on sale. (Note: I'm not going whole hog and sending everything I can. If the market goes down even more, I'll buy more shares then.) The people I know who lost their shirts in the Dot Com crash were either (a) invested in stuff they really knew nothing about (individual shares of start-ups with no capital, for instance) or (b) sold after their investments tanked. Me? I held onto all of my current investments and continued to buy equities as the market dropped and recovered ("buying on sale"). After the market had recovered, I was doing much better than my friends and family who had sold off their equities at market lows.

How much longer do you plan on working? At the age of 30, fixed income investments may be too much of a low-risk, low-yield investment to be honest. Investing in fixed income investments might make sense if you plan on stopping making any income in the next year or two but, if not, you really should consider something with a slightly higher risk and yield.

Something you need to consider, also, when you think about risk is that risk isn't just about how much money you have and where you have it invested. You also have other "assets" that can offset taking on a higher level of risk in your investments. You have your age, for one thing. Although you want to be FI sooner rather than later, if you lost every penny you have, you'd still have enough years to make it all back up. If you are in good health, that also counts as an asset to consider when weighing risk. Also, if you have a marketable education, good job history, reputation in your career... those are all strengths that can be counted on to help you weather investment downturns.

As far as losing FI status to the market... Some people (many, I would expect), set their lifestyle and withdraw a dollar figure sufficient to live that lifestyle. If, instead, you choose a withdrawal rate (say, 3 or 4% of principal) and adjust your expenses to live within that income, your money will last longer, even with market variation. That's what I plan on doing... keep at least one year's living expenses in cash and withdraw roughly 0.75% of principal from my equity investments each quarter. I'll need to adjust my lifestyle if there is a huge drop in the value of my investments and I may choose to withdraw less than 0.75% if that represents more money than I need/want in cash. But it offers a starting point that would guide me towards a lower likelihood of outlasting my money.

(Oh... and a 50% drop in the stock market is unlikely. If you want to run simulations, a number like 20 or 25% would be more reasonable.)

[tylerrr]

I'm worried about this recent pullback.

I believe it is driven by, and could get much worse as a result of, massive black swans including Russian adventurism and the manipulation of oil prices (here used as a weapon of mass financial destruction).

My risk tolerance is very low so I'm only 50% in equities (globally diversified non-distributing index funds), the rest in fixed income. I pushed a large lump sum into equities on December 5th, just before the recent downturn has started.

I consider myself FI since my portfolio currently represents over 34 years of expenses. A 50% decline in stocks will leave me with roughly 25 years saved, albeit with a 4% SWR which I consider to be extremely unsafe for my age (30).

Anything worse than that -- which cannot be ruled out given the current environment -- and I'm going to lose my FI status earned after years of aggressive saving.

What is the best way to cope with something like that? And by coping I mean not only in practical terms, but psychologically. I wanted to become FI in order to stop worrying about money, but here I am, ostensibly free but worried more than ever, since I don't have any serious income other than my withdrawals.

And, what's more, it is hard for me to accept the fact that the market can simply evaporate everything I've saved so I'll be forced to work again.

For those of you who are FI, what are your strategies for this scenario?

I hate to say it, but your current mentality is what the gangsters on Wall Street feed off of.....People who panic, buy high and sell low. You made a bad investment by buying in early December and now you're tempted to sell with a loss. Personally, I'd start buying more as the market heads down. Just buy something like vti each month. You are falling into the typical trap: most people lose playing the Wall Street game. You may not have the stomach at all for investing in the market.

Like others have said your low SWR should accomodate for huge swings in the market over time...So why worry about a big correction?

It doesn't sound like you have the education/knowledge yet to invest in the market if this current downturn is scaring you this much.

[elegant]

Thanks for all the thoughtful replies guys. I understand that my worries are emotional and that I should just stay the course and adjust my SWR as needed.

[jacob]

I wanted to become FI in order to stop worrying about money...

This is a self-contradictory position. It's like saying that I wanted to get in shape so I could stop worrying about what I eat and how much I exercise. In fact, if investing is your sole source of economic income (e.g. you buy 100% of the value you consume and you have 100% of your income from a single source) you should worry more than ever.

Worry, however, is not the right word. Paying attention is more correct.

When "paying attention", it is important to pay attention to the right things using the right priorities. This comes with experience. Most people almost make a sport out of getting their risk priorities wrong---completely wrong. This is due to the default wiring of the human brain. It ain't good. On the whole, most people just aren't being very scientific about things. For example, people worry far more about terrorist attacks than they do about getting run over by a car although the latter is far more likely to kill them. They worry more about getting cancer than they worry about that yummy doughnut they're about to eat. Interestingly, some of them most dangerous things in [first world] life---cars and being obese---are also the kind of things people tend to worry the least about. Conversely, some of the least dangerous things---say, terrorists and Ebola (in the US)---are also what people worry the most about. Same thing with markets. People worry about the most recent (whatever happened in the past few days) dip but they don't give a second-thought to e.g. secular-scale taxation-changes or class revolutions (which would throw any SWR "rule" out the window).

Basically, my solution is to diversify. I only pay [with money] for 25% of the value I consume, that is, I get $25k+ value but I only pay $7k because I'm being [very] smart about it. I have income not only from investments but also from royalties and business. And I keep enough in touch to pick up enough earned income at least in a couple of different fields. Losing 100% of my nest egg would not destroy me.

[El Duderino]

keep at least one year's living expenses in cash and withdraw roughly 0.75% of principal from my equity investments each quarter. I'll need to adjust my lifestyle if there is a huge drop in the value of my investments and I may choose to withdraw less than 0.75% if that represents more money than I need/want in cash.

Right on.

I wonder if folks that have attained FI in relatively short periods of time (< 10 years) and have a lot of their wealth in the markets will have the perspective necessary to stay the course when the time comes. Reminds me of Rudyard Kipling's If.

[JohnnyH]

I agree with stand@desk and tyler9000 about the PP; much lower volatility... Many have forgotten but the PP stayed positive when equities lost 50%.

If you do not want the PP, than perhaps something like bad_LNIP suggests. I'd agree with him that 50% equities is not especially low risk. If you're approaching retirement, invest like the financial status quo advises seniors to (fewer stocks, more fixed rates).

I disagree strongly with calls to "ignore" everything for a while. The universe doesn't care if you ignore it, it will continue on its way. If you known plans of action and have alerts set, go for it, otherwise it just seems like wishful thinking.

Just a blurb as of yet.


This though, wow, total crash.

[George the original one]

Markets are volatile. What goes down will eventually go up. What goes up comes back down. In a year or two, there will be a similar crisis, but this one will be ancient history. So you have to process the volatility and know that you're not bad off, there is plenty of time for bounceback.

The "point of no return" for those with a 30-year retirement ahead of them is 12-13 years of expenses saved, so you're probably safe with 20 years of expenses saved.

[Dragline]

This is a good thread. I agree with Johnny H that if you can't sleep at night with your current strategy, you probably need a different strategy. Because while the market may only drop 5% today, it certainly will fall 30-50% at some point during your investment lifetime.

There are a number of strategies that can work long-term that are relatively easy to implement (i.e., don't involve a lot of trading or derivatives). Some people focus on dividends/income and ignore the prices of the asset. Thus, they have a portfolio of dividend paying stocks, reits, mlps and other such things. JennyP posted a thread about this recently with a book and some article references. George The Original One is also excellent at implementing this concept. Others above recommend the Permanent Portfolio, which is essentially holding a basket of assets that are likely to do different things at different times.

For you right now, I might be most concerned not with the stocks, but with what is in your fixed income part of your portfolio. There are many types of fixed income assets, some of which are positively correlated with the stock market (like corporate high yield bonds) and others that are negatively correlated. For your peace of mind, you want to have mostly negatively correlated fixed income. To balance a US stock portfolio, your best choice is going to be something like TLT, which invests in long-term government bonds and generally moves opposite the US market.

See what happened to TLT vs. the stock market recently: http://www.marketwatch.com/investing/fu ... style=1013

When the market declines, TLT spikes. Your portfolio remains stable. If one side goes way up and the other down, you sell the winner and buy the loser. The very traditional "60/40" stocks/bonds retirement portfolio was based on this concept, and is still better than most more complicated options. The PP added additional assets to the mix. There are variations upon variations upon this theme with many baskets of assets, but the idea is fundamentally the same. It will not give you the best performing portfolio for any particular market conditions, but it will be relatively stable across pretty much all of them. And that may let you sleep better again.

[bad_LNIP]

One other thing I suggest everyone take a look at are the BXM and PUT indexes. The stats I have seen are VERY encouraging, particularly for risk management. As a method for riding out volatility and market craziness, I have found it helpful. The PUT Index is pretty simple, just throw out 2% OTM puts every month/week as you deem necessary and pocket the premium. These strategies have been killing the market for years. If you can build up a nice cushion of options premium, it certainly helps against a downturn.

http://www.cboe.com/micro/bxm/

Total Growth. Total growth for indexes since mid-1986 was 1153% for PUT Index, 830% for BXM Index, 807% for S&P 500® Index, and 368% for CLL Index (Exhibits 2 and 6).
•Lower Volatility. The PUT, BXM, and CLL indices all had volatility that was about 30 percent lower than the volatility of the S&P 500 Index (Exhibit 4).
•Left-tail Risk. Over the past 25 years, the worst monthly loss for the S&P 500 Index was a decline of 21.5 percent, compared to a relatively modest 8.6-percent monthly decline for the CLL Index (Exhibit 8e).
•Risk-adjusted Returns. One measure of risk-adjusted returns, the Sortino Ratio, was 0.90 for the PUT Index, 0.75 for BXY, 0.71 for BXM, 0.50 for S&P 500, and 0.31 for CLL Index (Exhibits 10 and 11). Please note that all the indexes had negative skewness.
•Monthly Premium Income. The average for the gross monthly premiums collected by the BXM Index was 1.8 percent. The index options usually were richly priced (Exhibits 12 and 13).

and

BXM Study by Callan Associates

In 2006 Callan Associates, an investment services consulting firm, published a new study on the CBOE S&P 500 BuyWrite Index, with an analysis of performance from June 1988 through August 2006. Their study builds upon the earlier studies done by Professor Robert Whaley (now at Vanderbilt University) and by Ibbotson Associates. The new Callan Associates study had several key findings, including:
•BXM generated superior risk-adjusted returns over the last 18 years, generating a return comparable to that of the S&P 500 with approximately two-thirds of the risk. (The compound annual return of the BXM was 11.77% compared to 11.67% for the S&P 500, and BXM returns were generated with a standard deviation of 9.29%, two-thirds of the 13.89% volatility of the S&P 500.)
•The risk-adjusted performance, as measured by the monthly Stutzer Index over the 18-year period, was 0.20 for the BXM vs. 0.15 for the S&P 500. A comparison using the monthly Sharpe Ratio yielded similar results (0.22 vs. 0.16, respectively), confirming the relative efficiency of the BXM over the 219-month study period.
•The BXM underperformed the S&P 500 during most rising equity markets and consistently outperformed the S&P 500 in all periods of declining equity markets, demonstrating the return cushion provided by income from writing the calls.
•The BXM generates a return pattern different from that of the S&P 500, offering a source of potential diversification. The addition of the BXM to a diversified investor portfolio would have generated significant improvement in risk-adjusted performance over the past 18 years.

[jacob]

I see all different levels of sophistication here. I want to say two things (in order of importance):

1) Becoming FI does not imply having reached the finish line in order to rest on the laurels. It simply offers the transition into a different quadrant: from working for money to making money work for money. The latter does not happen automagically. The SWR is NOT related to your networth. It's related to your strategy(!!!!)

2) Investing is much like swordsmanship in that it's an advanced art-form in which you learn certain skills at one level which allows you to understand certain truths/principles and proceed to the next level from which you realize that what you just learned merely served as a stepping stone to greater insight. Do not blindly apply techniques without understanding them.

[almostthere]

Everything dragline said.

Also note Meb Faber's recent post:

http://mebfaber.com/2014/12/12/be-a-good-loser/

Being in the emotional state of being in a draw down is three times more common than the elation of new highs. Note the arising and passing of these emotions, grasshopper.

[IlliniDave]

Having made a few laps around the track, this isn't much of a "pullback" yet. I believe were still in positive territory for the year.

I'm wired backwards I think. I get nervous when I see a 20-25% positive surge. A little bit of sideways trading calms me.

The right advice is above. If the last couple weeks make you nervous enough to stress over it, then you should consider lowering your equities or even finding someone to manage your investments for you.

Nothing in the world is permanent, and money is not an absolute defense against the all the universe's vagaries. Keep honing your skills. At 30 you have tons of human capital left. It sounds like you are still working. Just keep doing what you are doing. It is almost certain the storm will pass.

Also keep in mind that the X% SWR strategies are tested against crashes of historic magnitudes.

If you're 30, it might be better to plan for a 2% SWR. I wouldn't count on a 3% SWR for 60+ years. And as Sclass or someone said, you don't need to make your withdrawal systematic--you can employ an AWR (adaptive withdrawal rate, my term) instead of SWR that can be adjusted down as events warrant. If you pull 3% of your Jan 1 balance out every Jan 1 and don't touch it the rest of the year, you'll never run out of money unless the world collapses. But your yearly withdrawal could get very small.