Market volatility and the potential for a recession is what gives the stock market a bad name, right? No silly, as we’ve discussed here, it’s really the investor’s psychology that gives the market a bad name. Because the market always goes up…eventually.
With the recent market volatility we’ve been seeing in late 2018, it feels timely to discuss the impacts of a recession on someone living off their investments. Even if you care zero about financial independence and investing, a recession could mean an abrupt cessation of your paycheck. Let’s strap on bullet-proof vests together!
Luckily for us, the timing of the recent down-turn is frankly a little rude, but not worrisome from a sequence of returns standpoint. We’re still working and plowing money into our accounts regularly, so we’re only suffering from slower growth, not irreversible asset depletion. Phew!
But many folks in the FIRE community have stamped it in on a long-horizon retirement (40-60+ years) in recent years. It’s very likely that many are now sweating the red stock tickers flying by the screen every day of late. Us humans are fickle birds.
If the retiree has $1,000,000 and plans to spend $40,000 yearly (the 4% Rule), what the hell can you do if the market drops 50%? Does living off $20,000 sound worthy of quitting an otherwise decent job? Maybe. Let’s take a look at 5 ways to hedge against a recession.
1. Save a Bunch of Money
Data suggests (citation?) that saving a bunch of money has historically worked out well for most people.
I say this a bit tongue-in-cheek, but it should be obvious that the most vulnerable to a recession are those living too close to insolvency. If you are carrying consumer debt, a mortgage you can barely afford, and a car payment — how nimble can you be if you were to lose your job? You’re hosed buddy!
We’ve seen this situation unfold too many times in our careers. Trust me, listening to the hardships of that poor manager who makes $200k really breaks your heart.
The gentle suggestion provided on this site is to restructure your life to greatly increase your savings, eventually aiming for a rate of 50% or more. This is done by assessing value on every dollar spent. Invest those savings into low-cost and broad-based index funds, shake vigorously, and your required working life is drastically reduced. Read more on our investing strategy here and here.
Once your savings accumulates in the range of 25-30x annual spending, working is optional. Forever! In theory at least. The next methods elaborate on the ways to not run out of money.
2. Make More Money
As we’ve discussed, we don’t really buy into the “Retire Early” portion of the FIRE acronym (Financial Independence/Retire Early).
Once your working life is optional, you are going to pursue hobbies and passions that were kicked to the curb to make room for the 50+ hours spent working, commuting, or getting ready for work each week. Those hobbies and passions will likely provide a source of income, just not the kind of income you were making in your career – and that’s ok!
Remember in 7th grade when all your teachers told you to chase your dreams? Then you got out of college with a B.S. in Art History or Creative Writing and wondered how to buy groceries? Well now you can actually chase your dreams! The income needed to cushion a safe withdrawal rate is very low. For example…
Let’s say Big Mike and Candy have a $40,000 yearly spending and find themselves in the dark depths of a recession. From 2007-2009, the stock market lost 50% of its value, so let’s say our friends took the same hit, down to a $500,000 portfolio from a retirement value of $1,000,000. F!!
Between the two, a modest yearly income of $20,000 can cover the difference (assuming the very unlikely scenario that spending remains unchanged). Maybe Big Mike likes to work on Harley carburetors, or Candy enjoys whatever she enjoys. Chances are good that Mike and Candy can cover the difference without losing their dignity…unless they like that too.
3. Tighten Down During a Recession
Simply put, we will spend less on the optional line items of our budget during a recession.
The standard quip from the FIRE community goes something like this:
Our worst case scenario is everyone else’s norm. If the market tanks, we’ll just go back to working like the rest of you.
Aside from sounding pretentious and sort of mean, we don’t like that mode of operation as our only safety net. In 2008, there were no shortage of folks looking for jobs, and we don’t want our tail between our legs begging for full-time work.
The message here is that we want to have great flexibility to easily reduce expenses (when needed) and maintain a high quality of life. Between our “luxurious” discretionary budget and our “keep the lights on” scenario, we aim to have a margin of nearly 40% to account for depressed market conditions.
4. Plan for “Luxury”
…But to tighten down, there needs to be spending flexibility. “Luxury” spending to us might be “necessary” spending to others. This might come as a shock, but for example, we consider both cheese and gym memberships to be luxury items. In fact, with the growing irritability of my bowel, I’m beginning to wonder if I should move cheese from the “luxury” to the “forbidden” category.
Anyway, it’s probably not hard for any of us to take a look at our spending and find a lot of purely discretionary items. You can assess value on those items, and sure, maybe they’re worth the money. But if the poo hit the proverbial fan, you can let those items go.
That said, we find it critical to have margin in our spending. We could suffer our way down to a very low level of spending and award ourselves a financially independent merit badge today. Sweet, we’re done! Except of course you can imagine the consequences of such a tight margin during a recession. Beanie Weenies are going to get really old.
Where do we incorporate luxury? Let’s take a look at a few big categories….
Travel
We’ve budgeted for $4000 in travel expenses per year. That might sound crazy to you (too much or too little)! But we emphasize value spending, and by God we want to see the world. We’ve restructured our lives to reallocate funds to travel (e.g. sold a car, don’t use a dryer, almost non-existent heat/air conditioning, rarely eat out, etc.). It’s amazing all the ways you can find $4000 worth of slop in your spending habits.
With the remarkable savings and free travel we get through travel rewards (which we highly recommend), spending $4000 out of pocket each year on travel can afford a lot of exploration.
Food
We don’t live on a bare-bones food budget. As previously discussed, we don’t eat out much at all, but we do like us some food. Our current budget for food is $500 per month, which is silly for two people. But again, plenty of margin there.
Fitness
It should be obvious by now that climbing and exercise in general is sort of required for me. We’ve budgeted $2000/year for memberships to gyms and other exercise programs. The kick here is that we plan to approach our local gym/studios and do a few hours a week of odd jobs in exchange for free or reduced membership, which will likely eliminate most or all of this spending. But the margin is there. Will work for free climb.
5. Geoarbitrage
The beauty of living and having purchased property in the Front Range of Colorado is that almost any other place we’ve considered for potential relocation is cheaper.
But another interesting lever to pull in a recession is international geoarbitrage. Let’s take the popular expat city of Chiang Mai, Thailand for example. We’ve visited and greatly enjoyed the city. If we were to decide to live there for a time, we could realize about 40% savings in cost of living adjustments. Although, judging from my last experience, at least 10% of that might be lost to anti-diarrheal medicine. Hey-ooohh!!
Anyway, at least a year of living abroad (though not necessarily in Thailand) is high on our list.
What’s more realistic is that we hit the road for a time, living a fully-funded dirtbag life, which we’re sure will lower our cost of living significantly. This is a bucket-list item for me anyway, and has the added bonus of greatly hedging against sequence of returns risk.
Summary
These methods are particularly suitable for someone living on little to no W2 income. But who really does that for the long-term?
Not to monger fear, but a recession is coming. It may be in 2019, or it may be five years later…but it’s coming.
Is there margin in your life if you lose your job tomorrow?
Man, there is so much power in living simply, saving, and equally simple investment strategies. If we want to get all metaphorical, adding a small side stream of income can really shore up the sea-walls from impending storms. You won’t get caught with your pants down the next time the bottom drops out of the market.
This post is a continuation of our safe withdrawal rate post. Be sure to check that one out for more on the subject.