The long approach mentality is required to last as an investor. But first a story:
Everybodddy…! Yeahhh-ahhh! Rock your bodddyyy! Yeahhh-ahhh!
These were the lyrics absolutely shaking the walls of the Mercat de l’Olivar fish market in Palma, Mallorca as the mid-day closing time approached. The vendors were busy packing up product, mopping, and wiping down metal countertops in a cool and expansive room, rich with the briny, iodine smells of the sea and the thumping sounds of late-90s Backstreet Boys hits.
And oddly enough, hearing a 1997 boy band hit in 2019 left me thinking about staying power and the long approach. Tell em, boys.
2000-2016: Taking the Long Approach
I’ve had a handful of savvy readers reach out to me with the following sentiment:
“Hey Mr. CC, this investing stuff is great and all, but what about that time between the years 2000-2016(ish)?”
This is something we discussed in the interview with Lee Cujes and my post You Know a Recession is Coming, Right? as well. We absolutely must consider investing as a long approach, not some sort of get-rich-quick scheme.
Yeah man, those years would have sucked to be an investor. And that period is hardly an anomaly. Check out the periods following the Great Depression and the flat performance from the late 1960s through 1970s (especially when adjusted for inflation). The run of the stock market since the early 2009 low following the 2008 financial crisis is simply astounding, even in the face of a crushing global pandemic.
Unfortunately, don’t expect it to last.
Should We Fear Investing?
But does that mean we should be wary of investing? Not at all, but we should be wary of applying the returns of the past decade+ to the future.
The good news for passive investors with a long approach (who didn’t seal the deal on losses) is that good times followed all these crappy times. The timing of these cycles is inherently unexpected (dot-com bubble, housing bubble, pandemic, etc). However, the fact that these cycles occur is both natural and expected. And these cycles occur about every 10-15 years, on average.
But this is easy for me to write as a 36-year-old investor with a portfolio rocking out at all-time highs, isn’t it?
(Related Post: There’s No Way I’m Investing in this Economy!)
The 100% Stock Portfolio in 2000
Let’s examine a very aggressive portfolio of 100% US stocks*, a portfolio not uncommon of FIRE enthusiasts building wealth and even some in early retirement. This sort of portfolio can provide killer growth, but also a rollercoaster of volatility.
Portfoliocharts.com uses real data from investing periods between 1970 and today to reflect the inflation-adjusted performance of a stated portfolio through time. Here’s a heat map of yearly inflation-adjusted compound annual growth rates of a 100% US stock portfolio starting at all years from 1970-present**.
Let’s examine the year starting in 2000.
An investor didn’t see growth for 17 years! 17 YEARS!
What if you invested a huge chunk of money in January of 2000 in US stocks? Would you have sat there and waited for growth for 17 years before throwing your cards on the table, flipping it over and busting out the door in a fit of defeated, sweaty rage?
If you retired in January of 2000 with 100% stocks, would you have simply died of a heart attack in early 2009 after nearly a decade of watching your nest egg erode like red Georgia clay, meanwhile witnessing the collapse of several major financial institutions?
Well, the good news is that if you didn’t sell and didn’t die, you eventually saw returns. Time will tell if an early retiree in 2000 will survive a 50-60+ year retirement, but that depends on the withdrawal rate.
*For those just starting with investing or saving aggressively, I have no problem recommending a 100% stock portfolio for anyone that can handle the volatility. The trick is to know your own psychology and consider how to transition to other more stable asset classes once you are withdrawing these funds.
**Models are limited to 1970 and recent because some asset classes being modeled did not exist prior to 1970.
Withdrawal Rate and the Long Approach
The success of a retirement (long or short) is dependent upon how much is spent each year as a function of the total portfolio, also known as the withdrawal rate.
Classically, myriad studies have noted that a yearly withdrawal rate of 4% ensures a retiree will not run out of money over a traditional retirement timeframe. However, a traditional retirement is only assumed to be 30 years. And it’s important to note that this is a worst-case scenario for the retiree cohort with the worst timing (i.e., retiring at the cusp of the Great Depression, etc.). Other 30-year retirement windows could have enjoyed much higher withdrawal rates. Because hindsight is 20/20, we have to assume a worst-case scenario.
For example, using the 4% Rule, a $1,000,000 portfolio would support a yearly spending of $40,000 (plus inflation) and not be depleted over 30-40 years. In some cases, these models show portfolios that just barely made it. Having $2.36 in the bank in my final days is not success to me.
Thankfully we also have cautionary visionaries like Karsten at Early Retirement Now who do some heavy lifting on the modeling to ensure we know what kind of withdrawal rates can weather these times. As a matter of fact, he even wrote a comprehensive 2000-2016 case study as a check on the coveted 4% safe withdrawal rule. Hint: less than 4% is advised.
Well, I’m 36 years old. What if I never make another dime in my life (highly unlikely, but let’s play the game)? Can a 4% safe withdrawal rate over potentially 60+ years leave me undignified, crapping with wobbly knees and ashy elbows in an alley and licking discarded tuna cans with feral cats?
Well, maybe. So why cut it close?
Taking the Long Approach with the Perpetual Withdrawal Rate
We prefer the Perpetual Withdrawal Rate. The Perpetual Withdrawal Rate (PWR) not only keeps a portfolio from being depleted, but theoretically provides a level of spending that preserves the initial inflation-adjusted principal.
Even in the worst imaginable scenario (retiring on the cusp of a decade+ of negative returns), a retiree who stuck with a withdrawal rate of ~3.5% came out on the other side of a very long retirement with the original inflation-adjusted portfolio still intact. A 4% withdrawal rate would have kept you from running out, but a 3.5% withdrawal rate kept things hella solid.
Withdrawal Rates in Practice
So, how do we interpret this? Are we supposed to act like heartless robots and spend exactly 3.5% of our portfolio each and every year? Well, we could. But that would be weird and not human of us. In reality, our withdrawal rate will be variable.
If the market returns 29% in a year (like it did in 2019), spending 3.5% of that portfolio is going to generate far more income than we need. What’s more likely is that we spend what we need, which may be somewhere in the range of say 2.5% or less. We are in essence little squirrels saving acorns for the winter.
But when “Bad Mr. Recession” comes prowling and steals a chunk of our portfolio like a f**king thief, our normal spending might encroach higher than a 3.5% withdrawal rate, pushing 4% or more. In a world where equities are undervalued and depressed, that’s not such a horrible thing. Especially considering that the heady expansion years push our portfolio skyward and provide all those extra acorns, we can take a hit.
What’s really scary though is if “Bad Mr. Recession” comes along right when you throw in the towel on a W2 income and begin drawdown of a portfolio. That’s what I thought was happening when I (sort of) quit my job in February of 2020. The little scared squirrel that you are falls into a caloric deficit and will need a hell of a spring to get out of that hole. Thankfully the market collapse in early 2020 was shocking in magnitude, but extremely short-lived.
Human Psychology and the Long Approach
Let’s also be real about another human factor: psychology. If we see the market down year after year, we will both (a) cut spending and (b) generate some income. Honestly, we’ll probably generate some income soon anyway. I mean, waiting to dust off a resume in a recession sounds like a tricky proposition.
Mrs. CC was going to quit her job in early 2020 too. But when lockdowns began and the stock market was in free fall, plans changed. She simply kept her job and worked from home in comfortable pants. We kept making money and continuing to invest instead of drawing down on our portfolio. To date, 14 months later, we still haven’t sold a single share due to a cash reserve we socked away (and yes, I know, I don’t like cash either).
At this very moment, we’d probably withdraw less than 3% of our portfolio to fund our life. Honestly, that’s arguably overkill and not a level of savings that I can in good conscience recommend. There’s no historical scenario (yet) where a sub-3% withdrawal rate didn’t preserve the principal, much less run out of money. Tell that to Mrs. CC though!
Bottom Line: For someone who truly wants to retire early: Generate a portfolio where Year 1 spending pulls no more than 3.5% of the total portfolio value. Be flexible and mindful not to allow spending to creep above 4%, especially during the critical first 10 years. Better yet? Achieve financial independence, and find meaningful work where pay is not important. You’ll probably be happier than an early retiree anyway. Withdrawal rates will be a distant concern and none of this will matter.
Summary: The Long Approach
Our takeaway? We know that a sit-on-our-hands-and-wait philosophy is a winning one. This knowledge kept us sleeping well when the sky was falling back in late winter and spring of 2020. We also know that a theoretical retiree cohort that kept their withdrawal rates low (ideally 3.5% or less) weathered any of these times without issue. The key is to take the long approach.
Hindsight is always 20/20. All the information in the world means nothing if we don’t stick to the plan we created in good times. How will we all feel about investing if we’ve seen no returns for a decade or more? How many of us bloggers will still be making a convincing case to invest money in a stock market that goes nowhere, year after year after year? Will folks fall victim to market timing? Time will tell.
At this time in mid-April of 2021, we’re in the good times. Create a plan now and remember it when the poo hits the fan.
It takes an almost religious-like faith to believe that a market in the crapper for 10+ years will turn around and provide growth. We have to keep that faith.
What Other Option Do We Have?
So, we’ve seen that investing in the stock market can be a really wild ride. And surely, we’ve all known some coworker, uncle, or parent who was wrecked by investing through the 2008 financial crisis. But have you ever asked why they were wrecked? Did they pull the plug and cash out somewhere in early 2009, locking in 40%-50% loses? Was it simply the loss of a job with little savings?
In absence of investing, what other choice do we have? While I believe strongly that we should pursue meaningful work (paying or otherwise) as long as we can in life, we have to be real about the possibility that funding our later years is our responsibility in the earlier years. The Social Security program will likely be weak to non-existent by year 2037 and pension plans are going the way of the dodo. Saving enough cash to not only fund decades of living expenses but also outpace inflation is a tall order if we wait to get the snowball rolling. We must leverage The Wondrous and Fantastic Power of Compound Growth.
And to do so, we simply have to take a long approach.
(Related Post: Retirement? Don’t Worry, I’ll be Fine!)
Personally, even if I had ten million bucks I’d probably still invest. Is that greed for materialism or status? No, but I fancy living a life of discreet wealth, helping others along the way, and leaving a legacy of a fabulous philanthropist when it’s all said and done. Compound growth not only has the power to provide for our life, but can better the world as well.
I really believe that. How about you, friend?
Remember, the best laid plans mean nothing if you can’t take action today. Have questions? Need some feedback? Hit us up on the contact page.
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