In our 1st article in the series, we looked at the effect historically lower returns had on an early retiree and noted that this was a risk that impacts the early retiree in a much larger way than the average retiree. The early retiree with an initial probability of success of 85%, lowering stock returns by 1/4 resulted in their chances of not being in poverty falling to 55% - a pretty unacceptable number for most retirees! Are there tactics this retiree can employ to mitigate the risk of low market returns and get improve their chances, or are they set on a path that means it is about 50/50 if they end up in poverty or not? Let’s take a look at how cutting back during difficult times can improve an early retiree’s chances of success.
There are several ways to plan to cut back and several different ways to define what difficult times are, but let’s keep it simple and say that if our withdrawal rate for the upcoming year is above 5%. If you recall from our last article, this early retiree is planning to start withdraws at 4% ($40,000/year) on a $1,000,000 account split 50/50 between a taxable and non-taxable retirement account and adjust those withdrawals yearly for inflation. So that means if the withdrawal rate in any upcoming year is above 5% of the portfolio’s new value, then we will say the retiree has to cut back to preserve their wealth. This provides a very simple, rule-based strategy that a retiree can follow and understand intuitively.
The last question is how much to cut out of their budget, this is a personal question that is unique to each retiree and their circumstances. It also may not be cutting back, it could be a part-time job to generate more income, or dipping into a separate account to keep the bulk of their investment accounts invested instead of being depleted.
Cutting back by 10% has a positive effect on retirement, increasing the probability of success to 61% with an average ending account size of $326,000 instead of $170,000 with the cutbacks. 20% cutbacks increased their chances to 69% with an average ending account size of $510,000. 30% cutbacks increased their chances to 76% with an average ending account size of $653,000.
A few other things to note, with historically average returns the probability of success with a 20% cut back went up to 93% from the original 86%. Another important note is that cutting back 10% required the early retiree to cut back an average of 7.8 years, but increasing that percentage to a 30% cut back reduced the number of years they had to cut back to 6.4 years on average.