Rethinking Work in Early Retirement // Contingencies, Sequence Risk and Fail Safes

We have said from our second post ever that our vision for early retirement has never included mandatory work. And we’ve been more vigilant about this fact than probably any other in our early retirement plan. We’ve shifted our investments, we’ve changed our timelines, we’ve debated when to give notice, but we’ve never wavered on the no mandatory work idea. It’s why we call what we’re working toward early retirement, and not just financial independence. Partially because we’re already sort of FI. But mostly because we’re not just looking for a more flexible life, we’re looking for a life with no need for a paycheck, one where any work we do can be entirely for the love of it or for fun, never out of necessity.

You already read the title of this post. You know where this is going… but there’s some explanation before we get there.

Recently we took a deep dive into the employment data, and concluded that early retirees with significant gaps in their work history simply can’t bank on being able to go back to work. It’s a hard pill to swallow, but we’d rather go into our early retirement with a clear-eyed view of our options than to believe that going back to work is a realistic contingency plan.

We have other contingency plans in place, of course, but just as we don’t want to be forced to work, we don’t want to be forced to put those other plans in place either — that would mean downsizing our house, selling our rental, or any number of other choices we’d rather make on our own terms, not because we have no other reasonable option.

The First Contingency Plan

Our primary contingency in early retirement will always be to cut back our spending. Let’s say the markets underperform, or we have a large, unexpected expense or three. Our ER numbers are built on a spending plan that we can cut back by almost 50 percent if we have to, and still be fine. At that level, we’d still be able to pay for our property taxes, insurance, utilities, health insurance, and other necessities, along with a scaled back level of groceries and some tiny bit of wiggle room. And thanks to the years of heavy work travel, we have a lot of points banked, and we might even still be able to travel a little. But mostly we’d focus on living the mountain life if that became necessary, squeezing every drop of fun out of our local region.

That, to us, is the real value in living in a place we love — it may come at a higher price than other places, but there’s so much free stuff to do (hiking, mountain and road biking, backcountry skiing, climbing, mountaineering, paddling, etc. — plus a library!) that we can still live a plenty joyful life even if our budget shrinks significantly. (And yes, some of those activities require gear that isn’t cheap — we’ve already invested in that stuff. But you could tweak the list to focus on the truly cheap activities: hiking, sledding, bouldering, swimming, non-specific biking, etc. And the library stays on both lists!)

Avoiding Contingencies In the First Place

It’s a fun thought experiment to contemplate all the things we can still do around here without spending much, but then my risk-averse side comes in with that hard-to-shake question:

Doesn’t needing to fall back on a contingency plan mean that the first plan failed? Shouldn’t we be able to head that off before we need to trim our spending? Instead of creating more contingencies, how can we make our primary plan more fail safe? 

And it’s an important question. Because while we might be happy cutting our spending for a year or two to ride out a grumpy market, it’s hard to imagine that we wouldn’t go into year three or so thinking something along the lines of, “Really? This is what we worked so hard for for all these years? So we could watch all our pennies and avoid all spending?”

So lately we’ve been talking about ways we can bolster our primary plan, and make the need for our many contingencies a more remote possibility. Which brings us back to: Work.

Sequence Risk: Why the Early Years Are Most Important

Everyone who invests in the markets will have some good years and some bad years. The idea that the timing of those ups and downs impacts you more or less depending on where you are in your retirement is called sequence risk, and the risk that you’ll run out of money is highest if you have negative market returns in the earliest years of your retirement. (Kitces has also written that the sequence of returns matters a lot in the accumulation phase, but that’s a different subject.)

This example from NerdWallet, of three brothers who retired at different times and each spent $60,000 from their $1 million portfolio per year, makes the point well:

Despite having the same starting portfolio balance as his brothers and having the same spending, brother 2 is essentially wiped out 15 years into his retirement, all because he retired with bad timing, around the 2000 crash. Given that we’ve declared to the world that we’re retiring by the end of 2017, come hell or high water, we need to accept that we could potentially fall victim to bad timing, too.

Want to geek out over more sequence risk numbers? S&P has a great example, and so does MFS. Stanford even has regressions built into theirs.

Standard CW for Sequence Risk… and Its Shortcomings

Sequence risk is nothing new, and if you’ve been reading up on FIRE for more than five minutes, you’re probably familiar with it. Likewise, the conventional wisdom for riding out bad markets, especially in the early years, is well-trod territory. Most advice focuses on two key actions:

Keep a sizeable cash cushion — 2-3 years worth of living expenses seems to be the consensus

Invest a portion of your portfolio in bonds — 20-30 percent satisfies most experts, more if you’re over age 60

That’s solid advice, and we plan to follow it — in fact, we’re already mostly following it. We don’t yet have three years of expenses in cash (we’ll focus on building that up next year — this year we’re still focusing on taxable assets that can grow), but we have a good-sized cash cushion, and we definitely have a sizeable portion of our portfolio invested in the Vanguard total bond market index fund (VBTLX).

But the conventional wisdom is imperfect. It’s still conceivable that a bear market could last more than two to three years, or at least that it wouldn’t have regained its previous high points by the end of three years. The S&P was at about 1400 in April 2008, and didn’t get back to that level until the second half of 2012. So if you’d shifted to your three-year cash cushion when the markets started falling in spring 2008, you would have depleted it about 15 months before the markets could be considered to have rebounded, and that’s not even accounting for inflation. You could sell off bond shares during that time, but that would start to get scary — a depleted cash fund and dwindling bond shares put you completely at the mercy of the stock markets.

The Other Option: Reconsider Work

The biggest reason we’re reconsidering the role work could play in our early retirement is sequence risk. We aren’t worried about hitting our magic number — we continue to get farther ahead of schedule. Rather, we’re starting to ask, Could we increase our odds of success by putting off touching our portfolio for a few years?

Never mind that that would defer for a few years the tough emotional choice of selling off assets we’ve worked hard to save. Thinking about work differently could make a huge difference in whether we successfully bridge the gap between our early retirement date and age 59 1/2, when we can tap our much larger tax-deferred nest egg.

We started out this post talking about not wanting to have to rely on contingencies, and then shifted to talk about sequence risk, but both topics are potentially answered by the same answer: Finding a way to generate enough income for the first two to three years of our early retirement to cover our expenses, so we can delay tapping into our investments.

That delay would allow our portfolio to add two to three more years of growth, or — worst case — to avoid being further depleted if a bear market hits at that crucial early stage of our retirement. Those extra couple years of growth could easily make the difference between being flush for life or having to burn through our contingency plans to avoid running out of money.

Still at the Question Stage

Right now we’re just thinking about this question. We’re not making plans to find work after we retire next year, and we’re definitely not planning to stay in our careers beyond 2017. But we’re starting to ponder what post-retirement work that could pay all the bills for a few years might look like. Freelance work? Contract work that’s similar to the work we do now? If we do this at all, and if so what we do — it’s all TBD. But you know we’ll write about it when we make our decision, so stay tuned. :-)

Your Turn!

What role do you envision for work in your FIRE plan? We know some of you are planning for semi-retirement instead of full retirement — is that to avoid having to save the whole 25x magic number, or to cope with sequence risk? Anyone else planning to work a little after pulling the plug in response to sequence risk? Or think we’re overthinking it all as usual? ;-) Share away in the comments! We’d love to know what you think!

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