When the Crash Comes // Recession-Proofing Our Retirement Plans

We consider ourselves to be optimists, generally. I wrote a post on it a while back. Even if we might have things we’re unhappy about in the world at large, we’ve been pretty darn fortunate in our lives (a combo of hard work, support from others and legit luck — adding up to a solid bootstraps story). So — generally speaking — we’re optimistic about our upcoming early retirement, and our longer term “real” retirement.

But — and you can call me neurotic or superstitious or anything else you like — I also have a sneaking suspicion that things mostly work out only because we plan for what we’ll do if they don’t. Like last week when I was stuck in air travel hell. I irrationally yet sincerely believe that the only reason my supposed-to-be one-night trip ended up being three nights — and not four or even five nights — was because I had packed extra clothes and was fully prepared with warm outerwear, in anticipation of this very thing. I call it the anti-jinx, and though I know it’s not really a thing, I am also pretty sure it’s a thing. (It’s totally a thing.)

Think of it as a corollary to Murphy’s Law, which states that anything that can go wrong will go wrong. If instead, you prepare for all of those things that could go wrong, then maybe, just maybe, they’re less likely to go wrong. (Admit it — there’s a sick logic to it.)

I’m aware that this is a fairly wackadoodle worldview, but I’m also positive I’m not the only one in the FIRE community who thinks this way. Besides, Mr. ONL was a boy scout, I was a camp counselor, and being prepared is just hardwired into both of us, superstitious or not. Though it sounds deeply pessimistic to focus on all the bad stuff that could happen — bad optimists! — we find it reassuring to know that we planned for as many possible scenarios as we can think of. Sure, we can read about comforting-sounding things like the four percent “rule” all day long (“rule” in quotes because there’s no guarantee it will bear out in the future — we really should call it the “four percent best guess”), but knowing the long-term historical tendencies of the markets won’t stop bad things from happening to us in the future. The only thing that will protect us? Being prepared.

It’s easy to be optimistic when you’re prepared.

Market Crashes and Recessions Are a Fact of Life

Bad financial things are essentially guaranteed to happen — to us and to all early and regular retirees. Our investments are going to lose value at some point, maybe massive value, maybe at many times. We could endure long periods of stagflation. We’re already overdue for a recession, historically speaking. And pretending that crashes won’t happen, or that we’ll get a predictable historical average return on our investments like clockwork every year, only makes us ill-prepared to weather the storms. And that sounds — pardon me while I throw up at the thought — horrible.

As my dad recently reminded me, he only regained his 2008 balances this past year for some of his mutual funds, and I didn’t even ask if that was accounting for inflation. (I’m guessing not.)

And remember 2008? It was ugly. We were invested at only a small fraction of the level where we are now, but even with smaller numbers, it still took our breath away how fast our money (at least on paper) evaporated. We learned the lesson that we can’t always bank on going back to work, and the markets straight up nosedived. The Dow lost a full 50 percent in 17 months — 56 percent for the S&P. (The Balance has a fantastic play-by-play history of the crash, for those who want to relive the horror, or who weren’t yet old enough to absorb it at the time).

Of course 2008 was a special case, an especially bad crash and ensuing recession, and not something we’re likely to see every few years. But even in that case, most investors (not including my dad, apparently) were made whole again within two to three years. (Less than two years for European FTSE investors.)

With that comes a huge caveat: A huge driver of the post-2008 recovery was the U.S. federal government’s intervention, namely the bank bailout and later stimulus package (those “American Recovery and Reinvestment Act” signs are still visible at many a road and bridge construction projects across the land), and it’s hard to know if a fully GOP-controlled Congress and White House would take a similar action, given their apparent disagreement with Keynesian economics.

But regardless of which party is in charge, historically the average time from market trough to new market peak in bear markets is 684 days, about 22.5 months, a number that’s likely skewed higher by the especially long 1974-1982 recession. In market corrections — dips between 10 and 20 percent — the average correction is 107 days, just over three months.

Long-term, there’s no question that investing in the markets still pays off, so dealing with crashes and recessions is all about playing the waiting game.

Our Market Crash Game Plan

Let’s pretend that it’s 2018, we’re fully retired (yay!), and we don’t have any lingering attachments to our old jobs. Over the course of a few weeks, the markets start creeping down, and then suddenly they start dropping big time. In a few short months, we’ve lost 25 percent of our index fund value.

At this point, just before the crash, our cashflow is coming primarily from dividends from our index funds (about 25 percent of our annual budget), monthly payments from our personal loan (about 30 percent of our budget), rent we collect (a negligible 5 percent or less) and sale of investment shares (40-45 percent of our budget). But now we’re guessing the dividends will shrink and we’re leery about selling shares with the markets way down, because that could lead to our biggest fear coming true: running out of money before we hit phase two of our retirement.

What’s our plan of action?

Task 1: Cut spending

This should be a no-brainer for any remotely frugally inclined person. Our post-retirement budget is padded enough that we could easily cut 25 percent out of it by cutting back on travel and entertainment, and could more painfully cut it back by 40 or even 50 percent by going into ultra-frugal mode (think: beans and rice for most meals, and never going above 55 degrees in the house — which isn’t that much of a stretch for us, because keeping a cold house is our most freakishly frugal quirk). Those budget cuts conveniently align roughly to market recession stats — a garden variety recession tends to be somewhere in the range of 25 percent off market peak, while a major recession like 2008 is more in the 50 percent range. We’ll cut our spending to more or less match the severity of the crash. Fortunately, we feel confident that we can cover our season ski passes in all but the very bleakest budget scenarios, so there will still be joy in our lives.

Task 2: Stretch our cash cushion

We plan to have a little over two years worth of living expenses in cash when we retire sometime this year, but that’s two years of regular years’ living expenses. If we cut our spending, perhaps dramatically, that automatically stretches our cash farther, letting us go longer before we have to sell shares we don’t want to sell. But we’ll also try to stretch that cash in other ways, by doing any travel that we have planned but can’t cancel on miles instead of dollars (together we’re sitting on more than 1.6 million air miles, and though we know they’ll continually be devalued, we still expect them to last us a good, long while), bartering for goods and services locally, and generally taking more of a hustle attitude, even if we don’t expect it to be easy to find paid work.

Task 3: Try to hustle

Though we don’t buy the myth that we can “always just go back to work” (for a whole bunch of reasons), we will certainly try to earn some money if the economy is tanking! We doubt our main career skills would be in especially high demand if others in our fields are getting laid off, but we’re scrappy and would try hard to figure something out.

Task 4: Be smart about what shares we sell

Ever since Mr. ONL found Darrow Kirkpatrick’s 2015 post on Can I Retire Yet? on the best withdrawal strategies, we’ve been convinced that the CAPE Median Strategy is the way to go when it comes to selling our shares. And it applies whether the markets are up or down. Go read the post, but the short version is that we sell shares of stock funds when the markets are up, and sell bond funds when the markets are down, rather than selling blindly across all asset classes, and the CAPE (cyclically-adjusted price-to-earnings ratio, named by Robert Schiller) median helps us determine which assets to sell when it’s time to sell. Though in a lower spending scenario we’d be reducing how many shares we need to liquidate in a given year, we’ll never be able to escape having to sell some, especially once we get lower than an adjusted two-year cash cushion at our reduced burn rate. Though we’d do an analysis based on the particulars at the moment, we’d expect to leave our stock funds alone to recover in due time while selling only bond funds during this downturn.

Task 5: Exercise contingencies judiciously

Our hope is that the first four tasks will get us through most market corrections and crashes, and we won’t have to proceed farther down the task list. But if we do, we’re ready with our long list of contingencies. Of course, most of these contingencies are things we can only do once, so we don’t want to blow them capriciously. If and only if we absolutely had to, we’d consider one or more of the following contingencies:

1. Downsize into a smaller house (only worthwhile if the local market adjusts — currently small houses have an almost 70 percent higher price per square foot of medium houses like ours because of heavy demand for “starter homes”).
2. Refinance our rental property from a 15-year mortgage to a 30-year mortgage to take out cash and increase cashflow in the near term.
3. Take out a mortgage on our by-then-paid-off home.
4. Get roommates or Airbnb tenants in our spare bedrooms.
5. Rent out or sell our house and live in an RV.
6. Sell the rental property.
7. Take cash out of our well-stocked 401(k)s and eat the tax penalty.

But What About… ?

Our basic market crash game plan doesn’t account for every possibility, and is built around more run-of-the-mill crashes with fairly short recoveries of three years or less. But what about other bad stuff that could befall all of us? Let’s run a few other scenarios. What if we’re hit with…

Long-term stagflation: Though stagflation isn’t something the U.S. is accustomed to, it’s something the Japanese know well. If it happens here, we’ll be in long-term belt-tightening mode, or might consider something more drastic like geographic arbitrage, with a temporary move abroad to a low cost-of-living country, until things pick back up here.

A super-extended market recovery, like five-plus years: If we’re selling only bond funds, which make up a minority stake in our portfolio, we’ll run out after five years or so, give or take, maybe sooner. So a recovery that takes us past our bond cushion will require us to get creative, finding other ways to cut costs, sucking it up and selling some stocks in sub-optimal position, or maybe cashing in one of those contingency cards. Everything would be on the table at this point: asking for a reassessment to lower our property taxes, renegotiating our insurance deductibles, finding cheaper internet and cell service, you name it.

A Great Depression-scale market crash of more than 75 percent: It’s hard to imagine a second Great Depression happening without some other global-scale event like world war or a climate cataclysm. In which case we’ll be reacting to a lot more than just a major economic event, and it’s hard to predict what we’ll do. In that case, we might be mighty glad that we have our go bags packed and ready, so we can peace out at a moment’s notice.

A health care abyss: To be covered very soon in a more detailed post! “What the %#@& is going to happen with our health care?!” is the early retirees’ question of the year for 2017, and we’ll soon know more, given how quickly Congress has promised to act on it.

How Do You Prepare?

Let’s discuss: What’s your crash preparation plan? Any economic events you think we’re under-prepared for? Anyone else believe in the anti-jinx like I do? Or any hyper-rational beings out there want to smack some logical sense into me? Let’s dig into all of it in the comments!