The Case for Conservative Early Retirement Investment Projections

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The Doom-and-Gloom Predictions

At least once a day now, I see something in my Twitter feed that says we should all be planning for conservative investment returns for the next decade or more, and therefore we should keep our early retirement projections conservative too.

There was this headline:

Jack Bogle believes the stock market will return only 4 percent annually over the next decade (CNBC)

And this one:

Lower for Longer: The world economy will struggle to gain altitude, forecasts Leo Abruzzese (The Economist)

And this report summary:

Bracing for a new era of lower investment returns (McKinsey)

And even this theme among investment banks, who have a vested interest in keeping you optimistic so you keep handing over your money to them:

Why market returns may be lower in the future (Charles Schwab)

The Optimistic Dissonance

At the same time, in the same Twitter feed, I see stories of retired bloggers increasing their net worth more than they thought possible (maybe some because of undisclosed blog income, but certainly others because of legit investment growth). To hear some of them talk about it, early retirement is a risk-free breeze, and no one ever runs out of money.

That in turn leads other bloggers to assert that we’re all being way too conservative in our retirement projections, and we’ll probably end up with tons of money leftover based on our planning, which really means that we’re all working too long for no good reason when we could be retiring that much earlier.

What’s the Truth?

As much as I hope we don’t end up in a situation like Jack Bogle and others are predicting — netting low single digit returns for the foreseeable future — the truth is that I never think that stuff is truly predictable. Even if we can make educated guesses about things like employment, job creation, consumer spending, interest rates and price-to-earnings ratios, the stock markets are not always rational, nor are they always tied closely to economic factors that should have at least some impact on them (hi, current overvaluations). Add to that the fact that we have added new, essentially guaranteed influxes of cash into the markets since the last sustained bear market in the 1970s (mainly 401(k)s) which should act as a long-term stabilizing force, and I’m skeptical that we’ll stagnate or stagflate that badly.

But then again, way smarter people than me are predicting this stuff, and they spend all their time looking at data and thinking about this. So I’d be a bonehead to dismiss this possibility out of hand. I’m famously* risk averse, so if there’s a chance that markets really could give abysmal returns for an extended period, I’m paying attention and counting our contingencies. (famous among people who blog at ONL, a pool of exactly one)

But then there’s that nagging question that all aspiring early retirees should be listening to: What if we have one more year syndrome? What if we’re actually set mathematically, and we’re working longer than we need to out of fear? What if we get to the end of our planned work timeframe and then decide we should keep going, just a little while longer? That is certainly not what we want either.

So how do we balance those two competing concerns — concern about low future returns, and worry that we might end up working too long? Today we’ll get into all of that, and make a case for the approach we’re taking.

The Problem of Recency Bias

Let’s talk about recency bias. From WikiInvest: “Recency Bias is where stock market participants evaluate their portfolio performance based on recent results or on their perspective of recent results and make incorrect conclusions that ultimately lead to incorrect decisions about how the stock market behaves.” 

Consider for a moment that virtually every financial independence or early retirement case study you’ve likely heard of has been someone who achieved their goal fairly recently, most in the last decade. Know anything else about the last decade? Perhaps that much of it represented a historically bonkers run for the stock markets.

The stretch from 2009 to now is one of the steepest sustained lines you’ll see in the history of the S&P, and the same is true for the other market indices.

Now let’s look at that graph again, but accounting for when some notable personal finance bloggers began documenting their journeys:

So JD Roth and Jacob Lund Fisker (Early Retirement Extreme) both weathered a short dip, but for literally everyone else you’ve seen write about our current conception of early retirement, they’ve only ever written in this gonzo bull market era.

Which isn’t inherently bad. I don’t want to say anything to piss off the bull market (we love ya, pal!), because it has treated us incredibly well, just as it has all the folks who are retired already and are watching their investments grow every year, even as they cash out shares.

Where we run into trouble is when we fall prey to recency bias, and assume that because everyone we’ve ever known to write about early retirement has ended up way ahead of their projections (at least so far), that must mean that coming out ahead of modest projections is an inherent part of early retirement.

And it’s soooo not.

Don’t let recency bias fool you into thinking times will always be swell, and forget that this stuff ebbs and flows.

When the Wave Crests

At some point, this run we’ve all been on is going to end, and at that point we’ll just hope that it’s a brief correction with a fast recovery. But we certainly can’t bank on that.

Japan’s lost decade should always serve as a sobering reminder of what could absolutely happen here: overvaluations driven by sustained low interest rates leading to a massive crash and long, slow, painful recovery.

Whether this market era ends with a little correction or a massive crash (knock on wood), those of us relying on investment growth to fund our retirement will be in a very different spot from the one we’re in now, at least for some period of time. We can’t know if that time will be short or long, but it could be long. And if that happens, those who are banking on getting returns in line with what we’re getting now, or even banking on less dramatic historical averages, will be in a tough spot.

The Case for Conservative Investment Returns Projections

I know we are freakish outliers who need more contingencies to sleep at night than the average bear (I said “we” but it’s really me), and our retirement budget is padded so that we could easily cut 30 percent from our spending and still enjoy life. But if given the choice, we would always rather end up with too much money at the end of all of this and be able to leave behind a large sum (preferably in the form of a comically large novelty check) to the charities of our choice. That feels so much better than risking running out of money because we were in such a rush to retire that we left a year or two before we were really financially ready.

I’ll be honest. There are some people who are already retired or will soon retire who I worry about. Whose projections don’t leave any wiggle room for a sustained bear market, or a health crisis, or anything other than smooth sailing. Whose projections are based on getting the historical average returns every year, which isn’t how this works. Some years will do better than the average, and some will do worse. We can’t bank on predictable, linear returns, and there’s a huge luck factor that plays a big role, namely the timing of when we retire relative to the markets, and sequence of returns risk.

Fortunately, there’s an easy way to compensate for all of that: aim low.

If your plan is built on optimism about future returns, you get points for positivity, but you also open yourself up to much larger risk, no matter what your Monte Carlo simulations might say. Simulations are all based on historical averages, which are known, not future returns, which are entirely unknown and largely unpredictable.

This is probably the only time I’ll ever say this, but when building your plan assumptions and projections, it pays to be pessimistic.

Let’s weigh the downsides of each approach:

Overly optimistic projections:

You might have to have a lot of lean spending years

You might have to exhaust your contingencies or forego important spending (like on health care)

You might deplete your positions early and be forced to go back to work or downgrade your standard of living permanently

You might run out of money when you’re least able to earn more

Overly pessimistic projections:

You might work a little longer than you needed to

It’s up to each of us to pick our own poison, but we’ll take the pessimistic downside any day over the possibility that we could run out of money by being too optimistic. If we worked a year or two longer than we ultimately had to, something we can only know in hindsight? No big deal in the scheme of things.

What Is “Conservative”?

We’re not financial experts and I wouldn’t begin to tell you what you should base your projections on. But I can share how we’re thinking about all of this.

The 3 Percent Rule

We’re in agreement with those who say there are serious problems with following the 4 percent rule now, especially the differences with interest rates and bond yields, and the assumption built into the rule that we’d have 60 percent stocks, 40 percent bonds, which most investors would find waaaay too conservative nowadays given yields. So if we were going for straight adherence to some percent, instead of our actual two-phase plan, we’d almost certainly be following the 3 percent rule instead to account for lower future growth projections, and to retain as much of our portfolio as possible each year, to give it the best chance of beating those projections.

Projecting Low

We built our two-phase projections ourselves because there weren’t any reputable tools at the time to account for different phases of retirement: early retirement with cash flow from selling shares of index funds, early retirement with index share sales and rental income, traditional retirement with 401(k) income and rental income, etc.

These aren’t our real numbers — I REPEAT, THESE AREN’T OUR REAL NUMBERS — but this gives you a sense of how we’re planning for each phase:

We run all of our projections at the 4-6 percent ranges shown here, as well as at 3 percent. And we only consider a number safe if it lasts us until the next source of income kicks in at 3 percent year-over-year returns, which is suuuuuper pessimistic over the long term, we know. And these are assuming present-day values, so inflation would actually have to be added on top of these percents, meaning that 3 percent growth actually requires 4.5 to 5 percent returns with inflation, and even that not-too-optimistic 5 percent then becomes 6.5 to 7 percent or more when inflation-adjusted, which is then in line with past historical averages and well above what Bogle and others are predicting for the intermediate-term future.

Paying Off the House

When we paid off our house back in January, a small motivation to do that was future-oriented pessimism and the financial conservatism that accompanies that. Our rate was around 3.5 percent, which is an easy number to beat with investments in a bull market like the current one, but isn’t at all easy to beat in a bear market. So rather than follow the plans of others who invest more to make mortgage payments in retirement, we decided we’d sleep better keeping our fixed costs as low as possible in retirement by paying off the house first. That way, if our investments take a serious hit one year (or multiple years), we don’t have to lock in those losses by selling off enough shares to pay the mortgage. We can cut back the fun expenses and not freak out that we’re plowing through our portfolio too quickly.

What Are You Projecting?

I know we’re the conservative investing outliers, so tell us — what are your projections based on, numbers-wise and logic-wise? Any other conservative planners out there who want to raise your hands? Anyone going even farther than we are on the pessimistic assumptions? Got views that confirm or contradict Jack Bogle? Want to try to talk us out of this thinking? We’re all ears, er, eyes. ;-)