Protect your early retirement from sequence of returns risk // Our Next Life // early retirement, financial independence, investing, financial planning, retirementwe've learned

Protect Your Early Retirement From Sequence of Returns Risk

So it looks like we might finally be getting that market correction we’ve all been expecting for a while. Or maybe we just saw a few random days of market flukiness. Or maybe it’s the start of the next recession. Or maybe it’s nothing. Or maybe the world is ending. Probably not, though. But maybe…

Point is: Nobody knows. If anyone can actually see the future, they’re keeping the secret to themselves. And the rest of us just have to make guesses with whatever limited info we have. And the limited info might stress out certain people. Like those who retired recently. Like us.

Because, as you probably know, for folks who save a safe amount for retirement, say somewhere between 20 and 35 times your annual expenses, the chances are overwhelmingly high that you’ll make it to the end of your life with more money than you need, maybe much much more. (Make it rain for those charities in your will, y’all.)

A small fraction, however, won’t be so lucky.

Those who draw the short straw on sequence risk, a.k.a. sequence of returns risk.

Spoiler alert: You can prepare well for sequence risk without extending your early retirement timeline, assuming you are planning on a decently safe withdrawal rate already. And if you’re not concerned about sequence risk with the markets, you might still be wise to consider sequence risk on health care costs. More on all of this farther down.

Quick Refresher On Sequence Risk

We can talk until we’re blue in the face about historical averages for the markets, but virtually no years actually yield average returns. Most years give returns below or above the mean, but they average out, like if you draw a straightish line down the middle of a roller coaster’s arc.

As Dana Anspach of The Balance writes,

Because of sequence risk, plugging a simple rate of return into an online retirement planning tool is not an effective way to plan for retirement. The online tool assumes you earn that same return each year. A portfolio doesn’t work that way. You can invest the exact same way and during one twenty year period you might earn 10% plus returns, and in a different twenty year time period you would earn 4% returns.

Because we can’t see the future, plenty of us do our math and projections based on historical averages (or perhaps lower, to be safer), which is a great way to get a rough sense of things, but it’s almost guaranteed way to be wrong somewhere, given how market returns actually play out, as well as inflation, which is a major factor in retirement success. That’s why it’s so important to have contingencies built into your plan, in addition to maintaining a mindset of flexibility. (And speaking of returns, plenty of us also overestimate likely returns because historical averages factor in reinvested dividends, and once you’re no longer accumulating, most people will cash out the dividends since you have to pay taxes on them when earned, unlike capital gains which you only pay when you sell shares. With dividends cashed out, historical averages are a significant overestimation.)

If you have average or higher than average returns in your first decade of retirement, ideally outpacing the rate of your withdrawals or share sales, then statistically, you’re golden. Those early years virtually guarantee your long-term success. But if you hit low or negative returns in those early years (and most especially if you’re projecting average returns that assume reinvested dividends)? Then you’re in the unlucky group who could possibly run out of money, even if you follow the 4% rule or another safe withdrawal rate to the letter. That’s because higher returns early mean you’re compounding on bigger numbers, and even if later returns are crappy, low returns on a big number are greater than bigger returns on a low number. As Michael Kitces says, “It’s not enough for returns to average out in the long run, if the portfolio could be completely depleted before the good returns finally show up.”

If you’re thinking, “Cool, but I’m not retiring now or soon, so this most likely won’t affect me,” here’s some sobering info: In another Kitces analysis that I highly recommend everyone read, he makes the point that a sustained sluggish or even just mediocre market (what many analysts predict we’re in for in the near and foreseeable future) is worse for sequence risk than a big crash followed by a recovery.

I’ll say that again, because it’s so important: Sequence risk is very real even with positive returns every year, if those returns aren’t big. That means all of us could be facing some discomfort here, if the sluggish next decade predictions come true.

And another wrinkle: overspending in a given year or stretch of years early in retirement can have the same net effect as hitting a bad sequence of returns because you end up potentially depleting your portfolio too much for it to recover, even with level spending and good returns in later years. The most likely cause of overspending in the near future: increasing health care costs. So even if the markets keep doing well and never stagnate or dive, if health care costs keep outpacing market gains, we’re all going to feel that effect in the form of asset depletion.

That’s all the bad news, but we’re through it now. And it’s all mitigatable, so let’s not get all nihilist about it.

(Though if you want more on sequence risk, Big ERN also has some super helpful analysis on this stuff.)

Protect your early retirement from sequence of returns risk // Our Next Life // early retirement, financial independence, investing, financial planning, retirement

Sequence of Returns Risk Timeline

Research tells us that the most important period in terms of whether sequence risk will befall you is the first ten years of your retirement. After that, bad or mediocre returns are unlikely to hurt you so long as you stick with your safe withdrawal rate, and so long as you didn’t deplete your funds in the first decade to such a point that they simply can’t recover. However, within that important decade, the highest correlation between long-term success and market returns is in the first five years, and the steepest correlation curve of all is in the first three years. (I’m combining analysis from Kitces and ERN here, most of which is based off of Bergen analysis that undergirds the Trinity Study.)

Big ERN’s linear regression showing high importance of the first five years within the first decade:


Kitces correlation chart showing the steepest climb of correlation between annualized returns and long-term success within first three years (though high correlation over that whole first decade):


Knowing that, you can structure your retirement financial plan in such a way to minimize or even eliminate the need to sell shares of stock in those critical early years – all 10 if you want to be super conservative, five if you are medium conservative, or just the first three years if you are less conservative or if you already have a solid list of multiple contingency plans (or if you have a two-phase approach like ours and know you have fall-back money that you’re not depleting in phase 1). The whole idea is:

The longer you can keep your principle intact — shielding it from sequence of returns risk that only kicks in once you begin withdrawing — the more likely you are to have enough money to last your full lifetime.

In our case, though we definitely saved on the conservative side and know we’ve put ourselves in a solid position no matter what, we’ve been superstitious for years that we’d retire right into a recession. And while it’s way too early to tell if we’re about to hit one, we’ve been well braced for it for a long time. We’re also keenly aware that health care costs are rising much faster than inflation for everyone except those receiving the largest health care subsidies, so health care costs could turn into their own sort of sequence risk if you’re not able to scale back other expenses to accommodate rising health insurance premiums. Add all of that up, and we’ve been preparing ourselves to minimize withdrawals from our taxable stock funds – the bulk of our phase 1 savings — for the first several years of our early retirement.

And you might be wondering, “But what about safe withdrawal rates? Don’t those factor in bad sequences?” Indeed they do, to an extent. But 4% will not guarantee your success in the worst sequences, and nor will 3.5%. 3% might, based on historical data, but we also don’t have a ton of analysis on the long timelines that early retirees are looking at. And we’ve never had a time in the past that we could analyze when health care costs were rising as quickly and were as generally uncertain as they are now.

So while plenty of people may not feel the need to be as conservative as we are in our early retirement financial planning, if you can start with a lower withdrawal rate than 4% and build in some buffer against sequence risk, you can give yourself the best possible chance of never worrying about money again. All without changing your savings timeline or delaying your early retirement.

Let’s talk about how.

Related post: When the Crash Comes // Recession-Proofing Our Retirement Plans

Insulating Yourself From Sequence Risk in Early (or Traditional) Retirement

A question I think about often is whether I’d want to proceed cautiously even if the current economic cycle weren’t so overdue for correction or recession. Fortunately, much of that caution is already baked into our plan, so it’s not a choice we have to make now, or something that might have kept us working longer. It’s why our asset allocation in our taxable accounts includes a hefty dose of bonds. It’s why we have a large cash buffer. It’s why we didn’t burn any bridges on the way out of our careers. Because we may come to rely on any of those.

Here are the elements of a retirement plan that’s well girded against sequence risk, divided into allocation choices you can make as you’re accumulating your savings, and behavioral choices you can make throughout the rest of your planning.

Two Big Allocation Factors:

Invest in Low-Volatility Assets – That’s a fancy way of saying: make sure you don’t only own stock. In an extended downturn, you may be forced to sell shares, and in those cases, you’re better off being able to sell bond shares which are far less volatile than stock shares. We’re allocated roughly 70/30 stocks to bonds, and while that mix may feel too conservative or too aggressive to you, the idea is to make sure that you have something you can sell when stock markets nosedive, especially if markets take years to bounce back. Of course, make sure you’re factoring lower (or no) growth into your plans on those bonds or other low-volatility assets. If you own 30% bonds but project historical average returns on your whole portfolio, you could end up dramatically overestimating. Real estate could be another way that you achieve some balance in your portfolio and something closer to a guarantee of passive income even when you don’t want to sell off your stock shares. Whatever your preferred method of diversifying is, make sure you allocate some of your funds to assets that you can turn to when selling stock is a bad option.

Maintain a Large Cash Buffer – Every choice in life is a trade-off, and that’s certainly true with regard to maintaining a large cash cushion, e.g. multiple years worth of expenses in cash. Sure, by holding cash, you’re guaranteeing that you’ll miss out on market gains for that part of your portfolio. But you’re also guaranteeing that you won’t need to sell shares in the event of an extended market tantrum. We retired with just under three years worth of expenses in cash, which will feel like an extravagant and foolish amount if the markets keep going gangbusters, but like a wise and judicious amount if the markets start tumbling or stagnating. Again, find your own comfort level for balancing missing out on gains vs. security in a downturn, but make sure you keep a decent cushion on hand so you aren’t forced to sell when shares are down dramatically, locking in those losses permanently.

Four Big Behavioral Factors:

Make Sure You Can Dial Down Your Spending – If share prices are down and you want to avoid selling them, the best thing you can do is spend less to stretch your cash buffer. This is one area in which I’m convinced that less frugal early retirees actually have a slight leg up. (Hit up that love letter to the unfrugal folks if you need a little validation.) If you’re super frugal and your budget is already bare bones, you don’t have much room to cut when things get tight. But if your budget has a lot of wiggle room, it’s easy to cut the non-essential stuff. Likewise those who pay off their mortgages – if the markets tumble, we don’t have to worry about whether our investments are yielding enough to pay our mortgage, because we don’t have one. Not that renting or having a mortgage is the end of the world, but it does make it harder to chop your expenses dramatically if you see your investments taking a dive or flatlining. If, however, you can identify in advance a few ways that you’ll chop your spending should the need arise, say by 25-30 percent, you’ll be in a much stronger position in an extended bear market than will someone who has no good options for trimming. And related:

Be Willing to Reassess – Though the anchoring effect can be powerful and can entice us to want to keep our lifestyle at a certain level forever, if we hit a bad sequence of returns, the only way to right the ship might be to calculate a new yearly withdrawal amount that’s lower, maybe a lot lower, than where you started. That’s a risk we all need to be willing to take when embarking on early retirement, but remember there’s no risk-free life. The other alternative is risking spending all our good years on the job.

Hustle Just Enough – Our vision for early retirement has always been that we want work to be completely optional. But I’m not gonna lie – we’re both working a bit this year, and we probably will for a few years. Part of that is just that some super fun opportunities have fallen into our laps, part of it is concern about the future of health care costs, but the biggest motivator is knowing that we have better odds than plenty of other retirees of hitting bad sequence risk. So our goal this year is to earn enough to clear our annual expenses after taxes are taken out. That’s way less than we used to earn and feels totally achievable without having to work much (and while being able to be picky about what we say yes to), but it’s definitely not how we imagined we’d begin our retirement. On the flip side, though, we feel grateful to have been so keenly aware of sequence risk in our case because it’s much easier to pick up a few side gigs now, fresh out of our careers, than it would be in a few years, with cold leads. The “you can always just go back to work” notion is a lovely thought, but economic data does not bear it out. Better to keep your options open right from the beginning and earn a little in those first few years of retirement, until your gains are locked in and you’re set for life. And you certainly don’t have to hustle enough to cover all your expenses. Even reducing what you take out of your portfolio each year by 10 or 20 percent can make a huge difference in insulating you against sequence risk.

Maintain a Conservative Withdrawal Rate, At Least for a Little While – Though odds are good in a general sense that even the 4% safe withdrawal rate is unnecessarily conservative (for all but the worst sequences, 6%+ is safe), none of us know until we’re looking back in hindsight what kind of sequence we’ll hit. And given that it’s entirely possible to fail at stretching your money even at the 4% rate if you hit a bad sequence, it may pay off to start your retirement at a smaller, more conservative rate than you plan to maintain long-term. It’s what we’re doing. Our current intended withdrawal rate – assuming no extra earnings, like if we aren’t able to earn an amount equal to our expenses – is a bit under 3%. Though that’s always been the plan with our two-phase approach: live more modestly and travel more dirtbag-style in phase 1, and then step up the spending and lifestyle when we reach phase 2 when Mark turns 59 1/2. But if we get a good sequence in the first eight to 10 years, we could very well up that withdrawal rate sooner. And in phase 2, we’ll likely do the same thing: calculate a conservative withdrawal rate when we begin tapping those funds of, say, 3% and then upping it if we do well after the first decade.

Weigh In!

Alright guys, tell us all what you think! Are we seeing the start of the next recession? Just a minor correction? A total nothingburger? How are you thinking about sequence risk? Have any other strategies to head it off that you’re incorporating into your planning? Or think it’s all a myth and you’re just sticking to the 4% rule, come Hell or high water? Let’s dig into all of it in the comments!

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94 replies »

  1. We’re blaming this market madness on you and POF. You go and retire and POF rings the bell on Wall Street and all hell breaks loose. Thanks a lot…


    Nice post with lots of great advice. Who knows what will happen, but the media sure wants to make it more than it is right now. “Biggest one day drop in the Dow!”. Yes, by number it is. Obviously the concept of a percentage eludes the media and the drop is nothing major at all, yet. But click-bait headlines must be written.

    • Oh dude, it’s ALL PoF’s fault! Not mine. ;-) We shall see how this all shakes out — indications so far are that it could be a whole lotta nothing, or kind of a big deal. Fingers crossed it’s a minor correction at worst, but a solidly insulated plan won’t feel it either way.

  2. Hi Tanja! Great post, and particularly relevant for me as I retired at 40 at the end of September. I have close to 3 years cash cushion that I planned to live on/deplete over the next few years and then start drawing down the portfolio. But I’m wondering, is that the “accepted” thinking behind the cash cushion? Or do people generally hold onto it and in “good” years draw from the portfolio and in “bad/stagnant” years live off the cash cushion? Love the blog! Ann

    • Ann, I’m no expert, and still years off from retiring, but I’m planning to maintain a 5 year cash cushion in CDs. My thought is that if we retire into a reasonable market, we’ll be able to use our withdrawal rate, but if we retire and 6 weeks later the market tanks, we will have 5 years of cushion. We’ll have the option to wait entirely until we hit a better patch of the market, or we could cut our withdrawal rate in half for up to 10 years, etc. That 5 years of money means we have to wait longer to retire, but it’ll help me sleep well at night.

      • We are going for a 5 year CD ladder, and we chose CDs because we felt that would provide some inflation protection with little additional risk over just having the money in cash.

        My worst Worst Case Scenario (because you know I have several, right?) (and that each is the worst in its own way, natch) is that both my pension and Social Security get axed, and I lose my job just before we are planning to retire and have to go straight from wages to living off the money we have put away.

        Given our financial situation – and thinking very hard about the research on SOR that is read – 5 years was the number that I thought we could reach prior to retirement. There are other factors of course – this is something we have been talking about for a couple of years and we just firmed up the plan in December -but that is the core.

      • Thanks for this added detail! That all makes really good sense! Although it certainly feels like a big strength of your plan that your worst case scenarios hinge on losing two assets — a pension and social security — that are much more secure than many market-based assets. I’m sure that helps you feel more secure!

      • I definitely expect that we will get at least something from both the pension and SS, but both of these are vulnerable to the same type of risk (political). So it seemed like a good idea to at least consider what this would do. We arent planning on purchasing annuities or keeping LTC insurance outside of what is in my pension, and our health care is dependant on the pension system as well. So it is a big asset, but if a part of it goes I want us to still be able to live a dignified life. Actually, that’s listed as the purpose of our Investor Policy Statement: to enable us to live a dignified life without earning wages.

      • That’s a solid thought process since you’re so right that they would both be subject to the same forces and are therefore not super well diversified. You’re smart to consider the worst case instead of just trusting that everything will be fine! I LOVE that investor policy statement, too! Though I wouldn’t write off an annuity down the road if other things should go in the worst case direction. They can make sense under certain circumstances, and you don’t get dinged for buying them later in life. We’re definitely going to at least look at them for traditional retirement!

    • Yes, especially relevant to you, as it is to us! ;-) Check out Can I Retire Yet and Darrow’s drawdown strategy posts. Essentially, you should be maintaining your cash cushion at a fairly level state and selling shares when the markets are up to replenish what you’ve spent. And which shares you sell are dependent on your drawdown plan. But obviously if the market tanks, that’s when that big cushion really becomes valuable because that’s when you either stop selling or only sell bonds. So you’re mostly NOT living off the cash cushion — that’s the short answer. ;-)

      • This is the part I don’t understand. Let’s say you have “3 years living expenses” and the market is down for an extended period, like 8 years. How/when do you get to replenish your 3 year position? Or is that not the point? You just spend it and then hope the remaining investments cover you?

  3. I’m glad you are writing about topics like these, and I’m excited to follow along on your journey the next few years. As you point out in a different post, a lot of the other FIRE bloggers who have pulled the trigger did so while the market has grown like crazy over the last 8ish years. It’s going to be valuable for us aspiring FIers to see how you manage health care costs and an unpredictable market.

    • I’m glad you’re glad! ;-) And though we will not be stoked if we do in fact retire straight into a recession, at least we can provide that service or reporting back on bad sequence risk! Hahahaha.

  4. Great post!

    Being prepared is important, so thank you for sharing this with those still preparing :)

  5. Preach it! I get so nerdy excited on conservative articles like these and mitigating S.O.R. (let’s go ahead and get the acronym going) risk. Do you have a timeline for how many years you want to cover annual expenses with marginal work? It’s clearly going to be passionate and curated projects, so why not? Plus that’ll help make it rain for the charities! We’re aiming for a 2.5% – 3.0% SWR depending on market valuation metrics when we want to pull the trigger. Also, with a cash cushion and balanced investment portfolio, likely similar to the 70/30 split. Unfortunately, I have to mitigate: 1) leaving a well-paying job that would be extremely challenging (don’t say impossible, but do) to return to in a downturn; 2) no profitable side-hustles and passions don’t necessary align with money making opportunities; 3) healthcare (don’t we all).

    • Thank you for nerding out on this stuff with us. :-) We’re just looking at one year of expense-covering income FOR NOW. If the markets do okay this year and we don’t touch our investments, then everything shifts and we might be fine even if we were to suffer, say, a 40% dip. So it’s going to be a bit dependent on the particulars. But if we need to cover another year, that’s obviously not a huge deal, though we’d love not to need that. And yeah, I feel you on not being able to go back to the job — everyone says that like it’s realistic, and it’s often not!

  6. Thank you for such a great article Tanja!

    I retired 19 months ago and am thankful that the timing, so far, was incredibly lucky.

    I dare say I’m at least as conservative as you so I can check off all the things you recommend above: My cash buffer is 7 years x current spend and I don’t intend to tap it until the market drops at least 10%, Budgeted expenses were about 3% of spendable assets but actual expenses were just under 2%. I unexpectedly earned a bit of money so my drawdown was even less. I’m not super frugal so I could dial that down further if needed.

    My satisfaction with early retirement has been largely due to my flexibility. Not just in how I react to changing finances but also in how I spend my time. I enjoy being less efficient and having more time to read, learn and explore.

    • Thanks for that nice compliment, Liz! :-) And wow, you are indeed more financially conservative than I am, which is hard to do! Hahaha. I’m so glad your first 19 months have gone so well on all financial levels — that has to be a big relief and help you feel well insulated from whatever the markets dish out next!

  7. I don’t think much about sequence risk, because cashing out shares of stock isn’t our core retirement plan. Instead we are looking to have enough passive cash flow.

    I realize that we’re in a unique place with the wife’s military pension, but we also have real estate, my blogging, gig economy (dog sitting) in the mix. While the last two probably count as “working”, I think many people would consider doing them for free. We could probably pick any two of those (not including the military pension) and get by for years.

    It’s good to know that the market will be there if we need it. I suppose the dividends could be another nice income stream. I’d like our stock holdings to just be one of our contingency plans.

    Am I crazy for not thinking about sequence risk?

    • If you have a cash flow plan, then it’s a (mostly) totally different ballgame. At some level, you’re still subject to economic forces, but share price is of course less of a concern. If we get into a serious recession, no doubt your dog sitting income would decrease, but I have no doubt you guys would buckle down and be fine. And man that military pension is pretty much the best blessing ever — I don’t know of anything as solid as that!

      • I had never thought about the dog sitting business being hit by a recession, but of course it would. I suppose our rental properties would be hit hard too. Still, if it’s the kind of thing that is 5 years or less, I think we’ll do fine.

        I know it’s not particularly easy, but I believe that people should give some thought to a real cash flow plan. It doesn’t need to be 100% of your retirement, but just the kind of thing that can insulate you a bit from the markets.

      • I 100% agree with you, and I think it’s important to consider how economic forces can impact that stuff, not just the rise and fall of stock markets. (Bonds are an important piece to crunch the numbers on because they yield very little these days but are still talked about as the standard hedge.)

    • I just did my taxes and realized that my dividends, interest (mostly from high-yield saving accounts), along with capital gain distributions from actively managed mutual funds, kicked off close to 45k this past year.

      My plan in early retirement was to have three years of a cash reserve. However, now that I realize 70 percent of my yearly spend will be covered by these distributions, I probably won’t need a full 3-year cushion.

  8. Great summary! And thanks for the mention! Yes, Sequence Risk is on our mind, too, with retirement a few weeks away and seeing what happened over the last few days. A sub-4% withdrawal rate should do the trick and the portfolio will last a lifetime. Best of luck!

    • I’ll reply to ERN since this applies to both of you (my two favorite blogs as it happens — one for the math and the other for the feelings — I’ll leave it up to you to figure out which is which).

      Something that struck me as I read this is how closely the idea of 10 years being the biggest predictor sequence risk maps to ERN’s findings that a 60% -> 100% equities glidepath with 0.3%/month steps results in the highest SWR for 60 year retirements. This is like having a bit over 11.5 years of expenses (based on ERN’s 3.44% SWR) in bonds and then spending that bond cushion down over about 11 years while adjusting every year for changes in value and having one fewer year in bonds such that after 11 years (when the worst sequence risk has hopefully past) you’re all equities.

      It also happens to be pretty close to ONL’s 70/30 asset allocation, and probably even closer if you consider if you consider their 3 years of cash as being similar to adding to the bond allocation.

      Tanya, I wonder if you and Mark are planning to use a rising equity glidepath during the coming years as indicated by ERN’s research?

      • Thanks for that nice note, Terran! :-)

        We are still working on a drawdown strategy post that I think will answer your question in more detail, but the short answer is no. We were pretty persuaded by Darrow Kirkpatrick’s thinking on this over at Can I Retire Yet, and his look at Schiller PE ratios as the main indicator of which shares to sell when. And then, given the cash cushion, we’d have less need to rebalance our portfolios. But stay tuned for WAY more detail on this! (It also helps that we have rental income and other income sources, plus a whole second pot of money waiting for us at age 59 1/2, so we might be thinking about phase one differently than we would if it was all one pool.)

  9. Tanja

    Great post, flash crash aside (biggest single day point drop but not even one of the top 100 biggest loss days in terms of % drop so it’s really a blip) SOR risk is real and I think the multi year cash cushion is a better bet than a 70/30 split for early retirees.

    If you are in your 40’s (regardless of when you retire) that is too much of an over allocation to bonds – especially now with rates at historical lows, the inevitable rise of rates and inflation makes a 10 or 20 year investment of 30% of your wealth in bonds a huge sacrifice in terms of missed gains (and likely reductions in value) You can’t time the market but being completely on the sidelines isn’t the answer. it is why I like the cash approach (I retire next month at 52 and with my cash cushion and side hustle I don’t expect to need core assets for 5 years. During that time I will likely keep my portfolio in a 100% or 90/10 equity/bond allocation so I don’t miss the market opportunities over that extended horizon. Then the next 30 years should be fine with our plan and asset to expense ratio at 70:1 (or more)

    PS the last two sessions in the market are exactly why you have to be in for the long haul


    • Thanks! We shall see where this current market ride takes us! And all hope that it is in fact just the blip that it appeared to be last week. Re: your math breakdown, that all makes sense if you are reliant on larger gains and if you have a longer time horizon than we do. For our “phase 2” funds that we aren’t touching for a while, those are much heavier in stocks. But for phase 1, we need very little market growth to make it, so don’t require a heavy dose of stock and would in all likelihood be fine with even 50/50 (though even we aren’t that financially conservative!). But it’s all dependent on how aggressive your plan is and what your timeline is. In general, though, most financial advice would put you at least 70/30, if not a higher percentage of bonds, by the time you reach retirement. Trinity and other SWR studies looked at 60/40. I agree that a cash cushion can play that role instead, but it’s important that each person look at their own details to determine the right mix. I’ll happily take smaller growth in exchange for less volatility and downside risk. ;-)

  10. Thanks so much for sharing this information in such a clear, detailed and easy to understand way. That’s one of my favorite things about your blog. :)

  11. “Point is: Nobody knows. If anyone can actually see the future, they’re keeping the secret to themselves”

    “a sustained sluggish or even just mediocre market (what many analysts predict we’re in for in the near and foreseeable future)”

    Reminder: The analysts don’t know. Nobody does.

  12. I heard a story on NPR a month or two ago about people’s assets, the market, etc. The big point of the commentator was that most people don’t have a hedge. In your case, the hedge is cash. And to an extent, future rental cash flows when the property you rent becomes cash flow positive. I’m super conservative like y’all but conservative in a different way. I originally was shooting for the 4% rule but as sequence of returns risk grew, I settled on 3% as a big picture benchmark. Further, I wanted to create a way to access cash flow in my after tax accounts without touching any of the principal, so I did that with about 50% of my after tax assets in real estate backed loans and the other 50% in index funds/ETFs of all types with an 80/20 split between stocks and bonds.

    All this being said, a 100% equity account *may* do just as well over the long term as the more complicated things y’all and I have employed. I’m not sure I could sleep at night if I had done it that way, however. I was obsessed with creating mechanics that would allow me to leave the principal intact the first decade of my early retirement.

    So far it’s working. I don’t maintain a large cash balance at all… maybe 3 months of my projected expenses except that I have a 30% fudge factor on my expenses so it’s closer to 4 in practice.

    Currently, I’m having an argument in my own brain about using some of the excess cash flow I’m receiving to make principal reductions on my mortgage on a monthly basis since the market feels overheated. I originally wasn’t planning on this but the new tax laws have made me reconsider this strategy. What I think I’ll do is look at my bank account at the end of the month and take 50% of what’s left and apply it to the principal balance and plow the rest back into my hedge investment vehicles, for the time being. I have all my retirement accounts reinvesting all the dividends, etc. and my after tax accounts paying me the proceeds. If the market were to adjust substantially, I would change to reinvesting all the dividends I don’t need for expenses.

    I imagine I may be overthinking a bit, but that’s ok. I’m not stressed and I’m not feeling like I need to find a way to make any money right now to help me overcome SOR risk. I think that there is ONE thing that we can count on for 2018. It’s going to be a tumultuous year in DC and the stock markets will react in unpredictable manners, so we ought to buckle up and enjoy the ride.

    • You know I’m totally with you in saying: Do what lets you sleep at night. Sure, in hindsight we might not NEED multi-faceted plans (I don’t think ours or yours rises to the level of “complicated”), but we can’t possibly know that in advance, and it would be foolish to have no hedge or contingencies built in. So, given that, it seems like you actually have a pretty straightforward plan! But that doesn’t matter — all that matters is that it’s working for you, you don’t feel stressed, and you’ll be able to enjoy the ride instead of freak out. ;-)

  13. Great post as always!

    I’m curious though about this idea: “With dividends cashed out, historical averages are a significant overestimation.”

    How I’ve thought about it is:
    Whether I’m selling shares or not reinvesting dividends, its about the same.

    But the advantage of not reinvesting dividends is that I’m already paying taxes on that, so I might as well not reinvest it if I’ll need to spend the equivalent amount of money anyways. There’s not an option for not reinvesting dividends, not selling shares, and also not spending money. The spent money needs to come from somewhere.

    Am I missing something?


    • Thanks, Andrew! And I totally agree with your tax logic on dividends. We are doing the same thing. Especially in light of health care premium calculations, if something counts as income, then it better also be cash flow! ;-)

      In terms of your calculations, it’s hard to know without seeing your spreadsheet, but if you’re basing your market growth each year on historical averages AND looking at your whole portfolio (not subtracting cash, bonds and not-reinvested dividends from the amount that will grow at market rates), then you are likely still overestimating. However, if you’re aiming for much more conservative growth, then it’s less of a concern. (And you know I’d argue in favor of more conservative projections either way!) ;-)

  14. On asset allocation, to manage sequence risk, consider a rising equity glide path (Kitces and others). Once we achieved FI and approaching retirement, we didn’t want to lose it. So the asset allocation got more conservative. In the first years of retirement, the portfolio will be less volatile so less subject to sequence risk.
    You’ve written about your 2.5x in cash. Do you intend to maintain that? When the market takes a dive and you don’t want to sell stocks, will you live off the 2.5x or sell bonds?

    • We aren’t exactly doing the rising equity glide path, but we do have a more conservative allocation (currently 70/30 in addition to the cash cushion) in our phase 1 funds than plenty of people would deem necessary. (Our phase 2 401(k) funds are still invested more aggressively because we don’t need them for 19 years.)

      In terms of cash and what shares to sell, we have a more detailed drawdown post coming. Stay tuned!

  15. Tanja, I retired last April at age 57. Your blog has been an awesome resource both before and afterward, if just to read someone else’s thoughts about what’s been rattling around in my head with respect to FIRE without driving the rest of my family crazy. For that, I’m very grateful to you.

    Coming from the “buy and hold” school of investment, I wouldn’t have been too rattled by the market correction this week, except for sequence risk and how it might affect our retirement nest egg. Reading your post today and the the discussion that followed was a good sanity check and just what I needed to keep my blood pressure down (well, at least until the next news cycle).

    Thank you! By the looks of it, your first year of retirement is going to be anything but dull! :)

    • Thanks so much for this nice comment, RR! :-) I really appreciate that. And same here! I barely notice market fluctuations normally, but when it’s in the critical early months of retirement, it DOES feel a bit scarier. So it seemed like a good time to write this post and help us all breathe a little easier. (Or perhaps plan a little better, for those still saving!) ;-)

  16. Ooh, I can hear the Bogleheads squealing. Bonds in taxable. Aargh!!!! The end of the world is nigh…….LOL

    A fix would be to keep bonds in IRA for tax efficiency purposes. Sell equities from taxable, then shift allocation in your IRA by “selling bonds to rebuy equities in your IRA.”. Thus keeping your overall asset allocation steady. As one blogger has reminded me more than once. – Money is fungible!!

    Keeping a low SWR in the 2.5 to 3.25% range should keep that SoR beast at bay over a long and prosperous retirement. You will likely end up with a lot more to leave to charity and/or family or to have a local mountain ski run named after you.

    • Hahahaah… I’m sure the Bogleheads would have PLENTY to say about our plan. Oh, and the retirement police, too! And we need a new name for a new category of person starting to emerge who continues to tell us that we aren’t feeling the CORRECT EMOTIONS. (I am accepting naming ideas.) ;-)

      We *could* keep bonds in IRA, but that wouldn’t help us much tax-wise at this moment, given that we’ll pay almost nothing, and the ACA income limits make Roth conversions FAR LESS appealing than they once might have been. But I’m sure that’s a good plan for someone! ;-) And you know ski run named after us would be A-okay!

      • >>we need a new name for a new category of person starting to emerge who continues to tell us that we aren’t feeling the CORRECT EMOTIONS<<? “EmoPo”?

  17. Keeping your skills and connections fresh is probably the best step you are taking right now. Every $1K you earn is $25-28K you don’t “need” to have invested, or can just leave alone to grow. Clearly, I think this because it is what I intend to do. Keep my business open but reduce my workload to something that allows me joy. If it pays for itself and provides most of my expenses, then I can worry less about SOR. It also leaves me open to interesting other opportunities. Some invitations only come because of the business I engage in.

    • Yes to all of this! The reality is that if we didn’t mind working some small amount forever, we could essentially “retire” with zero saved, and just cover our annual costs, which wouldn’t require much time worked. And then, as you said, there’s no sequence risk. So I find your plan very sound!

  18. This is a seminal post for early retirees, many of whom, if we’re being real, are leaning hard on the heuristic of the 4% rule.

    Big ERN’s research really opened my eyes a bit to the real risk early retirees take on, and your post validates that a lot of that risk happens quite early in the plan.

    We’re stealing a lot of the same strategies (currently have a 75/25 AA, and plan on having a 2 year cash cushion…though 3 does sound nice). We go back and forth on paying off the mortgage or just having enough ‘extra investments’ around that we could.

    My ‘oh shit’ plan is to work enough to earn $10k, part time, if things really get hairy. It won’t cover all our expenses but will really reduce what we’d have to sell in a bad market. And depending on what I do (maybe a barista at Starbucks?) we might even have some healthcare benefits again.

    • Thanks, friend! I agree — leaning so hard on 4% makes me worried for a lot of folks. It’s why I’ll never stop writing posts like this, because “trust the math” just isn’t solid enough.

      Your plan sounds great with both a more conservative allocation and the cash cushion. You probably would only end up needing one or the other, but if you can afford to do that, I can definitely vouch for the peace of mind factor. And no need to decide on mortgage — honestly I’d let the direction that the health care debate takes drive that decision. If ACA income rules ever get fully enshrined, then paying it off makes more sense, but if the rules change, then the math changes.

  19. We ran into a the sequence of returns risk situation right when we retired because of the 2015 oil crisis (which impacted Canadian markets because of its reliance on oil). But luckily we mitigated it by a) keeping most of our expenses inside the yield of our portfolio (aka the Yield Shield) b) having a cash cushion to cover our expenses for 3-5 years c) travelling to south east asian where the cost of living is less than 20K/year per couple. There’s always the option of decreasing expenses and hustling more. The idea that sequence of risk will kill your portfolio because retirees will never reduce expenses, hustle to make money in retirement, or adjust their allocation is pretty unrealistic. No one watches their portfolio plummet and then keep withdrawing without changing anything. Cash cushion + yield + geographic arbitrage works wonders!

    • Are you guys fully invested in Canada, or are you able to take advantage of U.S. or other international indices? But yeah, I’m sure that oil crisis was stressful! It’s great you had that big cash cushion — it actually surprises me that it was that high, but I’m glad! And while it IS unrealistic that anyone would watch their value plummet without doing anything, the hard part is that if you get into a bad sequence, it might already be too late to reallocate, and in a recession is the hardest time to make money side hustling or to get a real job. So far better to set yourself up to be flexible when times are good. :-)

  20. Hi Tanja :) I have so many different models and projections that it makes my head spin sometimes. At the core of it, however, is diversification. Passive income streams from commercial rentals, residential rentals and dividends. When the properties are rented we won’t need to touch the portfolio and will reinvest the dividends. When they are vacant we will need to use the dividends and maybe sell equities.
    There’s no crystal ball but one can only prepare and hope that things pan out as planned.
    Fingers crossed for us all!

  21. I am intrigued that you would say have enough of a cash buffer so as your money will last longer. From the research I read, the important thing is to avoid a bear market 5 years before and 5 years after the retirement. But if you keep too much cash, or your allocation is a falling glidepath (more bonds as you age), the rate of return of your wealth is low that it did not grow more during retirement to last longer.

    The ideal solution seems to be to reduce the allocation to equities as you are near FI, but ensure that this reduction in equities still accommodate a 4-5% initial withdrawal rate.

    Instead of cash, use the cash as part of the allocation of equities and bonds. This means that your portfolio is larger than what you need and growing at a good rate of return.

    There after scale periodically more to equities. As you avert the potential bear, your money is able to grow at a higher rate of return and this would ensure you have more to last longer.

    Layered in a level of dynamic spending in that if you are hit with a recession or bear, do not increase the spending based on the necessary inflation adjustment. The key is to avoid the mistakes or over drawing it in the first 5 years.

    But thanks for the great article. You explain this subject better than a lot of people (including myself)

    • I think your approach is largely sound, so I’ll not try to dissuade you! But we’re talking about only a few years of cash, which is a standard traditional retirement recommendation, and it’s a short enough time horizon that the tiny difference between bond gains and cash gains is minor and doesn’t jeopardize the growth you need to earn on your total portfolio. (It also goes without saying that your projections should factor in the fact that part of your assets are in cash and therefore will not earn at the same levels as investments.) In addition, you don’t have the x factor of the taxable event when you withdraw cash vs. selling bonds, and that taxable event now has implications for both your overall tax bill AND the cost of your health care. With cash, you can manage your total income more precisely. I’ll also add that, for early retirement at least — what we call our phase 1 — we are NOT moving to a more conservative asset allocation. Our phase 2 funds for traditional retirement are 90% in stock, and our phase 1 funds are 70/30. So we still have plenty of market exposure to get that growth, but the cash to balance it out.

  22. Hi , my first time here, Its awesome post However, I am pretty far from the milestone but nevertheless it helped ! I have been reducing our liabilities and now have zero debt (after recently paid of house) but as far as passive income wise I am pretty behind but looking to be on track to get to FI one day :)

    Keep it up.

    • Welcome! And huge congrats on paying off your house! That’s so awesome. If you’ve already ticked a big thing like that off your list, I have no doubt you have what it takes to get to FI. :-)

  23. “We’re allocated roughly 70/30 stocks to bonds”!!! I am concerned.
    Market valuations are driving down the road without a bumper or a spare tire (unlike 2008).
    The Efficient Frontier is a harmless fiction, until it bites you.

  24. Thanks for the fine article. I made some different moves. I built a large post tax account because of RMD. When RMD takes over your life you loose all control to tax management. I also tax loss harvested aggressively. TLH plus cap gains = zero taxes. I call this my rich man’s roth. It was enough to pull 600K out of the post tax acct tax free. I am living off that cash. During this period I am Roth converting virtually all of my IRA and I will pay those taxes out of cash on hand. I analyze the best time to Roth convert is the 5 years period between medicare and RMD. The taxes from RMD will eat you alive, and if one spouse dies it will eat the remaining spouse alive even faster. The time to plan this conversion is now.

    My spending tact was to save enough for my 3% “number” and retire on 3%. I then tightened my belt until it started to pinch, but was doable. The difference was about 30% below my 3% number (2.1%) If I want something like a trip to EU I save up the monthly 30% differential till I have enough to travel, So I don’t tighten my belt I let my belt out in a controlled way. I also pre-planned one offs like a new retirement car while working. I also have some money in a backup retirement. If you stick 300K in a separate account and never touch it, it’s like a lifeboat. In 30 years 300k at 4% return is 1M. You can make 4% in a very low volatility portfolio so your lifeboat has a completely different risk profile than your boat.

    I’m totally with you on low volatility on the main portfolio. Learn how to use an efficient frontier calculator. Living on the efficient frontier means you are not paying too much risk for a given return. Also analyze SS. when to take it and how to take it. It turns out sequencing between spouses can yield a considerable increase in payout over a lifetime. I’m also into planning epochs. Accumulation epoch, early retirement epoch, Roth conversion epoch. Residual RMD and SS epoch, wife’s residual RMD and SS epoch. There are maneuvers you can do very remotely in one epoch like the accumulation epoch, which can grow using compounding to cover the cost of an epoch with 50% of the cost provided by compounding. Example: I put 20k on the side for my kid at age 2 for college not 529 but extra in a UGTM That money grew to 50K and covered her expenses travel, summer abroad, a European tour with her choral group, clothes and a monthly allowance. When she graduated it bought her a car. 60% of that cash flow was free money, and her need never touched my cash flow. I always look for ways to let compounding pay for my future. The life boat scheme is a example.

    I don’t much believe in calculaors like FIREcalc Here is FIREcalc’s disclaimer:

    “How can FIRECalc predict future returns from past performance?
    It can’t. And it doesn’t try.” I do use monte carlo, but only as a means to stress test the portfolio to try and understand failure.

    Big pile, efficient portfolio (low volatility), low draw, attention to taxes, pretty much cancels SORR and makes you pretty much bullet proof. The downside is it takes a little longer to make this plan happen.