Imagine retiring by age 40. You may have to prepare for a 50-year retirement! Traditionally, the average American retires by age 65 and prepares for a 20-25-year retirement.
However, with the median life expectancy increasing and more people desiring to retire earlier, we must plan for even more unknowns. Further, return assumptions for stocks, bonds, and other investments are coming down. As a result, more capital or a lower withdrawal rate is required to retire and stay retired.
When I first started writing about early retirement in 2009, I was 32 years old. My original plan was to work until 40 and call it a career in finance. I didn't know exactly what I wanted to do after finance. All I knew was that my interest in the industry was fading.
Instead of lasting until 40, I left a couple months before my 35th birthday because I negotiated a severance. The severance paid for five years of living expenses, which I translated into five years of time saved.
Leaving behind maximum earnings potential was a bummer for the first six months. But I got over it. The money you lose by retiring early will quickly be replaced with the joys of doing what you want to do.
The 50-Year Retirement Conundrum
If I made no active income after age 35, life would have been more difficult. I had about $80,000 a year in investment income coming in based on a $3 million net worth that was amassed over 13 years.
$80,000 was fine for an individual or a couple in a big city. However, it would be tight if we wanted to start a family. Therefore, we did the logical thing and waited for five years until we had generated enough passive income to take care of a child.
Thankfully, a bull market has lifted both capital values and passive income levels since I left in 2012. If you had just followed the returns of the S&P 500 since mid-2012, $3 million invested would now be worth about $10 million today, the ideal net worth amount for retirement.
However, is a ~14% compound annual return likely over the next 10 years? I think not. Further, few retirees are going to invest their entire net worth into the S&P 500.
We should probably expect lower investment returns.
Lower Investment Returns In Retirement
First of all, the historical return for the S&P 500 is about 10% a year. Therefore, why would we assume a 14% annual return into the future? We shouldn't.
After you retire, it's prudent to be more conservative in your return assumptions, not more aggressive. The last thing you want to do is have to go back to work because you have lost too much money or run out of money.
Second of all, the risk-free rate of return has come way down. Therefore, the expected real return for stocks should come down as well if the equity risk premium stays the same.
The simplified expected real return formula = risk-free rate + equity risk premium.
Finally, one could easily make the argument the equity risk premium should be lower as well. Given the opportunity cost to invest in a risk-free asset is low, investors don't require as high of an equity risk premium to take risk. Therefore, the expected real return should be even lower.
Here are some examples:
Expected Return For Stocks In 2001 = 4.5% (risk-free) + 6% (ERP) = 10.5%
Expected Return For Stocks In 2021 = 1.3% (risk-free) + 4.5% (ERP) = 5.8%
The only thing certain in the formula is the risk-free rate of return. The ERP and total expected return for stocks are academic guess work.
From this little exercise, we can make an assumption the 14% average stock market returns from when I left work in 2012 to now will likely not be repeated. We can also make a assumption the expected returns for stocks will be under the historical 10% average.
A Lower Safe Withdrawal Rate In Retirement
With lower expected returns for stocks, it is only logical to conclude your safe withdrawal rate in retirement should also decrease. By how much is debatable.
My proposal is the Financial Samurai Safe Withdrawal Rate Formula = 10-year bond yield X 80%. This way, your withdrawal rate adjusts with the times. To stay conservative, I recommend following this formula for the first two or three years of retirement.
Based on my experience of not having a paycheck since 2012, you will not be able to fully comprehend how it feels like to be retired until you are actually retired.
You may go through a series of unexpected, baffling emotions. You may doubt your decision, especially if you retire on the earlier side. The stock market could take a beating for a couple of years. Or your expense profile might rise significantly due to a medical issue or additional family members.
Because life is so unpredictable, it is prudent to be conservative for the first several years after you make your life even more unpredictable by retiring early.
Once you acclimate to retirement life, then you can start to withdraw funds more aggressively.
Flexibility Is Important For A 50-Year Retirement
The great thing about all of us is that we aren't pre-programmed robots. We are dynamic. We have the ability to change our financial habits if we want to.
After only one year into retirement, I was getting bored playing tennis and golf every day. Therefore, I decided to do some consulting at three startups for a couple years. The extra money was great as I reinvested almost all of it to generate more passive income.
After I had scratched the startup itch, I went back into retirement mode after my wife left her day job in 2015. Finally, I had someone I loved who has as much free time as me.
For two years, we aggressively traveled the world. Then our son was born in 2017 and it was back to making more money online. Our monthly healthcare bill ballooned from ~$300/month to ~$1,750/month.
Vanguard's 10-Year Stock, Bond, And Inflation Forecasts
Despite a lot of pushback about the Financial Samurai Safe Withdrawal Rate Formula, I'm pleased to say Vanguard, the behemoth money manager, agrees with the direction of my thesis.
A year after I introduced my safe withdrawal rate formula, Vanguard came out with its 10-year forecast for stocks, bonds, and inflation. Vanguard's return assumptions are much lower than the average historical returns. Have a look below.
The Vanguard Capital Markets Model has calculated only a 4.02% annual return for U.S. stocks, a 1.31% annual return for U.S. bonds, and 1.58% for inflation over the next 10 years.
If you have a portfolio mix in retirement of 60% stocks and 40% bonds, your portfolio may return just 2.93% a year if Vanguard's forecasts come true.
Therefore, if you plan to retire early with a potential 50-year retirement ahead of you, you may have to:
- Accumulate more capital before retiring – Shoot to accumulate 50X your annual expenses or more instead of just 25X annual expenses.
- Generate supplemental retirement income – Find something you love to do that also makes money through consulting, part-time work, or something entrepreneurial. It'll give you more purpose in retirement as well.
- Delay your retirement date – Each year you delay is a double benefit of saving more and having one less year of life to provide for.
- Lower your life expectancy by eating more junk food and not exercising – Not recommended.
It warms my heart that Vanguard has come out with its new forecasts. Now, when anybody wants to yell at me for being too conservative, I can just direct their vitriol towards Vanguard.
But one key lesson I've learned as an investor and a writer is to not be too forward-thinking publicly. If you don't have a strong mind, there's little upside to being ridiculed.
Will Vanguard's Forecasts For Stocks, Bonds, And Inflation Come True?
Only time will tell whether Vanguard's forecasts come true or not. Personally, I feel Vanguard's forecasts are a bit too conservative. I expect closer to a 6.5% return for U.S. stocks, a 2.7% return for U.S. bonds, and a 2.3% inflation rate. However, other money management firms like Goldman Sachs and Bank America have all lowered their future return assumptions.
Let's check back in 10 years and see who was more right. So far, the bear market in 2022 has argued towards expecting lower returns going forward. In the meantime, we can run a simple simulation to see how Vanguard's forecasts could be right.
For example, let's say you invested $100,000 in stocks. A 4.02% compound return for 10 years would mean you'd end up with $148,309. Not bad if inflation is truly only 1.58% a year.
There are many ways to get to $148,309 in 10 years.
One way is to experience a 10% compound annual return for nine years. Your portfolio will have grown to $235,794. Then in the 10th year, your 100% S&P 500 portfolio experiences a 59% crash after the Taliban start World War III.
Another way is to experience a 7% compound annual return for three years to $119,101. In the fourth year, your portfolio experiences a 10% correction that brings its value down to $107,191. Then over the next six years, your portfolio compounds at 5.6% a year to get to $148,309.
In other words, when you see expected return forecasts, don't think linearly. Think dynamically. Stocks correct by 10%+ every couple of years. Meanwhile, we've experienced two 30%+ corrections within one year since 2007.
Your Chance Of Not Running Out Of Money With A 50-Year Retirement
One of your main goals in retirement is to never run out of money. Therefore, it’s much better to die with a little too much than a little too little.
The Trinity Study confirms the work done by William Bengen, showing that a 4% withdrawal rate, over a 30–year retirement horizon, with a 50%/50% mix of stocks and bonds was 100% successful.
But remember, back in the 1990s when the 4% rule was popularized, returns for stocks and bonds were much higher. The risk-free rate of return was between 5% – 6%, so of course, withdrawing at 4% meant you'd probably never run out of money.
Today, the Vanguard Capital Market Model calculates an 82% chance of success with a 30-year retirement. The main reason is due to its lower expected returns for stocks and bonds.
However, if you are a FIRE investor with a 50-year retirement horizon, the VCCM estimates only a 36% chance of success.
Increase Your Chances Of Retirement Success
A 36% chance of success is terrible if we're talking about running out of money in old age. On the other hand, waiting for a 100% success rate seems too conservative.
The right percentage success rate before you retire will depend on your risk tolerance and your ability to generate more income and cut costs if needed.
Personally, I felt like I needed to have at least a 70% chance of success in order to leave my multiple six-figure job behind. If I failed at retirement, I would simply get another job after two or three years.
When I finally left work behind, I felt I had a 80% chance everything would work out. The severance package that provided five years of normal living expenses was the key. Without it, I would have kept on working until age 40.
Back when I left, a 50-year retirement was incomprehensible. Today, with 41 years left until age 85, it still feels like a long road that needs careful financial oversight.
Real Estate Seems Like A Better Asset Class For Retirement
If Vanguard's return assumptions for stocks and bonds holds true, then real estate may be the superior asset class for retirees.
For one, real estate investors tend to earn much higher income yields. It's common to earn high single-digit cap rates (net rental yields) in the heartland of America. Even in expensive coastal cities, cap rates of 4% are achievable.
When you then add on potential real estate price appreciation, real estate through REITs, rental properties, and private eREITs could continue to do well over the next 10 years. I expect real estate returns to average closer to 7%, which is 3% higher than Vanguard’s forecast for stocks.
As a retiree, you want steady income and lower volatility. These reasons are why I have ~40% of my net worth in real estate. If real estate can then outperform Vanguard's return assumptions for stocks and bonds, then even better.
Everybody's Retirement Lifestyle Will Be Different
I'd like everybody to take all retirement advice with a grain of MSG. Not only are people's definitions of retirement different, their actions are quite different as well.
Please be wary of any retirement advice from personal finance writers and bloggers like me. Some of us make a healthy amount of supplemental income from our freelance writing, books, and online activities. For example, this article has taken hours to write and should make me enough money to treat my family to In N' Out Burger.
Please beware of taking any retirement advice from retirement academics. All of them are still gainfully employed with big pensions waiting for them when they one day retire. Even William Bengen of the 4% rule fame has commented on this site saying he is actively working on multiple projects.
In addition, please be wary of taking any retirement advice from men who are stay-at-home dads and say they are retired but have a working spouse. Stay-at-home moms don't say they are retired when they have a working husband. Besides, being a stay-at-home parent is one of the hardest jobs in the world.
Finally, if you have children or want to start a family, taking retirement advice from a childless couple living in a one-bedroom apartment probably isn't appropriate. Children are a blessing. However, they make trying to generate enough passive income to pay for them much harder.
I'm not saying don't consider other people's retirement advice. I'm saying you must correctly “choose your fighter” to emulate and decide how you want to best live your life.
Stay Flexible With Your Retirement Plans
There will be plenty of twists and turns if you decide to retire early, especially if you have a 50-year retirement. But that's part of the fun of it all.
I'm planning on re-retiring sometime during the Biden presidency. If a bear market doesn't strike, we finally have enough investment income to care for a family of four. And if we miraculously have another child, then I will reassess retirement once again.
I'm not sure we'll be able to enjoy a 50-year retirement starting from today since we're already in our 40s. However, we sure as hell plan to enjoy as much of the remaining time we have left!
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Readers, what do you think of Vanguard's return assumptions for stocks, bonds, and inflation? With lower return assumptions, do you think it's logical to lower your safe withdrawal rate in retirement?
How would you plan for a 50-year retirement? Bank of America, BlackRock, GS, and JP Morgan also came out with their 10-year forecast for stocks. They all predict much lower than historical average returns.
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