If you're thinking about retiring, it's better to retire in a bear market than in a bull market. I've been “fake retired” since 2012 and I want to explain why this is so.
I put fake retired in quotes because these posts don't write themselves. My podcasts don't record themselves either. I also did some fintech consulting work for several years since I left my day job in finance.
Living a comfortable retirement life is all about managing expectations. You generally don't need as much as you think to be happy because the freedom you gain more than makes up for lost income.
However, if you retire at the top of a bull market, and don't change your risk profile, you might get screwed. The day you retire will be about as good as it gets.
If you retire at the bottom of a bear market, even if you change your risk profile to be conservative, your financial days will likely only get better. A recovery makes retirement living so much easier.
No matter how good we get at forecasting the future, we tend to extrapolate too positively for too long when times are good. While those who retire in a bear market will likely forecast lower returns than reality.
Better To Retire In A Bear Market
Here's why it's better to retire in a bear market. Although 2022 was a terrible year for risk assets, it was a wonderful case study in retiring in a bear market.
Let's say you retired with $3 million in after-tax investments in 2010, near the bottom of a bear market. You're a real millionaire. $3 million excludes the equity in your primary residence. However, you had closer to $3.8 million before the financial crisis hit. But you've decided you have enough to be happy.
Your $3 million is spitting out a comfortable $120,000 in gross passive income each year. 50% of your $3 million is in real estate while the other 50% is in a 50/50 stock and bond portfolio.
After tax, your $120,000 turns into $100,000 and you only spend $70,000 because you're not 100% sure you'll be able to stay retired. Besides, when you have no mortgage and no kids to support, $70,000 a year is more than enough, even in a high cost of living city.
Slow Recovery, Steady Portfolio Rebound
Instead of earning a 10%+ return a year as the S&P has done since 2010, you have only been able to earn a 6% return given your more conservative stock portfolio and lower leverage in your real estate portfolio.
After 6 years at a 6% compound rate of return with $30,000 a year in savings, your $3 million portfolio grows to $4,800,000. Applying the same 4% withdrawal rate, you're now able to comfortably earn or withdraw $192,000 a year in gross passive income.
After tax, the $192,000 turns into about $155,000, which means if you stick with your $70,000 a year budget, you can now save $85,000 a year instead of just $30,000.
Clearly, it's time for you to get more conservative with your investments because your after-tax passive income is 2X your budget. Meanwhile, your net worth is almost 70X your annual after-tax expenses.
Retiring During A Raging Bull Market
Let's say you've decided to retire with $3 million after 10 years of up, up, up in the S&P 500 and real estate market where you own a couple rental properties. 70% of your $3 million is in a 60/40 stock/bond portfolio.
Your portfolio also spits out a comfortable $120,000 a year in gross passive income or $100,000 net passive income. You forecast you'll earn at least $120,000 a year in gross passive income for the next 10 years because you believe your investments will grow by at least 3%, the current risk-free rate of return.
It's important for you to continue earning $120,000 gross/$100,000 net in order to maintain your retirement lifestyle and pay for your 8th grader's college tuition.
Your expenses are a little higher than the previous example at $90,000 a year versus $70,000 a year as a result. But at least you still have a $10,000 a year cash flow buffer, which equals 11.1% of your annual after-tax spend.
Then The Correction Comes
Let's say within six months after you retire, the S&P 500 corrects by 10%. The only way you could have earned 3% is if you invested 100% of your $3 million in to 10-year treasury bonds. But you didn't with a 60/40 equity/fixed income portfolio.
Meanwhile, a tenant vacates and one of your rentals is left empty for four months before you can find a tenant for 10% less than the previous rent. Your after-tax investments are now worth about $2.7 million.
At a 4% withdrawal rate, your $2.7 million portfolio can only produce about $108,000 in gross passive income, or about $88,000 a year after tax. No longer do you have a $10,000 a year cash flow buffer, you've now got a $2,000 annual deficit.
But 10% is only considered a correction, not a bear market, so let's keep going. After tightening up spending to $78,000 from $90,000 since you always want to save $10,000 a year, the S&P 500 and real estate market keep correcting by another 10%. Down 20% is officially the start of a bear market. Your $2.7 million now shrinks to $2.43 million.
The Downward Spiral Continues In A Bear Market
At a 4% withdrawal rate, your $2.43 million portfolio can only produce $97,200 a year in gross passive income, or about $80,000 after tax. Now your lifestyle is really getting crunched. You start to wonder whether the declines will ever end.
Retiring near the top of a bull market is one of the worst times to retire. After you retire, you face nothing but downside risk for 13-15 months, the average length of a bear market.
But of course, a 20% decline in the stock market and real estate market isn't uncommon. For good measure, let's model in another 10% decline. Now your $2.43 million portfolio shrinks to $2.18 million, meaning it can only generate about $87,000 gross or $71,000 in net passive income.
With a $70,000 a year college bill (tuition, room, board, transportation, books) just a year away, there is really no choice but to go back to work, do part-time work, or draw down principle. No matter how frugal you get, it's not enough.
One of the main reasons why so many people have a difficult time retiring is due to fear. Fear is one of the main ingredients necessary for achieving financial independence. But if there is too much fear, then the one more year syndrome shows up over and over again.
Retiring During Times Of Uncertainty
When I left work in early 2012, the S&P 500 had recovered about 70% of its losses from the financial crisis. The real estate market was still in the dumps, so I still had concerns we'd relapse into a recession.
We were neither in a bull market or a bear market. We had recovered from the 2009 lows, but there still wasn't strong conviction about the market or the economy yet.
Instead of going naked long, I used 100% of my severance check to buy a DJIA structured note that provided principal protection in exchange for only receiving a 0.5% annual dividend yield. The note offered 100% upside participation of the DJIA over the next six years.
Not only did the S&P 500 do well since 2012, the San Francisco real estate market also began to recover as well. In fact, both stocks and real estate reached record highs in 2021.
Only a fool would be unable to stay comfortably retired if they left work in 2012. Luckily I ain't no fool. But I did get very lucky as real estate and stocks have done extraordinarily well since.
Conservative Investor In Retirement
If you read the FS archives, you'll know I've been relatively conservative with my public investment portfolio since 2012. I believe this is the ideal retirement scenario for returns.
I've written my goal in retirement is to shoot for a return equal to 3X the risk-free rate of return. In other words, if the 10-year bond yield is at 3%, I am looking for a 9% return on my portfolio.
With a 4% – 6% annual target, I never went beyond a 75% equity weighting in my portfolio since 2012. Further, a large part of my equity investments were in structured notes that had downside protection with sometimes capped upside and sometimes leveraged upside like the one here.
My goal was to try and sleep as soundly each night without letting investing FOMO get the best of me. Investing FOMO is what crushed a lot of cryptocurrency investors after the collapse of FTX, the formerly second-largest crypto exchange.
With an average synthetic equity weighting of around 70% since 2012, my public investment portfolio ended up returning closer to 8.6% compounded. With $0 contribution, my public investment portfolio would be 65% more than I was already comfortable living on.
But since 2012, several other fortuitous things happened:
1) Bought and remodeled a ocean view fixer in 2014 that is up about 40% based on a comp that just sold last month. At the time, a large CD came due so I took some risk and leveraged up another $1,000,000.
2) Held onto my previous primary residence that I tried to sell in 2012. By holding it until mid-2017, it grew at a compound return of 11.3%. Since the property was 55% leveraged on average, the cash on cash return was closer to 23% a year for five years.
3) Stayed consistent writing on Financial Samurai 3X a week. As a result, Financial Samurai has grown at a faster clip than the property I sold.
All of these investments have been heavily boosted by a bull market since I left work. I was lucky the real estate market continued to perform well after I took on more debt. Otherwise, I'd be feeling the heat. I wouldn't have been able to sell the PITA property I had in 2017 at the price I got.
Given my content is more measured since I've written extensively about the dot bomb period and the 2008-2009 financial crisis, maybe FS would attract more readers during slow times compared to sites that only discussed the good times.
Experience matters during downturns. Further, sales for my severance negotiation book have ticked up as layoffs increase.
A Bear Market Is Still Risky For Retirees
If a bear market hit within two years after I left work in 2012, I'd give myself an 80% chance that I would have aggressively tried to find a full-time job again. The pain of losing money in retirement would simply be too much to sit idle. At the very least, I'd consult for some fintech companies part-time.
A bear market would have crushed my hopes of being a stay at home parent no doubt. Maybe our son would have never come because we'd be too stressed out about losing so much money after leveraging up with neither of us having any jobs!
Please realize your financial independence number is not real if nothing changes in your life after achieving it. Only if you take action to improve a suboptimal part of your life can you truly call yourself financially free.
Don't Get Too Greedy With Your Finances
If you are close to financial independence or were able to retire, it's not worth taking excess risk when you could potentially lose a lot of time and money. If you invest in funny money assets, as opposed to real assets, like stocks, you could easily lost of money.
Please do not forecast the good times will last forever. You've got to bake in some flat or negative returns when you do your retirement modeling.
You must always stay on top of your risk exposure. If you can continuously save in retirement while doing something to keep you active that makes money, all the better.
If you can retire in a bear market, then your finances will have been thoroughly battle tested. Therefore, you can likely remain retired forever. Besides, when times are bad, it's easier to leave things behind.
A Silver Lining Of A High Inflation Environment
The one silver lining about a bear market due to aggressive rate hikes is that it's easier to generate more passive income. With higher interest rates, risk-free assets like Treasury bonds offer higher yields.
Personally, I've been able to boost my passive investment income by about 10% thanks to the 2022 bear market. I've bought Treasury bonds and am seeing my rents go up as well. When the bull market returns, asset value increases should more than make up for any decline in risk-free income.
In a scenario where you have so much money it doesn’t matter when you retire, then feel free to leave whenever you want.
Generate Retirement Income Through Real Estate
Real estate is my favorite way to generate retirement income. It is a tangible asset that is less volatile, provides utility, and rises with inflation. By the time I was 30, I had bought two properties in San Francisco and one property in Lake Tahoe. These properties now provide about $150,000 in retirement income.
In 2016, I started diversifying into heartland real estate to take advantage of lower valuations and higher cap rates. I did so by investing $810,000 with real estate crowdfunding platforms. With interest rates down, the value of cash flow is up. Further, the pandemic has made working from home more common.
Take a look at my two favorite real estate crowdfunding platforms. They are free to sign up and explore.
Fundrise: A way for accredited and non-accredited investors to diversify into real estate through private eFunds. Fundrise has been around since 2012 and has consistently generated steady returns, no matter what the stock market is doing. For most people, investing in a diversified eREIT is the way to go.
CrowdStreet: A way for accredited investors to invest in individual real estate opportunities mostly in 18-hour cities. 18-hour cities are secondary cities with lower valuations and higher rental yields. Due to strong demographic trends, 18-hour cities potentially have more upside. If you have a lot more capital, you can build you own diversified real estate portfolio.
Recommendation To Protect Your Wealth
If you retire in a bear market, you need to be all over your finances. Sign up for Empower, the web’s #1 free wealth management tool to get a clear overview of your investments.
Empower clearly shows how your net worth is allocated. It can also help you get a better handle on your retirement cash flow needs. The more you can stay on top of your finances, the better you can optimize your wealth.
Why It's Better To Retire In A Bear Market is a Financial Samurai original post. I've been writing about FIRE since 2009.