Last night I had the opportunity to co-host a webinar with Jess from the award-winning blog The Fioneers. We had a fun conversation centered around the question: Am I still Coast FI even if the market is down?
I’ll share a recording when it’s ready, but in the meantime, here’s a recap in case you weren’t able to attend.
Am I still Coast FI even if the market is down?
With markets down 15 to 20% off all-time highs, people have been worried about what this could mean for their Coast FI plans.
At a high level, here’s what I think:
The further you are from withdrawing, the less this downturn impacts you.
Now that’s not to say you can’t feel nervous or upset about the current market conditions—those are normal emotions to have right now. Instead, it’s to say, the further you are from withdrawing, the less this downturn affects your Coast FI plans.
Zooming in, there are 3 things that are important to understand:
1. Bear markets are normal.
A lot of the projections we use in the financial independence community are built around the 4% rule.
That rule is the result of a large body of research that aims to answer one simple question: how much can you withdraw from your portfolio every year without running out of money? And fortunately, the 4% rule accounts for bear markets, recessions, and depressions. In other words—this is all baked into the plan. That doesn’t mean it doesn’t feel scary right now, but it does mean that this is normal, and your financial independence plan is accounting for downturns just like this.
2. Feeling bad about bear markets is normal.
All that said, it’s a perfectly rational response to feel cruddy about a market downturn.
Nobody likes to see their portfolio value drop, especially by double-digit percentages. But, feeling bad about your portfolio doesn’t mean that your plan is shot. Instead, it means that investing can be a bit of an emotional roller-coaster ride.
Hopefully, by realizing that these are normal emotions, we can separate our feelings of fear and nervousness from this thought or idea that our plan must be in trouble or we must take action to ‘fix’ our plan.
For most, your plan is still on track, this is a normal downturn, and no action is needed. But, that brings me to the final point to consider: there is a group of people that may be at risk.
3. Sequence of return risk is a legitimate concern.
During a market downturn, there’s one group of people that may be at true risk of negatively impacting their financial plan: new or soon-to-be retirees.
That’s anyone who’s just retiring or will be retiring soon, and the risk they face is called sequence of return risk. Simply put, sequence of return risk is the risk that the market tanks during your first couple years of withdrawing from your portfolio, forcing you to take larger than desired withdrawals as a percentage of your portfolio.
This can have a long-term negative impact on your portfolio and put you at risk of outliving your money.
To use an example, imagine you were planning to retire this year with a $1,000,000 portfolio. Using the 4% rule, you calculate you can withdraw $40,000 per year without running out of money during retirement. But, imagine the market takes a steep dive, dropping 30% off all-time highs. Now, your $1 million has become $700,000 and your $40,000 withdrawal is 5.7% of your portfolio ($40,000 / $700,000).
If you continue with this withdrawal, it has the potential to negatively impact your portfolio for the rest of your retirement, and it’s possible your portfolio may never fully recover.
But don’t worry, there are some powerful steps you can take to mitigate sequence of return risk:
First, lean into flexibility by having a contingency plan.
I think as coasters our superpower is flexibility. Many of us have taken an unconventional career path, choosing to dial down our work in exchange for freedom and flexibility now. So, if you’re approaching retirement during a downturn, consider leaning into flexibility a bit more.
For some, that could mean continuing to work part-time or as a freelancer for a few years, earning some additional income to offset your initial retirement withdrawals. Or, that could mean decreasing your expenses for a few years as you limit the withdrawals on your portfolio. This is when it can be important to know your barebones budget—the amount of money you would need each month to sustain your bare necessities if you wanted to reduce your spending.
Whatever you decide, remember that a little bit of flexibility can have a massive impact on your probability of a successful and healthy retirement.
Second, build a big pile of cash.
In the financial planning community, many planners recommend having 2+ years of living expenses saved in cash when you retire. This can be a powerful way to limit sequence of return risk because if the market is down you can simply live off cash reserves instead of withdrawing from your portfolio.
Third, downshift your portfolio risk by holding more bonds.
Lastly, as you approach retirement it can be wise to downshift your portfolio risk by increasing the amount of bonds in your portfolio. This can be a great way to limit the impact of a downturn on your portfolio because bonds typically don’t experience the same volatile swings as stocks. So if the market is down 20 to 30%, that will only affect the part of your portfolio that’s in stocks.
Now, asset allocation is one of the most personal things in finance because the right portfolio for you may not be the right portfolio for someone else. That’s because your asset allocation (the mix of stocks to bonds you should have) is based on your unique risk tolerance. And your risk tolerance is going to be a combination of your personal appetite for risk and your time horizon.
All that said, as a rule of thumb, a standard retiree portfolio is roughly 60% stocks and 40% bonds. That may not be perfect for you, but it can at least offer a benchmark to compare against.
In the end, I think you can feel confident that the further you are from withdrawing from your portfolio, the less of an impact this downturn has on your Coast FI plans. You’re still good to coast, and the math accounts for moments like this. But, if you’re near or approaching retirement, sequence of return risk is a legitimate concern and there are steps you can take to insulate yourself from that risk.
If you have any specific follow-up questions feel free to drop a comment below or send me an email, and if you were able to make it to the webinar I hope it was valuable!