Early in my blogging days I struck up an email friendship with a fellow financial writer named John.
John had an email list that he would send newsletters about personal finance, investing and retirement planning. We shared ideas and he shared some of my blog posts with his email list.
I was particularly interested in John’s own retirement plan since he called it quits at the absolute worst time to retire in the past 90 years or so — the spring of 2000 at the height of the dot-com bubble.
He shared with me a long piece he wrote about how he and his wife, Elyse, survived an unlucky retirement timing from a sequence of return perspective. I wrote a blog post outlining the strategy a number of years ago but John’s piece went into far more detail and I still receive requests to this day asking for the extended version.
Sadly, John’s wife informed me that he passed away suddenly in 2022. He had a knack for educating people of all ages so I wanted to share his extended thoughts to show how his retirement plan worked in practice.
I’m not suggesting everyone should rely on a similar strategy but find it helpful to see how real people deal with all of the uncertainties surrounding retirement planning.
Here’s John’s explanation of how they survived some very bad luck in retirement:
I retired on April 1, 2000 and my wife, Elyse, retired one month later. At that time we went from being wage earners contributing to our retirement plans to being retirees living on funds earned by and withdrawn from our retirement accounts. Fortunately we had been saving and investing since the 1960s, so from a financial perspective we were ready for retirement.
Just as we retired the stock market began a very choppy mostly down period during which it dropped more than 40%. That downturn lasted until October, 2002. It was caused by the bursting of the dot-com bubble, the tragedies of 9/11/2001, and the financial collapse of Enron in November 2001. However, because we had four years of living expenses cash reserve in place, we were prepared for a down stock market and never sold any shares of our stock index mutual funds at low share prices while the market was down.
Again, in the fall of 2007, after rising significantly for five years, the stock market stalled and then in 2008, under the weight of the bursting of the housing bubble and the collapsing of several very large investment banks plus other banks that held what became almost worthless mortgage backed securities the downturn accelerated and the U. S. economy headed into the worst recession since the Great Depression of the 1930s. The stock market dropped over 50% during 2008 through March of 2009.
As was true for us during the earlier downturn period — we never had to sell a share of our stock index mutual funds at the low prices. The market started rising again in the spring of 2009.
With the above as background I now pass on to you how we not only survived those severe down market periods, but also completely recovered from them with our net worth intact and essentially unchanged or somewhat higher than it was before the downturns occurred by following a relatively simple strategy. I have not written about this strategy until now because I wanted to test it twice to see that it really worked. It did work for us both times, so I have confidence in it and am glad to pass it along and recommend it to others.
Please note that what I say below is based on the following two key assumptions about the stock market.
- MAJOR STOCK MARKET DOWNTURNS LAST FROM 8 TO 24 MONTHS (AVERAGE LENGTH IS 16 MONTHS).
- MAJOR STOCK MARKET UPTURNS LAST 4 TO 8 YEARS (AVERAGE IS 5 TO 6 YEARS) AND THE MARKET RISES FASTER DURING THE FIRST TWO YEARS OF AN UPTURN.
Please note that when I say “replenish” the cash reserve for living expenses below, I mean exchange shares of the stock mutual funds within your retirement plan for shares of money market funds or for CDs within that same plan. To accomplish this, sell some of your shares of the stock mutual funds and use the proceeds of those sales to buy money market fund shares or CDs. I do not mean you are contributing additional money to your retirement plan.
The Strategy:
1. Five years before retiring start to accumulate a cash reserve (money market funds, CDs, etc.) within your retirement plan if possible (to defer taxes on interest). Your goal should be to accumulate four years of living expenses, net of any pension and Social Security income you will receive, by your retirement date. For example, if your total living expenses, including income taxes paid to the IRS, will be $84,000 a year and you and your spouse will receive a total of $36,000 a year from pensions and Social Security, subtract the $36,000 from $84,000 to determine your annual additional living expense requirement, which in this example would be $48,000. Your four year cash reserve requirement at retirement would be 4 x $48,000 for a total of $192,000.
2. When you retire, your portfolio should consist of your four year cash reserve plus stock mutual funds allocated appropriately. Then, if the stock market is up or relatively close to its historical high level take your withdrawals for living expenses only from your stock mutual funds, and continue to do so as long as the market remains relatively steady or continues to rise. Do not react to short-term minor fluctuations up or down. As you do this, be sure to keep your allocation percentages more or less at your desired levels by drawing down different stock mutual funds from time to time. On the other hand, if the market is down significantly from its historical high levels or is falling fast when you retire, take your withdrawals for living expenses from your four years of cash reserves.
3. In the event you are taking withdrawals from your four year cash reserve due to being in a severe, long-term falling market, when the market turns up again, continue taking your withdrawals from the cash reserve for an additional 18 months to two years to allow the market to rise significantly (the market almost always rises fast during the first two years of an up market period) before switching back to taking withdrawals from your stock mutual funds. Then return to living off of your stock mutual funds and also start to ratably replenish (over a period of 18 months to two years) your now significantly drawn-down cash reserve in order to bring it back up to its required level. Once the cash reserve is fully replenished you are ready for the next severe market downturn when it inevitably occurs.
So how did following that strategy work for Elyse and me?
1. In 1995, five years before we planned to retire, we started to ratably build a cash reserve consisting mainly of money market funds in our retirement accounts. The goal was to create the 4 years of living expenses after taking into account our income from pension and Social Security benefits. We accomplished this by putting all of our contributions into our retirement accounts in money market funds plus exchanging some of our stock index mutual funds into money market funds so that we built the reserve by 20% a year until we reached our goal at the end of 1999.
2. When the severe market downturn started in the spring of 2000, we continued selling shares in the stock index mutual funds for some months until it became clear that the market was going to continue to fall for a long time to come. At that point we stopped living off the stock index funds and started living off the money in our money market funds. We continued withdrawing from the money market funds not only for the balance of the downturn (it ended in October 2002) but also for an additional 24 months after it ended.
Starting in late 2004, after the market had risen significantly for two years, we reverted to living off money from our stock index funds plus we went on a two year program to replenish the money market funds we had drawn down so we would again have our four year cash reserve fully funded before the next market downturn.
Based on the assumption above regarding the market rising fast during the first two years of an upturn, we waited for 24 months (from October 2002 until October 2004) before starting to again live off of our stock index mutual funds and started to replenish our cash reserve. That turned out to be a good decision because after the 2000-2002 downturn the market rose more than 28% in 2003 and more than 10% in 2004 – almost 40% during that 24 month period.
By continuing to withdraw from our cash reserve during that two year fast-rising-market-period following the end of the downturn, we were able to start replenishing our cash reserve by selling stock mutual fund shares at much higher prices than we would have if we had started right after the market turned higher late in 2002. Our cash for living expenses reserve was back at the four year level by the end of December of 2006.
3. We did the same thing again when the market collapsed during 2008, dropping over 50% by early March, 2009. As the market fell severely, we withdrew funds only from our cash reserve and continued to do so throughout 2009 (after the upturn began) and 2010. The market rose over 40% from spring 2009 through all of 2010. Then, in 2011, we switched back to living off the stock mutual funds and ratably replenishing the cash reserve, with the goal of having it completely full by September 2012.
There is art as well as science involved in initially building and later, after drawing on it during a severe down market period, replenishing the cash reserve for living expenses. For example:
Initial cash reserve build. Back in the 1995, five years before we planned to retire, when we initially went on a program to create our four year cash reserve, we were in the midst of a roaring bull stock market that showed no signs of slowing down. That being the case, each year, starting in 1995, we contributed to money market funds and exchanged enough stock mutual fund shares for money market fund shares in our retirement accounts to fund 20% of our total four year reserve requirement.
Under different market conditions – a falling or fallen and now stagnant stock market – we would have started to build the cash reserve by having our contributions to our retirement plans go into just money market funds and we would not have exchanged stock index mutual fund shares for money market fund shares. Later on, once the market turned and rose again, we would have augmented those plan contributions to money market funds with additional funds by exchanging some stock index mutual fund shares for money market fund shares within the plan. Some judgment and a sense of how the economy is doing (getting better or getting worse) is required when doing this if one is to achieve good results.
Replenishing during volatile periods. From August 2011 through the end of that year the rising stock market was severely disrupted due to political conflict over extending the debt ceiling causing the market to fall a great deal very rapidly. In response we temporarily stopped replenishing the cash reserve and started drawing from it again for several months. We did that until the market calmed down and returned to its pre-August level at which time we switched back to drawing from our stock index funds and to replenishing our cash reserve.
Because we had stopped the replenishment process for several months, when we started it again, in order to meet our goal of it being fully funded by the end of September, 2012 we had to increase the monthly replenishment amount significantly starting early in 2012.
One final thought — I think the cash for living expenses reserve strategy is better than other strategies recommended by many financial gurus because it DOES NOT encourage you to sell stocks early in a stock market upturn period. It also bases the amount you put in the reserve on an actual calculation of what you will need to meet your living expenses rather than some nebulous rule of thumb that may be irrelevant given your particular financial circumstances. It also enables you to keep a larger percentage of your portfolio in stock mutual funds and therefore, over the long term, likely increases the total return on your portfolio.
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I’m a fan of case studies like this because it’s a real world example not just some theoretical exercise. Other retirement spending plans can work but I like how simple this one is.
We answered a question about the 4 year rule on the latest edition of Ask the Compound:
We also covered questions about my personal stock-picking strategy (or lack thereof), buy-now-pay-later spending strategies, playing catch-up on retirement savings after screwing around in your 20s and how return stacking works, with some help from Corey Hoffstein.
Further Reading:
Why the 4% Rule is More Like the 2% Rule
