I bet you fear running out of money. It is a common fear, especially for the early retiree. Let’s suppose you retired early. You love it more than you thought. You have time to read, sleep, workout, make friends, enjoy hobbies and to spend time with your family members while they are awake.
But you have no paycheck coming in. Is that ok? Are you spending too much? What if there is a big stock market crash? Does the thought of this cause your anxiety level to spike? Being on a limited fixed income can be scary. To make your money last decades takes a big chunk of equity in your portfolio. But in market declines much of that equity can disappear before your eyes.
Darrow Kirkpatrick, author of Can I Retire Yet? retired at age 50. He has thought deeply about this issue. The first question is how do you know there is trouble on the horizon. How do you know when you are spending too much of your portfolio? There are four indicators of possible trouble on the horizon.
Trouble is Brewing
Trouble Indicator #1
Being forced to sell at a loss. If you are having to sell shares at a value less than you paid for them, trouble is likely lurking.
Trouble Indicator #2
Withdrawal rate >5%. A withdrawal rate of 3-4% may be sustainable for decades but 5% or more will likely not be. If that is the rate you require to cover your expenses, that isn’t a good sign.
Trouble Indicator #3
High market valuations. While in the accumulation stage, market fluctuations have little impact. If anything, a market decline can be a good thing since it is an opportunity to pick up shares at an affordable price. When you are living off a portfolio, market decline is something else altogether.
One measure of market value is Shiller’s CAPE. The Cyclically Adjusted Price-to-Earnings ratio can be tracked at Multpl.com. Historically it runs in the 15 – 20 range, depending on the reference time-frame. If the CAPE is greater than its historical average, a market decline might come soon.
Trouble Indicator #4
Jim Otar, in his book Unveiling the Retirement Myth, wrote about the “Fourth-Year Check-Up.” Otar analyzed portfolios using historical data back to 1900. He compared values at year 4 and year 20. Portfolios that were winners at year 4 were winners in the long term as well.
To use this tool, do a spot check on the fourth anniversary of your retirement. Compare your portfolio value to when you first retired. Ask the simple question, “Is it now worth more than 4 years ago?” If it is worth less now, the SoR (Sequence of Returns) may be working against you. You are likely to run out of money unless you change something.
If you are an early retiree, you need a financial fuel gauge to monitor if you are doing okay. The four “trouble indicator” lights should serve that purpose well.
The Fear is Real
So what if your suspicions are confirmed and trouble is brewing. In that scenario your fear of running out of money is justified. Can anything be done about it? Kirkpatrick in his book, “Can I Retire Yet?” explained that without adequate savings, a frugal lifestyle, and regular financial/portfolio checkups, running out of money is a very real possibility.
At its simplest level, there are two ways to approach the problem. One is to reduce expenses. The other is to increase income. And of course, doing both would be best.
Reducing expenses is a solution that is most under our control. Mr. Kirkpatrick recommends reducing expenses prior to retiring early. That way you have a paycheck coming in and can adjust accordingly. Voluntarily living a more modest lifestyle is much more pleasant than being forced to change later in retirement.
There are many ways to increase income. One is to continue working or to start working again – full time or part-time. Early retirees always have the option of working for money in some capacity. You can also attempt to increase your investment return from your savings. This is an option particularly if you are very conservatively invested with a large portion of cash, CDs, short-term bonds etc. Of course, demanding a higher return from your portfolio will introduce new risks as evidenced by increased volatility or possibly a large drawdown at some point.
He also talks about “Lifeboat Strategies.” They can give you an action plan to continue living a comfortable life.
Steps to Avoid Running Out of Money
Cut Discretionary Spending
Many of us have a recreational budget that accounts for about 20% of our spending. This includes dining out, entertainment, travel, etc. If times are tough financially we can live without these for a time. We could make excellent, healthy, and tasty meals at home instead of going out. Amazon Prime would allow us to watch shows and movies at minimal cost. Low cost or free recreation options abound and include hiking, cycling, climbing, swimming, and camping.
Another expense strategy would be to downsize your house. Shelter tends to be one of our larger expenses. If you have a large house you may be able to downsize to a smaller house. If you are already in a small house you may be able to downsize to a townhouse, condo, apartment, or recreational vehicle.
For example, if your house is worth half a million and you look around and find a nice 2 Bedroom place near downtown for $200,000 you could invest the difference which is $300,000. Using a 4% withdrawal rate would result in $1,000 of extra monthly income.
You can safely increase your retirement income by purchasing a single premium immediate fixed annuity (SPIA). This generates higher cash flow than you would get from comparable investments. This also guarantees you will not outlive your income stream since the annuity payments are guaranteed for life. You may find that your bond fund is yielding only 3% but a comparable amount in a fixed annuity may yield closer to 6%.
If you own a house and have significant equity in your house (small or no mortgage against the property) then you may consider a reverse mortgage. This financial tool lets you generate income from your home equity that is guaranteed for life if you stay in your home. You will also never owe more on the loan than the value of your home.
Be sure to understand the costs and complexities associated with reverse mortgages. Nevertheless, it can be a predictable income stream and is particularly helpful for those who are “house poor.” Don’t forget the option of downsizing though. It may be a simpler and potentially more cost-effective way of cashing in on your home equity.
It is not unusual that one can double or even triple their available monthly cash flow by combining these tools such as annuitizing plus using a reverse mortgage. By having some assets and choosing to give up some control over the principal, you can significantly boost your retirement income.
The fear of running out of money can keep us vigilant. As long as we know the warning signs and take action accordingly, our money will continue to flow. What about you? Are you retired? Do you fear becoming broke? Does fear of running out of money keep you working longer than you would like?