Retirement is a bet: Will your assets be enough to pay for a comfortable life until you take your last breath? Such a bet comes with risk, and the risk is higher if you retire early. There are just more years to cover, which could come with some unforeseen surprises.
I am writing this at the end of March 2020. This time will likely be known as the time when the coronavirus COVID-19 became a major health and economic crisis. Stocks have dropped around 30% during a month, while the number of infections is still increasing exponentially in the US. States are announcing massive investment programs, but it is unclear if those come in time to save small and mid-sized companies. In short, this could result in a major economic downturn.
Retirement is a risk
Frankly, I am happy that I am not retired right now. I have a steady income that I can use to invest in stocks a bit more than usual. Being retired would mean two things:
- Selling stocks to pay the bills would be a major hit to the principle, which is the amount of money you have invested.
- My pension from the state or insurance would become less secure, and potentially it would increase less during the next few years.
So what should you do? Again, I suggest two things:
- Get a very good understanding of how stocks should be divested during retirement. Make a plan for this and start executing the plan before you retire. I have mentioned the bucket strategy in my post Investment strategy for early retirement. I found this detailed description of a particular bucket strategy quite inspiring. The basic idea is to only sell stocks when they perform well. And once we sell stocks, we fill buckets that contain safer investments like bonds or cash. Those safer buckets should keep us afloat during bad years. And chances are very high that they will get refilled by a good year before they get depleted.
- Keep a good margin. The past 70 years have been very stable in the western world. It is probably foolish to assume this stability will just continue. The coronavirus has the potential to become a major crisis. (I hope I will have to remove that sentence in a few months!) We are more vulnerable to crises after retirement because we rely on people, companies, and states to pay back their debt. Therefore, it is probably wise not to tailor our retirement plans too tight. If you go by the 4% rule, make it 3.5% instead…
You might say there is a third way of reducing risk: Keeping the option to start working again. I think this is a good idea in general. The question is if it can be a reliable plan. If you follow my reasoning, you will move to a less work-friendly place to retire. That alone will make it more difficult to get a job again. Plus, your skills might be a bit rusty and increasingly outdated after some years of retirement. I think there is a clear benefit in keeping an income after retirement, or at least an option. However, I would personally not want to rely on that income.
In summary, be aware that retiring is a risk and that early retirement increases that risk due to longer exposure. You can reduce the risk as I described. In the end, you should get a good understanding of the risk of your particular retirement plan. If it feels too risky, change the plan so you can sleep well.