With stock market volatility back, lower expected returns are a good possibility. Since 2009, investors have been able to make lots of money relatively easily. However, to expect double or triple-digit annual returns going forward is not wise.
In August 2020, when I came out with the Financial Samurai Safe Withdrawal Rate Formula = 80% X 10-year bond yield, I was largely ridiculed (review the 370+ comments).
As someone who went through uncertainty and doubt after I left my finance job in 2012, I encouraged new retirees to play it safe the first couple of years as they got used to change. The change can often be very jarring as you search for a new identity and adjust to a new routine.
A guest post I had written about my new safe withdrawal rate formula for another site was taken down as the host was pressured by his readers because my suggestion was too extreme. Meanwhile, another blogger called me unflattering names in his rebuttal.
I was disappointed, yet fascinated at the same time about how difficult it was for some people to think differently. As an investor and financial freedom seeker, it is always good to think about multiple scenarios.
The base case scenarios should be: Realistic, Blue Sky, Bear. From there, you can model out your finances to increase your chances of living your best life.
Lower Expected Returns Going Forward
A year after I introduced my FS Safe Withdrawal Rate formula, in August 2021, Vanguard came out with its 10-year forecast for stocks, bonds, and inflation. Essentially, Vanguard agreed with my thesis that retirees should lower their safe withdrawal rate in retirement or accumulate more capital before retiring.
The Vanguard Capital Markets Model calculated only a 4.02% annual return for U.S. stocks, a 1.31% annual return for U.S. bonds, and 1.58% for inflation over the next 10 years.
Therefore, if you have a portfolio mix in retirement of 60% stocks and 40% bonds, your portfolio may return just 2.93% a year if Vanguard’s forecasts come true.
Plenty of people, including myself, have their doubts about Vanguard’s lower expected returns forecasts going forward. The inflation forecast looks especially low during this high inflation environment.
However, during a stock market correction, I’ve noticed the rebuttals have stopped. Not only has Vanguard come out with lower expected return assumptions, so have GS, BoA, and a bunch of other investment houses.
Maybe stocks will return less than half their historical average going forward if we have one or two down years over the next 10 years. After all, a 20% return one year followed by a 10% decline the second year equals a 4% compound annual return over two years.
If the S&P 500 is down 10% for the year, maybe my safe withdrawal rate formula of 80% X the 10-year bond yield might actually be too aggressive! After all, when your $3 million retirement portfolio is down $300,000, you tend to fear it might go down further.
Therefore, withdrawing another $43,500, or 1.45%, might just feel too painful.
Things To Do In A More Difficult Return Environment
No matter how stupid you still think I am, we should agree that over the long term, our investments in stocks, real estate, and even bonds should provide positive real returns. However, we live in the short-term. And the short-term, here and now, is where plenty of unexpected things can happen.
You might think you can withstand a 35% drawdown. However, what you might not expect is losing 35% of your portfolio’s value AND being out of work for 18 months.
You might think you’ll happily live until 90 years old. However, you might not anticipate having a medical issue for you AND your aged children.
The more we can plan for suboptimal situations, the smoother our existence. Therefore, here are some things all of us should do if the Fed doesn’t save us.
1) Lower personal expectations
Happiness is about beating expectations. If you only expect a 5% return on your investments but return 8% for the year, you’re thrilled! However, if you expected a 15% return on your investments, but only returned 10%, you’re disappointed. Funny how our minds work right?
If you graduate from Harvard and pay full tuition, your expectations of doing great things will go way up. If you end up doing what every non-Harvard graduate does for a living, you might be sorely disappointed.
The key here may be to NOT believe the lower expected returns to the same degree. For example, if stocks are expected to return only 4.02% a year for the next 10 years, your 25-year-old self may want to dial back your stock exposure from 90% to 70%. Why risk so much exposure for a measly 4.02% return? Your stock portfolio could easily correct by 10% or greater.
But instead of reducing your exposure, you maintain your 90% exposure to stocks because you are young with plenty of income upside. You expect lower returns. However, you also secretly hope returns will be higher. If the returns are terrible for a year or two, you won’t be as disappointed.
2) Accumulate more capital before retiring
After accumulating 25X your annual expenses, please don’t stop or start taking it easy. 25X your annual expenses based on the inverse of the 4% rule is seriously outdated.
Instead, shoot to accumulate 50X your annual expenses or 20X your annual income. Sure, this may require you to work longer and save even more. However, make it a fun challenge. Once you’ve reached 25X your annual expenses, the incremental jump to 50X your annual expenses isn’t as difficult.
The same thing goes for reaching about $300,000 in investments, the approximate level where the feeling of financial freedom begins. Once you get to $300,000, getting to $500,000 or $1,000,000 won’t seem as daunting.
3) Generate supplemental retirement income
There is nothing more stress-relieving in retirement than generating supplemental retirement income. The extra income helps keep you busy while also erasing your doubts about your new life.
The fear of running out of money in retirement is overblown, especially the younger you retire. You will naturally gravitate towards doing something you enjoy because we all seek purpose.
If you’re still on your financial independence journey, then it behooves you to make side income to boost your investment contributions. If returns are indeed going to be lower going forward, you will need to shovel more capital to get to your target at the same time.
Consult or do something entrepreneurial. Some people actually work two jobs from home because they now can. Without Financial Samurai, I’m not sure what I would do with all my free time. It feels good to be productive.
4) Delay your target retirement date
Each year you delay retiring provides a double benefit of saving more and having one less year of expenses to provide for. Therefore, it’s like getting a two for one special. And who doesn’t like to get a good deal?
By delaying your retirement target date, you lower your expectations. When the year comes to finally take a leap of faith, you can then make a more precise decision.
Maybe you’ll discover that work isn’t so bad if you’ve only got one more year to go. Letting go of the desire to get promoted is a powerful feeling. So is working when you don’t really need to work.
Or maybe you are presented with an opportunity to get laid off with a severance. Ultimately, the severance accelerates your timetable to leave. My severance made it seem like I was leaving work behind at age 40, even though I was only 34 because it bought up six years’ worth of living expenses.
5) Boost your spending and live a little
Instead of being so conservative with your time and money, you may want to spend even more money. If your investments aren’t going to provide you solid returns going forward, then you might as well spend more of it on living a better life today.
With lower expected returns, your opportunity cost of spending money has declined. The Porsche 911 you’ve been eyeing while driving a Honda Fit all these years… go for it! The first-class seats you walk by on your way to an economy class seat that doesn’t recline next to the toilet…. time to live larger!
Aggressively find ways to spend your money before the stock market flushes your gains away. There is a great logic to spending more money during bad times to help make bad times better. It’s during good times when you want to invest more so you can potentially make even more money.
Personally, I’ve decided to permanently boost my spending by 20% starting this year. It’ll be a challenge, given over two decades of frugality. But gosh darn it, money is meant to be spent!
The Best Insurance Policy Against Poor Investment Returns
Losing lots of money in your investments feels bad. I get it. But the best way to feel better is by living a good life.
If you’ve got no friends in real life, no family, work a crap job, and spend lots of time venting on social media, you’re going to really feel it when your investments take a hit. Your self-worth is too wrapped up in your money.
But if your life is diversified with meaning, then I dare say you’ll start looking at ANY investment returns as a bonus. Your awesome job you never want to quit is already providing you the money you need to live a comfortable life. Your friends and family you wouldn’t trade for the world trump any amount of investment loss.
Find ways to use your money to improve the quality of your life. And if you can’t, there are a plethora of free things you can do to live well. I’m now off to go for a stroller walk and to play some tennis now. How about you?
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