This means that simple models like “a portfolio averaging 7% per year” don’t represent reality well at all. If you lose 30% in the first year, you have a much worse outcome than if you lose 30% in the 15th year. If you do this a bit, you’ll figure out quickly that the order of the good years and bad years matters. For instance, how would the portfolio have done if you retired in 1970? 1952? 1929? (Gulp!) How long would it have lasted if I took out 3% every year? How about 5%?
One way to start answering this question is by taking a reasonably diversified portfolio, and seeing how it would have performed during various time periods and various withdrawal rates. Instead ask, what percentage of my portfolio can I withdraw each year (adjusted upwards for inflation), without worrying too much about running out of money? The easiest way to figure this out is by inverting the question. Instead, you want to optimize for the most likely outcomes in a way that is reasonably robust against extreme outcomes.Īpplying this strategy to retirement, we want to determine how much money we need now to live for the rest of our lives without working, with a reasonable margin of safety for extreme events. Thus, you have to accept that early retirement does come with some small chance of a terrible outcome– say 1%–that you cannot avoid.īut it’s a bad strategy to optimize your life for extremely low probability outcomes. International diversification can help you a bit, but only a bit.
It’s possible that the politicians and bankers will mess up the country so badly that hyperinflation will destroy the savings of everyone, and it’s hard to guard against that without going to extremes that are completely horrible in any scenario except a complete failure of the country’s financial system. How the heck can you know how much a loaf of bread will cost in 30 years? Or 50 years? It would be horrible to retire in your fifties from a high-paying job only to run of money when you’re 80 and can only be employed as a Walmart greeter.īut we live in a world where stock market crashes happen and inflation rises and falls. The biggest challenge with early retirement is knowing that you have enough money, because life is sometimes capricious and work skills atrophy.
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