I suppose you’ve heard by now that the stock market
dropped big-time Wednesday. Thursday wasn’t so great, either.
As usual, a move like this has caused quite a bit of angst, worry, and pandemonium on social media and in the news. People are downright fearful and upset.
Want to know how I responded as an early retiree? Nothing. Absolutely nothing. Oh, I worked out, took a walk in an early Colorado snow, and played some video games. But I didn’t panic. In fact, I didn’t even know the market was heading down until I saw it later on Twitter
. I don’t watch the market much and I’m certainly not living my life based on whether it goes up or down. On a daily basis I give it less thought than what I’m having for dinner that night.
So how did I get to the point where I don’t care about the market? And more important, how can you get to that point and retire early no matter what the market does? Well, that’s what I want to share with you today.
Before I get started, let me say that much of this article might seem like I’m boasting. I’m hopeful you’ll read it as it’s meant: as advice from a good friend who’s been there and who’s willing to tell you the truth even if it stings a bit.
This is the one (yes, ONE) thing you need to do to retire early without fear that a market drop will kill your finances:
You must build in some margin of safety into your retirement plan.
And the more margin and number of ways you build it in, the better.
To explain a bit, you need to develop several efforts that will protect you in case something bad happens—you get sick, your property is destroyed or stolen, you get sued, or the market drops big time. Any of these (and more) can happen to you in retirement. If you’re prepared for them in advance, you will sleep as sound as a baby despite the challenges.
There are lots of options for creating margins of safety, but here are the five most useful.
1. Invest your assets to generate multiple streams of income
Retirement is less about building assets and living on them than it is about generating a livable income in retirement.
To illustrate this, let’s assume you need $50,000 a year to live on in retirement. Which of these two options do you think is better?
• You have $1. 25 million in investments which you can withdraw at 4% a year to get to $50,000.
• You have $600,000 invested in rental real estate that throws off $50,000 in income per year.
Now you could argue that the first is “better” because you own more, but the fact is that you make $50,000 in both scenarios. It’s the income that’s most important, not the size of the assets.
Given that you want/need income, isn’t it better to have multiple sources coming in? Of course it is.
This is why I have structured our assets to include income from rental real estate and dividends in addition to being able to draw from assets. In fact, if you invest correctly you can earn enough off your assets that you never need to draw them down (which is where we are). In this case, the market’s performance is a non-factor. As long as the income keeps flowing, you’re fine no matter the value of your assets.
In addition, by having multiple streams flowing in, you know that if one goes away or is severely constrained, you have others to pick up the slack. One is good, two is better, three even better, and so on.
2. Create additional income separate from investments
Besides arranging assets to churn off income, consider other ways to grow income. Developing a side hustle is a great option. Two amazing benefits to developing a side hustle include:
• Helping you get to retirement much faster. In fact, a side hustle can be the vital part to allowing you to retire in 10 years or less.
• Providing yet another stream of income in retirement so you both earn more and have an even more diversified sources of income.
And if you pick the right side hustle, one that you enjoy, you can earn extra income and it will never feel like work.
After a year of retirement I bought a business and can truly say I’ve enjoyed working on it. It gives me a fun, creative outlet and something to challenge me a couple of hours every day. It’s not burdensome and yet it does provide a need to keep active mentally. After all, you do not want to retire then crawl into a hole. This side business allows me to keep “in the game” without being too taxing. It also provides a very nice extra income.
3. Build a bigger nest egg than you need
One of the biggest issues early retirees have with a market drop is with a situation like this:
• You need $50,000 per year in income from your assets in retirement.
• You have $1.25 million in assets, so at 4% you can withdraw $50,000 per year.
• Then your assets fall to $1.1 million and now you have $44,000 per year.
The problem here is that the retiree is playing it too close with their funds. Everything has to go right for the numbers to work.
Here’s a news flash: everything NEVER goes right. Something always happens. Income is lower than expected. Expenses are higher than expected. And so on.
It’s easy to combat this by saving more than enough for your needs. Consider this scenario:
• You need $50k per year in income from your assets in retirement.
• You have $1,750,000 in assets, so at 4% you can withdraw $70,000 per year, more than enough to cover your spending and add to your next egg.
• Then your assets fall to $1.25 million and now you have $50,000 per year.
You’re still OK even after your assets fell by almost 30%.
See how this margin of safety can be so powerful?
4. Earn some extra income
Once you retire you’ll find that the thought of going back to work is close to being as painful as pulling out your fingernails. It’s just something you don’t want to do.
But if push comes to shove, you could go back to work either as part of your retirement plan or as a safety measure in case the market leaves you with a shortfall.
A simple $15 an hour job for two days a week (16 hours) will earn you $12,480 a year. At 4%, that’s equal to investments of $312,000.
This is why having a part-time job (or a side hustle) is so great for retirement. Which is easier, working two days a week or saving an extra $312,000? I think you know the answer.
And the truth is that most people retiring early or even considering it could earn significantly more than $15 an hour. We’re talking teachers, business people, doctors, and so forth with many valuable and marketable skills. It would quite easy for them to earn much more than $15 per hour, making this suggestion even more beneficial.
If you don’t want to go back to work, you can always sell some things to provide temporary income relief. Most American households are so crammed with stuff that having a sale would actually make life more pleasant.
I walk by homes where people park outside their garages for the simple fact that the garages are filled with “stuff”. And these are 3,000 square foot homes. When you fill up a house that big with so much stuff that it takes over your garage, you need to sell some stuff. And don’t even get me started on those who rent storage units long term to keep stuff they will never use.
Sell your stuff, declutter your life, and make some extra money along the way to tide you over.
5. Cut back on spending
Even a retirement budget can be trimmed in most cases, so if the market collapses and your income suffers, get out the chopping block.
The most likely categories for cutting back include travel, entertainment, eating out, and the like—all the discretionary expenses that many Americans consider needs but are really luxuries.
And if things get really drastic, you can permanently lower some large expenses by downsizing your home. You’ll save on so many expenses that almost any market drop can be compensated for.
So you can see how each of these suggestions can provide a margin of safety to protect you when bad things happen. Even better than having one of them is having multiple ones so you have backup plan after backup plan. That’s how you can live in retirement peace and not even pay attention to the market.
How to get margins of safety
This raises the question, how do you get these margins of safety? Here are some thoughts:
First of all, it’s personal finance 101. You need to earn as much as you can, save as much as you can, and invest for growth initially and then income. I break this down into the simple acronym E-S-I. Do these for 20 to 30 years and you’ll be set.
Second, consider developing a side hustle along the way. Even an extra $10,000 per year can make a big difference. If you don’t want to “trouble” of creating a side business, consider getting a part-time job when you retire to help ease the financial pressure a bit.
Third, as you get closer to retirement (5-10 years out or so), look for ways to invest that generate higher returns than the 4% withdrawal rate allows. Real estate is a great example of this.
Finally, consider postponing retirement a year or two if it allows you to accumulate extra assets for a needed buffer.
If you do these things now in preparation for retirement, you, too, can then ignore the stock market drops and withstand many other calamities that might come your way.
Then you can spend more time on the really important stuff—like wondering what’s for dinner.
More Info: marketwatch.com