July 4, 2022

“Be Fearful When Others Are Greedy and Greedy When Others Are Fearful.” – Warren Buffet

A major recession can wreck havoc on your portfolio but it can also be a time of opportunity. If it happens during the accumulation phase while you are working and saving, then it is a great time to buy equities at better valuations. The concern comes when a major recession comes soon after you retire. Essentially, that is what is happening to us since we retired September 17, 2021 and a severe bear market began in January of 2022 with the market dropping over 20% within 6 months. How does this compare to the historical worst case scenario in the US and what can we do to ensure our portfolio survives? In order to answer this question, I decided to do a case study on The Great Depression which began in the autumn of 1929. The Stock Market began to fall in September 1929 and on October 28th and 29th, known as Black Monday and Black Tuesday, the market fell by 23.05% in only two days. In order to compare to the 2022 bear market I overlayed the graphs to show the Stock Market from 1929-1945 vs. 2022. The Green Line below is the 2022 US Stock Market and the Black Line is the US Stock Market from 1929 to 1945 during the Great Depression.

During the Great Depression, the Dow Jones Index lost 89% of it’s value in 3 years! That represents a devastating start to any retirement. As you can see from the graph above, the stock market took 16 years to recover and to start to move ahead.

However, if we are considering an early retirement scenario, we need to look at a longer timeframe than 16 years so let’s zoom out to a 60 year timeframe from 1929 to 1989.

The chart above shows a long period from 1929 to about 1950 with very minimal growth (and actually some gruesome drops when you zoom in as we showed earlier) but then the market begins to rise and shows excellent performance after 1980.

If someone retired in August 1929, right before the Great Depression, how would their portfolio have performed and how much could they have withdrawn each year without running out of funds? The graph below shows the performance of a $1M Portfolio with the Portfolio Value tracked in Orange and the US Stock Market index shown in Blue for reference. Assuming an Expense Ratio of 0.05% (Fees/Expenses/Taxes Affecting the Portfolio) and a Withdrawal Rate of 3.14% per year adjusted for inflation, the portfolio will hit zero just as we reach the 60 year mark in August 1989, having started our retirement in August of 1929.

COMMENT: I was expecting the analysis to show 3.25% since that Withdrawal Rate showed previously to never have failed during a historical 60 year period. Note though that in this case study, I used an Expense Ratio of 0.05% whereas prior analysis did not include any expenses or taxes. I was unable to determine the cause of the remaining 0.06% delta between the 3.14% + 0.05% = 3.19% and the 3.25%. Over a 60 year period like this, very small differences in rounding, etc. can have a significant impact. Also, in this analysis, I used Monthly data and started the retirement at the peak month right before it dropped. Using Annual data would probably give a different figure.

While the scenario above would be considered barely successful, it would be a wild ride along the way.

How much adjustment would it take to end with more of the portfolio intact? i.e. What could an early retiree do to improve the situation? Should they reduce the Withdrawal Rate and how much would be necessary to have an impact? Should they shift their Asset Allocation?

Here are the scenarios that I ran:

1. Adding Supplemental Cash Flows of 5% of the Withdrawal Rate when the Portfolio is below the Initial Value. (i.e. if the Withdrawal Rate is 3.14% of a $1M Portfolio that equals $31,400 USD/year. Supplemental Cash Flows of 5% of the Withdrawal Rate would then be $31,400/year X 5% = $1,570 USD/Year.)
   1. An equivalent effect is also achieved by reducing the Withdrawal Rate by 5%. (i.e. if the Withdrawal Rate is 3.14% of a $1M Portfolio that equals $31,400 USD. Reducing it by 5% would make the new Withdrawal Rate $31,400 – $1,570 = $29,830 USD.)
2. Shifting the Portfolio Allocation from 80% Stocks/ 20% Bonds to 90% Stocks/ 10% Bonds over a period of 120 Months (10 Years) from the start of retirement. Big Ern has done a great deal of analysis on these types of asset shifts in retirement which he calls Glidepaths. Based on his analysis, they should be used when the market valuations are high based on the CAPE (Cyclically Adjusted PE Ratios) at the start of your retirement. See his analysis HERE for more details.

I chose these specific scenarios because I felt that I could actually earn Supplemental Cash Flows of 5% of the Withdrawal Rate or $1,570 USD/Year (Per $1M in the Portfolio). This seemed both reasonable and achievable via side hustles or a temporary job. Alternately, if I really did not want to try to earn money, I felt I could reasonably reduce spending by this amount.

The other scenario involving shifting the portfolio allocation over the first 10 years gradually to more equities is simple and also achievable.

Here are the results of these scenarios for the 60 years from 1929 to 1989.

Orange is the 80/20 Portfolio

Yellow is an 80/20 Portfolio with Supplemental Cash Flows

Grey is a glidepath from an 80/20 Portfolio to a 90/10 Portfolio over the first 10 years of retirement

Blue is just the US Stock Market Performance for reference

As you can see, the glidepath and the supplemental cash flows have a fairly similar effect in this scenario. The Supplemental Cash flow scenario ends with $817k USD and the Glidepath ends with $767k USD, much better than the static 80/20 Portfolio which ends with $0 USD. .

In 2022 Interest rates are going up so Bond prices are going down (BND is down 10% since January 1, 2022). It was known the Federal Reserve was planning to gradually raise interest rates, so we are holding very few bonds. Therefore, we plan to pursue the Supplemental Cash Flow scenario. We expect to add Supplemental Cash Flows of at least 30% of our Withdrawal Rate this year in 2022 (via consulting and other part time jobs, business ventures, etc.). My actual goal is Supplemental Cash Flows of 100% of our Withdrawal Rate this year but that may not be feasible. Jobs right now are still fairly easily available but that may change quickly if we sink into a major recession and unemployment spikes.

Summary

In conclusion, this case study on the Great Depression indicates that the performance of a retirement portfolio can be significantly improved by:
1) Using a glidepath from cash/bonds to equities during a major recession (even a 10% shift had a major impact)

2) Adding Supplemental Cash Flows of even small amounts (5% of Annual Expenses) during the recession also had a large impact on results. Decreased spending by 5% would have the same impact.

These strategies are successful because they allow you to either sell less of your equities during a recession or they allow you to buy more equities during the recession when stock prices are cheap.

Note: I am not an Investment Advisor and in no way qualified to give you investing advice. This article is meant for entertainment only. Consult an investment professional prior to making any investment decisions.