Preparations for the coming bear market

What am I going to do when the bear market comes?

It is easy to get good returns when the market is going up. It is just carrying you up. 
But the a bear market will come. And then you will find yourself on the edge of the waterfall and the strong waters will carry you down very fast.
And no one knows when the turn will happen.


We are in an extended bull market right now. There might be a couple of genius people out there who know when this bull market ends. I don't know that and I don't know anyone who knows that. So I am on my own here.

In the last 70 years, there have been 13 bear markets. The average length of a bear market was 13 months. The average decline was about 25%.
Compared to the bull markets for the same 70 years there were 14 bull markets. The average length of a bull market was 46 months. The increase was on average 125.3%.

We judge our success by comparing to others and that leads either to "better" or "worse" evaluation.
But what if you compare your results only to that what matters?

What if I compare my results just to the one goal I had in mind when I started the 'Cash flow" challenge - to cover the yearly expenses. As long as I can achieve this, it is all fine.

Without knowing when the bear market comes, what remains for me is to prepare for the unknown.

What I have to work with:
I don't know when the market turns down.
I know for certain that it is going to happen.
I don't know how deep the drawdown will be. It could be as much as 50-60%.
I don't know how good the recovery will be.
I don't know if some of the stocks will ever recover (some stocks still didn't after 2018).


What I can do:

I can try to cover yearly expenses with the income from "Cash flow challenge". It is certain that all stocks will go down significantly. What will be left are just the dividends some of which may be reduced. I can try to cover the expenses with dividends but I think that will not be enough.  

Also I need to make sure that the other income sources will cover the time when the cash flow is insufficient. The other sources are jobs and emergency fund.

As long as I have the job, the yearly expenses are covered.
As long as my husband has a job, the yearly expenses are covered too.
Our emergency fund will cover at least 2 years of  absent income.

That way we have triple safety in case if the bear market will not produce the sufficient cash flow. That way the pressure is off.

The second step is to optimize the investments for the time of the bear market:

1. I need to go trough my holdings and see how they reacted to the last bear market and maybe eliminate those which didn't recover from the last one in 2009.
2. I will only use dividend paying stocks that in case of the bear market, there still will be some income from the dividends.
3. Bear markets are temporary and shorter than bull markets so the savings for retirement should not be severely affected. Even if the retirement savings will be affected, I am not planning to retire early or at least not before the next bear market is over. That should give the retirement funds enough time to recover.

Do you celebrate financial milestones?

M. asks: Do you celebrate financial milestones? For example reaching 500k in total investments/retirement savings? I saw a list of goals in an article suggesting celebrating. 


The article she is probably referring to is the one from WCI: 14 financial milestones worth celebrating.  
The post suggests to celebrate 14 financial milestones as they are reached, including becoming student debt free,  paying off the mortgage and being financially independent. Reaching 500k in net worth is goal #6.

Yes, I celebrate all the milestones mentioned in that article and many more. 

I celebrate everything. And I support everyone who is celebrating. I like to celebrate whatever it is. For example for my Birthday I don't limit my celebrations to one day, I celebrate the entire month. 

People from Russia will know the Russian calendar which suggests reasons for celebrations for each and every day. I remember as a child I was looking at every new page every day to see what can I celebrate that day. 

One day I thought that if I celebrate so much, I must be a happy person. 
I found a psychological test online testing how happy you are.

I filled out all questions and my result was: "You are too happy. Please abstain from using drugs while taking this test." Imagine how surprised I was, I was laughing a lot. I am so boring in terms of drugs, I dont' even drink alcohol. That was just too funny.  

The non-financial freedom. Should you care about opinions of others?

M. asks:
How do you define moderate selective frugality? And what separates selective frugality versus being cheap?
I recently had an experience where I questioned this. I went to Target with a discounted gift card. They couldn't scan it and asked me to download their store app. I automatically asked if they had a free Wi-Fi so I don't have to use my data.  I realized, after getting weird looks, that I was carrying my Louis Vuitton bag. I was a little embarrassed.



I never heard of moderate selective frugality. I thought it is either frugality or it is not. 


It seems that M. is embarrassed to appear frugal to others.  Probably because for some people frugal equals cheap. And cheap sounds negative. So there is a certain fear of negative judgment from others. 

How to stop caring about opinions or judgment from others?
I am not sure if my advise will help, I am not a psychologist, but I will try.

What separates frugality from being cheap?

It is the emotional valuation of "good" versus "bad". 
Many people use the word cheap in a negative sense. Frugal sounds a little better. It is similar to cheap but is considered to be a good and responsible solution.

As I already mentioned in one of the previous posts, I replace "good" and "bad" with "useful" and "useless". The emotional valuation of cheap being "bad" and frugal being "good", is useless to me.

I would have asked for free Wi-Fi, if the savings were significant. One time I downloaded an app in the store using data because the discount was $20. That was useful. If the savings are only $1, I would use free Wi-Fi and use of the data would not be as useful. 

If the cashier gives me a weird look, this look is useless to me, because this person has zero influence on my life.

This emotionless evaluation as "useful" versus "useless"  may be difficult to practice for some people. Let's try to look at the situation from a different angle.


On the surface it looks like there is a mismatch between M.'s appearance decorated with a Louis Vuitton bag and her asking for free Wi-Fi. 
Her appearance signals that she is well off. 
Her question about free Wi-Fi signals that she is trying to save money.
This mismatch was noticed by a random cashier. 
Why should this cashiers reaction bother M.? 

M. has fear of being judged by others. Can this fear do any good? 

I think, at least, the fear of judgment should to be adequate.

In few areas opinions of others can matter. For example, at work you have to fit in with your behavior and dress code because of certain standards.  If people give me weird looks because of my appearance or behaviour at work, it is necessary to catch those looks and act on them, because that can have consequences.

If the the weird look is coming from a person who is unrelated to my financial well being, like a cashier at Target, I usually completely ignore it.

The fear of judgment from a random cashier is inadequate.


Supposedly the cashier is judging M. for having an expensive bag but trying to save money.

The cashier may think:

1. Is it a real Louis Vuitton bag if you are so frugal? Are you pretending about how rich you are?

2. Oh you poor girl with an expensive bag, you are so cheap that you can't spend a dollar on your data?

4. I hate you and your expensive bag. You should not care about spending money on data.

What may be coming over from the cashier is jealousy or contempt. 

What is the worst that can happen after M. got that weird look?
The cashier only spent 1-2 seconds on that look. He probably immediately forgot about that. In the worst case he went home and told about that to his friends or family: "There was a weird woman at the store today, she was carrying an expensive bag but asked for free Wi-Fi. How cheap of her."

Let's make it worse. If that person is a real freak, he may tweet about it or post something on Facebook.
But in reality he may never think about it again.


What actually happened in a neutral view of things:
A random non-related to M. person expressed jealousy or contempt toward her. 
M. cares about opinions of others and she is hurt by the opinion of the cashier because he doesn't like something about her. 



Of course if M. is afraid of judgment, she can just try to avoid all situations which may produce weird looks. She can either stop carrying expensive bags or she can stop trying to save money, because others will be unhappy with her. 
And even if she manages to please most, there will still be somebody who will be unhappy with her for some reason. Will she ever be able to please everyone? 

Those efforts to please others and to avoid negative reactions from others - what are they worth to M.? Are they worth $1 she may have saved in this case? 

I will take $1 over an irrelevant opinion. I have enough of my own opinions.  

What if she is going to buy a car and the salesman gives her a weird look because of her bag? Will she stop negotiating for a better price and agree with a higher price just to make the salesman happy who she will never see again? That will be worth more than $1. But is the situation really different? 


It is very helpful to realize that:

1. Other people don't really care as much about you (and  me) as you think.

2. You may spend more time thinking about what others think about you then they really do. 

3. You are very generous to random people to give them control over your emotions.


No one really spends a lot of time thinking about others. Others are mostly busy with thinking about themselves. 

Realizing that no one really cares about you (and me) should give you FREEDOM! 
With this freedom you can do whatever you want. 

And if others notice you doing whatever you want, they will very judmentally say: "She does whatever she wants". And you will just smile and not bother spending your time or your thoughts on an irrelevant opinion.   


When you care about opinion of others you give others power to influence your life. They take the wheel of your car and you let them drive the direction they want. Just because they want to take your wheel, should you really give it to them?







   

Challenge "Cash flow" update September 2018

Today I hit $100,000 in cash flow from the investments for this year so far.
And with that I reached Level 2 of my "Cash flow challenge" - "Sailing".

With $100,000 the yearly expenses are more than covered. Anything above that will be just fun.  

Below is my cash flow per month compared to the S&P 500 performance. 

my cash flow

S&P500 returns in % to date (September non included yet)

Deadlines for tax advantaged accounts 2018

Deadlines for contributions


Age 50
Start catch up contributions for 
401k ($6,000) - total $24,500

IRA, traditional and Roth ($1,000) - total $6,500

Age 55
HSA ($1,000) - total $7,900

Before age 70½
If you are completely retired, you can't contribute to retirement accounts because it requires to have earned income. 
If you have a side job, you still can contribute but the contribution amount can't exceed the earned income amount.

Age  70½
Have to stop contributions to traditional IRA even if you are still working. 
If you still have earned income, you can still contribute to Roth IRA.

If you are still working, you can still make contributions to the work sponsored 401k.



Deadlines for benefits

Age 62
Minimum age you can start receiving social security benefits. If you are still working, your benefits may be reduced. If you have high combined income even if you are not working, your benefits may also be reduced. 

Age 65
Eligible for Medicare.

Age 67
For anyone born after 1960, 67 is full retirement age.

Age 70
If you wait until 70, you will receive the largest possible monthly social security benefit. More time delay will not produce any more increases.

Age 70½
Must begin taking required minimum distributions (RMD) from traditional 401k and traditional IRA. 
However, if you are still working, there is a "still working" exception for delaying taking RMD from the work sponsored 401k plan. 

If you are not working and don't take required minimum distributions, you will have to pay additional tax of 50% on the difference between the amount  taken out and the required amount.

There are no RMDs on Roth 401k and Roth IRA.



Deadlines for penalties

Age 55
If you leave work you can start taking distribution from work related 401k without 10% penalty.

Age 59½
Withdrawals from 401k and IRAs are not subject to 10% penalty.

Will social security still be available in 20 years for high income earners?

M. asks: Will social security still be available in 20 years for high income earners?

I am wondering that myself.
Social Security already exists for about 80 years. It was established to provide supplemental income in retirement. 


The social security expenses are rising mainly because of following reasons:


1. Lengthening of life expectations 
2. Increasing numbers of retired baby boomers
3. Changing of worker to beneficiary ratio with beneficiaries increasing and workers decreasing.



There are three social security sources of revenue:

1. Payroll taxes on earned income (approximately 87%)
2. Interest earned on reserve assets (approximately 10%)
3. Taxation of benefits (approximately 3%) 

The social security already started to the reserves in addition to the incoming funds.
It was estimated that the reserves will disappear by 2034. 


That means that the revenues will have to be increased. What are the ways to increase revenues?

1. Increasing the retirement age
2. Increasing payroll taxes
3. Increasing taxation of benefits
4. Decreasing the benefit amounts

So, most likely the social security will still exist for a long time. But the once the reserves are depleted, the revenue will have to be increased. 

High income earners will very likely be the most affected by this. It will be easy to move or remove the social security tax cap (currently at $127,000). 
High income earners can be hit by introduction of eligibility criteria. It could be based on total amount of all yearly retirement income (including non-earned income like investment related gains or dividends or rental income). 


High income earners are at risk for both, paying in more and getting out less.   


For the high income earners the social security benefits are already taxable and they pay federal income tax rate on up to 85% of the social security benefits.
 
In retirement the federal income rate is based on the combined income (adjusted gross income plus non-taxable interest and plus half of social security benefits).
 
Adjusted gross income is the total gross income minus deductions. Gross income includes wages, dividends, interest, business income, rental income and all other types of income. In retirement most deductions become irrelevant except allowances for personal exemptions.
 
Example:
In retirement your combined yearly income is $200,000 (401k distributions, IRA distributions, rental income, capital gains and dividends from taxable accounts and bank interest).
After adjusting it by taking out variable deductions it may reduce it to $160,000 (approximate number).

The federal tax bracket for $160,000 is currently 22% (2018). But in retirement the non-taxable interest and a half of the social security benefits will also be added to this number.
 
For example, if the yearly social security benefits are $24,000, that will bring you over the limit of $165,000 for the 22%  bracket into the 24% bracket.
 
Following that your social security benefits will be taxed based on your status.

If filing as single and your combined income is over $34,000, you will pay 24% taxes on 85% of the social security income. That means you will pay 24% on $20,400 of the social security, which is $4,896. 

If filing married and joined and your combined income is over $44,000, you too will pay 24% taxes on 85% of the social security income.

If filing as married but separate, there is no threshold and the benefits will be taxed regardless of how much is your combined income.
 
Those are federal taxes. If you leave in the state that taxes social security benefits, add that.

Does 25 times annual spending estimate work?

M. asks: Did you use 25 times your annual spending to estimate your "magic number" for retirement savings?

She is referring to the post about my "magic number" challenge, which is $3,000,000.

When I was estimating my number, I did not use the popular among FIRE community members 25 times annual spending calculation. it seemed to be an underestimation to me. 

I went another way and calculated my annual expenses, added comfort margin and ran it trough inflation calculator.

I also made some optimistic assumptions about the life expectancy (at least 102 years, see why in the Challenge 102 post).
And I made some pessimistic assumptions about the investment growth which included absence of social security income and low returns).

I also didn't assume that I will retire early, and my estimated retirement age was 65.

 
Per official government actuary table I as a female of 44 years of age have life expectancy of 38.65 years more to live and my estimated expiration date provided by the government is in 2056 at age of 82.65.

If I just take 25x my annual expenses, first thing that bothers me is that 25 is less than estimated 38.65 and the second is that the expenses in this calculation don't appear to be adjusted for inflation.

I will make some example calculation with the following data:
Female 44 years old, official life expectancy 38.65 years (age 82,65 years)
Retirement savings: 25 x annual spending = $1,250,000
Retirement date - now at 44 years of age (FIRE)
Yearly returns - 7%
Estimated annual inflation - 3%
Calculations done on www.mycalculators.com, you can use your variables for your own calculation.

You can see that at 7% annual growth rate on the investments the yearly withdrawal is around $62,000 per year. For the first few years that will work.
 
It looks like in this calculation the annual inflation rate is only applied to the growth. The withdrawal amount is the same each year and is not adjusted to inflation (you can see it on the withdrawal schedule which is provided by the www.mycalculators.com.  

But how much are the $62,000 in today's dollars are worth in 38 years?

I calculated it on www.smartasset.com. The $62,000 will be equivalent of approximately $190,637 in 2018 dollars.
It doesn't look like it will be enough.

That supported my suspicions that FIRE is not for me.

Next, I used the Retirement Income Calculator from www.bankrate.com
It gave me the monthly income at age 45 (the same for the next 38 years).

 

 

 



I decided to check the only 3% yearly return which is what you can reach with government bonds. The monthly income decreased appropriately.

 

 

 

 

 

With the inflation, the necessary withdrawal amount will have to increase. The monthly withdrawal amount income should change with estimated inflation of 3% from $4,217 to $12,966 in 2056.

 

 

 

 

 

 

The inflation increases the amounts substantially. That was my main reason not to use the 25x yearly expenses estimate. The number $1,250,000 seems to be too low.

 

My estimates gave me the number of $3,000,000 as a comfortable minimum.  

If I don't retire early and keep working as planned until 65, this number should be reachable for me.

 

If I figure out how to stay alive until 102, this amount should be enough.

 

For calculation, that will be 37 additional years from age of 65 to 102.

According to the inflation calculator the $50,000 of yearly expenses will be approximately $93,000 in 2039 (retirement year).

At that time I will be able to withdraw about $152,000 (according to the calculator below) every rear for 37 years until age of 102 (year 2076).

 

 

 

The inflation calculator from www.smartasset.com doesn't go until year 2076, it only goes until 2068 and the value adjusted for 3% inflation for that year is $219,000. If I use less in the beginning and more later, it seems to be enough.

 

I am finding it very funny to plan until 102 years of age. That is probably a serious overestimate. I am really curious about how it will turn out.