Handling A Market Downturn

The masses are very skeptical about early retirement. They are insecure, their own choices reflect financial servitude, and they believe a life of forty-hour work weeks for forty years is predetermined for them.

When you run around with these mental blinders on it's easier to condemn financial freedom than make the changes in your life that open up early retirement for you.

Many people are critical of early retirement by pointing out failure with two main questions:

  • What would you do all day? and
  • How will you handle a scary market downturn?

The first question assumes that you will turn into a deviant or a useless blob if you don't have an outside commitment of forty hours a week to keep you in line. We talked about that here.

Dealing With the Markets

We all know that stock markets go up and down. Market movements often dominate media. Financial media is a narrative between market optimists and pessimists. The talking heads and the predictors who strive to provide entertainment value.

Depending on where you go and what you read, the talking heads predict roaring bull markets that will go straight up and make everyone rich. Or they make your fear investing because markets are on the edge of a collapse.

Truth is they don't know. I don't either. In the last 100 years, the U.S. stock market had four occasions where stocks crashed 50% or more (inflation adjusted). It will likely happen again at some point.

A net worth that moves like this freaks people out!

S&P500 1995-2011. Source: Yahoo! Finance

The fear of losing half your money is enough to make most people just avoid the markets all together. They huddle together and put their money in "safe" GICs, bonds, and real estate. They try pay off their mortgage.

Many don't save at all and wait for the government to spoon feed them a promised stipend sometime in the future.

Rational thinkers who pursue independent thought and understand risk know there are strategies to help deal with these massive, and generally temporary, downturns. A little bit of risk acceptance can go a long way towards better, more profitable investing.

Saving Enough

You can't retire early if you don't have enough money. Not having enough money and hoping for outsized returns or perfect market conditions is a recipe for disaster. Accumulation of investable net worth matters.

If you have 30x your annual spending needs invested in productive assets, you will virtually never fail financially in retirement. You can increase your spending with inflation every year, you can maintain various asset allocations, you can "set and forget". The margin of safety at this level is immense.

Even if you have 25x your annual spending invested in productive assets, you are very likely to avoid a financial catastrophe. But you must be broadly invested, follow a sound strategy, and watch your spending. You would theoretically be far more likely to die before running out of money.


The next easiest guard is diversification. Successful investors reduce exposure to any single market.

Way too many people have too much of their portfolio permanently in one broad asset class. It might be U.S. stocks and bonds, it could be Canadian dividend stocks, it could be rental houses. Concentration is dangerous.

Simply put, you don't want to be an infallible Japanese early retiree in 1989 fully invested in the roaring, never-goes-down Japanese stock market.

In the next two decades, you would see your portfolio fall off a cliff and plunge into the depths of the Pacific. This epic market crash might never come back; nearly three decades later, Japanese stocks are still at around half their peak level.

Nikkei225 1989-2009. Source: Yahoo! Finance

If the same Japanese retiree would have invested in a global stock portfolio, their investment account would have chugged along averaging 7% per year since 1989 (in Japanese yen terms).

While others sweat a salary job and jump off buildings because they're bankrupt, the diversified retiree would be tending to their bonsai and calligraphy with nary an ulcer.

You can diversify across countries, currencies, asset classes, and strategies to guard yourself from financial failure.


Proper use of investment strategies is very helpful in preventing a market downturn catastrophe. Some strategies are complementary while others are correlated.

Buy-and-hold 100% in a stock index is probably among the most dangerous in early retirement because you can't dollar cost average into a falling price scenario. You're basically rolling the dice that you don't retire just before a market crash or high inflation period.

If you are withdrawing money from a falling asset, the effects of the fall are exacerbated. This is known as sequence of returns risk. To limit sequence of returns risk, you can hold a cash cushion, invest in complementary assets, or you can follow a disciplined timing strategy.

Cash cushions are effective in their purpose of limiting withdrawals in a drawdown environment, but they also reduce overall returns. Depending on your investment strategy, large bond allocations can actually reduce your financial success rate.

Complementary assets allocations, such as mixing a hedged strategy (like long/short or managed futures) with a stock strategy, can reduce the full effect of a stock market crash. Hedged strategies tend to do well in market downturns while holding their own in bull markets. However, the best of these are often only accessible to larger investors.

I invest in a disciplined timing strategy. I'm always trying to simply, simplify, simplify while maintaining an edge. So far it has worked out well. In the future I believe the lessons learned will mean better discipline, fewer mistakes, and better results.

Confidence in Strategy

The biggest advantage going into early retirement is having complete confidence in your chosen strategy. I don't mean blind confidence because you read a few good books and read an amateur blog or two.

Rather, I mean having experience and controlling your emotions. Ignoring market swings and sticking to a sound process is how you win the long game.

This is why I'm a huge fan of managing your own money instead of hiring a financial advisor—especially if you are young. Nothing is better than making your own mistakes when you are young, learning from each experience, and forging your own confidence going forward.

An honest, fee-only financial advisor can do a great job of steering your investments and helping you avoid big mistakes. But they can't outperform broad markets over the long term and they can't prevent you from overriding their advice. They're basically just there to help you make good money decisions, promote tax efficiency, and manage your investments using basic models.

It's easier to have true confidence in yourself than to rely on confidence in others.

Comments & Questions

All comments are moderated before being posted for public viewing. Please don't send in multiple comments if yours doesn't appear right away. It can take up to 24 hours before comments are posted.

Comments containing promo links or "trolling" will not be posted. Comments with profane language or those which reveal personal information will be edited by moderator.

If You Won the Lottery Tomorrow…

It's always interesting listening to skeptics of early retirement. In my offline life I often avoid talking early retirement because it freaks people out and induces that eye-rolling look.

It seems impossible to your average, not-very-Moose-like individual who bury themselves into a monster mortgage, car payments, property taxes, hockey fees, and a job to "earn" a 2 week vacation once a year.

People are even more skeptical about the idea of living from a passive income. It's like they know the Amway flogger will fail, or that it's not "real" retirement if you spend your day running around selling flavoured water and dish soap. That's just a new job. But no job at all? It's just not possible in today's economic environment.

The more astute observer will ask two main questions:

  • What would you do all day? and
  • How will you handle a market downturn?

Let's tackle the first one...

What Do Early Retirees Do?

This question is loaded with heaps of social guilt and pressure. In our society our minds have been twisted since birth that we owe it to everyone to perform labour for others. Idle hands are the devil's playground our forefathers have said.

You must work now, study for work purposes only, work some more, take a short vacation here and there, work overtime, and after forty or more years of sweat and toil, the government will finally allow you to exist a few years in retirement with a social hand out. Most likely because you're too old to be a good worker.

Even our tax system is structured to suffocate labourers. People with jobs get taxed at rates ranging from 20% to 60% or more. Someone living from investments, or a business owner, often pays half the tax or less. Yet it is still conventional wisdom to find a good, stable job.

On every popular TV show the characters work all the time and identify themselves with their jobs: the always-shouting lawyers on Suits, sexy doctors and interns on Grey's Anatomy, scientists on The Big Bang Theory, cops on True Detective, actors on Entourage, and the list goes on. It's work-centric entertainment.

Society has ingrained in us that we deserve to work all the time, the harder we work the better person we are. And we are not just Daren; we are Daren the *insert a certain government job*.

It's almost always the first thing we do when we meet someone; work dominates our conversations and our thoughts. Ask them what they do. Everyone knows what's meant by that question.

Doing Nothing

What if you answer that question with a word? Nothing.

Well that's impossible. Then you are judged as a nobody. You must be lazy, or one of those leaches the Conservatives whine about and Liberals fawn over, pity, and pamper.

How can you do nothing all day? You will certainly become an alcoholic, drug user, or perverted necro-manga porn addict with all that free time.

Truth is that no one naturally does nothing, our brains are not wired to do nothing.

If you doubt me, try sitting down on a chair, set a 10 minute timer on your phone, and think about nothing. You will quickly find it's impossible to do nothing. Even for just 10 minutes. You will think about worries, you will think about the things you could or should otherwise be doing in that 10 minutes, you will worry more about those thoughts, you will think about the time, you will think about what you are going to do when 10 minutes is up, you will think about how many minutes are left, etc.

Our brains are designed to be naturally creative, active, and thoughtful; they're not designed to spend 8 or 10 hours a day slogging through an uninspiring job.

That's why I—and probably you—have never been at a job for more than a few years before a form of boredom sets in. You still do the work, you're still productive, but your brain is running in a type of "standby mode" most of the time. Natural inspiration is lacking.

True Freedom

There's a better answer to the question: only what I want to do.

Wouldn't life be genuine and deeply fulfilling if you only did the things you truly wanted to do? If you want to build a house, you build a house. If you want to take some university classes for the sole purpose of learning something new, you take those classes. Let's say you want to learn a new language, you just go to a language school. If you want to write a book, you sit down and write.

Today, if you love poetry for example, you have little chance of devoting yourself to that passion. At a young age, mom and your school guidance counselor remind you that poets don't make money. So you reluctantly go to college for a career degree, find a job, and live miserably as an inspiring poet. Poetry feels so far away, you almost begin to resent it. If someone else is a successful poet, you might even jealously scorn them only because you can't do the same. Or you might envy them and become more depressed.

You could substitute poetry for just about any passion. Did you ever notice that all the fun things in life, the things we actually want to do, the things our brains naturally aspire to, all apparently make no money? They are all "unacceptable" labour choices; they're relegated to mere hobbies.

If you're an early retiree, you could be an author, a poet, a musician, a tinkerer, a creator, a traveler, a learner, a giver, an adventurer, a builder, an artist, an athlete, a chef, a truly great parent, a mentor, or anything else you want to be or do.

Being an early retiree is like winning the lottery. You don't have to do anything you don't want to do because of financial obligations. You are free to do the things you naturally aspire to do. I'm betting that's not working a job forty hours a week.

Early retirement is the opportunity for true, individual freedom.

Part 2 talks about market downturns...

Comments & Questions

All comments are moderated before being posted for public viewing. Please don't send in multiple comments if yours doesn't appear right away. It can take up to 24 hours before comments are posted.

Comments containing links or "trolling" will not be posted. Comments with profane language or those which reveal personal information will be edited by moderator.