I ran into my former coworker, Bob, in the office lobby the other day. We started talking about retirement. He’s planning to fully retire later this year. He’ll be 62-years-old.
The last time we spoke about retirement, his target age was 67. I congratulated him for being five years ahead of schedule.
He’s one of the featured characters in a post I wrote more than three years ago called Learning From Your Coworkers Who Cannot Retire.
The post was a little rough around the edges but still managed to get a feature on Rockstar Finance. It was the first article of mine to earn that distinction (see a complete list of featured articles here).
At the time, I worked with a lot of older people. Many were in their late-fifties and sixties and unable to retire because of family situations, health problems, divorces, bad choices, and lack of planning.
I remember one former coworker telling me he couldn’t retire because he wouldn’t be able to afford his SUV payment. Once he paid it off, he bought a bigger SUV!
Another guy in his mid-sixties was still working to support his aging mother. He retired not long after his mother died in her late nineties.
Bob used to come by my desk and talk about all the surgeries he needed. Occasionally we’d talk about money.
Back in 2013, he told me he was nine years away from retirement despite recently paying off his house. I found it hard to believe he needed nine more years with a paid for house.
Well, apparently, he didn’t. He’s ready to retire in the Fall.
We don’t work together anymore since I abandoned my cushy job. But we’re still in the same building. I keep tabs on all my former coworkers’ retirement plans because it’s so interesting to me.
Before Bob and I parted from our recent run in, I congratulated him again and quipped that I’d see him at his retirement party. Instead of smiling, he turned to me with a serious look and said:
As long as the stock market doesn’t crash.
Portfolio of Cards?
As an investor in his early sixties, Bob has seen a few ups and downs. Surely, he endured the roller coaster ride of the late-nineties and the dot-com bubble crash. Then in 2009, he knows the damage felt when markets tumble due to systemic uncertainty.
So it’s no surprise he’d make a hedging statement like that.
What’s frightening about his upcoming retirement is it’s heavily built on the success of the stock market over the past few years. His 401k balance is where it needs to be and he’s ready to pull the trigger.
He wasn’t expecting to be able to retire by now based on his previous estimate, but returns have been sweet. The stock market is up about 40% since our last conversation.
As long as the stock market doesn’t crash, he’s good to go.
The Expectations Gap
A few days later I came across an article on CNBC about what the author calls an “expectations gap”. According to the article:
More than 80 percent of workers recently surveyed by BlackRock expect their retirement account returns will continue to match or exceed the returns of the past.
During the current eight-year bull market, annualized returns of the S&P 500 stand at 19.5% (CNBCs number, presumably since the March 2009 bottom). That’s double the average annual returns of ~10% dating back to 1926.
In other words, when the stock market is performing well, most retail investors tend to think that will continue, regardless of valuations. The returns of this bull market are not sustainable.
Overdue for a Correction
It’s foolish to time the market. Nobody can successfully call market tops or bottoms with any consistency.
However, when the stock market is due for a correction, it doesn’t hurt to have some cash waiting on the side in the event of a decline.
That’s not timing the market, that’s being opportunistic.
So how do we know when the next correction is?
We don’t know. It may come tomorrow or it may be many years away.
But as the following chart from American Funds points out, and as we all know in the back of our heads, declines are an inevitable part of investing.
Base on this table, a market correction of 20% or more occurs on average every 3.5 years.
We haven’t seen one in eight years.
Declines of more than 15% happen on average every two years. The current streak is more than five years old.
Of course, this doesn’t take into consideration the current strength of the economy, politics, and a myriad of other factors. Just history of the market.
The market could very well keep going higher. The longer it does, however, the more the psychology of market history will weigh on Wall Street. When markets fall, especially in the age of high-frequency trading, they go hard and fast. We won’t know what will trigger the downturn until it happens.
The Shiller PE Ratio (aka CAPE)
As for valuation, one of the most widely recognized trackers is the Cyclically Adjusted PE Ratio (CAPE Ratio), also known as the Shiller PE Ratio. CAPE was developed by Robert Shiller, author of Irrational Exuberance,
a book about high valuations and market psychology during the dot-com bubble era.
The CAPE is a PE ratio (price to earnings) based on the average inflation-adjusted earnings of the S&P 500 index for the previous ten years. Shiller uses the ten-year average to smooth out volatility.
According to the Shiller PE, at a level of 28.76, the market valuation is currently higher than before the 2007-2009 financial crisis and approaching the level of the stock market crash of 1929.
Chart as of 03/27/2017
In other words, the market is clearly overvalued from a historical perspective. Doesn’t mean an extended declining period or crash is imminent, but it’s worthy of investors’ attention.
Click here to see the latest Shiller PE Ratio chart. Also, check out a recent write up about CAPE over at Wallet Hacks.
What This All Means for My Coworker
All of us who invest in stocks are putting our faith in the U.S. economy and stock market to growth our wealth and lead us to retirement. Markets fluctuate, sometimes violently. Sometimes irrationally. But over long periods of time, stocks go up.
Part of why I choose to invest in dividend stocks is for predictability. Dividend payments are easy to predict as long as a company is managed well and not overwhelmed with debt. I’m also heavily invested in index funds and ETFs. These securities fluctuate directly with the market indices.
When markets go down, dividends ease the pain to some extent, at least mentally while funds recover. Declines become an excellent opportunity to buy high-quality dividend stocks and index funds if you have the money available.
Based on some basic market history, today it’s apparent that the market is both overvalued and due for a decline.
Unfortunately, my coworker is likely unaware of both. He’s probably looking at his 401k balance expecting it to keep growing as it has for the past eight years. Or perhaps, the serious look he gave me was an acknowledgment of the risk he’s taking.
As he eerily pointed out, his retirement this year is contingent upon the stock market not crashing. That, to me, is a discomforting plan. Having witnessed two major market declines (2000, 2009) that severely altered the retirement plans of people I know, I’m determined not to let that happen to me.
That’s why I’m building multiple income streams and a couple side businesses. Market declines suck. Knowing one could hit us at any time is one reason why I don’t feel wealthy today.
Nonetheless, the bull market we’re in today feels pretty darn good.
But as Warren Buffett reminded us in the 2013 Berkshire Hathaway Letter to Shareholders, quoting former Morgan Stanley analyst Barton Biggs:
A bull market is like sex. It feels best just before it ends.
Photo credit lane wunderli via Pexels
The Green Swan says
Great post, RBD, very interesting read. Hopefully your co-worker won’t be let down by the market 🙂
I think the high valuations today are putting a lot of value in tax reform. Now that the administration is turning its attention toward it we may have some answers soon about the strength of this rally. Hold tight!
Retire Before Dad says
GS,
Indeed, tax reform is on the minds of investors. Hopefully reform includes some simplification in addition to more investor-friendly policies (like repatriation) that don’t bankrupt the Treasury.
However, the market will be angry if tax reform doesn’t live up to the current optimism. The new dynamic in Washington has so far proven unable to pass significant legislation. If a real plan isn’t passed by August, how long will the market wait?
-RBD
Matt @ Optimize Your Life says
This is pretty much what I was thinking. It looks like the market started stalling out right around when it became clear that Republicans couldn’t even pass the repeal and replace plan they’ve been working on for 7 years. I’d imagine people are getting less optimistic about tax reform actually getting done.
That said, I am the proverbial analyst who has predicted 9 of the last 5 recessions, so take that for what it’s worth. I don’t even trust my own predictions, so I will be continuing to DCA the same amount every two weeks regardless of the market’s movement.
Retire Before Dad says
Matt,
Glad you bring up dollar cost averaging. I’m an advocate of it, and practice it in my 401k like most of us. I used to do more in stocks, but decided to cut back and be more selective. DCAing into irrational exuberance of the late 90’s worked for a while, until things got really out of hand. This particular streak feels vulnerable due to the lack of a pause, the consistent upward trend, and the contingency on government action, which is far from guaranteed to be timely, certain, or well designed.
=RBD
fiscalvoyage says
Great post. There will be a drop sometime. The question is when?? lol
Dividend Growth Investor says
RBD,
Very interesting conversations. It is so fascinating how our experiences shape us.
I have had conversations with older co-workers in 2013, with S&P 500 hitting an all time high for the first time in 6 years. The usual response was – I have seen this before. Translation – do not get too excited about it. Of course, after living through the past two bear markets and the highs in 2000 an 2007,it is normal that someone thinks this way. On the other hand, it is also possible that this past experience blinds us into selling too early or trying to catch the top, while stocks keep on going higher. I know this sounds crazy, with valuations high, and earnings growth lacking. But as we all know, things can be crazier for far longer than a rational person can stay solvent 😉
I do agree with you that having multiple lines of defense is paramount. For me too, it means living off the dividend income, having some fixed income, and one day in a few decades earning social security. Having an active source of income is a really good diversifier as well. I may also dip my toes with some real estate at some point, either buying a home or a rental like you have.
Retire Before Dad says
DGI,
Yeah, things can get crazy and out of hand for a long time without consequence. Plenty will profit on the way up, up, up. I’d hate to see another huge up, then crash. Would much prefer a more subtle and sustained downward trend. Of course, the market doesn’t give a $hit what I would prefer. That main source of income is a good way to protect against the big drops, but my coworker is looking to ditch that. It reminds me of one guy I worked with in 1999 who was planning to retire the next year. Then dot com happened. I ended up working with him again in 2008 and he’s still on a payroll!
-RBD
Ty Roberts says
Best of luck to your former coworker. Can he pull out and get into something less volatile that being all-in on stock?
I like your retirement plan RBD and am doing my best to get those multiple income streams up and running as well.
Retire Before Dad says
Ty,
Well, I don’t know his entire situation. He may be fully diversified and ready to weather any storm. But his date accelerated thanks to the market. Perhaps he could start easing off the stocks soon. This guy, however, is not a sophisticated investor by any means. He’d make a good stock market ‘victim’ you’d see on 60 minutes piece about the bad economy!
-RBD
Rich from www.pennyandrich.com says
If someone wants to dollar cost average for 20 years, I have no quibble with that. As long as you don’t NEED to withdraw the money, you’re probably fine. Just remember that when you retire you will not be able to dollar cost average, so it loses its effect the closer you get to living off a fixed income.
Regarding the current market … I don’t think you can rationally look at the market peaks in 2000 and 2007 as bubbles (which they were, obviously so in hindsight) and look at 2017 as “normal.” If I had a friend close to retirement who was heavy in stocks, I would just ask him what he would tell someone in 1999 …
The timing thing is overblown in my opinion. You don’t need to call the top or bottom exactly, you simply need to recognize risk / reward. Getting close is ok. If you need to capture the final 20% of a bubble, you probably have too much risk and don’t know it. People aren’t talking about this very much right now, but early 1999 (still 25% from the tech bubble top) to early 2012 (13 years), the S&P 500 went from 1200 to … 1200. That’s a long time and a lot of volatility. Again, no biggie if your time horizon is indefinite. But if you need to make regular withdrawals post-bubble, you’re out of luck.
Retire Before Dad says
Rich,
Thanks for adding those S&P 500 numbers. I thought of looking that up but was too lazy 🙂
Thise of us who are younger can have a greater tolerance for wild swings. As I age, I’m more cognizant that the stock market could do a number in my ability to retire in the event of an untimely downturn. Or even to pay for college if I don’t become more conservative as my kids approach age 18.
-RBD
Dividend Diplomats says
RBD –
Great & valid story here. Multiple streams of income/different sources diversifies shakes in any sort of market – and investing simply for appreciation is a tough pill to swallow to hope on. I wonder how long Bob invested for and/or if he ever pulled out of the market. Wonder if he used a dividend producing fund of some sort, as well. I hope that in 9 months you don’t seem him in the lobby…
Thanks for sharing RBD.
-Lanny
Joe says
He should talk to a good financial advisor. The stock market is going to crash at some point and the worse case scenario is right after you retire. Hopefully, your coworker can get some help planning his retirement finance. He might need to keep working a little while longer.
Financial Samurai says
Good food for thought post. Why doesn’t he just diversify away from stocks and lower his risk? That’s what I’ve been doing for the past year and it feels great!
It’s important not to confuse brains with a bull market.
Sam
Retire Before Dad says
Hey Sam,
Maybe he should turn his ‘funny money’ into real assets as you like to say. He’s not a sophisticated investor. Far from it. He probably realizes his gains are due to the market, but he wants to retire badly. So it’s a combination of having enough, hoping it doesn’t go away, and really wanting to quit due to his health problems. Although he has told me he sometimes trades stocks.
-RBD
Duncan's Dividends says
I absolutely agree with this, if this gentleman hasn’t considered that the market could turn he is somewhat delusional with his thoughts of retirement. Either he needs to know that these stocks/bonds/etc can fund his lifestyle, or he needs to keep working. Honestly if it’s purely predicated on the figure in his portfolio and he believes that this is all he will need to finance himself for the next 30 years he should mitigate his risk and turn a large portion of it into fixed income assets like bonds to prevent himself from having that opportunity to experience another crash. It still amazes me what people are willing to put themselves through when they know that a crash is not an “if this happens” but rather “when the next one hits” type of event.