Dow drops by 50%.
Can I stay retired?

This article was updated on March 30, 1999.

From the front page of the Wall Street Journal, March 30, 1999

"The rising market has created a leisure class of such size that it can descend on a region like an occupying army. Just north of San Diego, nestled along scenic seaside cliffs, towns like La Jolla and Del Mar have been lifted by "an amazing decade of growth, with middle-aged retirees coming here to live off their investments," says Doug Wheeler, 40, pushing his young son in a stroller on a recent Saturday by the sumptuous shops, galleries and cafes of La Jolla. Mr. Wheeler, who runs a convention-planning business in town, has been buying and selling equities with vigor of late, getting rid of "some dogs" and putting $20,000 into high-tech mutual funds. "I'm young, so I can embrace some risk. I feel I've got to do that, so I can be one of these middle-aged retirees, too."

With the Dow Jones Industrial Average climbing over 10,000 and many of the highly paid Wall Street pundits who told you to sell at 5,000 on the Dow advising you to sell again (that is, if you have any stocks left to sell), what should you do?

If the stock market dropped by 50% could you stay retired? Or would you suffer an untimely, pride swallowing, return to the workforce. Can you ensure you remain a member of the leisure class that occupies La Jolla and Del Mar?

In a continuing spirit of public service, Retire Early has given this question a lot of thought and developed a financial planning tool for interested readers. Retire Early's Calamity Planning Spreadsheet allows users to analyze the effect of a plummeting Dow on their retirement income. It allows you to measure the effect of changes in asset allocation, inflation rates, and your annual withdrawals for living expenses.

This program assumes the value of the stock portion of the retiree's portfolio drops by the amount input by the user in the 2nd year. Dividends earned by the equity (stock) holdings are assumed to decrease by 10% in the year after the Stock Market Drop. (For example, at a 2.00% yield, a $100,000 stock portfolio would have $2,000 in dividend income. After a 50% drop in value and a 10% decrease in dividend income the $50,000 portfolio would have $1,800 in dividends for a new yield of 3.60%.) The stock portion of the portfolio then increases in value at the rate of inflation until it returns to its initial amount. Thereafter the rate of increase for the stock portion of the portfolio then returns to the historical rate of return input by the user.

User Instructions.

The Calamity Planning Spreadsheet is shown below (Figure 1.). The input parameters that the user must define are in the upper left hand portion of the spreadsheet. The items requiring input are shown in blue. Each of input parameters are explained in detail below in Figure 1.

The "results" area of the spreadsheet shows three items: 1) The number of years required to recover the value of the stock portfolio after the drop in the 2nd year, (2) the dollar amount of the annual withdrawal for the first year (the annual withdrawal in increased for inflation each year.), and, 3) Portfolio value at T+55 years. This is the value of your portfolio after 55 years. The idea is to make sure that this is a positive number.

You may want to print this page so that you can refer to these instructions while you work with the Calamity Planning Spreadsheet.

Input parameters.

The user must input the following parameters starting in column B of the spreadsheet with the Year. The values in the cells requiring user input appear in blue on the spreadsheet.

Year Enter the current year. (date)
Age Enter your age. (years)
Initial Portfolio Value The total value of your retirement portfolio. (dollars)

Asset Allocation

Stocks Percentage of your portfolio in equities (stocks). (percent)
REITs Percentage of your portfolio in REITs. (percent)
Bonds Percentage of your portfolio in bonds. (percent)
Cash Percentage of your portfolio in cash (e.g., money arket funds). (percent)

Input Values

Total Return. Enter the percent return for each asset class (stocks, REITs, bonds, cash). The total return is comprised of two components: 1) capital appreciation, and, 2) interest and dividends. For bonds that you hold to maturity and cash the capital appreciation should be zero.
1st Year Annual Withdrawl Enter the percentage of your portfolio you need to withdraw for living expenses. (percent)
Inflation Rate Enter your assumption for annual inflation (percent).
Stock Market Drop in 2nd Year Enter the percent decrease in value for your equity (stock) holdings in the 2nd year.

Results

Years to Recover Stock Market Value This is the number of years needed to recover your initial stock value, assuming the stock portion of your portfolio increases at the inflation rate.
Annual Withdrawal in 1st Year This is the dollar value of your annual withdrawal in the 1st year. The program assumes that your withdrawls in subsequent years increase at the rate of inflation input above.
Portfolio Value at T+55 years This is the value of your portfolio at the end of 55 years. If its a negative number you've run out of money if you live that long. Try reducing your annual withdrawal percentage to turn it positive.

Run some scenarios.

The Calamity Planning Spreadsheet allows you to input different parameters and see the results immediately. Use your imagination. Investigate the effect of a 1% increase in the inflation rate or a 1% decrease in your annual withdrawal. It will make you think.