Latest / The Financial Freedom Podcast with Fexingo: Quitting Your Job, Living Off Investments, Independence / How Early Retirees Handle Market Volatility With a Rising Equity Glidepath
Transcript
- Lucas: You've probably heard the conventional wisdom that as you approach retirement, you should reduce your stock allocation. But for early retirees, that advice can backfire spectacularly. Luna: Backfire how? I always thought going more conservative in retirement was just standard practice. Lucas: It is, but the standard practice assumes you're retiring at 65 with a 30-year horizon. If you retire at 40, you've got a 50-plus-year horizon. The biggest risk isn't market volatility itself — it's sequence of returns risk. That's the danger of a bad market hitting in the first few years of retirement when you're also withdrawing money. Luna: Right, because if the market drops 30% in year one and you're pulling out 4%, the math gets ugly fast. Lucas: Exactly. And the rising equity glidepath is a counterintuitive solution. Instead of reducing stocks as you get older, you start retirement with a lower stock allocation — say 30% stocks, 70% bonds — and then gradually increase your stock allocation over the first 10 to 15 years of retirement. Luna: So you're actually taking on more equity risk later, not less. That seems backwards. Lucas: It does, but the logic is solid. In early retirement, you're most vulnerable to a bad sequence of returns. A lower stock allocation shields you during that fragile period. After a decade, if the market has cooperated, your portfolio has grown, and you can afford to take on more equity exposure for the long haul. Luna: Is there actual research backing this up? Or is it just a theory people talk about on forums? Lucas: There's real data. A 2010 study by financial planner Michael Kitces and researcher Wade Pfau modeled this. They used historical returns and found that a rising equity glidepath starting at 30% stocks and ending at 70% over 10 years actually improved the safe withdrawal rate compared to a static 60/40 portfolio. Luna: Improved it by how much? Lucas: The static 60/40 portfolio historically supported about a 4% withdrawal rate with a low failure rate. The rising glidepath bumped that up to nearly 4.5% in many historical scenarios. That extra half a percentage point can mean thousands of dollars a year in income for a $1 million portfolio. Luna: But here's what I wonder — if the market crashes in year eight when your stock allocation is already up to 60%, aren't you still vulnerable? Lucas: That's a great point. The key is that by year eight, you've already survived the most dangerous period. Your portfolio has had seven years to grow, and ideally, you've withdrawn less than the full amount if you followed a guardrails approach. The crash in year eight is still painful, but it's not the same as a crash in year one because you have a larger portfolio cushion. Luna: So the glidepath is really about buying insurance for the early years. Lower returns initially, but much lower downside risk. Lucas: Exactly. Now, let's talk about how to actually implement this. Say you retire with $1 million. You start with $300,000 in stocks and $700,000 in bonds. Each year, you rebalance and gradually increase the stock target. Over 10 years, you move to $700,000 in stocks and $300,000 in bonds. Luna: And you do this by selling bonds and buying stocks every year, regardless of what the market's doing? Lucas: That's the theory, but in practice, you can be a bit flexible. If the market is down sharply in a given year, you might pause the glidepath or even delay it. The goal is to increase stocks over time, not to mechanically rebalance into a falling knife. Luna: Makes sense. I also imagine you'd want to keep an eye on taxes. If a lot of your bonds are in taxable accounts, selling them might trigger capital gains. Lucas: Absolutely. Ideally, you'd hold bonds in tax-deferred accounts like a traditional IRA or 401k, and stocks in taxable or Roth accounts. That way, rebalancing within the IRA doesn't create a tax event. But reality is messier. You might have to accept some tax drag for the sake of the strategy. Luna: One thing I've heard early retirees struggle with is the psychological aspect. Starting with a low stock allocation during a bull market can feel like you're missing out. Lucas: That's a very real challenge. If stocks are soaring and you're only 30% invested, you'll watch others get rich while your portfolio grows more slowly. But the whole point is to avoid the catastrophic loss in a downturn. It takes discipline. Luna: Speaking of discipline, this show takes discipline to produce. Lucas and I try to bring you something useful every day, but it's entirely listener-supported. No ads, no sponsors — just a few hundred people who chip in monthly through buy me a coffee dot com slash fexingo. We keep it going because of them. Lucas: Yeah, it's a small group, but they make a big difference. If our money conversations have helped you think about a decision differently, that's the same link. No pressure, just the reality of how this gets made. Luna: Alright, back to the glidepath. One more nuance: what about Social Security? If you're retiring early, you might not claim until 70. Does that change the math? Lucas: It can. Delaying Social Security is essentially buying an inflation-adjusted annuity. If you delay, you have less need to generate income from your portfolio, which means you can afford a lower withdrawal rate and less equity risk early on. That pairs beautifully with a rising glidepath. Luna: So the ideal early retiree might use a rising equity glidepath plus delayed Social Security, plus a guardrails spending strategy? Lucas: That's a powerful combination. Let's put some numbers on it. Assume a 40-year-old with $1.2 million, spending $48,000 a year — a 4% withdrawal rate. With a static 60/40 portfolio, historical data shows about a 95% success rate over 50 years. With the rising glidepath, that success rate climbs closer to 98%. Luna: And if you add guardrails — cutting spending by 10% if the portfolio drops below a certain threshold — you could push the success rate even higher. Lucas: Right. The guardrails strategy says if your withdrawal rate exceeds a certain percentage of the current portfolio, you cut spending. That adds another layer of protection. Combined with the glidepath, you're essentially building a fortress against sequence risk. Luna: What about the argument that you could just use a bucket strategy instead? A cash bucket for 2-3 years of expenses, bonds for 5-7 years, and equities for the rest? Lucas: The bucket strategy can work, but it's more about mental accounting. The rising glidepath is grounded in portfolio theory. With buckets, you have to decide when to refill the cash bucket from stocks, which can be emotionally difficult. The glidepath automates the gradual increase in equity exposure, removing that decision. Luna: True. The glidepath is more systematic. For the DIY retiree, that's probably a good thing. Lucas: One more point: the glidepath doesn't have to be a straight line. Some people prefer a gradual increase over 15 years instead of 10. Others use a target-date fund that automatically does it for them. The key is the principle: lower equity exposure early, higher later. Luna: So if I'm 45 and planning to retire in 5 years, could I start implementing the glidepath now? Like, lower my stock allocation before retirement? Lucas: You could, but the glidepath is specifically designed for the withdrawal phase. Before retirement, you're still accumulating, so you generally want higher equity exposure. The glidepath starts when you stop working and start withdrawing. Luna: Got it. So the sequence is: high stocks during accumulation, then drop to low stocks at retirement, then glide back up over the next decade. Lucas: Exactly. It's a V-shaped pattern in equity allocation over time. That's what the research supports. Luna: But doesn't that mean you have to sell stocks right before retirement to get to that 30% level? If the market's been strong, you're locking in gains. If it's down, you're selling at a loss. Lucas: That's the tricky part. Ideally, you'd start reducing stocks a few years before your retirement date to avoid a forced sale at the worst time. So if you plan to retire in 2028, you might start shifting from 80% stocks to 30% stocks gradually over 2025-2027. That way, you're dollar-cost averaging into bonds. Luna: So the glidepath requires planning ahead. You can't just decide to retire next month and then set up a glidepath. Lucas: Exactly. It's a multi-year transition. That's why early retirement planning should start at least 3-5 years before the actual retirement date. Luna: Alright, so let's say someone does all this — the glidepath, the guardrails, delayed Social Security. What's the worst-case scenario they're still exposed to? Lucas: The biggest remaining risk is inflation. If we enter a prolonged high-inflation period like the 1970s, bonds get crushed, and the early low-equity allocation could hurt. TIPS ladders can help, but they're expensive. There's no perfect strategy. Luna: But the rising glidepath does address the most common risk — a severe market crash early in retirement. And it does so without sacrificing long-term growth potential. Lucas: That's the trade-off most early retirees are willing to make. You give up some upside in the first decade for dramatically lower downside. Over 40 or 50 years, that's a good bet. Luna: I think the hardest part is psychological. Starting retirement with only 30% stocks when everyone else is 80% stocks takes guts. Lucas: It does. But remember: you're not trying to beat the market. You're trying to fund a 50-year retirement without running out of money. The rising equity glidepath is one of the best tools we have for that specific goal. Luna: Alright, I think we've covered the essentials. For anyone listening who wants to dive deeper, the Kitces and Pfau research is a good starting point. Lucas: Absolutely. And if you're already retired or approaching retirement, it might be worth running your numbers through a Monte Carlo simulation that includes a glidepath. The difference could be a few extra years of financial independence.