Retirement and FIRE: Assessing the Likelihood of Setbacks (Risk, Diversification, and Withdrawal Rate)

This article looks at how likely you are to go broke as retired or FIRE. Low interest rates make many pensioners and those who retire early (FIRE) allocate more and more capital to risky stocks. Many tend to forget that a bear market can last for a decade – even longer. What happens to the value of your portfolio if you are “unlucky” with the sequence of returns and/or the withdrawal rate? When do you run out of money?

You are very likely to go broke as retired or FIRE if you don’t have a huge margin of safety. If you are unlucky with the sequence of returns, you might be in big trouble right off the bat. Or if your withdrawal rate is too high, you risk bleeding to death. Furthermore, if you are poorly diversified you might be liable to Black Swans. Put short, being dependent on capital for “income” involves many “ifs”.

In this article, we provide examples of how bad it can get if you are not focusing on survival or have a low margin of safety.

What is FIRE?

Let’s start by explaining that FIRE is an abbreviation for Financial Independent Retire Early. This is an acronym that pops up frequently – especially after a series of good returns in stocks or any other assets (crypto, for example). Investors tend to get optimistic and exuberant, and see no skies on the horizon. This is human nature and most people are pretty optimistic – and that’s perhaps a good thing.

Let’s move on with an example of an unlucky FIRE (it could, of course, be a retired person or couple):

An example of an unlucky FIRE (or pensioner)

It’s January 2000 and you’ve had a terrific decade. You’ve worked your way up the corporate ladder after graduation in 1982, and your two daughters have just left for greener pastures.

You and your wife’s modest monthly savings into mutual funds and a few internet stocks have reached an all-time high of one million USD, recently fueled by five years in a row with 20% or more annual returns.

Things are good, except you are not happy in your job, neither is your wife. Long hours, commuting, city life, and expensive living are all taking their toll on you. The dream of a small farm in the countryside has been in the back of your head for years.

The thought of breaking up, selling the apartment, and moving to somewhere bigger (but cheaper), is an idea that becomes more and more appealing by the day. Who doesn’t want to be a FIRE and do exactly what you want, travel when you can, and enjoy life?

You and your wife take the plunge and decide to invest conservatively by investing passively into a fund that tracks US Large Caps. You plan to withdraw 50 000 once per year adjusted for inflation every year. This amount is needed due to expected traveling three times per year.

How did it go?

Using hindsight and a simple backtest, it’s easy to simulate the performance of the portfolio and its withdrawals.

It was not pretty and both of you were at some point forced to return to work. Without additional income, you ended penniless in 2017:

How Likely Are You To Go Broke As Retired Or FIRE?

The above visualization of the portfolio, performed in Portfolio Visualizer, isn’t even adjusted for inflation.

You drained all your capital and even a raging bull market from 2010 didn’t manage to recoup the first ten years which was just a roller coaster going sideways.

Why did our FIRE couple go broke?

When you are depending on a fixed income you better be sure you have a margin of safety in the sequence of returns and the withdrawal rate. Any kind of diversification also most likely helps.

These are crucial components in determining your source of “income”. (We write “income” because we believe withdrawal from capital is not income in any sense. Income is what you get from labor or offering your services in exchange for your time. If you are interested in learning more about this please read our multiple articles on dividend investing.)

Our couple made three mistakes:

  1. The first mistake is having too high a withdrawal rate.
  2. The second mistake is not having any kind of diversification. As a rule of thumb, ANY diversification helps.
  3. The third mistake was exposure to randomness and sequence of returns risk. There was no margin of safety. They were “unlucky” by starting with three annual losses in a row. The bars below show the annual returns of the passive large-cap fund. The fund lost 37% of its value at the end of year three without even considering the 150 000 withdrawals during the period:
How Likely Are You To Go Broke As Retired Or FIRE? Annual returns

Even worse, after a few years with positive returns right after 2003, they were hit by the financial crisis in 2008. Their portfolio never recovered when they kept on withdrawing capital from the portfolio while the value was declining. The sequence of returns was incredibly bad timing.

Keep this in mind if you plan early retirement:

FIREs, retirees, and pensioners are fragile – very fragile

The example above illustrates how fragile you are as a FIRE or pensioner. You are fragile because any negative surprises can have a devastating effect on your lifestyle. If you’ve had no employment for ten years, it probably feels pretty awkward and depressing searching for jobs – especially if you have passed the magical 50 years of age.

If you retire in your 40’s you might have 40 more years on this planet. That leaves a lot of room for random outcomes.

You better understand three concepts: sequence risk, withdrawal rate, and diversification. Please also read Benjamin Graham’s concept of always making sure you have a margin of safety.

What is sequence risk? The sequence of returns matter

Sequence risk refers to how the monthly, quarterly, or annual returns are shuffled.

For example, the average annual return in the stock market is around 10%, but you can still have three years in a row with negative returns. Those three single years might influence your compounding ability for decades to come! Mark Spitznagel writes that the compounding effect is the most destructive force in the universe if you are “unlucky” with the returns.

Our couple above would have completely different results if the first three years were positive instead of negative.

Because of the compounding effect, or the lack of it, these sequences of returns matter a lot. Even with 10% annual returns, simulations reveal that the chances of getting low returns are most likely much higher than most FIRE and pensioners believe because of the difference between geometric and arithmetic returns.

In a previous article about dollar-cost averaging, we showed how the sequence of return risk might lead to very different results depending on how you shuffle the annual returns.

A realistic simulation of return risk: How likely are you to achieve good returns in the stock market?

Mark Spitznagel has written a good book about safe haven investing. In one of the chapters, he explains an interesting Monte Carlo simulation of the 120 different annual returns in the S&P 500 from 1901 to 2020 (including dividend reinvestments).

Obviously, the S&P 500 has had only one path or sequence of returns, which has led to a CAGR of 9.5%. But with the help of computer power, we can take those annual returns and change the order of how they appeared. We reshuffle the sequences.

What did Spitznagel do? He used the 120 years of annual returns and simulated 10 000 sequences (or paths) of a virtual portfolio for 25 years. Why 25 years? Simply because that is the “normal” length of an investment period for most people.

In simpler terms the simulation was done like this: if we have a dice that has 120 sides, we roll the dice 25 times to calculate the end result of the portfolio. This is repeated 10 000 times (if you roll quickly this should be done in a week?). Computer power comes in handy as we can do this in just a few seconds.

What happens if we take those 120 annual returns and reshuffle them 10 000 times? Here is the simulation that Spitznagel did:

How Likely Are You To Go Broke As Retired Or FIRE? (Sequence Risk, Diversification, And Withdrawal Rate)

The average return of the Monta Carlo simulation is around 11%, but the median simulation ends up at 9.5%. You have a 10% chance of getting a CAGR less than about 3% (but also a 10% chance of getting more than 16.5%).

How do you mitigate sequence risk? How to reduce sequence of return risk for retirees and FIRE

Besides diversification, the best way to mitigate sequence risk is to live moderately and spend less than you want. It’s a pretty boring answer and probably not what most people want to hear, but it’s the best advice there is.

The rest of the article looks at how to mitigate the risk of going broke as a FIRE or retired:

We start with the withdrawal rate. What is the best withdrawal rate? The 4% has been a benchmark for many years:

What is the 4% rule?

In 1994 William Bengen published a paper that eventually should become well-read and very popular. Bengen, an engineer from MIT turned Certified Financial Planner after selling the family business, created the 4% rule as a rule of thumb for withdrawal rates from retirement savings.

Bengen did simulations of historical returns and concluded that a person could take out or withdraw 4% annually from their portfolio without running out of money as long as they lived.

Today, even the world’s biggest sovereign wealth fund (SWF), Norway’s, employs much the same principles with some small alternations. Norway’s withdrawal rate has recently been lowered to make room for lower future expected returns (now at 3%).

Keep in mind that Bengen simulated for pensioners and retirees – not FIREs. Because FIREs have a longer runway, so to speak, any misfortune in the sequence of returns might influence the compounding substantially more. There is simply more risk the longer the time frame s it allows for black swans.

To mitigate sequence risk you need a withdrawal rate that is very conservative. In the example above with the unlucky FIRE couple, what would have happened if the annual withdrawal rate was 40 000 instead of 50 000? It turns out they would have fewer worries – for a while, at least:

How Likely Are You To Go Broke As Retired Or FIRE?

Even with a 4% withdrawal rate, the couple is most likely just delaying the inevitable: they’ll go broke. The last bull market from 2010 has not managed to recover the portfolio, and they’ll most likely end up broke during the next downswing.

What about a 3% withdrawal rate? After going almost broke in 2009, they were saved by the bell (QE) and ultimately able to recover:

The simple examples above show how sensitive the result is to the withdrawal rate. The lesson is simple: aim for survival and calculate a conservative withdrawal rate.

Diversification can offset higher withdrawal rates

Another tool to avoid the risk of ruin or running out of money is diversification.

We made some changes in the composition of the portfolio (basically just added some other assets from the top of our head). We made the following portfolio and weightings and rebalanced annually:

Trading Rules


We simply took a basket of assets that should at least (perhaps) go the opposite way when the US stock market plummets. The result is much better (this is with a 50 000 withdrawal rate – 5%):

However, this is a theoretical exercise and we use a bit of hindsight and survivorship bias in our backtesting.

The problem with diversification is that the future will never pan out exactly like the past. Correlations are non-stationary and change.

Edward Thorp and sequence risk of returns

Edward Thorp (the first quant) had a short comment on sequence risk at the end of chapter 27 in his book called A Man For all Markets. We quote his conclusion:

What if you want the payouts to continue “forever”, as you might for an endowment? Computer simulations showed me that with the best long-term investments, such as stocks and commercial real estate, annual future spending should be limited to the inflation-adjusted level of 2 percent of the original gift. This surprisingly conservative figure assumes that future investment results will be similar in risk and return to US historical experience……The 2 percent spending limit is so low because, if the fund is sharply reduced in its early years by a severe market decline, a higher spending requirement might wipe it out.

The last sentence is pivotal: this is exactly what happened to our retired couple. If you retire into a severe recession, you might never recover. This is precisely why you need a huge margin of safety or a low withdrawal rate!

Conclusion: How Likely Are You To Go Broke As Retired Or FIRE?

Unfortunately, most retirees and pensioners underestimate the risk of running out of money: because of black swans and randomness retirees and FIREs are fragile. You need a huge margin of safety.

From the portfolio simulations above it should be pretty obvious that you need a margin of safety to be reasonably confident about your ability to survive and prosper economically as retired – whether as a FIRE or regular pensioner.

You need a low withdrawal rate to offset the risk of being “unlucky” with the sequence of returns, and additionally, you should have some diversification to other stock markets and also include a couple of other asset classes.

How likely you are to go broke as retired or FIRE depends very much on planning, the margin of safety, and frugality.


Why is it mentioned that retirees, including FIRE individuals, are likely to go broke?

The likelihood of going broke in retirement, whether traditional or FIRE, is discussed due to the impact of factors like low interest rates, sequence of returns, withdrawal rates, and lack of diversification. The article highlights the importance of having a substantial margin of safety in retirement planning.

What is the 4% rule, and why is it discussed in the context of retirement planning?

The 4% rule, introduced by William Bengen, suggests that retirees can annually withdraw 4% from their portfolio without running out of money during their lifetime. The article explores its applicability, especially in the context of FIRE, highlighting the need for a conservative withdrawal rate.

Why is diversification considered a tool to avoid the risk of running out of money in retirement?

Diversification is discussed as a risk mitigation strategy. The content explores how a diversified portfolio, including assets like US large caps, REITs, emerging markets, gold, and long-term Treasury, can potentially offset the impact of market downturns and enhance the sustainability of retirement funds.

How can retirees and FIRE individuals reduce sequence risk?

Besides diversification, the content suggests that living moderately and spending less than desired is an effective way to mitigate sequence risk. The FAQs elaborate on why conservative financial habits are crucial for offsetting the potential impact of unfavorable sequence of returns.

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