The Anti-Withdrawal Strategy: How To Beat Sequence Risk

Reader note: My example in the original version of this post was poor. Thanks to Shaun and TMV for pointing this out in the comments. I have rewritten parts of the post with a better example.

Perhaps the biggest financial risk for an early retiree is sequence risk. This is selling your stocks into a bad market early in retirement. Here’s a fancy definition:

Sequence risk is the danger that the timing of withdrawals from a retirement account will have a negative impact on the overall rate of return available to the investor. This can have a significant impact on a retiree who depends on the income from a lifetime of investing and is no longer contributing new capital that could offset losses. Sequence risk is also called sequence-of-returns risk.

–Investopedia

What the heck does that mean? Consider a scenario:

1. You save $1,000,000 for retirement
2. On 12/31 you quit
3. On 1/3, the market drops 40%, kicking your portfolio down to $600,000.
4. On 1/4, you take $40,000 out of your account to fund the year

So, now you have $560,000.

Now, let’s say the stock market bounces back and appreciates 25% the rest of the year. (25% is a big number, but bull markets typically follow big drawdowns and most gains happen early in the rally) At the end of 2022, you’ll have $700,000.

How could we improve our returns? The best way to defeat sequence risk is to avoid selling stocks. Allow me to introduce you to Mr. Margin Loan.

What Is A Margin Loan?

A margin loan is a loan against your post-tax investment account. When many think about margin, they think about buying stocks with the loan proceeds. However, you can also use the money to buy houses, pay for home improvements, or in this case, fund your existence.

For a detailed explanation of margin lending, see MMM’s write-up.

Now, let’s reconsider the scenario, but using the margin loan instead of selling stocks:

1. You save $1,000,000 for retirement.
2. On 12/31 you quit.
3. On 1/3, the market drops 40%, kicking your portfolio down to $600,000.
4. Instead of selling stocks to fund your existence, you take out a margin loan of $40,000 at a rate of 2%. At this rate, you’d pay under $1,000 in interest if you held the loan for a year.
5. Going with the same numbers from the example above, the market appreciates 25% and you have $750,000.
6. You sell $41,000 of VTSAX and pay back the margin loan, so now have $709,000 left over.

In the margin loan scenario, you’re $9,000 ahead of where you would have been otherwise. This may not sound huge, but:

• $9,000 almost 25% of your annual spending.
• If you assume a 10% return on your investments, that $9,000 is worth $288,000 35 years down the road. This is nothing to sneeze at:

$9,000 -> $18,000 -> $36,000 -> $72,000 -> $144,000 -> $288,000

I know what you’re thinking:

But I hate debt! I paid off my house! I own all of my cars! Wah, wah!!!

The same reason you don’t want to sell your stocks back to Mr. Market in a severe downturn is the same reason you don’t do business with a pawn shop. The pawn shop is going to pay you $15 for the tool you bought for $100 a year ago. Why sell your assets back to Mr. Market when he’s not paying a reasonable price?

The Good

Margin loan rates are variable

The rates change frequently. The good news is that when bad things happen in the world and the stock market tanks, rates tend to go down. This is because governments know that keeping money cheap helps juice the economy. So, when you need money most, it’s the cheapest to borrow. Yay!

It’s really cheap to borrow on margin

Interactive Brokers is known for its great rates. Currently, you can borrow up to $100,000 at 1.58%. Between $100,000 and $1,000,000, the rate goes down to 1.08%:

While Interactive Brokers is the leader with margin lending, I negotiated a similar rate with ETrade. They even threw in a cash bonus for me to transfer my funds to them.

Note that if you’re not on Interactive or a firm that has low margins rates, you can initiate an ACATS transfer to move money without selling any assets or paying capital gains.

It’s really easy to borrow on margin

It takes about 5 minutes to log into your account and take out a withdrawal. In my experience, the money has always appeared in my bank account the next day.

Take as much or as little as you need

In my simple example above, I took out $40,000 in one chunk. In the real world, you could take out smaller amounts of money with greater frequency to minimize interest.

Margin loans don’t hit your credit

These loans aren’t reported to credit agencies. So, you can borrow money and your credit doesn’t take a hit.

The Bad

Margin loan rates are variable

Didn’t I just put this one in The Good section? The rates change frequently. Just because you can borrow money at 1.5% doesn’t mean it will stay that way. I would not count on this as a long-term solution. I would borrow money in small increments (monthly?) and have a plan to pay it back when Mr. Market has stopped behaving like a pawn shop.

It’s tied to your post-tax account

You can only execute this strategy with a post-tax stock portfolio. This does not apply to a 401(k), IRA, or any other tax-advantaged account.

Your loan could get called

Don’t go anywhere near the lending limits. If your account value drops too much, your broker has the right to sell your stocks to pay back your loan. Borrow just what you need and no more.

Market timing

This strategy smells a little bit like market timing, right? I agree, but just a little.

• Don’t do this every day: This strategy is meant for only exreme situations and when the spread is large. If stocks are down 25% but you can borrow money at 1.5%, there is a good chance that you’ll come out ahead by borrowing from Mr. Margin for a short period.
• 4% Rule: And yet another mention of the 4% rule! ** yawn ** If you’re a FIRE Fan, you probably believe in the 4% rule which means that over the long term, you expect your portfolio to return better than 4%. If your confident in this, borrowing money at less than 2% to avoid selling when the markets are down 25% seems like a no-brainer.

Be Flexible

Remember that this strategy is the nuclear option. For you to need it, three events would have to happen close together:

1. You are very early in retirement. Remember that sequence risk only matters early on. If you’ve retired to a market that has performed normally and used the 4% Rule for withdrawals, you’ll have a healthy buffer before long.
2. The market has a big downturn: There have been 10 bear markets, corrections of more than 20%, since 1950. That’s one about every 7 years.
3. You need to sell stocks in the middle of the downturn: The average breakeven time since 1928 for a bear market is a little over 2 years, but less in modern times.

I think sequence risk is overrated. Let’s say you save up $1,000,000 and three months after you retire, your portfolio drops in half. Stop freaking out! Life isn’t over! You don’t live in a binary world. You probably won’t go broke:

• Go back to work: The best time to go back to work is shortly after you left. You still have your skills and connections. Since you were able to save up a healthy chunk of money early in life, you were probably pretty good at what you did and someone would love to hire you.
• You still have $500,000: Half a million is not a small chunk of change. You could go to a coding boot camp or spend years getting another degree with that amount of money. Or, just move to a corner of the world where everything is cheaper and wait it out.

Or, hit up Mr. Margin for a quick cash infusion. When the economy starts moving up and to the right again, pay Mr. Margin back and continue with your retirement.

Disclaimer: I AM NOT a CFA, CFP, or anything like that. I’m a middle-aged dude who plays with plastic dinosaurs and has an extensive Hot Wheels collection. Please do your own research!

More 1500 Days!!!

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