This is 3x Worse Than a Market Crash

20 Oct 2018 12:42

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In a previous post I attempted to determine how much emergency cash I would need to weather a market crash by comparing the annual S&P dividend payout to the great recession market crash of 2009. The results showed if one declared financial independence just prior to the market collapse that income dropped and took 4 years to return to pre-crash levels. To get through 4 years of income loss an income portfolio would need an emergency cash fund of 60% of annual expenses to weather the storm and a dividend growth portfolio would have required a 38% cash fund.

I decided to follow-up that analysis by analyzing what would happen to your portfolio income in a prolonged market with high inflation. The time frame chosen was from 1973 to 1984 and the results were shocking as it showed inflation can be up to 3x greater of a loss than that of a market crash!

The Analysis

The analysis was based on two different people going into financial independence (retirement) in 1973 and that all portfolio income met 100% of annual expenses. The differences between the two is that one portfolio is a traditional income portfolio and the other is a dividend growth strategy.

With the traditional income portfolio scenario, inflation over time devastates the ability to meet rising expenses and ends in 1984 with an income gap of -58%.

1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984
Inflation 6.20% 11.00% 9.10% 5.80% 6.50% 7.60% 11.30% 13.50% 10.30% 6.20% 3.20% 4.30%
Expense Gap -14.59% -25.16% -25.75% -24.69% -30.31% -38.38% -47.40% -52.87% -55.72% -57.33% -58.21%

There are very few steps one can take to avoid this situation. Our investor could have started with a portfolio that provided income that exceeded expenses by 70% or had just over 4 years of expenses in a cash emergency account. Either solution is completely out of the realm of possibility unless one was extremely wealthy to begin with. This explains why so many retirees were struggling in the 1980's and were in desperation mode to reduce expenses, (remember retirees buying canned dog food to save money).

I was born in 1968 and was raised during this time period. I remember well the struggles with unemployment, inflation and the oil crisis. I also remember seniors desperate to get into public senior housing (rent controlled) and the wait lists to get into one of these communities was usually measured in years. This was definitely a tough time period to be living without a job.

In the dividend growth scenario we use the same starting assumption but supplement that with an organic annual 5% dividend growth rate. The results show our investor is slightly more successful but still suffers.

1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984
Inflation 6.20% 11.00% 9.10% 5.80% 6.50% 7.60% 11.30% 13.50% 10.30% 6.20% 3.20% 4.30%
Expense Gap -5.71% -9.84% -10.68% -12.26% -15.04% -21.94% -31.81% -38.47% -40.05% -37.65% -36.73%

By 1984 our investor reaches an income gap of -37%. Considerably much better than our first scenario but that does little to comfort our investor as they still have issues with paying expenses and will be struggling mightily to reduce expenses.

Since the income gap is smaller there are some realistic steps that can be taken at the start of retirement based on a combination of investments and emergency cash to avoid this risk:

Annual Div Payout to Expenses Emergency Cash Needed
Income = Expenses 1.9 x annual expenses
Income 10% > Expenses 1.1x annual expenses
Income 15% > Expenses 70% annual expenses
Income 20% > Expenses 30% annual expenses

All of these solutions require the saving & investing of additional money and hopefully is enough to help us plan how much to invest and save. It also assumes all cash is in a laddered CD portfolio earning interest. As a note, for those who do not like to keep cash you would need to have a starting dividend growth portfolio that provided income greater than 40% of your annual expenses in order to have no income gaps.


Inflation is just downright scary. One of the obvious things we notice is that long term inflation is similar to dividend growth investing in that the more time in the market the bigger the snowball effect. Essentially INFLATION IS THE ANTI-THESIS TO DIVIDEND GROWTH! It explains why so few companies can beat inflation year in and year out and why we should appreciate companies like McDonalds (MCD), Johnson & Johnson (JNJ), and Automated Data Processing (ADP) whose dividend raises have beat the rate of inflation for more than 30 consecutive years.

As for my personal goals and objectives this analysis does change things. I originally planned to have income that exceeded 10% of expenses and have an emergency fund equal to 40% of annual expenses. I will need to up my targets to now have income exceed expense by 15% and increase the emergency fund to 70% of expenses. With 9 years left to retirement this will be a challenge and I will have to dig deeper to find additional money but luckily I have identified this now and not a couple years before retirement.

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