Seven reasons in defense of debt and leverage: Yes, you CAN have too little of a bad thing!

We hope you had a great holiday weekend and a very Merry Christmas! If you are looking for the fourth installment of the Safe Withdrawal Rate series (see part 1, part 2, part 3), please come back next week. Who is in the mood for heavy-duty number-crunching when we’re still digesting the heavy meals and scores of eggnog from last weekend? Yup, every year around this time we reconfirm the concept known as “too much of a good thing.” Only those of you free of the sin of overconsumption can throw the first meatball, uhm, stone. I’m waiting… Still waiting… Nobody? See, we’ve all experienced overconsumption between Thanksgiving and Christmas. But is the opposite true as well?

Can there be too little of a bad thing?

The bad thing I’m talking about is debt. To many of us in the FIRE community, debt is a four-letter word – figuratively! An entire niche of the Personal Finance blogging world is dedicated to getting out of debt and that’s a really good cause especially for those with a low or negative net worth. Paying off credit card debt at 18-20% or student loan debt with high single-digit percent interest rates should be priority number one. But that doesn’t mean that all debt is bad. For us in the ERN household, we’re blessed to never have had any sizable debt, except for a 30-year mortgage that we plan to pay off not a day earlier than we have to. We enjoy the ultra-low interest rate (3.25%), the tax-deductibility and putting our money to work with higher expected returns elsewhere. We love leverage! Our blogging friend FinanciaLibre has written excellent pieces on the topic of leveraging your equity portfolio with the cheap borrowing costs of a mortgage, see hereRead More »

Advertisements

The Ultimate Guide to Safe Withdrawal Rates – Part 3: Equity Valuation

Update: We posted the results from parts 1 through 8 as a Social Science Research Network (SSRN) working paper in pdf format:

Safe Withdrawal Rates: A Guide for Early Retirees (SSRN WP#2920322)

Welcome back to our safe withdrawal rate series! Over the last two weeks, we already posted part 1 (intro and pitfalls of going beyond a 30-year horizon) and part 2 (capital preservation vs. capital depletion). Today’s post deals with yet another early retirement pet peeve: safe withdrawal rates are likely overestimated given today’s expensive equity valuations. We wrote a similar piece about this issue before, but that was based on cFIREsim external simulation data. We prefer to run our own simulations to be able to dig much deeper into this issue.

So, the point we like to make today is that looking at long-term average equity returns to compute safe withdrawal rates might overstate the success probabilities considering that today’s equity valuations are much less attractive than the average during the 1926-current period (Trinity Study) and/or the period going back to 1871 that we use in our SWR study.

Thus, following the Trinity Study too religiously and ignoring equity valuations is a little bit like traveling to Minneapolis, MN and dressing for the average annual temperature (55F high and 37F low, see source, which is 13 and 3 degrees Celsius, respectively). That may work out just fine in April and October when the average temperature is indeed pretty close to that annual average. But if we already know that we’ll visit in January and wear only long sleeves and a light jacket we should be prepared to freeze our butt off because the average low is 8F =-13C! Likewise, be prepared to work with lower withdrawal rates considering that we’re now 7+ years into the post-GFC-recovery with pretty lofty equity valuations.Read More »

The Ultimate Guide to Safe Withdrawal Rates – Part 2: Capital Preservation vs. Capital Depletion

Update: We posted the results from parts 1 through 8 as a Social Science Research Network (SSRN) working paper in pdf format:

Safe Withdrawal Rates: A Guide for Early Retirees (SSRN WP#2920322)

Welcome back! This is our 50th post, as I just learned from WordPress. Cheers to that and thanks to our readers for coming back every week! As promised in last week’s introductory post, we present some additional results about safe withdrawal rates for early retirees. Today’s post deals with an important issue that all retirees (whether retiring early or in their mid-60s) should ask themselves:

Do we want to deplete our savings or maintain a certain minimum real value of the principal to bequeath to our heirs?

We are amazed by how little discussion there is in the personal finance community about this. Hence, today’s topic:

Capital Preservation vs. Capital Depletion

  1. capital preservation: target a certain minimum asset level (as % of the initial value) at the end of the retirement horizon. Under full capital preservation we’d aim to keep the real, inflation-adjusted value constant, by consuming “only” the capital gains, dividends, and interest over time, while keeping the principal (plus inflation-adjustment!) in place.
  2. capital depletion: target a zero (or at least positive) final portfolio value, by consuming gains as well as principal over time

Read More »

The Ultimate Guide to Safe Withdrawal Rates – Part 1: Introduction

Update: We posted the results from parts 1 through 8 as a Social Science Research Network (SSRN) working paper in pdf format:

Safe Withdrawal Rates: A Guide for Early Retirees (SSRN WP#2920322)

We just calculated over 6.5 million safe withdrawal rates. Well, not by hand, of course, but by writing a computer program that loops over all possible combinations of retirement dates, and other model parameters. Not a big surprise here, but it took a lot of work to put this together. We can’t possibly fit all results into one single post, so we publish our results in multiple parts. Today, we briefly introduce our research and some baseline results. Stay tuned for more to come in the next few weeks/months:

The plan to work on this research came after one of those moments when we realized that if you want something done right and exactly applicable to our own situation, we just have to do it ourselves. We wanted to do a lot more robustness analysis than we had seen anywhere in the blogging world.

Read More »