Ask Big Ern: A Safe Withdrawal Rate Case Study for “Captain Ron”

A month ago, I did a case study for a fellow FIRE planner (“John Smith”) and the reception was awesome. So why not do more of those? Without even asking for volunteers, I already got two more fellow FIRE planners who contacted me via email and shared their financial parameters. Today’s case study is for “Captain Ron” and, of course, Ron isn’t his real name, though he is indeed a Captain. Not the “Captain Ron” from the 1992 movie, but just a captain. More on that later!


Why are case studies so exciting? One of the most important lessons I learned from my Safe Withdrawal Rate research (jump to Part 1 of the series here) is that the safe withdrawal calculations are best performed on a one-by-one basis. As we pointed out in our post last week, a withdrawal rate strategy should respond to market factors like equity valuations and bond yields as well as personal factors like age, retirement horizon, and expectations about pension and Social Security benefits. Further complicating the whole calculation is also the fact that we all have different distributions of assets over taxable, tax-deferred and tax-exempt accounts. So, let’s take a closer look at Captain Ron’s situation…

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The Ultimate Guide to Safe Withdrawal Rates – Part 17: More on Social Security and Pensions (and why we should call the 4% Rule the “4% Rule of Thumb”)

Welcome back to our series on Safe Withdrawal Rates. This is already the 17th installment! See Part 1 here and make sure you also check out the Social Science Research Network Working Paper we posted on the topic, now with 2,000+ downloads!

In any case, if you have followed the series so far you must have noticed that we are no fans of the 4% Rule and much of what we posted here dealt with the “4%” portion of the 4% Rule. For example, in Part 3 of this series we show that when equities are as expensive as today (Shiller CAPE > 20), failure rates of the 4% Rule have been unacceptably high in historical simulations.

But I think I missed this really important point:

The only thing more offensive than the “4%” part is the word “Rule”

That’s because the word “Rule” makes it sound as though the 4% is some sort of a scientific or mathematical constant. But it’s not. It ain’t scripture either, even though it’s often portrayed that way! There is no one-size-fits-all solution for withdrawals in retirement. With today’s lofty equity valuations and measly bond yields, a 3.25% to 3.50% initial withdrawal rate would be much more prudent. But there is another element that creates just as much variation in SWRs: Different assumptions about Social Security and/or pension benefits: The benefit level, the number of years before benefits kick in, how much of a haircut you want to assign to account for the risk of potential future benefit cuts, etc. and they all create so much variation in personal SWRs that the whole notion of a safe withdrawal rate “Rule” is even more absurd. The 4% Rule should be called the 4% Rule of Thumb because 4% is merely a starting point:

SWR = 4% Rule of Thumb

+/- adjustments for equity/bond valuations

+/- adjustments for idiosyncratic factors, e.g. age, Social Security, pensions, etc.

How much of a difference do these idiosyncratic/personal factors make? A huge difference! A prime example is the case study I worked on over at the ChooseFI podcast: a couple in their early 50s expects pretty generous Social Security benefits after a long career and probably wouldn’t have to worry too much about future benefit cuts. If they both wait until age 70 to claim benefits and are able to reduce their withdrawals from their portfolio dollar for dollar once Social Security kicks in, their Safe Withdrawal Rate estimate goes up from a measly 3.5% to somewhere around 4.5% or even 4.75%. Instead of saving 28.6x annual expenses, they’d need only 22.2x or even 21.1x. That’s a difference of several $100k!

How to quickly and easily gauge the impact of future cash flows from Social Security or pensions on the SWR is the topic of today’s post!Read More »

We are so skewed!

Note that I didn’t say “screwed” but skewed. Well, it wouldn’t have made a difference because today’s post is about how we get screwed by skewness. 

But I’m getting ahead of myself. The other day I asked myself why would anyone buy lottery tickets? The return profile is atrocious! The average payout is probably only about 50% of the money raised. In a hypothetical lottery with a one in a million chance for a $500,000 prize and a ticket price of $1.00, your expected return is -50% in one week, which means essentially -100% compounded over a year. The standard deviation is $500, so 50,000% relative to the $1 investment. And that’s on a weekly basis, which translates into over 360,000% annualized. What’s worse, that jackpot payout is usually stretched over many years or decades with a much lower lump-sum payment. And it’s subject to income taxes, so the after-tax return is even bleaker! If Vanguard or Fidelity or Schwab offered a mutual fund with return stats like that everybody involved would be facing federal indictments!

Then why not invest the lottery ticket money in stocks? No one can tell me that they’re afraid of equity risk (about 10-15% annualized) when they buy lottery tickets with 360,000% annualized risk. Nowadays you can buy stocks or equity mutual funds in very small amounts. Our 529 account has a $25 minimum investment and you can buy single stocks on Robinhood. Then what’s the appeal of a lottery? In one word: Skewness, see the Wikipedia definition. In particular, positive skewness!

Positive Skewness: higher probability of large positive outcomes (e.g. lottery). Negative skewness: higher probability of large negative outcomes (e.g. stock market). Source: Wikipedia

Positive Skewness means that the likelihood of large positive outliers is much higher than that of large negative outliers. Case in point, a lottery ticket: Your worst return is -$1, or whatever the price of the lottery ticket may be.  The largest positive outlier might be in the hundreds of millions. Read More »

Good and Bad Reasons to Love the Mortgage Interest Deduction

Welcome back to the Early Retirement Now blog! I hope everybody had a safe and relaxing Fourth of July holiday. And if you don’t live in the U.S. and had to go to work yesterday we hope you had a nice Fourth of July, too! We are currently on vacation in Paris and I am sure even here I smelled some barbecue in the air yesterday, so folks seem to celebrate worldwide!

In any case, as we detailed last week, we plan to rent during early retirement, at least in the beginning. But even if and when we buy a house we’d likely pay cash and forego the mortgage deduction. Won’t we miss the deduction? Probably not! We found a few reasons to really appreciate this tax deduction but also two very bad reasons. Let’s start with the bad reasons!Read More »