**March 2, 2021** – A while ago, I wrote about the challenge of designing pre-retirement equity/bond glidepaths (“What’s wrong with Target Date Funds?“). In a nutshell, the main weakness of Target Date Funds (TDFs) for folks planning an early retirement is that if you have a short horizon and a large savings rate then the “industry standard” TDF is probably useless. 10 years before retirement, the TDF has likely shifted too far out of equities, likely below 70%!

The problem is that the traditional glidepaths are calibrated to the *traditional* retiree (who would have guessed???) with a sizable nest egg ten years away from retirement. In that case, you want to hedge against the possibility of a bear market so close to retirement from which you might have trouble recovering due to the relatively small contributions of “only” 10-15% of your income. But people planning early retirement with a small initial net worth and a massive 50+% savings rates should clearly take more risk to get their portfolio off the ground.

In any case, back then I mentioned that I had some additional material about glidepaths toward retirement for the FIRE community, to be published at a later date, which is today!

Why is this post part of the Safe Withdrawal Rate Series? First, today’s post is a natural extension of the FIRE glidepath posts (Part 19, Part 20) in this series. Moreover, the majority of readers of the series are not necessarily retired yet. Many seek guidance during the last few years before retirement. In fact, one of the most frequent questions I have been getting is that people who are almost retired and still holding 100% equities wonder how they are supposed to transition to a less aggressive allocation, say 75% stocks and 25% bonds at the start of retirement. Should you do a gradual transition? Or keep the allocation at 100% equities and then rapidly (cold-turkey?) shift to a more cautious allocation upon retirement?

My usual response: It depends on your parameters and constraints. You can certainly maintain your 100% equity allocation much longer than the traditional TDFs would make you believe. If you are *“flexible”* with your retirement date you can even keep the equity weight at 100% until you retire. If you are really set on a specific date and want to hedge the downside risk, you probably want to gradually shift there over the last few years. So, let’s take a look at my findings…

### Simulation setup

**Basics:**

- I assume the investor is
**10 years**away from retirement. (a 5-year version follows below) - He/She saves $1 every month for 120 months at the beginning of each month. Contributions are
**adjusted for inflation.**You can scale this up to your desired savings level if you want. All the calculations and optimization results are independent of the scaling. If a glidepath is “optimal” (in a sense defined below) for a $1 monthly contribution, it will be optimal for $1,000 or $2,000 or $12,345 monthly savings. - I consider actual historical stock/bond returns (01/1871-12/2020) and also Monte-Carlo-simulated returns, that mimic the same number of months and force the average returns and the variance-covariance matrix to match the historical ones.

**Glidepath design:**

There are a “gazillion” different equity/bond asset allocation paths because if we have 120 months and we allow equity weights anywhere between 0% and 100%, say, in 5% steps, we’d have 21^120 different combinations of equity weights. To cut down the number of possible paths, I propose the following: Every glidepath is characterized by only three parameters: The equity weight in months 1, 60, and 120. For the months in between, I simply do a linear interpolation of the three base weights. Moreover, I constrain the equity weights to be:

- In month 1: between 60% and 100% in 5% steps (9 possible values)
- In month 61: between 50% and 100% in 5% steps (11 possible values)
- In month 120: between 40% and 100% in 5% steps (13 possible values)

That gives me 9x11x13=1,287 different glidepaths. If I further constrain the equity weights to be (weakly) monotonically decreasing, i.e., W1≥W61≥W120, I’m left with 408 different glidepaths.

This gives me quite a bit of flexibility in the shape of glidepaths. The path can be flat, even at 100% throughout. Or it can be a straight line down or a concave or convex shape, see below:

**Objective/utility functions:**

When people ask me what is “**the** optimal glidepath” I always respond: it depends on what objective function we try to maximize. One investor might be comfortable taking on a lot of risk and is happy with maximizing the **average** final net worth after 10 years, not worried about the variation around the mean. Maybe because this investor has a lot of flexibility in the retirement date could just work a little bit longer if the market tanks right at the 10-year mark. Another investor might be really inflexible and wants to hedge against the risk of retiring at the bottom of a recession. And then there’s everything in between.

I simulate the performance of the glidepath for each historical starting point and the Monte Carlo simulations. Then I calculate the objective function in several different ways:

- The mean over all simulations (i.e., simulation start dates).
- A concave (risk-averse) utility function U(x)=[x^(1-γ)-1]/(1-γ), i.e., of the type CRRA (constant relative risk aversion), with a curvature parameter γ. (and note that for γ=1, the CRRA formula simply reduces to the natural logarithm)
- The minimum, i.e., we maximize the failsafe. (this would boil down to a CRRA utility function with γ=∞)

And then simply pick the glidepath that maximizes that utility function. Note that each objective will obviously give you a different “optimal” glidepath.

**A few more words on the CRRA parameter**

What kind of γ parameter in a CRRA utility function is “appropriate”? Well, for γ=0 we’re back to caring only about the mean (risk-neutral) and at γ sufficiently high we’re back to worrying only about the minimum/fail-safe. What is a reasonable γ parameter, then? Here’s one way to gauge this. Imagine you’re offered the following gamble: a coin flip determines your final portfolio value: $500,000 for heads and $1,500,000 for tails. And one other version, imagine you can get 5 different portfolios: $500k, $750k, $1m, $1.25m, and $1.5m, each with 20% probability.

What is the “utility” or the “value” of this gamble to you under different risk-aversion parameters? I always like to calculate not just the expected utility but also the “certainty equivalent value” by transforming the expected utility value back into dollars through [(1-γ)U+1]^(1/(1-γ)). This tells you the value of the gamble if someone offered you one fixed and risk-free payout. Clearly, for γ=0, it’s $1,000,000, because you value that gamble at the expected value. For a few other values of γ, please see the table below.

- Personally, if I had to imagine I’m starting with $0 again and I’m given the gambles over the different payoffs at a future date, I’d probably be happy with a certain payoff of somewhere around $750k-$800 in the coin toss gamble and $800k to $900k over the 5-ways. It looks like, I’m a γ=2-kinda-guy.
- When I researched glidepath design, years ago when I still worked in the industry, I found that the glidepaths commonly used in the industry TDFs, look like they’ve been calibrated to a traditional retiree (40-45 years accumulation phase) and to maximize a CRRA utility function over the final Net Worth with a γ=3.5.
- A γ=5 seems overly risk-averse. You’d have to be crazy risk-averse to accept less than $600k to get out of a $500k/$1.5m coin toss gamble.
- So, for my simulations here, I’ll be using γ=2 to model a moderately risk-averse early retirement planner with some flexibility and a baseline γ=3.5 as the typical CRRA parameter of a traditional retiree with less flexibility.

**A word of caution about the CRRA utility functions**

I already foresee people complaining that the risk aversion is off because many readers would value the gamble at an amount much closer to the $1m expected value. And they are completely correct! For example, if you already have $5m in the bank and someone offers you the $500k/$1.5m coin flip gamble you’d have to be crazy risk-averse to accept a certain payment of only $750k. But to do the calculation right you can’t apply the CRRA utility function to the **gamble** only. It has to be applied to the **total final net worth** numbers ($5.5m and $6.5m in this case) and then with a γ=2 you get a certainty equivalent of about $5,958,000. So, the coin toss gamble is worth $958k to you, just a notch below the expected value.

**Equity valuations:**

As always, I will look at optimal glidepaths not just over the entire history but also slice and dice the data to see how much of a difference it makes when we face very elevated equity valuations. This would also give us optimal glidepaths conditional on expensive equities, not just for the average FIRE investor between 1871 and 2020. Notice that we can do this analysis only in the historical data. Monte Carlo doesn’t track the CAPE over time!

So I look at two criteria:

- Valuation based on past earnings: optimize the historical glidepaths conditional on an elevated
**Shiller CAPE**ratio. In this case, above 20. And I know, it’s actually closer to 34 right now, but historically there have been very few instances with a CAPE above 30 and people have made the case that a CAPE of 30+ today is not quite as scary as it would have been in the past, due to different accounting standards and lower dividend yields (i.e., more earnings retention and thus profit growth) - Valuation based on past index levels: optimize the historical glidepaths conditional on the S&P 500 standing at the all-time high or
**within 5% of the recent all-time-high**. In other words, the drawdown from the recent high is within 5%. So, if you don’t like the CAPE so much, this would be a good alternative conditioning rule.

### Results

I plot the glidepaths as four different lines (in case you can’t read the legend in the charts):

- Dark Blue = unconditional historical return data
- Light Blue = historical data, conditional on CAPE>20
- Yellow/orange = historical data, conditional on the S&P 500 within 5% of the All-Time-High
- Maroon = Monte Carlo simulations

And each chart has four subplots for the four different initial net worth levels: 0, 50x, 100x, and 200x monthly contributions.

Let’s start with the objective function with no risk aversion, where the investor cares only about the mean of the final net worth. Not surprisingly, the optimal glidepath under those objective function assumptions is to pretty much stick with 100% equities right until you retire. The only exception: for a very high initial net worth (200x) and high CAPE ratio you’d stay at 95% for ten years, see the chart below:

How about CRRA γ=2? See the chart below!

- Quite intriguingly, even for this assumption, you end up with 100% equities throughout the accumulation phase for both the unconditional historical data and Monte Carlo.
- When you factor in expensive equities (CAPE>20) you’d start with 100% equities for the first 5 years if you have a zero initial net worth, but then walk it down to 50%. And with higher net worth starting points you indeed start with 60%-70% initial equities.
- Conditional on the S&P being at or within 5% of an All-Time-High you’ll still keep 100% equities for 5 years, for all initial Net Worth numbers between 0-200x. And even between years 5 and 10 you only walk it down to between 90 and 95%. Very gutsy!!!

Once we get more risk aversion (γ=3.5) we notice some action, though. We notice the typical downward-shifting glidepath, see the chart below:

- Quite intriguingly, if using (unconditional) historical returns, then for all initial Net Worth numbers between 0 and 200, you’d still keep 100% equities for the entire first 5 years and then shift to 80% over the final 5 years.
- Conditional on a CAPE>20 you start a lot more conservatively and then shift all the way down to 40% upon retirement!
- Conditional on the drawdown less than 5% below the recent All-Time-High, you still keep equities at 100% for the first 5 years and net worth levels under 100x. But then shift down to 50% upon retirement.
- The Monte-Carlo results are much more conservative than the unconditional historical glidepaths. Even more conservative than the DD<5% paths!

And finally, let’s look at the most conservative objective function, the failsafe:

- Quite amazingly, the unconditional historical GPs and those conditional on an equity drawdown <5% are very little changed compared to the γ=3.5 assumption. You keep the equity weight at 100% for the first half!
- Conditional on a CAPE>20 you start with a very aggressive equity weight but then also walk it down very aggressively!
- The Monte-Carlo glidepaths are now much more conservative. You’d still start at 100% equities when the initial net worth is zero. But for all the other initial portfolio values you start between 60-70% and then walk down to 40%.

**A quick note about Monte Carlo vs. Historical Return Simulations:**

Notice that universally, the Monte Carlo Glidepaths are more conservative than the ones derived from unconditional historical return data. Sometimes the MC glidepaths (unconditional, by definition) look roughly as conservative as the glidepaths based on historical data conditional on expensive equities!

As I mentioned previously, Monte Carlo has the weakness that it doesn’t generate the mean reversion observed in the data. One bad bear market 5 years before your retirement and Monte Carlo will have a hard time ever recovering from that loss. In contrast, looking at actual equity return data, you will often observe a bounce coming out of a bear market (think 2009 or most recently in 2020!) and that is highly unlikely in a no-memory random walk!

Of course, one way around the pure random walk assumption would be to draw “blocks” of actual historical data. But if you have a 10-year horizon and you draw blocks of data long enough to preserve the mean-reversion observed in the data you’ll need blocks of roughly 10 years, so the block-Monte-Carlo is equivalent to historical return simulations! 🙂

**The role of initial equity valuations**

What I found quite surprising is that when the initial net worth is zero you’ll still start with a very aggressive equity allocation (100%) and keep it there for at least the first half of the accumulation phase, regardless of the equity valuation. That’s true even for risk-averse investors with a CRRA γ=3.5 (and even really crazy risk-averse investors with γ=5, results not displayed here, though, for brevity). So, I always tell people that even when stocks are expensive, it may still be a great time to invest in stocks. Even your **entire** portfolio.

I have shared this anecdote multiple times before: I got two major pay hikes in my life that triggered a major boost in my savings and investing. Once graduating with my Ph.D. in 2000 and once moving from the Federal Reserve to the private sector in 2008. Each time sounded like a bad time to jack up my investing (2000 bubble, 2008/9 Global Financial Crisis). But since the market tanked right after I accelerated my investing and I **kept** investing through the bear market, I was underwater with my investments only really briefly and then participated generously in the subsequent bull markets.

Notice how this is completely different from the equity valuations challenge that retirees face. If you start withdrawing money and the market tanks right after that, you face the negative side of **Sequence Risk! **As I outlined in Part 14, the Sequence Risk that **hurts** the retiree will **aid** the new investor and vice versa. The retiree keeps withdrawing through the bear market which will hamper the recovery of the portfolio. In contrast, the saver will contribute through the bear market which will accelerate the portfolio recovery once the next bull market starts. Thus, retirees and investors are always on the opposite side of the Sequence Risk headache. So, my warning about expensive equity valuations is targeted mostly at retirees. If you just start on your path to FIRE, by all means, you should be much more relaxed about equity valuations!

### What about a 5-year horizon?

As promised, here’s the same simulation output when using a 60-month horizon. Now the kink point in the middle is at the 30-month mark. As starting capital levels, I use 100x, 150x, 200x, and 250x monthly savings. That’s because 5 years before retirement you should already have a sizable initial portfolio.

Moreover, to be consistent with the 10-year glidepath equity weight constraints, I use 50%/45%/40% as the lower bounds for the equity weight at the beginning/midpoint/endpoint. In other words, the 50% lower bound in month 1 corresponds to the 50% lower bound at the midpoint in the 10-year horizon simulations.

So, here’s the first chart, **maximize the mean final value:** All glidepaths stay at 100% throughout!

**For γ=2: **Still very aggressive, except for the high-CAPE conditioning.

**For γ=3.5: **Everything looks more like a traditional glidepath, shifting down to 40-70% final equity weight at the beginning of retirement.

**And the Failsafe: **Monte Carlo and CAPE>20 rules are very conservative. The other two rules start quite aggressively. But the endpoint is always 40% for all the initial Net Worth numbers!

### Limitations

Just for the record, I like to point out a few limitations in today’s analysis:

**1: Taxes**

I don’t factor in **taxes**. If you plan to keep 100% equities until retirement and go “cold turkey” and lower your equity share to 75% upon retirement to hedge against sequence risk in retirement, you should consider the tax consequences. Most of us will have plenty of wiggle room to shift assets in tax-advantaged accounts (401k, IRA, Roth, etc.) and perform the shift without any tax consequences. If you have **only** taxable accounts, you probably can’t just yank 25% of your equity holdings and shift them to bonds all at once. That might take some planning ahead of time and would require contributions and equity dividend payments to shift to bonds over the last few years before retirement.

**2: Bellman’s Principle of Optimality**

My optimization calculations here still solve “only” for one fixed glidepath that will stay in place no matter what asset returns you experience over time. For the mathematical purists (and I’m one of them) that’s not the “true” optimal path. Quite the opposite, a truly optimal path would allow you to respond to the stochastic returns and portfolio values over time and then regularly reoptimize the glidepath. In other words, you’d have a “path-dependent” glidepath. See the section on the **“Principle of Optimality”** in my post last year for more details. Well, allowing for path-dependency would create a level of complexity a bit above what’s appropriate for a personal finance blog post. I have done the more advanced calculations (dynamic programming, Bellman Equation, optimizing via backward induction; my math honchos will know what I’m talking about) but that would be more appropriate for a separate post or even an academic paper.

That said, I was amazed that the efficiency loss from the constrained maximization wasn’t that significant. If you start with the 10-year version of the GP and then maybe **reoptimize** once more when you hit the 5-year mark to whatever is the constrained optimal GP at that point for your net worth level at that time, you will get pretty close to the final expected utility under the truly optimal GP that satisfies the Bellman Principle.

**3: Combined accumulation/decumulation glidepaths**

Today’s analysis is purely for the accumulation phase. It could be desirable to perform a **combined accumulation/decumulation glidepath** for the last few years of saving and the first few years before retirement. I can certainly “hack” my MATLAB code to do exactly that: simply assume that during the first 5 years you contribute $1 each month and in the final five years you withdraw $1 and then maximize a utility function over the final net worth. I’d likely get a glidepath that looks exactly like Kitces’ bond tent, at least qualitatively.

The only problem: the withdrawal amount should depend on your net worth at the start of retirement, which is unknown now. We can certainly assume that the withdrawal amount is, say, 4% annualized or one-third of a percent monthly of that (unknown) month 60 net worth. But we’d now have (at least) two outcomes over which to maximize our objective/utility function: 1) the withdrawal amount and 2) the final net worth. One could certainly define a “period utility function” for every month, likely again a CRRA-type function, and then compute the discounted sum over all dates(as is standard in dynamic macroeconomics). But it gets a bit messy and the scope of that analysis is a bit beyond the blog post here today, which is already pushing the limit in terms of word count. Maybe I will look into that in a future post. But as I said above, all of the pre-planned glidepaths run afoul with the Bellman Principle of Optimality anyway. So, it isn’t even very troublesome to run the glidepath optimizations in stages. And then I would argue that running a separate analysis somewhat mimics the path-dependency and re-optimization along the way in a truly dynamically optimal mathematical setup. So, nothing is really gained from doing a combined accumulation/decumulation glidepath.

### Conclusions

To answer the question from the post title:

**It’s not crazy at all to keep 100% equities right until you retire!**

At least if you’re planning an early retirement with 1) high contribution rates and 2) some flexibility about your retirement date. The 100% equities throughout would certainly be defensible if you find yourself in the middle of a bear market a few years before retirement. Then just keep the 100% equities and ride the subsequent bull market until you retire!

Even if you apply some more risk aversion, you will certainly still **start **with a 100% equity allocation, but you’d likely walk that down over the last 5 or at least 2.5 years before retirement. Also quite intriguing is that the high initial equity weight is defensible even when considering that the S&P 500 is at or close to its all-time-high.

So, for all of the folks out there who regularly make fun of me as the über-conservative retirement blogger and call me the Grinch of the FIRE movement, you all should take a positive and uplifting message away from today’s post: **Before retirement, I certainly endorse a very gutsy and high-risk approach to investing.** Only when you get close to retirement you want to take it down a notch and walk down the equity portion to well below 100%. And when retired you definitely want to lower the withdrawal rate when equities are expensive!

### Thanks for stopping by today! Please leave your comments and suggestions below! Also, make sure you check out the other parts of the series, see here for a guide to the different parts so far!

*Title picture credit: Pixabay.com*

Since you mentioned equities at an all time high, can you model CAPE based withdrawal rates especially if we get to extreme Japanese like levels at the peak?

If we get that high, all bets are off. But I doubt we’ll get all the way to CAPE close to 100. If you plug in a CAPE=100 into the CAPE-based SWR formula such as 1.5%+0.5/CAPE then you’ll get a 2% SWR. Not very appealing.

Shouldn’t someone who wants to retire early optimize the distribution of time until they hit a certain net worth and not the net worth after a fixed amount of time?

I’m trying to figure out my accidental retirement glidepath as we speak. I am in that flexible retirement zone you spoke of. Currently around 80% equity, but have the cold turkey approach as an option to reduce further…

Very nice! It’s great to have the flexibility pre-retirement! Best of luck! 🙂

That’s another option. Because the length to retirement will then potentially vary quite a bit it no longer makes sense to tie the GP to the time but more to the asset level. Intersting idea! 🙂

There is at least one reason the answer to your question is no, that Ern’s series has revealed. Namely, retiring when you hit a high number with an expensive CAPE and d the stock market at its high yields a safe withdrawal absolute amount substantially lower than retiring with the exact same amount with lower CAPE and/or the S&P substantially below it’s high.

I.e. retiring with $2M on Jan 1, 2000 or August 1, 2007 yields very different results than retiring with the same amount on Oct 1, 2002 or March 31, 2009.

This is quite apart form the flexibility people do or don’t have re when they can / want to retire.

Excellent point! The “target” amount should not only be budget times 25, but more like budget divided by CAPE-based SWR rate to raise the target amount when equities are expensive. That would alleviate some of the issues I raised in Part 22:

https://earlyretirementnow.com/2017/12/13/the-ultimate-guide-to-safe-withdrawal-rates-part-22-endogenous-retirement-timing/

Sorry, I didn’t read the article yet. I scrolled through to comments to gauge how readers liked it :-), but here’s a question from a not PhD minded person:

What is the “CAPE based SWR rate” today?

Can you tell what it would be for 100, 70/30, and 60/40 AA portfolios?

I’d like to see where my target amount should be today (high CAPE environment, right?).

I’ve been doing budget times 30 to 40 in the last couple years (based on the market’s mood) and I don’t know if I’m OK to quit or not yet considering that after I quit I’ll have no work earned income (and hard to get back in+I’d have a huge salary drop if managed to find a job) and I’m in mid-40’s only with early teens at home.

Today’s CAPE is around 35.

There is not fixed rule it depends how much of a stomach you have for fluctuations and drawdowns in withdrawal amounts. In the Google Sheet you can simulate different rules for different S/B allocation and check if you handle the vol.

I wouldn’t mind a rule with an intercept between 1.5% and 1.75% and slope of 0.5 on the 1/CAPE.

Also, keep in mind that this would be calibrated to preserve capital. If you are willing to deplete part (or all) of the capital you can go a bit above that.

Would you still see place for selling options when arguing to increase EQ allocation?

In retirement, yes. I have shifted more and more into this and I like the stabel income.

For people just starting out saving for retirement, it’s still best to stick with 100% stocks.

Big ERN,

Funny thing…you mention that you like ‘stable income’ in reference to option trading. I think dividend investors say the same thing :-). OTOH, you don’t support dividend investing, but in the end, isn’t money fungible in this case… you understand option trading and DGI’s who cannot crack ‘the code of options’ prefer DG investing.

I know that dividend investors will

saythat. But look at the total return series of a dividend fund (VYM) and you will notice that the return is pretty much the market return, 0.95+ correlation, and about the same volatility. A dividend portfolio would not have protected you from the 2008/9 bear market (and probably even hurt you, see Parts 29/30/31).Take the total return series of my options trading strategy and you will see that I get roughly the same return as the S&P 500 but at less than half the volatility.

In fact, over the last few years, the vol of the options trading ONLY was even lower. My portfolio volatility came from the fixed income portfolio to hold the margin cash because I shifted into some higher-yielding but also riskier instruments.

Retirees can avoid sequence risk by investing in non-correlated assets.

take for example the following allocation:

US Stock Market: 15%

US Small Cap Value: 15%

Gold: 15%

Long Term Treasury: 20%

Short Term Treasury: 35%

Since 1978 the CAGR is 9.17% and the worst year -2.84%

what do you think?

I doubt this portfolio returns anywhere near a CAGR of 9%, it’s too bond heavy and the time frame (birth year?) was a time where bond rates dropped epically! That won’t be happening again anytime soon. If your SWR is low, say 2.5%, then it won’t matter, just don’t bank on 9%.

For me, 50/50 at the start of retirement seems about right, which is 1-2 years away. Glide that up towards 70/30 over 10 years or so. Most is outside of tax protected accounts, so I’ve taken a lot of the tax burden up front. Still had to do some selling to get the balance where I wanted to, but my timing (January last year) ended up being lucky and while the tax Bill this spring sucks I have the income to address it.

I agree, if we take periods of rising rates like 2015-2018, the CAGR of the portfolio is just 2.5% becuse of the poor returns of small cap value stocks, long term bonds and gold.

but this periods is the worst for this kind of portfolio and it is not that bad by comparison to worst periods of heavy equity portfolio.

if you 100% in equity, there are periods when your withdrawal rate is very high, and you expose your portfolio to serious sequence risk.

@fellow Daniel

BigERN has done some extensive analysis on the right ratio to avoid sequence risk, a good read if you haven’t seen. 50/50 is probably too conservative for him. Bottom line is you need equity returns to make it over the longer term of FIRE. If you’re a more traditional retiree, have substantially larger savings, or plan on some income, and are risk averse, then I could see this being an appropriate mix.

Yeah, 9% for that portfolio seems excessive.

50/50 seems defensible especially if you shift back to a more aggressive 70/30 over time. Sounds like a great plan! 🙂

Thanks BigERN! I should note for context that I’m approaching 50, so being more conservative than I would have been at 40 for sure.

I’ll also add that through my 40s my number has increased more than I originally expected it to be and my risk tolerance has decreased. A combination of not wanting to build up the savings again, the realization that life can be unexpectedly expensive at times, and a desire to not fret over money during retirement has led to some extra padding. We’re aiming for 3.5% SWR including an extra 10% spend cushion over our current budget (so technically 3.15%). We have been fortunate to have good income and jobs where we could be very efficient in our time spent doing them while still making good income.

Sounds like a great plan! Good luck! 🙂

Interest rates decreased from 1980s to now… no shit your 55% allocation to treasuries worked well.

I agree, but even we replace all the bonds with cash we get: 7.8% CAGR.

Again, going from single-digit CAPE in 1982 to a CAPE of 34. Unless we believe the CAPE will triple again, we will likely see much lower returns in equities.

Yeah, going from double-digit to almost 0% certainly helps. Not only will we not get a similar drop in yields, we might now move in the other direction again…

Maybe, but people say this for a decade now. I do not belive that we will see this kind of raising rates unless inflation is double-digit and then the 15% gold will kick in.

Well, there’s a natural bound to how far the yield can go. We can’t go from 15% in 1981 to 1% today and then down another 14 percentage points to -13%. It’s more likely interest rates will go up again in the medium-term.

This can work for short retirements (up to 30 years) and when you’re happy with depleting your assets. You only need a bit over 1% annual real returns to sustain a 4% SWR.

For longer horizons, your allocation doesn’t have enough expected return. Apply today’s expected real returns of 3% on equities, 1% on gold, 0% on bonds (all after inflation) and this portfolio returns just above 1% over the next 10 years.

Would you ever feel comfortable being at 100% equities post retirement? I understand that portfolio optimisation would let you get the “free” benefit of diversifying into bonds without added risk, but is there a level of safe withdrawal where you can just have 1 investment in VT or equivalent?

I think at 2.5% SWR, you would have survived even the worst historical bear markets with a 100% stock portfolio.

If you have over-accumulated that much already and you can live comfortably on 2.5%, then go for it! 🙂

Of course there is. I think BigERN has touched on it, and you can view the historical numbers with his spreadsheet.

For example:

With a 30 year retirement and a 25% ending value, the failsafe number for 100% equities is 2.72% going back all 150 years, and it’s 3.48% since 1950.

(Note that 3.48% number comes from someone retiring in 2000 and assumes low returns going forward; it’s 3.57% for the worst-luck retirees from the 1960s)

With full (100%) capital preservation at the end of 30 years, the failsafe numbers are 2.30% since 1926 and 2.53% since 1950.

Yeah, all good points! Very well-written response! 🙂

Thanks. Your spreadsheet has practically become my retirement planning “bible”!

This series and that sheet are by far the best thing anyone contemplating retirement – with less than 40x their spending needs/desires, anyway – should consume and understand. I’ve learned so much from them.

Thanks for your kind words! 🙂

Thanks for this post, Big Ern! I was very interested by your finding that with CAPE above 20, the optimal stock allocation drops down so much at retirement. Even for those only moderately risk-averse (CRRA γ=2), stock allocation walks down to 50%, and with greater risk aversion, stocks shift all the way down to 40% upon retirement!

That 40% stock allocation just happens to match the allocation needed to generate the maximum Sharpe ratio used in tangency point portfolios with leverage.Very intriguing!

Yes, indeed. I set the lower limit to 40%, so it might have potentially gone down even more.

It seems the low point of 40% stocks applies regardless of CAPE level or risk aversion. You demonstrated in previous posts that the Sharpe ratio is maximized at 40% stocks / 60% bonds. Do you think the max Sharpe ratio portfolio serves as a kind of lower limit beyond which further reductions to stock allocation result in inevitably non-optimal portfolios?

Not necessarily. I set the lower bound on the stock portfolio to 40%.

There are some TDF providers that shift all the way to 20% equities, I believe. But that’s probably overkill.

Great analysis and very timely for me at the moment. Hadn’t been thinking about retirement until covid burn out. Now I’m contemplating it. Would end up in the 3-7 year timeline from now depending on some life events in the background plus market performance (I’m inside 3.25 percent covering current expenditures but I’m contemplating that my expenses may increase in retirement so I’m not quite to the right asset level).

I’m fairly risk adverse sitting somewhere between 85-90 equity before this change in direction. With this direction I’ve recently adjusted to 75 equity weight although I’m still contributing large amounts. I tend to rebalance quarterly. I do not intend to drop below 75 equity until I’ve set a real date. My guess is that will be a year out

This post has me thinking perhaps I’m a bit too conservative.

Yeah 3-7 years is a lot of time. Most aggressive savers can still hold on to much ore than 75% equities. 🙂

I have an intuition that the greater your [ net worth / required cash flow ] metric is, the more you should keep in equities even after retirement. If you can tolerate an 80% drawdown in retirement and still meet your required cash flows, as an example, shouldn’t you be 100% in equities even post-retirement?

Where does it become rational to be >100% in equities?

Depends on your objective function. THe historical safe withdrawal rate was only about 2.5%. So you could severely draw down your portfolio with 100% equities. But if you like to maximize the upside potential, sure 100% equities seems OK. Others will say that if they accumulated enough capital they will become MORE risk averse. Why keep gambling when you’ve won the game?

You can justify >100% equities pre-retirement. See the “Mortgage your Retirement” in the other parts (19/20) and ChooseFI episode 34.

Well, if you’re a robot guide purely by logic and math, then the answer is sure, 100% equities is the way to go. However we are humans and philologically I’d never go there. 50% is already too much for my stomach unfortunately.

Well, I can lead the horse to the water, but can’t make it drink. Using an allocation that’s too cautious produces less risk in the short-term but raises the risk of long-term shortfalls.

Interesting stuff! I currently allocate 100% of my portfolio to equities, but approximately 20% of free cash flow goes to retiring additional mortgage principal. I consider that my bond allocation.

The other consideration that plays into this for me is whether/how to pay any remaining mortgage at retirement date in a tax efficient manner. It would be beneficial to have some bonds in a taxable account for that purpose (but of course I’d probably rather pay tax on the additional equity returns than accept the lower bond returns). Maybe a staggered liquidation approach in the 1-3 years after retirement would work best in managing tax consequences of retiring the mortgage.

The mortgage is another thing I didn’t consider here. Keep in mind that with the mortgage you have essentially >100% equities (i.e., equities with leverage). So, walking that down is the right thing to do. But you’d likely need more than 0% actual bonds at retirement. Not just 100% equities and 0 mortgage.

Oh, I plan to downshift to something like 60/40 at or just before committing to retirement, and then gradually walk it back up (thanks for the glidepath post!) The question is how to make all those changes and also liquidate the mortgage without taking a big tax hit, since I’m likely to end up with the bulk in taxable accounts. Maybe I should use that 457(b) plan after all…

The mortgage is a big headache indeed. We didn’t have that issue because we sold our place in SF and bought a cheaper place in WA State with cash. If you can’t do that you’re probably left with aggressively paying off the mortgage during the last 3-5 years.

Wouldn’t it just be a matter of adding values over 100% equity to the glidepath design and repeating the analysis? I wonder what the result would be.

It would be an incomplete approximation. A mortgage is not exactly (-1)xBond due to amortization and the prepayment option.

“I was underwater with my investments only really briefly and then participated generously in the subsequent bear markets.” – Should read “bull markets,” I believe.

You are the best! Thanks a lot for catching that mistake! 🙂

Hi ERN. I haven’t even started working yet (I’m still in medical school), but I’m having a lot of fun planning for an early retirement and this series has been supremely helpful. So thank you.

Based on what I’ve learned: if we combine this post with the glidepath results in parts 19/20, would it be reasonable to keep 100% equities until about 3-5 years before retirement, then walk down the equities to 80% by retirement date, and finally increase by 0.2% each month until back to 100%? I plan on using that strategy for a 50 year horizon with a 3.5% SWR and a separate cash cushion for sequence of return risk.

Yes, exactly! That would be appropriate for a moderately risk-averse FIRE planner!

“moderately risk-averse”. U kidding right?

Risk Averse I’d consider me, with 45% in stocks and almost killing myself at every dip (36 yrs old)

Jim, you may just be extremely risk-averse. Nothing wrong with that, but even the major target-date retirement funds are going to be 80 or 90% equities 20 years out.

For example, the Vanguard target retirement 2045 is 89.5% stocks.

Good point. But in retirement some TDFs indeed shift down all the way to 30% and even below.

I think the key is mental accounting, so always expect a portion of gains to be given back to the market. Don’t mentally baseline on every new portfolio high.

A good exercise would be to go back to the 2007 peak and compare a 80/20 account versus a 50/50 account through today. While there would be bumps in the road, I would wager that 80/20 account could take a 50% drop tomorrow and still be ahead.

Risk level is a very personal topic, but there are other risks like working an extra 5-10 years, inflation risk, etc.

Yeah, good point. Hence my point: even the worst historical cohorts still had higher WRs than the WARM method.

Great post. 100% equities makes sense for the young. But I advised my kids to go 80% equity and 20% debt in their work 401k. Why? Retirement investing isn’t just math it’s emotion too. While they don’t have as much at stake, now is the time to learn the discipline of rebalancing. I bet they will have a hard time selling debt to buy equity during the next correction/disaster. But the lesson needs to be learned when there is less at stake.

I’m torn on that one. Should we reinforce the (likely irrational) fear of market vol or try to educate people and convince them of the mathematically more reasonable approach?

Another great article ERN! For a retiree who has paid off their home mortgage, would you consider the equity in their home as a potential replacement for a percentage of their bond allocation? In other words, let’s say someone wants a 60/40 target asset allocation when they reach FIRE. Rather than having 60% in equities and 40 % in bonds, might it be reasonable for a retiree who has 20% of their net worth in their home’s equity to have the remainder of their assets distributed 75% to equities and 25% to bonds?

I’ve heard about people using reverse mortgages as part of a de-accumulation plan in retirement. By “waking dormant equity” in the home, they can use a reverse mortgage as a way of smoothing out market risk by tapping into an alternative source of spending during market declines. For the sake of discussion, this retirement strategy assumes that the retiree doesn’t necessarily need or want to pass on their home to heirs, but rather to have a secure retirement with stable spending income.

You could argue that a house is something of a bond that pays you rent. And it also has a final value to be added to the estate (or to be liquidated before then through a reverse mortgage). It would mean you can get away with a slightly smaller bond portion in your retirement portfolio.

I’m not a big fan of reverse mortgages due to the excessive fees and high interest. It’s really only a last resort.

Do mortgage companies ever allow retirees to do cash out refinances as a lower cost alternative to reverse mortgages? Seems like they would have little risk if they only allowed 50% loan to value.

It certainly sounds like a good business idea. The constraint would be the securitization of many mortgages. Maybe that’s not allowed. But it sounds like a better (cheaper) alternative to the reverse mortgage!

Why not setup a HELOC before retirement instead?

It would be especially helpful in managing income (mAGI) for ACA subsidy purposes for retirees under 65.

I like that idea. Wasn’t an option for us because we bought well after I left my job.

But that said, I can get a very cheap margin loan, cheaper than any HELOC in fact, in my IB account.

Then you should add that “rent” to your expense number and house equity to your assets. Since it cancels out it doesn’t affect cash flow, just your expense to capital ratios. You either need some cash flow to cover rent. Or you need a paid off house (I.e. capital) for the same consumption .

I know the rent and rental income cancel out. Hence, there is nothing to include as an additional cash flow.

But you should include the final value of the house somehow. Likely as a positive cash flow in the end. Or as a reduction in the estate target.

Thank you so much for the great post! I’ve been 100% in equities for a while now and this reinforces the rationale for that choice. I’m interested in getting your take on one particular argument against a 100% equity portfolio: I read on places like the Boglehead forum that one should *always* have some bonds because (1) people underestimate their risk tolerance and react poorly in the heat of a downturn and (2) it allows them to rebalance into stocks during downtowns. I’m particularly interested in whether you’re sympathetic to this second argument? Is there some potential gains that are left off the table by not having another asset class to rebalance into? Thanks for the post and what you do!

My response:

1) Automate your savings/investing and listen to ChoosFI, read my blog, read JL Collins and you should be fine. 🙂

2) I like to see the people with an 80/20 portfolio who had the discipline to shift out of bonds and into stocks in March last year. More likely outcome: most were too scared to rebalance to 80/20 (i.e., shift into stocks) and the 20% bond allocation is just a drag and dead-weight on the accumulation path.

I’m 49, 7 years to retirement, and allocate at 85/15. Last March after the dip I dumped 100% of my bonds into TSM and then shifted back into 85/15 when it got the previous high.

Nice market timing! 🙂

How crazy? I gotta say, it’s pretty crazy.

You must be very detached from your money to do that. My hard earned money, no, I just can’t do it. But I understand those who don’t feel that way because their money wasn’t hard earned, it just came with the market or business or something easier that the 8-5 daily grind!

My money was earned just as hard as yours.

Good point, so why risk it?

I more than doubled it. Why let the money sit in an account that pays 1% interest?

You *do* understand that you are almost certainly risking yours to inflation at least, right? [Implicit in your comment is that you are keeping your “money” in primarily very conservative investments.]

There is no such thing as a completely riskless portfolio. So one of the questions is: which risks do you most want to protect against?

Excellent response! Couldn’t have said it better! 🙂

Well, basically I don’t want to risk losing a dime of my hard earned money. I only buy treasury notes and TIPS and have very little in a SPX fund which I’m thinking about moving 100% bonds. I like like and “Wasting Asset Retirement Model” approach presented by Mr. JL Collins. Call me crazy but I’m starting to implement it

Noted.

But keep in mind that the “wasting asset retirement model” is not necessarily endorsed by Jim Collins. It was merely a guest post on his site and it goes against everything Jim would otherwise recommend.

Because you’d need such a large nest egg for retirement (or reversely you have to cut your spending by about 50% relative to even my cautious SWR recommendations) I think the approach is not really workable for most early retirees. But I certainly with you a lot of luck!

yes, that’s what I meant, Mr. Collins only presented the idea which I really liked. It’s the only strategy I’ve read so far that would let me sleep well at night.

Now with interest rates going up, hopefully around 3% again, I’ll increase my allocation to bonds quite a bit, ruduce exposure to equities while keeping less in cash. I know I’ll need at least 20% more than a regular 3.5 SWR would dictate, but I’m ok with that. It’s the price you have to pay for not ever trusting Mr. Market. Thanks for you replies. I hope you write to some of us scolded and afraid people someday which some strategies that wouldn’t entail 50+% in equities. Thanks a ton

“I know I’ll need at least 20% more than a regular 3.5 SWR would dictate,”

Hmmm…wonder if ERN could write another blog post on this subject…i.e. is 20% more really enough assuming we get back to more typical annual inflation rates (e.g. higher than today, but still single digit)

After all, it wasn’t just high valuations those “failed” (4% rule) late 1960s retirees faced, but also high annual rates of inflation, including up into the double-digits, in the first decade after they retired.

I doubt that you can get away with 20% more. With the WARM method you’d set the WR to 1/(100-age) = 1.67% for a 40-year-old. You need 100% more than someone who uses a 60/40 or 75/25 portfolio.

“I know I’ll need at least 20% more than a regular 3.5 SWR would dictate,”

You can plug in your assumptions into ERN’s SWR toolbox but it looks like going from 75% equities –> 100% bonds lowers your SWR from 3.5% for a 40 year horizon to < 2% SWR for 100% bonds! Of course you could put it in TIPS and make it on 1/40 = 2.5% SWR but you'd still need to save 40% more than going with a equity heavy portfolio! Not many people are interested in working 40% longer than they need to.

Well said! Yes, 20% more capital is not enough!

If only one could guarantee stock market’s historical returns. I don’t like the WARM approach but I can certainly understand why people want to use it. It’s just total peace of mind that something like 1929 (which we’re due for) wouldn’t affect you!

It’s myopia. Plain and simple. People prefer short-term vol reduction but messing up their long-term financial picture.

If I think about it, all financial mismanagement, (overspending, credit card debt, not planning for retirement) is based on valuing short-term pleasure over long-term health.

Jim, it’s clear BigERN can’t convince you, nor I either, but be aware that “increasing your allocation into bonds quite a bit” is fairly risky in the short and medium term.

If your retirement (time you would ever draw down on the assets) is 15 years out or more, you are in fact taking huge risks not having something like 50% of your money in equities.

While it’s not something BigERN recommends, even 25% equities, 25% gold, 25% REITs and 25% cash would be better – and I mean *less* risky, not just higher mean/median return – over a 10 year period than your “TIPS, cash and moving into bonds now that yields are 3%” strategy is.

Good luck to you.

Well said. Yes, and good luck to Jim! 🙂

If you bought long-term bonds already and interest rates go up you won’t benefit from that rise. Only if you hold short-term bonds now, then shift to longer bonds when rates go up. Sounds like market timing. And not a very stress-free retirement when you pin your retirement on the hope that rates go up enough again…

Aren’t you the wide-eyed optimist now, BigERN (“you won’t benefit from that rise […unless] you hold short-term bonds now, then shift to longer bonds when rates go up.”)!

Even that statement is only true if *real* long bond rates are positive after they have gone up, *and* said long rates don’t go up much further after those long bonds are bought.

“Even that statement is only true”

No, my statement is universally true. I am referring to the methodology that pensions funds use to perfectly “duration-match” their liabilities. If an uber-conservative retiree were to perfectly hedge the cash flow needs that way (whether nominal CFs with nominal bonds or real CFs with TIPS), he/she will not not lose but also not benefit from interest rate changes. If the rate goes goes up you lose on the principal but gain on the higher interest, for a net gain of exactly zero. That’s the whole idea of duration-matching.

JL Collins actually personally has 75+% equities in his retirement portfolio

Exactly. I was surprised that he published that post without a clearer warning about how nonsensical this method is. I mean it’s OK to publish something you disagree with to start a discussion. But it almost sounded like Collins liked the idea. Strange!

With the benefit of hindsight, it is clear that over the past two years, inflation killed this heavy bond portfolio in the big “Bond Debacle”. So it turns out he was taking a giant risk that in fact hurt his portfolio greatly.

As always very interesting post. If I understand this correctly, you’re looking at the risk adjusted mean portfolio after a set number of years?

I’ve run a similar analysis, except calculating how soon one can reach their FI number based on various asset allocations. I’m a few years out from reaching FI and wanted to see what’s the best asset allocation to reach FI the fastest. My analysis was not nearly as detailed, but the results were very similar. For all CAPE levels 100% stocks are best. Only at CAPE>25 AND when one is close to their FI number does it make sense to decrease stocks below 100%. But even then nothing less than 80% stocks. I never made any risk adjustments (CRRA utility function), so I imagine doing that would decrease the stock asset allocations a bit.

I’d be curious if you have plans to run a similar analysis in the future?

Good point. I have a ton more sim results not displayed here and one was the speed of reaching a certain goal.

And I got similar results: You maximize the equity portion, i.e., 100%. The only exception is when you’re already almost there, you take a bit of risk off the table.

More than doubled….in just the past 5 years with dividends reinvested! Meanwhile most savings accounts now pay out less than 1%, talk about opportunity cost!

Oh, yes, depending on the starting point you are at way more than 2x. Hard to get that with a MM account! 🙂

This is very timely advice for my situation. I’m thinking about retiring in 7 years at age 55 and recently calculated that my portfolio was 96% stocks. Coupled with a 22 year mortgage it felt like it was time to shift toward bonds, so I paid off enough of the mortgage to bring it down to 7 years, matching my retirement date goal.

I was thinking about ramping up my bond holdings with new contributions, but your article has me rethinking the timing. Our current contributions are about 1/266 of the portfolio.

Maybe I should stay at nearly 100% stock for another 4 years, then move more aggressively into bonds. What do you think?

Thanks for all your hard work on this.

Sounds good. But I’d be a bit worried about the mortgage. Will you be able to pay that off before retirement?

Thanks for your response. Yes, we will continue making the same monthly payment that we have been making for the past 8 years. The new, smaller principal makes the last payment coencide with my planned retirement date.

BTW, I listened to one of your interviews on ChooseFI. Very informative. Listening to you talk made it sink in that your retirement plan is specific to your age, lifestyle, and goals. My situation is a bit different, but I somehow got stuck on the “Big ERN says SWR is less than 3.5%” message. Your following on Reddit is having the same problem with oversimplifying your message down to a single number.

Yeah, that’s a message hard to undo again. I’ve done case studies for retirees with a recommended SWR of 5%+.

But I guess the bumper sticker message is all that “sticks” (pun intended).

Agreed! Based on SWR Toolbox, I have around a 5.75% SWR when SS and pension are included.

Nice! That’s a good example where folks can do almost 1.5x compared to the naive 4%Rule! 🙂

Hi Big Ern and community. Found this site 3 years ago. (My first comment so be gentle!) The SWR series is the best I have ever seen for its depth and breadth of content on this incredibly important subject. It has been my go to for my early retirement (now almost 2 years). It has given me the confidence to back my judgement and the detail to influence my decisions on SWR and Sequencing Risk.

I didn’t know about Sequencing Risk until I read this site. I always felt the autopilot increase of bond portfolio percentage with age was too high an opportunity risk. Your articles showed this to be true. I fell into a Cash/Bond allocation (25%) due to an inheritance 1 year prior to retirement. Prior to this I thought a 100% equity allocation was my default. Through happenstance my 70 to 100% equity glide path is close to optimal for CAPE >20 scenarios.

Now I am slowly reducing my bond portfolio at 0.3% per month. I did take the opportunity to move 20% of my bond portfolio to equities during the March 2020 “blip”. I didn’t move it all, as particularly the US and International markets, (I am not in North America) only got down to a CAPE in the high 20’s.

In some ways I feel this forum a better sounding board than a traditional financial planner who is “behind the times”.

How much of success is due to effort and good planning versus luck? Perhaps the good planning allowed for opportunities to be taken.

Thanks for sharing, Carl! Looks like you’re well-prepared for a comfortable and confident retirement!

Luck plays a huge role. People who retired in 2013 or so who “recklessly” put 100% in equities fared really well, after the fact. The “good preparation” is only needed if you experience bad luck. 🙂

How do you think about the optimal glide paths approaching big lumpy short to medium term expenses like funding children’s college expenses? I’m finding that you can’t just just plug a 25% SWR over 4 years and be totally safe. It’s not something you can really push back if the market doesn’t go your way so you can’t be too aggressive. I’m leaning towards just going with the “aggressive age-based” 529 plans that are around 100% equities until 10 years out then glide to only 20-30% at college age.

I never understand why people stress out over college expenses. You COULD certainly model the college expenses as a large short-term lump sum expense x years into retirement. My Google sheet is set up for that.

Ideally I’d separate college expenses from retirement. We set up a 529 plan for our daughter and contribute every month. When she goes off to college she can pay her expenses. If it’s not enough, sorry kid, you will get student loans. More likely the money will be more than enough and she can keep the remaining money for grad school.

Lots of ways to pay for college w/o a need for a lump sum or 529 account…e.g. borrow & pay back gradually (I’d think a HELOC would be cheaper than private parent loans), or my favorite, use other people’s money.

For those of us in the U.S. there’s a surprising amount of military money available for college.

Just joining the National Guard in many states covers tuition at public, in-state schools.

My kids used ROTC scholarships to pay tuition so I only paid room & board… one managed to move on to a service academy after their first year of undergrad, so then even room & board was covered.

Thanks for sharing! All good points! Yes, that’s on our radar screen, too! The military certainly offers some good deals!

I’m confused by the last sentence of your post: “And when retired you definitely want to lower the withdrawal rate when equities are expensive!”

In retirement, wouldn’t you want to decrease withdrawals when equities are cheap? (ie: don’t sell low)

No. From my post

https://earlyretirementnow.com/2020/08/31/the-half-percent-safe-withdrawal-rate/

Look at the following scatter plot

https://i1.wp.com/earlyretirementnow.com/wp-content/uploads/2020/08/Lie-with-PF-Part-3-Chart03.png?resize=863%2C627&ssl=1

1/CAPE (left = expensive, right = cheap equities) on the x-axis vs. sustainable withdrawal rates on the y-axis. Why do I want to raise my withdrawals when stocks are expensive?

Also keep in mind the distinction between withdrawals and stock/bond market timing/rebalancing. You certainly shift out of stocks and into bonds when stocks get expensive either due to market timing or plain rebalancing. But the withdrawals are also lower when everything is expensive.

Many thanks for your prompt reply (and for ALL that you do!)…but unfortunately your reply is cut off at “Why do I want to _____” so…now, I’m on the edge of my seat!!! 😭

Oh…I think I get it now. The last TWO sentences of your post were: “Only when you get close to retirement you want to take it down a notch and walk down the equity portion to well below 100%. And when retired you definitely want to lower the withdrawal rate when equities are expensive!”

In the second sentence, you were talking about SWR and high CAPE (“when equities are expensive”). Got it. Thanks again 🙂

Exactly! 🙂

Added the thought was cut off. 🙂

Hi Jim:

Maybe this will help on how to react when equities are high (i.e. expensive):

1. As ERN says roll back the withdrawal rate from, for example 3.3% to 3% (per the CAPE formula) (Note that this may not reduce your amount of withdrawal very much as ERN pointed out in SWR Series #18 AND

2. As you seem to imply in your question, do liquidate for your monthly living expenses the equity portion of your Equity:Bond mix since the equity portion is high (i.e. expensive) and this goes with the rules:

a. “Sell high”

b. And helps to “keep your Equity:Bond mix % near your target %” (as determined by your chosen risk level) since if equities are high the % in equities has also almost surely drifted above your target %, and so selling equities (high) is bringing your Equity:Bond mix % closer to your target %.

I just reread the SWR Series #18 for about the 3rd time. I appreciate this strategy more every time I reread it.

Hope this helps.

Very well said! 🙂

Hi Jim:

I see that while I got my thoughts on paper and posted, you figured out ERN’s comment on your own. And we came up with the same explanation from what I can see. It was a good original question since it got me thinking.

Thank you RIX! I appreciate you taking the time 🙂

Hi ERN, Just out today on Kitces “Weekend reading”, another Dynamic spending rule. Here is the reference to the original article (just published): https://www.advisorperspectives.com/articles/2021/03/22/beyond-the-4-rule-flexible-withdrawal-strategies-using-certainty-equivalent-spending

Druce Vertes, the author, uses CCRA utility functions to optimize rules like this for example:

“A safer rule:

• Allocate 75.20% to stocks. Each year, withdraw 3.54% of starting portfolio + 1.06% of current portfolio.

• Starting spending: 4.60%

• Average spending over 30-year retirement: 5.29% of starting portfolio

• Worst-case spending: 3.58% of starting portfolio

Chart of 30-year spending outcomes of 64 retirement cohorts 1928-1991, risk aversion=16 (Shaded area is middle 50% of outcomes.)”

My intuition is that this rule of X% of starting portfolio + Y% of current portfolio (amount) has a relationship with your CAPE-based rules since if CAEY (=1/CAPE) has increased (e.g. CAEY from 3.3% to 5% [and CAPE from 30 to 20]) then current portfolio has also dropped (close to 37% drop?) and so goes well with your formula from SWR #18:

W_t = (a + b * CAEY_t) * P_t

So this would appear to even more reinforce your CAPE based formula’s validity.

I would appreciate if you could take a look at this publication of a couple of days ago, and see if what my intuition says is actually holds water.

Doesn’t work. Not sure what this guy did, but I simulated this rule and if you put a floor of 3.54% of the INITIAL portfolio as a floor plus withdraw another 1.06% the 1929, 1965, 1968 cohorts run out of money after about 26-27 years.

Also: if someone uses the UNCONDITIONAL distribution of past retirement cohorts to determine retirement strategies for today when the CAPE is at 35, then this research failed my Litmus Test.

Also, no, this has nothing to do with the CAPE-based rule because the CAPE rule does not tie any of the withdrawals to the INITIAL portfolio value. Only the current value and you also employ equity valuations!

TLDR: interesting idea, but a failure nevertheless.

Thanks, ERN, for your quick and clear reply.

I’m all on board with waiting until the last minute to buy any bonds but I struggle with the decision on when and how much to start prepaying on my mortgage. I realize a mortgage is like an “inverse” bond, but say for example I’m 10 years out from retirement and starting a new mortgage should I get a 30 year and stay leveraged until a few years to retirement or go with a 15 year mortgage and get a slightly lower rate then not have to prepay as much just before retiring. After 5 years of payments on a 30 year mortgage, you still owe about 90% of your remaining balance so it seems a little risky to carry that much leverage in addition to skipping the bond tent <5 years from retirement even if you have a semi flexible retirement date.

Thanks Ern. Very insightful as usual. Are you familiar with the research by Andrew Clare? It uses CAPE and trend following to smooth and essentially increase SWRs.

If I understood correctly, you have also been using CAPE and distance from peak to smooth the SWR, but assume buy and hold. I’m wondering if a trend following filter could further improve results.

I’ve employed that method to avoid the major drawdowns while accumulating. I’m wondering if it would also be useful during decumulation in worst case scenarios such as 1960s cohort, which was more of a sideways market, which is probably the most challenging conditions for trend following, particularly when bond yields are low.

Have you looked at adding a trend following filter (obviously could be a multi-signal combo to reduce whipsaws) to your decumulation approach?

I should add the context that if trend following were employed, does it have the potential to increase the stock allocations or alter the glide path approach?

Yes. You’d keep 100% stocks when you have positive momentum and lower the equity allocation when the trend goes south.

Thanks. Yes, I plan to write something about trend following and the impact on SWRs soon.

While accumulating, hedging against a big drop is a lot less useful. I never did that when I was still working. Quite the opposite: I bought more stocks when the index was down. But market timing like that is a lot more useful when retired, that’s for sure. Sequence Risk!

Thanks Ern!

Hi,

Reading the title I was hoping, you will address cases where people use glide path to get to correct target allocation from wrong allocation. In my case I am only 30% allocated to equities and I am planning to retire early in 3-4 years and I am going to be 44 years old at that point. So it is certainly a long retirement duration. Can you suggest to me, should I use the rising equities glide path to get to 60% from 30% with 1% monthly increment for the next 3-4 years and then keep it constant 60% throughout retirement, would that be a good idea?

Thanks in advance!

You’re at the other extreme: normally people start with too much stock exposure and have to scale it down. You’re way underinvested in stocks. You could go cold turkey and shift all at once or at least shift linearly to a more normal allocation (60/40) over the next 3-4 years. Whatever makes you comfortable…

If your new contributions are fairly large compared to your current portfolio, you might be able to get from 30% to 60% equities in 4 years, just by making new contributions into 100% equities until you get your total portfolio has 60% equities.

That’s a good point. Doesn’t really work for most people who already have 20x or more saved, though.

I already have about 60x saved. Actually what works in my favor is the geographical arbitrage. I work in Singapore and my home country is India, where I plan to retire early. So every year I save from my salary an amount that is worth 3 times my annual expenses in India.

Pretty impressive! But keep in mind that the rapid growth in India might also necessitate a more aggressive increase in spending every year to keep up with the Joneses.

Thanks!

Thanks. Indeed my new contributions are fairly large and if I just keep moving my new contributions to equity and the accruals from my bond fund portfolio to equity, I would get to 60% equities in 4 years. I feel this is good for people like me with low risk tolerance. It is like my fixed income corpus remains constant and acts like a safety ballast for my portfolio. I am very inspired from this paper by Wade Pfau and Jeremy Cooper where they talk about Safety first principle vs the SWR which is more of a probability based approach.

http://www.modernretirementtheory.com/wp-content/uploads/2014/12/Challenger-The-Yin-and-Yang.pdf

Thanks for the link. Nice writeup about the different philosophies!

Sorry but I didn’t understand much of this post. Not a math pro here.

Do you have anywhere a chart showing how much you should have in equity at different FIRE starting ages?

There is no set percentage.

In part 19 (https://earlyretirementnow.com/2017/09/13/the-ultimate-guide-to-safe-withdrawal-rates-part-19-equity-glidepaths/) I looked at failsafe rates for different fixed allocations and glidepaths.

Somewhere around 75% stocks, 25% fixed or 60% stocks in the beginning and then gliding to 100% stocks over 10-15 years seems to get the best outcomes in historical sims.

There was a thread on the Bogleheads forum a few years ago about someone who went with an approximately 200% equities allocation; in other words, they used leverage (margin accounts etc.) to have more than their net worth invested in equities. They had done some research to conclude that it would be the optimal strategy for the accumulation phase; the general idea was that they had time to recover from a drop in values. It didn’t work out for that investor – they started this strategy right before a sharp selloff in the markets (maybe in 2008?) and were forced to liquidate at a nearly total loss (or perhaps wound up with negative net worth, don’t remember the details).

Have you considered looking at this strategy? I’m guessing, based on your 100% equities analysis, that it would be pretty sensitive to high CAPE ratios and wouldn’t be a great idea in the current environment, but a rigorous analysis could be informative and might show when it’s a feasible approach.

I don’t think 200% is a good idea. It’s best to look up the max-Sharpe Ratio portfolio and then lever up that one:

https://earlyretirementnow.com/2016/07/20/lower-risk-through-leverage/

Market has gone up 500+% since 2009. I missed most of that. Do you recommend going all in now or wait until the next recession?

Depends on the horizon. If you’re still 5+ years from retirement, I’d still go back in.

Big ERN, I always enjoy your posts, podcasts interviews, and willingness to stick to the mathematically optimal not the feel good answers!

I know you have a wide range of readers and field many questions: Have you written anything that helps answer optimal asset allocation for those lucky few retirees that have 50% of their spending covered by a FERS pension (that has some COLA adjustment)? Or, similarly those with 50% of their expenses covered by social security? I am 54 and just pulled the plug.

Thanks for any insights!

Optimality according to what objective function? Max failsafe rate? Do you want to do a fixed asset allocation or can you do a glidepath?

Generally speaking, most retirees will benefit from a roughly 75/25 fixed allocation with a long horizon. 60/40 for traditional retirees.

If you want to do a glidepath, start with more bonds and shift slowly into more stocks.

If you have significant COLA cash flows from pension or SS right around the corner you could justify going either way:

1) in light of the big future cash flows, you can take more risk with your investments and target a higher equity allocation at the end of the glidepath

2) you could also take risk off the table and go more into bonds/money market, i.e., set aside a chunk of money and build a CD ladder to bridge the time before the pension starts.

Depends on your preferences.

I always enjoy your posts. I’ve always kept my asset allocation near 100% stocks. However, the CAPE yesterday hit 39 and a new market high.

Your analysis calculates glidepaths for CAPE > 20. If you had chosen a data set with the CAPE closer to 39 I’d imagine the glidepaths would favor bonds more. But then in the beginning of the post you mentioned that things are different today and a CAPE of 30+ isn’t so scary.

So how should one select their asset allocation given these market conditions as they approach their FI number? What would you recommend for someone that is 3-5 years from FI? Currently I’m at 95% stocks, but considering dropping to 80%-90%. Potentially a bond tent where I glide down to 70%-80% stocks as I near FI?

Because there are so few observations with a CAPE this high, I’d becautious about putting too much weight on the exprience. Who knows, a CAPE=39 may be only as bad a s a CAPE=25 in the 1960s. But even back then the SWR was pushed down to way below 4%!

Your glidepath sounds like a good plan for a moderately risk-averse investor. 3 years before retirement is not a bad time to scale down and start the bond tent.

How will the glidepaths look for a 5-year out retirement when the starting portfolio is not 250x but let us say 1500x expected monthly contributions? If I try to extrapolate from the charts in the post, the initial equity allocation for the scenarios where γ 0 is likely to go down and then quickly converge to the floor (which you set at 40%). Correct or not?

The formatting did not work out. I meant the scenarios where γ is not equal to zero.

If you have that much money, you’d target the same allocation as someone with 0 months to retreatment, because your future discounted earnings are essentially zero relative to the accumulated earnings.

So, it’s not the necessarily floor, it’s the AA at FIRE. For risk-tolerant people it can be 60%, even all the way to 100%. For risk-averse, yeah, you might want to take it down all the way to 40%.

Is there anywhere that you’ve evaluated asset allocation recommendations for your taxable accounts vs tax advantaged accounts? I am 45. I have accounts that need to get me to age 65 and I have accounts that I’ll touch after 65. I’m looking to keep the 401k and Roth closer to 90% equities. The “short-term” taxable accounts are currently about 70%, but seeing as I’m at 3.25% swr now with at least a little more time working ahead of me, I’m considering dropping that.

I hold a good chunk of my taxable accounts in my options trading strategy.

Most recent ramblings on it here:

https://earlyretirementnow.com/2021/10/18/passive-income-through-option-writing-part-8-2021-update/

Dear Big ERN:

This article was forwarded to me, on approx March 24, 2022.

I have recently built a retirement contribution calculator website,

https://www.nesteggcycle.com/

and after reading your article, I used my calculator site to examine

three scenarios of 20 years of working and saving, followed by 60 years of retirement,

with payouts of 50% of final years’ salary and COLA’s of 2.5% per year.

Raises are assumed to be 3% annually.

The investment yields shown, need to remain in effect for life — both before and after retirement,

and show the salary contributions needed for each,

and the max savings / salary ratio achieved before payouts begin.

Yield: Contrib: Sav/Sal:

5.5% 52.55% 14.05X

7.0% 33.43% 10.53X

8.5% 22.21% 8.26X

Nothing is assumed about security selection.

This is more abstract: ONLY the math that needs to be satisfied to make this retirement work.

This tells me something interesting:

Unless I’m doing the 52.55% contributions and expecting only 5.5% return,

or an even more extreme combination of lower return and higher contributions,

I really cannot afford to have the money out of equities for any length of time: I just won’t earn enough.

This supports the article’s case for being 100% into equities almost the whole time.

Thank you. “FRED401K”

I’ve preached this on my blog since the beginning: retirement savers can’t afford to derisk. It’s totally OK to keep 100% equities:

https://earlyretirementnow.com/2021/03/02/pre-retirement-glidepaths-swr-series-part-43/

In retirement you want to be more cautious. Sequence Risk. Which is something you can’t model with your fixed returnassumption.

That’s why I always caution against simple retirement calculators that use a fixed “yield” and no volatility around that. The best outcome always comes from taking maximum risk, which is not advisable in the real world.

Big ERN,

I would appreciate more discussion on the holdings in the Bond portfolio used in you Glidepath analyses. I came across a Kites article which indicates some benefit of Treasury Bills over Bonds for reduced SOR risk albeit with less accumulation opportunity:(https://www.kitces.com/blog/valuation-based-tactical-asset-allocation-in-retirement-and-the-impact-of-market-valuation-on-declining-and-rising-equity-glidepaths/).

Recent performance of long term bonds demonstrates bond risks during periods of rising interest rates. Curious if you have thoughts on the duration on bonds in the fixed income allocation of Glidepaths and if there are ways to apply a long-term value methodology to bonds, similar to the CAPE for equities, that might be useful in dynamic allocation strategies.

A reliable tactical asset allocation model that moves out of equities at the right time and into the fixed-income sector that offers the best protection (short-term if inflationary, long-term if deflationary) is the Holy Grail. But alas, it’s not that easy to accomplish. It’s a very hard problem and I would certainly not look for help from Kitces on that topic. He knows certain things, but tactical macro asset allocation is not his wheelhouse. That proposed equity weight at only 30% for much of the past 30 years is pretty awful.

So, based on the past two years of bond markets, there are substantial risks to moving to bonds, even short term, or intermediate term bonds, just before retirement to deal with Sequence of Returns Risk in the equity markets. I would love to see a “where are they now” type post today indicating what would have happened if someone had moved from 100% equities to 30% equities, 70% bonds, to deal with Sequence of Returns risks in equities, based on this post due to an upcoming retirement. It is important to deal with Sequence of Returns risk for equities, but I think there is a separate dimension to the problem regarding Sequence of Returns for bonds, especially where there is a sudden and dramatic drop in bond values due to a big shift in interest rates.

Would it also make sense to look at a “CAPE” ratio for bonds—- and not do a shift to nominal bonds when interest rates are lower? Maybe the answer is to shift out of equities to inflation protected assets, such as short term money market funds, stable value funds, or real return commodity/energy funds instead of nominal bonds. Also, I am not sure TIPS funds or etfs are the answer, they got hammered as well in the past two years, even the short term funds. Maybe only a TIPS ladder is safe?

In hindsight yes. But what qualifies as low changes over time. Even with relatively low interest rates in February 2020, you still got a ton of diversification out of it when the yieldwent EVEN lower.

But I agree with you generally. And looking at yields today they are high enough that it’s absolutely worthwhile to shift into Treasurys now given that equities are still expensive and bond yields are high.

And we don’t need a CAPE for bonds because we have the yield.

The risks are now water under the bridge. Unless you believe the crazy talk about 7% fed funds rate.

A bond bear market (1970s to 1982) would have been part of all the simulations. So, a glidepath is still useful.

Do you have a spreadsheet for determining the optimal glidepath (That maximizes SWR) given different tax assumptions?

It seems intuitive that someone in a higher bracket would be less inclined to be in bonds longer or with a higher allocation than someone with no taxes.

I never coupled SWR simulation analysis with tax calculations. Too many moving parts.

But I agree that for estate planning, equities make more sense.

I’m not sure if this is the right glidepath post to leave this question on, so if it belongs elsewhere please accept my apologies (feel free to move it if appropriate).

I was wondering if there’s been any examination of a ‘beta-based’ glidepath instead of a stock allocation glidepath – in other words, to decrease the level of beta in one’s portfolio as one gets closer to retirement (or possibly to have a ‘reverse glidepath’ of increasing beta in retirement?). Seems like it might reduce SORR a fair bit without losing too many of the benefits of a stock portfolio?

Thanks for all you do and thanks in advance for any insight you might have on this!

There is some research by AQR (google “betting against beta”) that shows that low-beta stocks offer a better return. So, this is generally a great idea. But I doubt we have long enough returns to check this.

But also keep in mind that your suggestion would involve some financial engineering. Imagine you want the same beta as a 60/40 portfolio.

You now invest 100% of your portfolio into 0.60-beta stocks. The 40% bond portion has to come from bond futures. Not every investor is sophisticated enough to do that. In fact, the AQR research points out that it’s exactly this leverage constraint that causes the low-beta alpha. 🙂