Timing Leverage in Retirement – SWR Series Part 52

March 21, 2022

Last year in Part 49 of the Safe Withdrawal Series, I wrote a post about using leverage in retirement, and in today’s post, I like to explore some additional issues. 

A quick recap, the appeal of using leverage in retirement is that we would borrow against the portfolio instead of liquidating assets. Nice! That might help with Sequence Risk if we avoid liquidating assets at temporarily depressed prices. There could also be a tax advantage in that we keep deferring the realization of taxable capital gains, potentially until we bequeath our assets to our daughter who can then use the “step-up basis” for complete forgiveness of all of our accumulated capital gains. That’s the famous “buy, borrow, die” approach popular with high-net-worth folks.

The gist of the post last year: Not so fast! Leverage could potentially even exacerbate Sequence Risk if you are unlucky and retire right before a bad market event that’s deep enough (like the Great Depression) or long enough (like the 1965-1982 stagflation episode) to compromise the portfolio so badly that the margin loan becomes unsustainable relative to the underwater portfolio.

One solution proposed by several readers: instead of always borrowing against the portfolio, maybe we should carefully time when we use leverage. For example, borrow only when the stock market is down “far enough” and use withdrawals from the portfolio otherwise. And if the market is doing well again, potentially pay back the loan again! Sounds like a reasonable and intuitive plan. But I want to put that to the test with some real simulations. Let’s take a look at the details… 

A quick recap of the 1929 and 1965 cohorts

In the post last year, I modeled the margin loan with a fixed real interest rate. I realize that a slightly different assumption might be more realistic, namely using a fixed spread over a short-term government reference rate. That’s because if you want to borrow on margin, your broker will likely not quote you a rate as “x% over CPI inflation” but, more likely “x% over the Federal Funds Rate (FFR)” or some other short-term rate like the 3-month T-Bill rate or LIBOR. What would be a reasonable assumption for the margin loan spread?

  • A Home Equity Line of Credit (HELOC) often has an interest rate tied to the Prime Rate, which is itself about 3 percentage points above the (overnight) Federal Funds Rate (FFR). I remember back in the good-ol’ days you could get HELOCs for Prime minus 0.75%, even 1.00%. But I think today’s rates are closer to Prime +/-0% or maybe minus 0.25% if you have good credit and shop around a bit. So, if you get a HELOC with a rate equal to prime minus 0.25%, you’ll pay around 2.75% above the FFR.   
  • M1 Finance offers rates between 2% and 3.5%. That’s a wide range. It looks like the upper edge is actually inferior to the average HELOC. I couldn’t ascertain what benchmark rate they use, but I’d suspect, the range of interest rates will likely move up in line and 1-for-1 with the Federal Reserve policy rate.
  • Interactive Brokers will lend to you at a rate of 1.50% above the FFR for smaller amounts, and 1.00% for medium-sized loans ($100,000-$1,000,000). Loans up to $50,000,000 go for 0.75% above the policy rate. And 0.50% for loans $50m+, if you’re loaded enough. This is all for the IBKR PRO account. The IBKR LITE account charges significantly more.
  • Borrowing through a box spread trade as I discussed in my post in December 2021, you might get rates as low as 0.3-0.5% above the T-Bill rates. That’s likely the lowest rate you will encounter anywhere. (side note: most likely you’d choose a longer-term loan, maybe 1-2 years. Potentially as long as 5 years. The 0.3-0.5% spread refers to the spread above the T-Bill or Treasury bond of the same maturity, not necessarily the spread above the realized Fed Funds Rate. But over shorter horizons, the T-Bill rate is a pretty accurate prediction for the average FFR over the same time span)

It turns out that the choice of the loan rate will make quite a difference in the margin loan calculations. For example, last time I used real rates of 0%, 1.5%, and 3% with the middle value of 1.5% above CPI as my “preferred” value. I like to recalculate the scenario for the November 1965 retirement cohort with a $1,000,000 initial portfolio withdrawing $30,000 annually and supplementing the withdrawals with a margin loan worth $10,000 annually. For the CPI+x% loan rate, I use the middle value of 1.5% and contrast that with three different FFR+x% loan scenarios: a 0.50% spread (best possible case: box spread trade), 1.25% spread (margin loan with Interactive Brokers), and 2.75% (HELOC, and other not so attractive brokers). The portfolio value net of the 3% withdrawals is the same in all four scenarios but the loan balances are quite different, see the chart below. It turns out that the FFR+x% loan interest looks far worse in the 1965-1995 time span than I had previously assumed. That’s bad news because it means that the margin issues that hamper our “buy, borrow, die” efforts would have been even more constraining than I previously assumed. Inflation-adjusted short-term rates were much higher during the crazy 70s and early-80s than I previously assumed!

Portfolio vs. loan balances (top) and loan-to-portfolio ratios (bottom) for the 11/1965 cohort. 75/25 portfolio. $40k p.a. retirement budget, $30k from the portfolio, $10k from margin loan. Simulated monthly.

That said, what hurt us in 1965 would have helped the September 1929 retirement cohort! If I redo the exercise with the different margin rates we get the following picture, with far lower loan-to-portfolio ratios when using the FFR+x% rule. That’s obviously because the realized short-term real rates were quite low during the Great Depression.

Portfolio vs. loan balances (top) and loan-to-portfolio ratios (bottom) for the 9/1929 cohort. 75/25 portfolio. $40k p.a. retirement budget, $30k from the portfolio, $10k from margin loan. Simulated monthly.

Simulations for the 1965 cohort

Let’s get to work and run some simulations. I want to start with the November 1965 cohort because, as the results above show, that seems to be the most constrained cohort and potentially the one with the most to gain from timing the margin loan draws.

Let’s start with the base case simulation, where we use a 4% annualized withdrawal rate, and a quarter of the monthly budget is financed through the margin loan, every month. I display the simulation results, for this and all the subsequent scenarios, in this simple chart plotting the real CPI-adjusted time series of the portfolio, loan, and net worth balances (left axis) and the monthly margin loan draws (right axis). The monthly budget is $3,333.33 (4% annualized), $2,500 of which comes from withdrawals and the remaining $833.33 from the loan. There is no timing (yet). We confirm again that this would have been at the very least a very unpleasant retirement experience, with the net worth depleted to $133,000 about 17 years into your retirement. The maximum loan-to-portfolio balance would have been 72.3%. That means for every $100 of portfolio value, only $27.70 was your net worth and $72.30 came from the loan. That’s almost a 4x leverage, which would have likely busted your portfolio and caused a forced liquidation by the brokerage, considering that I simulated this only at a monthly frequency, and daily and intra-day fluctuations would have easily pushed you beyond your margin constraints.

November 1965 cohort simulation. Time series of portfolio loan and net worth balances (left axis) and the monthly margin loan draws (right axis). 75/25 portfolio, 4% WR, 25% of withdrawals financed through the loan. No timing.

Lower WR, less leverage

Since a 4% withdrawal rate and 25% of consumption financed through the loan wouldn’t have worked in 1965, let’s see how much we have to reduce our budget to make this work. Let’s assume that this retiree wants to keep a $250,000 safety cushion after 30 years. Without any leverage and using a 75/25 portfolio, I compute the baseline safe withdrawal rate as 3.58%.

How about with leverage? I use the built-in Excel Solver function to maximize the retirement budget subject to the $250,000 final net worth target and the 50% upper limit on the loan/portfolio ratio (=2x leverage), by changing the withdrawal rate and the “Borrow%” value, i.e., the share of retirement budget funded by the margin loan. This is still without timing the margin loan, i.e., we withdraw the same (real CPI-adjusted) amount every month. The results are pretty disappointing. Even with an extremely inexpensive margin loan rate, we can only finance about 10.76% of the retirement budget (a little over $300/month). And lift the safe withdrawal rate to 3.78. Better than 3.58%, but still no panacea for sequence risk either!

November 1965 cohort simulation. Time series of portfolio loan and net worth balances (left axis) and the monthly margin loan draws (right axis). 75/25 portfolio, 3.78% WR, 10.76% of withdrawals financed through the loan. No timing.

Timing the margin loan

Let’s look at the following timing mechanism: we fund 100% of our retirement from withdrawals unless the S&P 500 drops to a certain percentage below its most recent all-time high. Let’s start with a 20% drawdown target. We can indeed raise the withdrawal rate and margin loan percentage to 3.84% and 26.48%, respectively. Still a bit shy of the 4% Rule but not bad. Notice how the margin loan draws, about $850/month, occur briefly during the 1970 recession and bear market, the 1973-1982 stagflation era, and again briefly during 1987/88 stock market hiccups. Out of the 360 months of retirement, we’d use the margin loan “only” 125 times. Also notice that we easily spot the time when the margin loan constraint binds: When the blue line touches the green line we’d have loan+net worth=portfolio, and thus loan=0.5*portfolio, i.e., exactly 2x leverage.

November 1965 cohort simulation. Time series of portfolio loan and net worth balances (left axis) and the monthly margin loan draws (right axis). 75/25 portfolio, 3.84% WR, 26.48% of withdrawals financed through the loan, if the S&P 500 TR index is 20+% below its all-time peak.

Pay back the loan when we’re back at a fresh all-time high!

If we look at the time series chart of the previous simulation, we notice that the 50% margin ratio hits you relatively late in retirement (month 349), during the 1994/95 Peso Crisis and the resulting stock market weakness. During the ugly 1982 stock market bottom, we had a loan to portfolio ratio of “only” about 32%. One way we might be able to increase both the margin loan use and the safe withdrawal rate would be to pay back the loan during the 80s/90s stock market rally to relax the 50% margin constraint in 1994.

So, let’s assume that if we reach a fresh all-time high in the S&P 500 Total Return Index, we’ll start paying back the margin loan. I assume that we simply double the withdrawals from the stock/bond portfolio and use the excess to pay down the margin loan, i.e. set the margin loan draw to -100% of the monthly retirement budget. This method allows us to raise the WR to 3.91% and the margin loan portion of the withdrawals to 41.08%. We still draw the margin loan during 125 months but we also pay back the loan for a few months in 1972, and then again starting in 1985, for a total of 47 months. Notice that the maximum margin constraint is now binding in 1982 again at the bottom of that recession when the margin loan touches the net worth line.

November 1965 cohort simulation. Time series of portfolio loan and net worth balances (left axis) and the monthly margin loan draws (right axis). 75/25 portfolio, 3.91% WR, 41.08% of withdrawals financed through the loan, if the S&P 500 TR index is 20+% below its all-time peak. Pay back the loan when the S&P 500 TR index reaches a new (real) all-time-high.

Complete Simulation Results

I also played around with more restrictive drawdown constraints, i.e., use the margin loan only when the stock market is down by 25%, 30%, and 35%, respectively. I don’t prepare separate charts, but report the complete simulation results in the table below. Indeed, we can push the safe withdrawal rates even a little bit higher if we move to a 30% cutoff, but at 35% there is a huge deterioration again. Having to wait until the market drops by 35% appears to be too restrictive, at least during the 1970s. But it seems that anything between 20 and 30% seems like a neat option. The no-leverage withdrawal rate would have been only 3.58% and we can improve that by about 33-36bps, or about 9-10%. Not bad at all!

Also, to explain again how the numbers were created: with the exception of the first column, where I just calibrate the WR and the Borrow% at 4% and 25% (and we clearly get way too much leverage), I use the Excel Solver function to maximize the retirement budget subject to the $250,000 final net worth and the 50% upper limit on the loan/portfolio ratio (=2x leverage), by changing the withdrawal rate and the “Borrow%” value, i.e., the share of retirement budget funded by the margin loan.

I also included a reader suggestion in the last column on the right, where the loan draw vs. payback is timed not by the S&P 500 drawdown, but by what I call a “Portfolio on Track” indicator. I check if the projected portfolio value net of withdrawals, assuming a 4% real return rate. And then subtract the current margin loan balances with interest. If you’re below the final bequest target of $250,000, draw down the loan, if you’re on track then withdraw the retirement from the portfolio and – if applicable – pay back the loan as well. I haven’t played around very much with this rule, and maybe it can be optimized some more, but the equity index drawdown rule appears to be superior for the 1965 cohort.

11/1965 cohort: Summary of simulation results.

A few caveats

As always, there are a few warnings and caveats to keep in mind here:

  • There is no way an actual retiree in 1965 would have been able to borrow at a rate of FFR+0.50%. We’d have to view my calculations here as a “thought experiment” of whether with today’s financial innovations – index funds, low expense ratios, low margin rates – we can use leverage and still survive a repeat of the return patterns of a historical worst-case scenario!
  • If your margin interest is higher, say FFR+1.25% (IB margin loan) or FFR+2.75% (HELOC), some of the appeal of the margin strategy evaporates. The withdrawal rates for the 25% drawdown timing mechanism go from 3.92% to 3.87% and 3.75% when raising the loan spread rate from 0.5% to 1.25% and then to 2.75%, respectively.
  • If you indeed plan to use the box spread trades, keep in mind that those loans tend to be “lumpy”. I initiated three box spread loans so far, one with a 200-point spread and two with a 1,000-point spread, worth $20,000 and $100,000, respectively. Rather than doing a box trade every month, most people would likely to draw down the IB margin loan at a slightly higher interest rate until they reach a large enough loan balance and then initiate a new box spread loan, in the low-to-mid 5-figures.
  • Also, keep in mind that most actual retirees face an even tighter margin constraint than what I model here because only traditional brokerage accounts allow margin loans. You can’t do this in a retirement account!

The 1929 Cohort

Just for completeness, let’s redo the same exercise for the September 1929 cohort, right at the stock market peak before the Great Depression. The unleveraged safe withdrawal rate was 3.61% in this cohort. Quite intriguingly, the margin loan would have provided a tremendous improvement in the safe withdrawal rates. The base case with the 4% WR and 25% borrow share would have stayed way below the 50% margin constraint. So, even without timing the margin, you could have gone to a 4.39% withdrawal rate and financed 31.86% of your expenses with the loan. And it gets better when you time the loan draw and the repayment. With a 35% drawdown criterion, a 4.93% withdrawal rate would have been feasible.

9/1929 cohort: Summary of simulation results.

Conclusions

There is no panacea against Sequence Risk. I didn’t expect this to be one either. But I was positively surprised that a small dose of leverage can indeed smooth out some of the headaches of even the historical worst-case retirement scenarios.

A negative surprise: even if you use the margin loan very occasionally, i.e., only after a stock market drop of 25% or more, it would still be too risky to fund all of your retirement expenses with a margin loan. I would use the loan only very sparingly, to replace only about 50% of the retirement budget, even after a 25% drop! Applying this rule to the more recent retirement cohorts, you wouldn’t have utilized the margin loan even during the 2020 bear market because the month-end drawdown in March 2020 would have been just under 20%. Even though the February 19 to March 23, 2020 drawdown was almost 34%! Under the leverage timing rules studied here, you would use leverage only during the 2002-2003 or 2007-2009-style market meltdowns, not the garden-variety volatility we’ve seen post-2009.

I am also surprised about the margin loan working so well in the 1929 case study. I would have expected the reverse, i.e., I thought that the margin loan would have worked better during the 1970s/80s stagflation than during the deflationary 1930s. But of course, the inflation rate alone doesn’t matter so much. Real interest rates were painfully high during the 1970s but relatively benign in the 1930s.

But make no mistake, leverage doesn’t work as well as some hand-waving “experts” on the interweb want it to appear. We can’t “just use the margin loan” and all worries about sequence risk go away. The historical worst-case scenario retirement starting in 1965 needed to tread much more carefully. Don’t even think about using the margin loan to fund your entire retirement. That’s only for the ultra-rich with a nine-figure+ net worth and a 1% withdrawal rate. But, again: using leverage sparingly, say, 40-50% of the retirement budget is funded through a loan and only when the stock market is down significantly, we can make a noticeable dent in the effect of Sequence Risk.

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!

PS: For the math wonks, I posted the Excel Sheet here. This is not a sheet that would work well with Google Sheets due to Google’s inferior solver function. So, it’s an “*.xlsx” file. Since I never intended to share it, it might take a bit of a learning curve to figure things out. It doesn’t have enough documentation to serve as an easy plug-and-play toolbox.

Title picture credit: pixabay.com

27 thoughts on “Timing Leverage in Retirement – SWR Series Part 52

  1. I’ve been hitting the refresh button for a few months waiting for this post. Bravo!

    Is it possible to add sub 20% draw downs to your analysis?

    Better yet, any chance we can play with your model?

    Thanks for all you do!

    1. Thanks! Just because of you hitting the refresh button, my site clicks went up 750%. Thanks for that. Just kidding. 😉

      I added a link to the Excel Sheet at the end. Feel free to play around.

      Going to 15% or 10% draw down cutoffs lowers the success of the strategy, at least in 1965. Same problem as before: you’d draw in way too many months. To keep the margin in check you’d be able to supplement only very little of your retirement budget with the margin loan. But it would have helped in 2020!

      1. Hi BigErn, one question on the technical issue of this site
        1/ I tried to register for the forum, but never receive any confirmation email. Is it the technical issue or the forum close for new members now?
        2/ I couldn’t find places to make a new comment on your post, hence do it here. Maybe I’m lowtech. But glad if someone could show me how

        Btw, I like your Option strategy using SPX. I’m using /ES though. But recently I noticed /ESM (expire in Jun) has lower price than /ESU (expire in Sep). Normally ESU will be around 10pt lower than ESM. Is it considered “backwardation”. If that’s the case, should we be better off shorting ESU and long ESM?

        1. 1: I sent an email with a new forum password to the email registered under your name. Let me know if that works.

          There is indeed a term-structure for the ES futures. Depending on dividend yields and risk-free rates, you could have contango or backwardation.
          Also caution with the slope of the term structure: the currently most liquid contract is the June ES-M-22 and the others are not traded much (ES-U-22, ES-Z-22, ES-H-23, etc), so take the exact slope with a grain of salt. 😉

  2. I was just listening to Frank at Risk Parity Radio and he took a dig at you Big ERN because of your very negative view on future returns and the CAPE risk in particular. I don’t know if you listened but I’d love to hear your arguments to counterpoint his views.

    1. Didn’t know Frank Vasquez had a podcast. Very strange that he “took a dig at me” for two reasons:
      1: he seemed to be a nice guy. I met him at the 2019 Fincon in D.C.
      2: I’m generally positive on equities (TINA = there is no alternative). I merely say that with a high CAPE the risk of a major drawdown is high and the SWR should be a bit lower. The high CAPE is less of a headache for FIRE savers (the usual ChooseFI crowd). I said this many times (incl. SWR Part 43). He’s a lawyer by training, so he should understand the nuance.

      In any case, I don’t know what exactly he said. If he really thinks that way and badmouths me behind my back without even giving me a heads-up (or a link – SEO, baby!) I would find that quite odd. Maybe it was mostly “tongue-in-cheek”???

      1. Maybe “took a dig” was not the right term. To be fair he was just commenting about the Morningstar article about the low SWR in the future and he mentioned that you were among those overly pessimistic about the future returns and that’s just crystal ball. He’s a nice guy though. And so are you. Thank you for all the hard work

        1. It’s obviously a gross misrepresentation of Morningstar and my work. It’s hard to argue with the following three crowds: 1: dividend growth investors, 2: small-cap value investors, and 3: risk parity investors. They all think that they can ignore basic financial and economic principles because they are so much smarter than everyone else. Dunning-Krueger effect.

  3. Quick question. I’m a Chinese working for a big tech in California for the past 5 years and in two year my visa expires and I’ll move back to China (can’t wait).
    My question to you is: Should I keep maxing out my 401k knowing I won’t be able to tap it until 59/5 (I’m 37) and I’ll be living in China, which means I’ll have to pay income tax there on any dollar withdraw from my 401k/IRAs here (or worse, will be under sanction judging by the way things are going in the west)? Thoughts?

    1. I don’t blame you. I left CA in 2018 and didn’t look back. But it’s find it curious that people want to flee from the Sacramento Communists and prefer the Beijing Commies. You can criticize CA all you want, but at least they don’t have concentration camps for a million Uyghurs (yet).

      But back to the question: if that’s really true, that you have to pay taxes on your 401k distributions twice, once in the US and once in China, then it sounds like you should have never contributed to the 401k. Another issue: even after leaving California and living abroad, you might still have to pay CA state income taxes on your 401k distributions. See here:
      https://brighttax.com/blog/california-state-taxes-americans-living-abroad-guide/
      This article is for US citizens working abroad as expats, but I’d be surprised if CA wouldn’t want to dip into your earnings as well, even after you’ve left the country and state. From that article:
      “This means that former residents of the Golden State who qualify to pay foreign taxes in their new country of residence (depending on local tax rules there) may find themselves unfortunately and unavoidably subject to double taxation. To avoid this scenario, some expats choose to move states before they move abroad. While not always possible, moving residence and ties to a zero tax state such as Florida before moving abroad could mean a significant tax saving in the long run, especially if the move abroad is going to be long term.”

      So, long story short, if you already know that you’ll be leaving it’s likely not a good idea to keep maximizing the 401k.
      You might want to cut ties with the state of CA and move to NV, or WA or FL or TX before you leave the country. That would possibly cut the ties with CA and avoid the tax hit in 22 years.
      Probably you want to consult a tax lawyer to help you in this matter.

      1. First of all, thank you for your words and analysis. And yeah you’re probably another one who believes the western fake media about the concentration camps in my country. If you knew what the Chinese media says about the west and people there believe and it’s not true as I attested in person. It’s the same crap just on the other side. Besides, do you know the history of the Uyghurs, what they represent for a traditional Chinese person? yeah I do.
        Well one more reason to hate California and the USA in general. I don’t trade China for any of this and believe me, China is not the kind of communism you are use to think.. And the food here? horrible.
        I’ve contributed to the 401k because of the 100% match up to 5% which sounded good but now…I don’t know anymore. Maybe it’s worth paying the 10% penalty, withdraw everything and send to China before I leave? Would that be a smart option?

        1. You came to my blog to ask a question. Coupled with an insult of the country I live in and love. Don’t be offended if I include a bit of snark in my reply. If you can’t take the heat, get out of the kitchen!
          God Bless America!

      2. Propaganda is one hell of a drug, ERN. I know Chinese and Russians who truly believe what their state TV tells them. It’s sad. Let Wang enjoy his native China.

        California has become a state best avoided because of these “clawforwards.” Few people who move there realize what they are signing up for. Thanks for making it more visible.

  4. ERN,

    I’m usually a huge fan of your SWR series, but for many reasons this one left me scratching my head, wondering the following (combined comments and questions each):

    1. Are you saying that when the market does dip 20%+, you intend to use leverage yourself this way? If not, why not?

    2. The choice of 75-25 stocks with 25% FV seems strange on multiple levels:
    2a. It’s nothing close to supporting a 60 year retirement.
    2b. As you showed in part 34, using 60-27-13 stocks-bonds-gold would yield a much better SWR [4.04%]
    2c. Wouldn’t it make a lot more sense to first sell off all of the bonds, and use leverage only on the (now pure) stock portfolio? This way, you’re borrowing to buy 10 year bonds, which seems both risky in general and particularly “crazy” going forward from here in 2022, given nominal and real bond yields. It’s not even clear whether in the 1960s you aren’t doing a negative carry with the borrowing-short-to-buy-bonds trade.

    3. You justify your conclusion by looking at only two cohorts, when usually you caution that it’s important to judge against al 1700+ possibilities. Why the change? Are you confident that the benefits of leverage would be at least as good for all of the other cohorts? Why?

    4. It seems to me that if you’re moving into considering market timing schemes that, in addition to the point above about first selling off all the bonds before applying leverage, variable asset allocation (a.k.a. market timing) can do much better by avoiding the biggest part of the biggest stock downturns altogether, rather than only trying to use leverage after a big drop.
    – even before timing stocks, using a Bonds+Gold mashup where you use bonds as the ballast for stocks before dollar convertibility of gold in August 1971 and gold thereafter using a 65% stocks weighting and 35% this mashup delivers a SWR of 3.93%
    – using Meb Faber’s 10 MMA stock signal combined with the above mentioned Bonds+Gold mashup as the ballast during sell signals, you get a SWR of 4.09%

    [There are other market timing schemes that can do even better than simple 10 MMA, of course – I’m tinkering with one myself – but that’s nowbeyond the scope of this post.]

    All of the SWR numbers cited above are higher than the combined benefit of using leverage on the 75-25 portfolio.

    For backing on the SWR numbers cited, please see the hacked ERN SWR sheet with the two custom series posted on your Forum here:

    https://earlyretirementnow.com/Forum/swr/hacked-ern-sheet-with-custom-series-for-10-mma-variable-asset-allocation-a-k-a-market-timing-and-simple-bonds-gold-mashup/#post-1867

    Still a (huge) fan, just maybe not of this entry.

    Thanks in advance. One of the very best things about your blog is not just the fantastic content posted but your replies to most comments; I think I’ve learned as much about retirement finance reading your replies as your original posts!

    1. Hi Andy! Thanks for your comment. Very thoughtful as usual. My replies:
      1: Any question that begins with “Are you saying that…” has a high chance of a “No” response. The exercise in this post is for an average fresh retiree looking to get to about 3.5-4% WR. I’m not the average retiree. My assets have grown, I have some other income sources and my WR is currently around 2%. I don’t have to worry about running out of money. See SWR Series Part 50, item #7. At least I’m transparent that I can be nonchalant about failures. Not all my readers can.
      2a: 75/25 with a 25% FV target is actually a pretty good general approximation that “works” for early retirees who expect Social Security and pensions, maybe 20 years into retirement. It’s also a good approximation for traditional retirees who like to have a safety margin and/or bequest target.
      2b: I start with the most basic assumptions. We can always throw in more bells and whistles afterward.
      2c: The “sell bonds first” method will likely suffer from some of the same problems as the leverage strategy. Selling off bonds too early is also bad timing because the 1965 retiree would have run out of bonds already by 1982 when the crap hit the fan. It might be better to sell equities early on, while they are still within 20% of their all-time high. Then sell bonds when things get really bad. It’s just a conjecture. But it would be a good topic for a future post.
      3: I looked at more cohorts but restricted my attention to the historical worst-case scenarios when writing this post. Leverage will obviously help you when things don’t turn out as badly as 1965-1982. I could obviously “transcribe” the Excel Sheet into a Matlab or Python function and loop over all generations. But it wouldn’t have enough value added to justify the extra work.
      4: Yes, we can look at more market timing schemes. I am working on both momentum and valuation-based rules. But keep in mind that the momentum rules are likely extremely overfitted to make past data look good. Also, these are never either/or. We could clearly do both momentum and leverage. Or momentum plus valuation plus leverage. But as I indicated before, I like to keep things simple in the beginning and throw in new stuff only one at a time, because I want to see how each new flavor would add to the SWR at the margin.

      1. I think I am with Andy on his (2c): how does it make sense to be “selling bonds” (borrowing) while still holding bonds (lending)? Is it not a net loss always, given that we can’t quite borrow at the bond rates? Or is this some kind of “duration arbitrage” by paying less for a shorter-term loan while holding longer-term bonds? If so, would we not be at the mercy the future yield curve?
        The same question in other words: does it ever make sense to borrow in order to buy bonds?
        (Having large capital gains embedded in one’s bond position would add a wrinkle, but that’s not terribly likely these days, is it?)

          1. Were bonds negatively correlated with stocks from 1965 to 1982?

            Do you think it likely they will be negatively correlated when stocks are down (we don’t really care that much when stocks do well) over the next several years?

      2. Thanks for the replies.

        I hear you on the replies to 2a, 2b, 3, and even most of 4 (though the idea of momentum combined with leverage scares me a bit)

        On #4, you make the very valid point that momentum rules risk being overfitted. Yet for the first time I can recall in the SWR series, seems a decent chance you might be doing that here, in particular when you “played around with … 25%, 30%, and 35% (drawdown constraints)” though deciding on 20%.

        On 2c, it’s not that I’m advocating for “all bonds first” in isolation, but buying bongs leveraged still doesn’t make sense to me here, even as an exercise. It violates your “makes no sense to have a mortgage and bonds” rule. Did you calculate what percentage of months it resulted in a negative carry from 1965-1982? And the logic of buying bonds using leverage based on when *stocks* that are down I find curious, too

        But most important, re: #1, I now find myself rooting for lifestyle inflation in the ERN household!
        It was more comforting – and a tiny bit more credible – when I thought you had “skin in the game” with the SWR calcs, rather than it being just an “academic” exercise.

        C’mon, Karsten, you can take nicer trips, eat at better restaurants, give more to your favorite charities, etc… I promise if you listed to ERN’s advice, it’ll be *safe* to do so! 🙂

        1. A definition of overfitting? I know it when I see it.
          Examples of overfitting: the ever-more intricate portfolios of Merriman, for example.

          Maybe I’m overfitting. But keep in mind that I still keep things simple, with just S/B portfolios. I also try to come up with the S/B allocation that is robust to both supply shock (1970/80s) and demand shock recessions (1930s). But who knows, maybe I’m overfitting too and what ahead for us all is very different from both 1929 and 1982.

          2c: Not a contradiction. Bonds are not equal to cash. There’s usually a term premium and there’s a duration effect that you don’t get from cash and short-term borrowing.

          1: Rest assured, my own analysis helped me pull the plug in 2018. Now I’m retired and don’t exactly need this. But I hope I still serve as a contrarian voice in the ocean of happy-talkers. And also rest assured, we will eventually raise our budget if the portfolio keeps going like this! 😉

  5. Hi ERN,

    I have had the idea of using timed leverage based on S&P 500 drawdowns in my head for a while now but never got around to doing the analysis. Really glad that you did! An additional analysis that could be interesting would be to use dynamic leverage based on the current drawdown percentage instead of fixed leverage that begins at a specific amount of drawdown. I.e. leverage = m * (S&P 500 drawdown %) + b and then either lower or get rid of the threshold on when to start utilizing leverage.

  6. I’ve been tracking the Rates at M1 as the Fed has been hiking. Their benchmarks for borrowing appear to be Fed Funds Rate + 3.25% (Standard M1 Account) and Fed Funds Rate + 1.75% (M1+ Account). These benchmarks have been quite consistent. Their rates have moved up exactly 1-for-1 with the Federal Reserve policy rate the day following each rate hike.

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