May 16, 2024 – Welcome to another Safe Withdrawal Rate Series installment. Please see the landing page of the series for a guide to all parts so far. In Part 60, dealing with the “Die With Zero” idea, I mentioned working on an upcoming post about the “Safety First” approach, and I finally got around to writing that post. What is Safety First? It involves using asset allocations different from those in the Trinity Study or my SWR Toolbox (see Part 28). For example, we could use Treasury Inflation-Protected Securities (TIPS) as a default-free and CPI-hedged investment option. However, TIPS are no hedge against longevity risk. An annuity hedges against longevity risk; though the most common annuity option, a single premium immediate annuity (SPIA), is usually not CPI-adjusted. Also, for the longest time, low interest rates rendered the Safety First approach all but useless because neither TIPS ladders nor annuities generated enough income for a comfortable retirement. You would have been better off taking your chances with the volatility of a 60/40 portfolio.
In other words, there is no free lunch. You don’t get peace of mind for free. Rather, you likely pay a steep price for that safety by giving up most, if not all, of your portfolio upside and/or bequest potential. However, since interest rates started rising again in 2022, the entire fixed-income interest rate landscape looks more attractive now. Could this be the time to reconsider Safety First? Let’s take a look…
Safety First or Safety Worst? It all depends on the Interest Rate Landscape!
One of the reasons I have held back writing about Safety First is that interest rates were so low for the first six years of my blog (2016 to 2022) that the implied withdrawal rates utilizing a 30-year TIPS ladder would have been rather unappetizing. Specifically, for much of my early blogging career since 2016, the real interest rate on 30-year TIPS has languished around 1% pre-pandemic and then dropped further to below zero post-pandemic. Only recently have we seen TIPS yields in the 2.0-2.5% range again.
Consider the following example: a traditional retiree with a 30-year horizon who faces a real rate of 1.0% could have used a TIPS ladder to structure a withdrawal rate of 3.85%; see the table below. This would have assumed a 1.0% TIPS rate at all TIPS horizons, which is likely a bit too optimistic, so the actual rate might have been slightly lower. At a -0.5% TIPS rate, your safe consumption rate would have dropped to only 3.09%. Specifically, it would have been less attractive than even the failsafe from a standard safe withdrawal rate analysis.
Also, notice that over a 30-year horizon, guaranteeing even a modest bequest (or cushion) worth 25% of the initial balance would have further reduced your safe consumption rate: 3.14% for the +1.0% real rate and 2.19% for the -0.5% real rate. Leaving a more significant bequest (50% of the initial balance) would drop the safe consumption rate to 2.43% for the 1.0% real rate and 1.29% for the -0.50% real rate. In comparison, a balanced portfolio (75% stocks and 25% intermediate-term US Treasury bonds) would have yielded a 30-year failsafe rate of 3.82%, 3.58%, and 2.90% for 0%, 25%, and 50% final value targets, respectively. And those are the rock-bottom failsafe rates if we encounter a repeat of the Great Depression and/or the 1970s and early 1980s. In the not-worst-case scenario, you would have done much better.
But admittedly, using today’s TIPS rates of around 2.25%, you would have a 4.56% safe consumption rate for a zero bequest, 3.98% for a 25% final value target, and 3.41% for a 50% final value target. Not bad! However, with this TIPS ladder, you still face longevity risk. How risky is it for a 65-year-old to plan for a 30-year retirement and not have any money set aside past age 95? That brings me to the next issue:
What is my expected vs. potential lifespan in retirement?
Since I posted my actuarial toolkit in Part 56 in 2023, people have asked me if I can add more features to the SWR Toolkit (see Part 28 for the link to the Google Sheet) to gauge the expected and potential lifespan. Planning a TIPS ladder only up to your life expectancy generates a significant risk – approximately 50% – of running out of funds in retirement. If you opt for a TIPS ladder, you must plan well beyond your life expectancy. And as a couple, you must hedge not just the individual but also the joint survival. True, some expenses may decrease if the household size goes from two to one late in retirement, e.g., food. However, some expenses may stay the same, such as housing and utilities, for example, if the surviving spouse prefers to stay in that same home. Some expenses may rise if one of the spouses passes away, for example, if the surviving spouse no longer feels comfortable living alone and then needs in-home or even nursing home care.
So, what retirement horizon is appropriate for 65-year-olds? Let me introduce a new tool in the SWR Google Sheet. It’s in the tab “Life Tables,” and the only inputs we need here would be the gender and health status of the two spouses. My sheet uses the age you specify in the “Cash Flow Assist” tab, so that’s not even an input here. I use the SSA 2019 life table. If you like using your custom table or a different cohort, you can copy and paste those values in columns AC-AI in that tab.
In any case, here’s the output using a 65-year-old couple with average health, i.e., using the death probabilities from the SSA 2019 table; see below. Individually, they may have a life expectancy well below the 30-year horizon. The two spouses have a conditional individual life expectancy of only 18.1 and 20.7 years, respectively. However, the last survivor has a life expectancy of 24.5 years. At the end of the 30-year horizon, there is a 21.1% probability that one of the spouses is still alive.
Summary so far: using Safety First to build a TIPS ladder with a defined end date, at which point your funds run out, is indeed the antithesis of Safety First. You introduce a significant failure probability if one of the spouses outlives the predetermined end point of the retirement horizon. If you’re an avid reader of the ERN blog, you may remember that I made a similar point in Part 32 of the series “You are a Pension Fund of One (or Two).” This one aspect of retirement planning is more challenging for a one or two-person household than for a pension fund with thousands of participants. A pension fund can rely on actuarial tables to predict the rate at which the number of covered participants will decline over time and then match its assets and cash flows with its predicted future liabilities. But as an individual retiree, you can’t work with actuarial math like that. You’re either 100% alive or 100% dead.
Recall that the SSA tables are for the nationwide average. Most people I know consider themselves significantly healthier than the “average” American. If I set the health of both retirees to “Good,” I will extend the life expectancy by about two years for each. The way I twist the SSA survival table is that for people in good health, death probabilities are reduced by 20% every year, resulting in a rise in conditional life expectancy by about 1.8 years for both spouses. Even though both spouses still have a life expectancy well below 30 years, the joint life expectancy is now at 26.5, and the last survivor has a 32.1% chance of outliving the 30-year horizon. Pretty scary! So, operating with a fixed retirement horizon and drawing down your savings to zero until age 95 seems quite risky. Safety First isn’t that safe if you use a TIPS ladder.
Finally, I also display the results for people in excellent health (40% reduction in death probabilities, resulting in a roughly 4-year extension of the conditional life expectancy). Now, the last-survivor life expectancy is 29.2 years, and the probability that you outlive a 30-year TIPS ladder is almost half (47.5%).
Safety First, through a TIPS ladder, is even less attractive to early retirees!
Another reason I never felt a big urge to write about Safety First is that there is likely only limited use for this approach outside the traditional retirement community, say 65-year-old retirees with a 30-year horizon. That’s because even with today’s 2.25% real rate, we get a 50-year safe consumption rate of only 3.33% with portfolio depletion, according to my table above. We’re down to 3.06% with a 25% bequest target and 2.79% with a 50% final value target. Those are pathetic withdrawal rates. TIPS rates would have to rise again to about 3.5% (as they were in the late 1990s) for early retirees even to take notice.
Or we could calculate the real return necessary to achieve certain withdrawal rates and bequest targets over different retirement horizons; see the table below. For example, if I want to achieve a 4% initial rate over a 50-year horizon, even with capital depletion, I’d need a real rate of 3.25%. With a bequest target of 25% of the initial portfolio, I’d need a 3.5% real rate—far above today’s rates.
Worse, the Safety First approach is still not 100% safe because, with the financial tools available today, we can only hedge our real, CPI-adjusted retirement spending over the first 30 years, the longest TIPS maturity available today. Any horizon longer than that faces the reinvestment interest rate risk. So, Safety First, through a TIPS ladder, is unattractive for today’s early retirees trying to hedge 50+ years’ worth of retirement spending.
Safety First through Annuities
How about annuities? We would eliminate the longevity risk issue but introduce another headache: inflation risk. The most common annuity is the Single Premium Immediate Annuity (SPIA), where you hand over a fixed amount up front and then start collecting monthly checks until you pass away. They can also be structured as joint survivor annuities, i.e., they pay for as long as at least one spouse is alive. Earlier this month (May 3, 2024), I grabbed some annuity quotes for folks between ages 40 and 80. I got quotes for males and females as well as joint survivorship annuities that pay for as long as at least the spouse survives (assuming couples of the same age). The annuity quotes are per $100,000 surrendered immediately; see the table below.
Importantly, these initial payments are in nominal dollars and are not adjusted for inflation. Thus, the raw annualized “withdrawal” rates seem pretty high. For example, a couple, both 50 years old, can get a 5.80% initial withdrawal amount, i.e., $58,000 p.a. out of a $1m portfolio. Does that mean we can beat the 4% Rule? Not really, because your initial $58,000 annual payout will slowly dwindle to under $40,000 within 13 to 19 years, depending on the inflation rate; see the chart below. If you survive 40+ years, your purchasing power is down to around $26,000 with 2% and a measly $17,800 with 3% inflation. Over long horizons, nominal annuities have too much inflation risk! SPIAs alone are the antithesis of “Safety First.”
Of course, instead of annuitizing the entire $1,000,000 portfolio, we could also guarantee an initial $40,000 payout by committing about $644k to an SPIA and keeping the remaining $356k in a portfolio to compensate for any shortfalls caused by inflation. But you still introduce uncertainty through multiple routes:
- Inflation Risk: We don’t know how quickly the initial $40,000 melts away from inflation and how much and how quickly we have to sell our portfolio to purchase additional SPIAs to make up for the inflation drag.
- Market Risk: When selling assets in our portfolio, we are subject to market risk. Hence, we still face Sequence of Return Risk, because your SPIA retirement plan depends on well or poorly your portfolio performs early on in retirement.
- Interest Rate Risk: You also face interest rate risk because of uncertainty over future SPIA annuity quotes.
In a worst-case scenario, you would liquidate part of your portfolio at the bottom of a bear market at depressed valuations: Sequence Risk. Then, you also shop around for annuities when interest rates are low again due to the accommodative Federal Reserve policy. That’s Sequence Risk squared! Safety First became Safety Worst!
Annuities with COLA
How about annuities with COLA? Some people claim that annuities can overcome the inflation risk if we simply buy an annuity with a cost-of-living adjustment (COLA). That’s only partially true. Annuities with precise CPI adjustments are still rare and often overpriced. Annuities with a fixed payout increase (e.g., contractual, fixed 2% increases yearly) are more common but are still not a perfect inflation hedge. First, that 2% annual COLA will imply that your initial annuity payment has to be lower. I ran some quotes recently, and a 50-year-old would get a flat $527 monthly payment with a standard SPIA. With the 2% COLA, the initial amount would be only $406. $351 with a 3% COLA. So, you would trade off initial cash flow with future cash flow growth.
Also, if inflation runs hotter than your 2% increase, you still lose purchasing power in retirement. For example, if you receive annuity payments with a 2% COLA, those annual increases would have been insufficient to keep up with realized inflation over the last 4-5 years. Due to the post-pandemic inflation shock, you would have lost about 10% of your purchasing power even with 2% annual COLA. And since year-on-year CPI is still not back to 2%, that gap between CPI and the 2% trend keeps rising. In other words, an annuity with 2% fixed COLA only hedges against a 2% trend inflation, not the uncertainty around it.
Side note: The popular platitude/truism in the personal finance world is that Social Security is the best annuity deal available because it offers genuine, inflation-linked COLA. I agree. Let’s assume we already optimized our Social Security, likely deferring benefits until age 70; see Part 59 for more details. But most people can’t live on Social Security alone. That’s why I started this blog, and that’s why you come here: we study how to transform financial assets into cash flows to supplement our (optimized) Social Security strategy.
A TIPS ladder plus a (deferred) longevity annuity
This approach is not my invention, but it was proposed in a paper a few years ago: Stephen C. Sexauer, Michael W. Peskin & Daniel Cassidy (2015) Making Retirement Income Last a Lifetime, Financial Analysts Journal, 71:1, pp. 79-89. The authors suggest constructing a 20-year TIPS ladder and hedging the longevity risk beyond age 85 with a deferred annuity. You’d hedge the inflation risk over the first 20 years, but there is some residual inflation risk from two sources:
- The deferred annuity only guarantees a nominal amount, so you’ll have to predict the inflation rate over the next 20 years and pick a nominal annuity payout amount to reflect this estimate.
- Subsequent annuity payments are nominal only, and there is no further COLA. This may not be a good approach for young, early retirees, but I can see that a couple, 65 years old, would be OK with some real spending decreases after age 85 when they likely slow down. But you better hope and pray for no unexpected medical or nursing home care expenses!
So, let’s put this approach to the test with today’s TIPS rates and annuity quotes. I will use a 2.25% real return assumption, close to the most recent 20-year TIPS quote I got was 2.22% on 5/6/2024, according to FRED. Assuming 2.5% inflation over the next 20 years, we target $1.6386 in year 20 for every $1 in real spending. I also gathered an annuity quote from Immediate Annuities (no affiliation, just a neat site to check quotes quickly) for a 65-year-old couple who spends $100,000 today on a 20-year deferred annuity. To guarantee $1 in real spending, they would spend $193.89 on a TIPS ladder and $50.16 on a deferred annuity for a total of $244.05. Or if we convert this into annual spending for a, say, $1m retirement portfolio, you’d get around $49,171. That’s not bad. It’s an implicit 4.92% safe withdrawal rate. That’s a lot more attractive than the 4% Rule of Thumb.
The problem with this approach is that there is no bequest. The only way you would leave anything behind for the next generation is if both spouses pass away before they reach age 85 – a pretty small probability; see the life tables for the joint survival of a healthy 65-year-old couple! Even if both pass away before age 85, they will likely leave a small inheritance equal to the leftover TIPS ladder, while the longevity annuity becomes worthless. So, you must set aside extra money to leave an inheritance. Again, due to the inflation risk inherent in this strategy, it would be an apples-to-oranges comparison if we were to compare this 4.9% rate with a safe withdrawal rate calculation. However, I can see how retirees without children would opt for this route rather than taking their chances on the stock and bond markets over the next 30 years. You likely “Die with Zero,” but you maximize the cash flow now. But you better hope you don’t have any unforeseen emergencies later in retirement!
This approach is unattractive for younger retirees, at least with today’s interest rate landscape. The deferred annuity would be a lot more expensive for younger retirees. What’s more, for a 40-year-old couple, this approach would currently generate only a 3.73% SWR. That’s very low, considering you will get no more COLA to your retirement budget starting at age 60. That might be too early to scale back expenses for most active and healthy FIRE folks. You’d likely do better with a traditional retirement portfolio approach.
Safety First: practical concerns
Few retirees will be comfortable shifting their entire nest egg into annuities or TIPS. Some retirees don’t like annuities because they lose control over their money. Also, the portfolio-based approach offers you tremendous upside potential if we don’t have a repeat of the Great Depression or some other historical worst-case scenario. In the better-than-worst-case scenario, I’d have extra cash that could serve as a cushion to hedge against unforeseen healthcare shocks. Academic research points to health expenditure shocks as the main reason elderly households keep excess savings.
There are also practical concerns when shifting your entire portfolio. Retirees may have a large portion of their nest egg in taxable accounts, and liquidating existing assets with significant built-in capital gains may not be advisable. So, most retirees would like to keep a share of their nest egg in existing assets. Of course, not all is lost. A partial Safety First approach might still be helpful for early retirees who are concerned about Sequence Risk. This brings me to the next section…
Safety First “Light” to Hedge Sequence Risk in Early Retirement
Let’s assume we shift a portion of our portfolio into Safety First assets. Here’s an example:
- Let’s assume we start with a FIRE couple, both 50 years old, with a 50-year horizon and a 25% final value target, say, either as a bequest or a cushion in case there are unforeseen expenses late in retirement.
- Assume they have a $2,000,000 portfolio currently comprised of 75% stocks and 25% intermediate government bonds.
- The couple wants to shift half of their portfolio to “safety first” and keep the remaining half in their portfolio. This is possible because they have enough assets in tax-free accounts (e.g., Roth) and tax-deferred accounts (e.g., IRA/401k) to make the sale of appreciated assets and move to the Safety First assets tax-efficient.
- First, they have access to a joint-survivor annuity that would immediately pay $4,830 per month for $1,000,000 surrendered today; see the table with quotes above ($483 per $100k). I assume the annuity will slowly lose purchasing power via 2.50% annualized inflation.
- Second, they consider a TIPS ladder with a 2.25% real annualized return. How long should we plan the TIPS ladder? I played around with different lengths and found that 300 months or 25 years worked best in increasing the failsafe withdrawal rate. Assuming a monthly rate of 0.185594% (=1.0225^(1/12)-1), the monthly payment would be $4,342. Via Excel formula PMT(0.00185594, 300,-1000000,0,1)
- In the third scenario, we split the $1m half-and-half between the annuity and the TIPS ladder.
- The fourth scenario is the same as the third. However, we also moved the remaining portfolio into 100% equities because we already have plenty of fixed-income exposure and can now take more risk with the remainder.
Let’s look at the results. Here are the failsafe withdrawal amounts, i.e., the highest amount we could have withdrawn to succeed even in the worst-case scenario cohort; see the table below. Pretty impressive: the safety first portfolios all do significantly better than that baseline, but about 8-11%. The TIPS ladder would have done the best in historical cohorts. But the annuity is close behind. I also confirmed that with a slightly lower inflation rate going forward, 2.25%, the annuity would have outperformed the TIPS ladder by a few $100 annually. So, I don’t want to make too much of the TIPS vs. annuity comparison. They are both valid “safety first” assets.
Side note: TIPS have been around only since the late 1990s. We cannot reliably simulate how a TIPS portfolio would have performed in the 1930s. However, we can certainly perform a thought experiment: how a portfolio with some of today’s tools would perform if historical returns repeated themselves? I do not claim anyone could have used a TIPS portfolio or SPIA a hundred years ago!
Let’s not focus only on the worst-case scenario. If we look at withdrawal amounts to target other failure rates, we get the following picture: see the table below. The Safety First approach outperforms the 75/25 baseline even in the 10% worst scenarios. The price you pay is that you do worse in the median outcome and even the 25th percentile of historical cohorts (except for the half/half Safety First + 100% equities in the remaining portfolio). In other words, we should think of Safety First as insurance: it helps in the Sequence Risk worst-case scenarios, but you will underperform the baseline most of the time, i.e., when we don’t have another Great Depression or other economic and financial disaster scenario.
Of course, I could have made the picture look better if I hadn’t displayed the results for all historical cohorts but focused on the initial conditions that would have been most conducive to a Safety First approach. If I report the withdrawal amounts for failure probabilities conditional on expensive equities, i.e., the Shiller CAPE above 20 and the S&P index at an all-time high. And conditional on that initial condition, i.e., similar to the conditions we’re facing now, the Safety First approach certainly outperforms the baseline more reliably. The Safety First plus 100% equity portfolio does the best when looking at the median outcome.
Safety First vs. Glidepath
If you’re a regular reader of my blog and this Safe Withdrawal Rate Series, you’ll know that Safety First resembles something we’ve encountered before: increasing the fixed-income portion early in retirement and shifting to a more equity-centric portfolio is essentially a glidepath. I wrote about this approach in Parts 19 and 20. How would the Safety First portfolios compare to a simple glidepath, then? Let’s put that to the test in the worst-case cohort, i.e., September 1929. Let’s simulate a glidepath from a 37.5% stocks plus 62.5% bonds portfolio back to a 75/25 portfolio, shifting the weights linearly over 25 years, withdrawing 3.25% (=the baseline SWR). The final portfolio after 50 years would have been over $5m, much higher than with either of the Safety First portfolios.
So, Safety First is no new magic solution to the Sequence Risk problem. In the 1929 cohort, a simple glidepath would have achieved the same goal and even better than the Safety First approach.
Conclusion
Safety First has gained popularity in the personal finance world thanks to the rise in interest rates over the past two years. It’s an attractive approach for traditional retirees who do not plan for any (or at least no sizable) bequest and would instead maximize their guaranteed cash flow. Or maybe folks have already given their excess nest egg to their loved ones and charitable causes and now like to maximize their steady retirement cash flow and then literally “Die With Zero.”
But Safety First is no panacea, especially not for early retirees. Hedging expenses over a 50+-year retirement horizon is too expensive, even with today’s higher rates. Moreover, Safety First faces inflation risk when we use SPIAs, and even a TIPS ladder currently only hedges inflation for a maximum of 30 years.
But not all is lost. A partial shift to safe assets like TIPS and annuities can be worthwhile for most retirees. But it’s nothing new. It has the same flavor as a glidepath, i.e., start with a large bond allocation and liquidate those safe assets to avoid selling equities too early in case of an adverse Sequence Risk event. But I find the glidepath approach preferable: First, you don’t have to permanently give up control of your assets like in the case of an annuity. Second, you need less portfolio turnover; there is no tax headache when selling half of your portfolio to purchase an annuity or TIPS ladder. Third, the example of the 1929 cohort seems to indicate that the glidepath performed a bit better than the Safety First methodology.
So, my takeaway is that Safety First is a marketing gimmick by financial advisers to sell higher-commission products. Sophisticated investors can achieve the same or better results with a glidepath.
Please leave your comments and suggestions below! Also, check out the other parts of the series; see here for a guide to the different parts so far!
Title Picture Credit: knowyourmeme.com
Interesting post, and good with the life expectancy calculator.
Readers outside the US should be aware that life expectancies in other rich countries are often 5-6 years higher: https://en.wikipedia.org/wiki/List_of_countries_by_life_expectancy
Here is for example Denmark, without adjusting for lifstyle: https://www.pensionforalle.dk/pension-helt-enkelt/hjaelp-til-selvhjaelp/hvor-gammel-bliver-du-se-din-forventede-levealder
Thanks for the links.
Please note that those life expectancies are at birth. For a 65-year-olds the gaps between USA and other countries shrink.
In the US, if you’re not an “average” resident but are generally in good to excellent health, you will likely come close to the average Danish citizen.
So get out and walk!
Yes! 10k+ steps every day! Plus, my name sounds Danish, so I should have a long life expectancy.
You are right, choosing “excellent health” lands me on the number in the Danish table.
I would expect the readers of ERN in any case are both wealthier, better educated, eating better and having better healthcare than the average American; all of which increase life expectancy. I believe the averages hide perhaps even larger differences than in other rich countries.
So be aware, statistics can lead you to underestimate _your_ longevity risk.
Exactly! I recently had a Twitter spat with someone who claimed that you’re less likely to be a crime victim in Italy than USA. The aggregate statistic is not that meaningful. Depending on your personal characteristics, you can have very different conditional victimization and life expectancy stats. There is a name for it in statistics: Simson’s Paradox.
Interesting post ERN, been wondering a lot about tips. In my own market (South Africa) they sit at an attractive 5.25% real on a 10 year, but there are a few issues:
1. Taxes, calculated on the full interest rate, so at a reasonable CPI of 6% in my own market, you’d pay on 11% yield. Also taxes are at marginal tax rates of up to 45%, start at 20%, at c$10k, and ramp up quickly to the top rate by $100k of income. We can split it between partners, inside retirement vehicles, to help reduce the impact somewhat.
2. CPI/inflation – since we assume that we’re doing a 0%-50% balance, inflation has two side-effects for us, namely that at 6% the balance will quickly reduce to no value in any case, and secondly my actual inflation and official inflation has been markedly different.
3. Concerns on currency and government risk, but I’ll leave that for now. The same taxes and inflation questions are raised if I go for US Tips, so perhaps the extra real yield I get on SA Tips are worth it, but I’m no currency speculator/expert so I’ll just diversify across many assets.
But, I still find the rates so attractive, that I’m trying to max them out just for their steady cash-flow and reduce my equity risk component =)
This is a concern with all bond funds. Whether you get a TIPS real rate of 2.2% plus 2.3% inflation adjustment (=4.5%) or a nominal bond with 4.5%, usually the entire income is taxable. Thta’s why a lot of planners recommend keeping bonds in tax-advantaged accounts. I wrote about this issue in Part 35:
https://earlyretirementnow.com/2020/02/05/asset-location-do-bonds-belong-in-retirement-accounts-swr-series-35/
This tax-drag effect for bonds gets worse in high-inflation and high-tax countries. So, I don’t envy you dealing with the situation in SA.
ERN, thank you for this very timely post! For the last few months I have been seriously considering the purchase of an Income Annuity rather than a SPIA. Please let me know your thoughts on using a Fixed-Indexed Annuity with an Income Rider rather than a SPIA based on the information below:
The payout rates for a Fixed-Indexed Annuity with an Income Rider are much higher than those used in the article.
I went to https://www.stantheannuityman.com/annuity-calculators/income-rider and obtained a quote for an annuity with an Income Rider. I am a 63-year-old male and want to buy a $400,000 annuity that will start paying me income in one year. The annual payout rate from A-rated National Western Life is $33,876, which is 8.469%. I have no heirs, so I am not overly concerned with having a large bequeath. Then I went to the ERN SWR Google sheet and compared two scenarios.
Scenario A was based on my total portfolio of $2,200,000, 80/20, Final Value Target of 50%, and Social Security of $4,400 per month starting at age 70.
Scenario B was A was based on my total portfolio of $1,800,000, 80/20, Final Value Target of 50%, Social Security of $4,400 per month starting at age 70, and the monthly non-adjusted for inflation income from the annuity starting at age 64 of $2,823.
For Scenario A without the annuity, the WR for a Failure Rate of 0 was 4.75%.
For Scenario B with the annuity, the WR for a Failure Rate of 0 was 6.5%.
For Scenario A without the annuity, the WR for a Failure Rate of 8.63 was 5.5%.
For Scenario B with the annuity, the WR for a Failure Rate of 7.71 was 7.25%.
For Scenario A without the annuity, the SCR for a Failure Rate of 10% was 5.58%.
For Scenario B with the annuity, the SCR for a Failure Rate of 10% was 7.35%.
Based on these results, does an Income Annuity with a payout rate of 8.469% make sense? Especially when allocating about 20″ to 25% of your portfolio to an annuity.
Thank you to all that comment about this. I appreciate your thoughts and help as I try to decide on an annuity or not.
8.469% for a 64-yo is a very good rate. I found $644 over $100k for a 65-yo, which is only 7.7%. It’s essential to shop around! But I hope your annuity is comparable and there are no differences in the fine print.
Your simulations results are likely off:
1: You compare apples and oranges, because in Scenario A you target a $1.1m final value (=50% of $2.2m) and in Scenario B you have a $900k FV target (=50% of $1.8m). So, that explains some of the advantage of the annuity.
2: I suspect you entered the annuity payments into the real cash flow column. It should be entered into the nominal column, starting in month 13, and discounted by 2.5% expected inflation. It’s unthinkable that a mere 20% shift of the portfolio can generate such a large impact on the SWR: 4.75 to 6.5%.
Also: I don’t doubt that the annuity helps with Sequence Risk. The question is, does it help more than a simple glidepath? I think with that 8.5% payout rate you may beat the glidepath. Just don’t assume a 6.5% SWR. That number is almost certainly wrong.
Thank you very much for your comments. For point number 1, do you know of an adjustment I can make to account for this? For point number 2, I entered the monthly payout in column J in the Cash Flow Assist tab. Should I go through and reduce the monthly payout by 2.5% for every year? Any additional thoughts you have on how to make this a more fair comparison is greatly appreciated. Thank you!
Oh, I have talked with two reputable CFPs about the payout rates just last week. I am confident the 8.469% is a solid lifetime income payout rate.
I did reduce the monthly payout in column J by 2.5% per year. This resulted in a WR of 6.25% for a Failure rate of 0, compared to 4.75% without the Annuity.
Then I also changed the Final Value Target to 60% from 50%. This will result in a Final Value Target of $1,080,000, which is about the same as the scenario without the annuity. This resulted in a WR of 6.0% for Failure rate of 0, compared to 4.75% without the Annuity.
I realize it might be difficult to do an apples to apples comparison. Any insights you have would be appreciated. Thank you.
Please see my other comment on the 2 issues!
1: Use the same final value amount, e.g., $1m. So in Scenario A I would use 1/2.2 = 45.4545% and Scenario B: 1/1.8=55.55555%
2: Column J is for nominal cash flows. So that’s correct. No further adjustments needed. I would make sure you set the inflation estimate (E6) to 2.3-2.5%
So, with a high payout rate like that it seems that an annuity is attractive. Just don’t dumo your entire nest egg into an annuity! You strategy of keeping half in your portfolio seems really sound!
Interesting post. We use a 10 year rolling TIPs ladder which is liability matched against the gap between future income and expenses. The ladder is fed by rebalancing between stock and bond index ETFs and is about 1/4 of our investable assets which are about 50/50. Shorter term rungs on the ladder can use T Bills or CDs. Overall strategy goal is to preserve legacy, address longevity, hedge interest rate risk with duration, hedge inflation risk and sustain purchasing power of the maturing bond. We are in the 7th year of this strategy in early retirement and it works fine.
Thanks for sharing. Have you replenished the TIPS ladder or are you now down to the last 3 years?
Its a rolling ladder so it is continually replenished by rebalancing to stay at 10-years.
But then what does the ladder really do? You use the TIPS proceeds to pay for living expenses. But then you use money from the other portfolio to replenish the TIPS ladder. So, effectively, you still withdraw money from stocks to pay for living expenses.
Unless you use the TIPS to avoid withdrawing from equities at all there is no true protection from SORR. Or do I misunderstand this?
Great post. Confirmed my rough intuition on these questions. I am not planning on using either in our early retirement strategy.
However, the other potential benefit of annuities is cognitive decline insurance. Everyone who reads this blog is obviously capable of, and enthusiastic about, managing their own portfolio, withdrawals, glidepath, etc. But that ability is likely to weaken with age, at least for many. “Mailbox money” from an annuity that can be spent carefree could provide some relief to a DIYer that begins to experience cognitive decline later in life (which might otherwise lead to portfolio mismanagement, dramatic underspending, or harmful overspending).
I’m not sure what my personal strategy will be. I could see waiting until age 70, when SS has kicked in, and buying an annuity that pushes guaranteed income up to some stopgap level. Not because it’s a mathematically optimal strategy (it won’t be), but as insurance against declining ability to manage your own portfolio.
Have you given this any consideration?
That’s an interesting point. I will certainly revisit this idea at age 65-70. Crossing my fingers that the interest rate landscape is attractive around then.
The other issue that crossed my mind: An annuity flow gives people around you more incentives to treat you well and help you live a long life. 😉
An annuity flow might make people think you should be the one picking up the tab for dinner as well! I am 63 now and not nearly as financial literate as most of your readers. I suspect my ~$2,000,000 portfolio is much smaller, too. I am looking for ways to stretch my money, within reason, yet keep my plan simple. I’ll be waiting until 70 for SS and have been thinking the currently high payout rates on a FIA with Income Rider annuity would help.
Annuity flow might do that. Or a $2m portfolio as well, which is very impressive.
Yes: good thinking, I also plan to delay SS until age 70.
Yes. I had the same thought. I think every plan needs to consider four risks that we all face.
1) Cognitive decline. I like the term ‘cognitive decline insurance’
2) Mistakes (whether due to #1, overconfidence, spending too much, helping others too much…)
3) Fraud victim (whether stranger or family). It happens. #1 can be a factor, or not.
4) Survivor ability (ie my wife might not have any interest or ability. And/or is also subject to the other risks listed above.
We are both 60. For me I will have a baseline of SS, modest pension, annuity and deferred annuity in place by 70. And hopefully a good financial advisor who can follow a plan like the glide path.
That’s why I plan to slow down at around age 65 or 70 and do something mostly passive, like a mix of living off dividends and maybe an annuity. I don’t think I will be trading options in 20 years.
But until then it’s still worthwhile to study how to beat SORR.
Makes sense. But I have two concerns around reliance on dividend income:
1) Dividends aren’t guaranteed, so not a particularly reliable source of income compared to say Social Security or annuities.
2) “dividend investing” (selecting only stocks that are expected to pay high dividends) is inefficient (from a total returns perspective) compared to selecting from a broader pool of stocks/passive index funds and selling assets as needed.
Taking income from, rather than reinvesting, dividends from an equity allocation not specifically selected for dividend investing makes sense, of course, once in drawdown.
Correct, there are serious issues with dividends only. I have written about those in Parts 29,30,31, and 40.
In retirement, the dividend inefficiency becomes less of a headache because I consume the dividends and there is no inefficiency of compounding the dividend taxes.
Great article, yet again. Thanks Karsten
The historically attractive real yields on TIPs of ~2.25% has me constantly mulling what sorts of clever ways to take advantage of them given long term estimates of bond real yields is closer to ~1.5% (at least according to Damodaran).
Is there merit to the idea? How might you suggest taking advantage of them if at all?
My intuition starts with holding the TIP to maturity to make it risk free at the time horizon(s) selected though that implies no portfolio re-balancing and any associated benefits.
Some methods could include: glide path, Faber’s “T-Bills and Chill” approach, other.
As a thought experiment, at some point TIPs yields north of 3% have to crowd out other asset classes. What I mull on – Whats the break point? How do we use them?
Would love your thought (or eventual post 🙂
Cheers!
-Mark
Correct. It’s true that TIPS started with 3+% in the late 1990s, but since the GFC, interest rates have been so low, nominal and real, that 2.25% seems like a real treat. But again, according to the tables, 2.25% real is still too low to rely too much on bonds only in retirement, especially early retirement.
I have been modeling a flip of the script – using an “10 Year Period Certain” annuity as my primary income source for the first 10 years of FIRE, and letting a stock portfolio appreciate unmolested for a decade. This type of annuity pays for 10 years and then quits with no return of investment.
ImmediateAnnuities gives me a payout rate of 12.38% for such a 10-year product, which is equal to depleting an allocation of ~5.5% bonds or CDs over the same timeframe*. That’s about $12,384 income per year per $100,000 invested, so a person with a 4% WR could cover their expenses for 10 years with approximately the following AA:
76.95% SPY with dividend yield of 1.34%
24.05% 10y Period Certain Annuity yielding 12.38%
The hard-to-model twist is you’d have to sell some SPY shares as your spending increased with inflation. Yet this would be a relatively small depletion of the SPY allocation compared to other approaches in the same situation. You’re betting the untouched shares of stock appreciate so quickly over the course of a decade that it overwhelms:
-depletion of the annuity
-inflationary increases in spending over 10 years
-any share sales that must occur after dividend cuts during bad market times (maybe have some side cash to mitigate this risk, as the SPY yield accounts for $10,311 of annual income per $1M allocated to this overall strategy)
The idea would be to spend 24.05% of your portfolio upfront in exchange for probable avoidance of most SORR and so that you can emerge – like stepping out of a time machine – a decade later with whatever 76.95% of your portfolio has grown into. The median 10-year inflation-adjusted annual return is about 6.5%** so it seems like a portfolio mostly left alone would likely grow quite a bit in that time.
Side benefits:
-Taxes: The annuity allocation is small enough some people could put a decent portion of them into their Roth IRAs, with the rest of the annuity in taxable. This could be used to manage tax brackets down to near zero in those first 10 years and maybe qualify one for healthcare subsidies. The downside might be not having much Roth left at the end of 10 years, though you might simultaneously start doing conversions starting in year 5 if you won’t be 59.5 at the end of the 10 year period.
-Advance Warning: If you hit a major SORR event during the first 10 years, you’ll probably have plenty of time to get a job and earn more money before the 10 years runs out, and the stock portfolio becomes all you have. You get to do this while you’re still young and not yet fully dependent upon selling stocks at the bottom of a SORR event.
-Interest Rate Risk: Is greatly reduced.
-Longevity Risk: Probably the stock portfolio takes off in value and you’re set for life for that reason.
*The benefit of an annuity would be locking in your rate, non-callable. Non-callable 10y A rated bonds with the same yields would be preferable of course.
**https://fourpillarfreedom.com/heres-how-the-sp-500-has-performed-since-1928/
Nice! That’s a very attractive IRR.
A few caveats:
1: as you mention, there is a drag from inflation over the first ten years.
2: 10 years of SORR protection may not be enough in the really bad SORR events: 1929 and 1970s. Your SPY index may still be severely underwater, especially if you withdraw dividends and account for inflation.
Nice post and some very interesting results too.
Thanks for sharing.
FWIW, I agree that the comment [from John] about cognitive decline is rather important too.
Did you consider the [hybrid] floor and upside (F&U) approach? In F&U just the floor uses safety first principles and the key trade off revolves around how willing you are to risk losing your standard of living for the chance of having an even higher one – to paraphrase the late great Dirk Cotton.
I’m not a big fan of mental accounting exercises like that.
But either way, using half your portfolio to buy a TIPS ladder is in essence a floor (say, for essential expenses) and using the rest for discretionary. With today’s rates you do better, but then again, you can achieve the same result with a glidepath.
AIUI the default ‘glidepath approach’ offers no guaranteed downside protection.
No, it’s just a regular SWR analysis with changing asset allocations!
Thanks. So, from all your SWR series and this article, the only thing you really recommend is the glidepath? I don’t have much time to read them all and I need to find a single strategy to use without much complications or overthinking it. Is this it? Glidepath? Thanks in advance
As a one-size-fits-all strategy, yes, I would recommend a GP. Nothing else really beats the GP. But even a GP is no 100% protection against Sequence Risk.
I am confused on why the glidepath approach did so much better than the TIPS Safety First. They both started with the same equity percentage and then transitioned to 75% equity over approximately the same time period. Thus I would have expected very similar results. Was the bond real return better than 2.25% over that particular time period? And/or did the 25 year vs 30 year glide period make that much of a difference? I would not have expected the latter would have made this big of a difference. Or am I missing something in how the TIPS safety first light was implemented?
I tried duplicating the glide path results here using the SW tool so I could try different time periods and other parameters my self. I was able to replicate the TIPS “lite” safety first numbers with the 9/1929 start date, but the glide path was lower finishing at $4.35M. The first 20 years or so were spot on, but after that they diverged.
However, when I switched the GP transition to 300 months instead of 30 years indicated in the text, it was spot on. 300 months would be comparable to the TIPS transition of having a 25 year ladder, though.
On the Case Study page I entered Year: 1929, Month: 9, Initial Portfolio Value: $2,000,000; initial Consumption pa: 3.25%. Glidepath was 37.5% stocks, 62.5% 10Y Bonds (Initial) and 75% stocks, 25% 10Y Bonds (Final). GP transition of 360. I also had to copy the last row 120 times to extend to 50 years.
Yes, the GP is over 300 months. I double-checked my results and it should come out as roughly $5m.
and correct, you extend the rows to month 600.
If you bundle the entire S/B portfolio into one you do a lot of rebalancing and you shift vast amounts of the bond portfolio into stocks right around the bottom of the stock market. That helps you during the recovery. On the other hand, the paper gains of your TIPS ladder just sit there and do nothing.
20 vs 25 vs 30 years ladder wouldn’t make a big difference. But 25 seemed to be the slightly better choice.
Playing around with it some, I did notice that it really depends on how volatile the equity markets are. The more volatile, the better the GP does because of that rebalancing.
Note my question I asked minutes before you responded. I thing the GP example you used in your post was 25 years and not 30 years.
Exactly: The GP does a good job grabbing the market bottom and then also avoids withdrawing too much form equities during the recovery. It’s a neat invention.
Thanks for checking: yes, 25y, not 30y. 🙂
Were you planning on updating the text of your post? It still states, “Let’s simulate a glidepath from a 37.5% stocks plus 62.5% bonds portfolio back to a 75/25 portfolio, shifting the weights linearly over 30 years, withdrawing 3.25% (=the baseline SWR).”
Not trying to be a pain here. Just checking in case you were thinking of clear that up. (Or maybe I’m missing something.)
Yes, I updated the post. Thanks for the reminder.
You showed that the glidepath worked even better than the safety-first approaches for 1929 retirees. Would be nice to see the same analysis for 1968 retirees — because the 1930s had deflation while the 1970s saw stagflation.
Mike Finn
The other prominent market peak that’s a SORR headache is 12/1968.
A similar exercise over 50y with a 3.25 WR would have yielded the following final portfolio values (CPI-adjusted):
Baseline 75/25: $1,345,000
Safety First Annuity: $4,217,000
Safety First TIPS ladder: $4,978,000
Glidepath 37.5/62.5 to 75/25: $2,343,000
The annuity and TIPS ladder now do much better than the GP. But I’d use these numbers with caution. I used a 2.5% assumed inflation rate to deflate the nominal payments. The cleaner way would have been to use the actual CPI rates to deflate the annuity payouts and then plug that payment stream into the real cash flow column. With that approach you would have done much worse. You would end up with -647k after 600 months. Money would run out after about 500 months.
TIPS did really well. If you had had access to TIPS during that time, it’s no surprise that they would outperform nominal bonds during that time.
The TIPS ladder value of $2.149M doesn’t match what I got in the SWR Tool (which was just shy of $5M). The $2.149M is the same value from the 9/1929 cohort. Was there a mixup there?
Correct. I will update the results. Thanks for letting me know.
Good and thorough presentation as always. Just some general comments: Of the 20+ “Retirement Safety/Asset Protection” presentation I’ve attended, only one was not suboptimal designed to generate fees (more accurately a scam).
Hedging against CPI is not useful for retirees. CPI includes the consumption bucket of a 27 year old immigrant from Venezuela and a 65 lawyer from Bridgeport with dementia. CPI for a retiree needs to be the CPI among retirees and not include all consumers as the consumption bundle is never the same.
Life span vs Health span. Living long is not the real risk for FIRE or any retiree, but becoming ill, staying alive for a long duration is the risk. Dementia, strokes, Ocular Degeneration, etc. can devastate any retirement plan. Something like a conditional probability of living, but requiring excess medical expense for 5+ years is the real risk (P Excess Medical Expense/Living). Very few portfolios will bust when someone lives to 100, but most will bust if one requires excess medical expenses at 65 but lives to 75. Most people who live past 90 have portfolios in runaway mode and die with absurdly high balances, while many who die in their 70’s are broke.
Glancing at a few posts here and other places, WAY too many investors are “convinced” (conned) into complex products that just generate fees and commissions for brokers and usually introduce other risks into the accounts. 100% equity with non-cash flow needs for a year is always the safest portfolio (not started in 1929 and when policy makers don’t use the inflation magic to paper over bad debts).
Yes, that’s a good point: a lot of safety-first-style sell pitches look like fee-generators for the presenters. A giveaway is that there’s a free steak dinner offered as part of the pitch. 😉
About CPI: it’s a flawed measure. But it’s still the best we have. If you already know your personal bucket, you can certainly make adjustments and do a personalized CPI+/-x, where the x mut be carefully calibrated to your circumstances.
And good point about the 100yo vs. 65-75yo. That’s a huge unknown and most people like to keep some extra cash cushion to hedge against the unknown.
Today’s environment is tough to predict, however IMO “tbill and chill” has provided an excellent strategy to leverage as part of a glide path. I set up a 6-24 month ladder about 18 months ago and have been rolling them since. I target 5%+ and quarterly rollovers. Will it work forever? Unlikely. Is it simple to implement with plenty of flexibility? Yes. Is it a decent sequence hedge with the ability to reallocate? Yes. Is it all of our portfolio? Of course not.
Correct: It will not work forever. Because the 5% rates will eventually go down. Even today’s 5% nominal is only a little over 2% in real terms. It’s not a long-term, sustainable strategy. But as a partial hedge against SoRR it certainly works.
Thanks for your post. There certainly are a lot of different variables to consider. It’s nice that TIPS have high yields now and something strong to consider. I’m adding bonds.
I’m curious to know your thoughts on Financial Samurai’s dynamic safe withdrawal rate. I remember you were critical about his concept in the past. But he provided a case study that seems to make a lot of sense and you seem to be advocating being dynamic as well.
https://www.financialsamurai.com/dynamic-safe-withdrawal-rate-case-study-in-retirement/
How have you withdrawn from your retirement portfolio over the past four years? Do you mind sharing some insights into what your family has done? Thank you.
Oh, my, he’s at it again. I thought his 0.5% post was mostly a troll post to get a shoutout from Suze Orman. But he may be that mathematically illiterate after all. The new post is just as stupid and uninformed as the old one. For the exact reasons I laid out here: https://earlyretirementnow.com/2020/08/31/the-half-percent-safe-withdrawal-rate/
Most importantly, the nominal bond yield x0.8 is meaningless for the SWR of a traditional portfolio. What’s worse, the bond yield x0.8 is even meaningless for a 100% bond portfolio due to the effects of inflation and amortization.
My personal story: My portfolio has been up since 2018, though my budget hasn’t increased much. I also use the options trading method (https://earlyretirementnow.com/options) to supplement my retirement income, and so far, I haven’t even liquidated any principal. I have lived off the cash flow (dividends + interest + options profit) in my taxable account only without touching any equity-holding principal.
Troll post to get a shout out from Suze Orman? That seems random. I’m not following you. What does Suze Orman have to do with anything?
I read the post and it is extremely insightful. I like how he explains the importance of the risk-free rate in determining the economic environment and investment decisions. His dynamic safe withdrawal rate is both simple and effective. Normal people can understand and implement it.
Your work is detailed and thorough, but I don’t think it’s comprehensible by most people. If most people don’t understand it or use it, is it really effective?
Suze Orman: It’s an inside joke. When the 10y yield was below 1% and the Sam rule would have recommended a 0.5% SWR, you’d need a retirement nest egg similar to what Suze recommends.
Maybe you should (re-)read my post showing that Sam is wrong. Here’s the link again: https://earlyretirementnow.com/2020/08/31/the-half-percent-safe-withdrawal-rate/
If it’s incomprehensible (to you), that’s not my problem. My post is still accurate and correct and Sam’s post is not. I’d prefer complicated but correct over easy but wrong, wouldn’t you?
When can a retiree on a glide path to 70/30 or 80/20 consider their glide complete? Is it predetermined based on X years, or is their end point determined by satisfying a given calculation, like, their funds should be sufficient to weather a 1929 scenario at a given SWR (say, 3.5%) without their savings declining below their chosen parameters (say, bequeathing 50% with a 50 year live expectancy)?
Thanks!
How come nobody has considered Treasury STRIPS (aka zero-coupon bonds) as maybe the best way to guarantee planned spending? It helps replace the highly flawed drawdown-percentage strategies that seem to dominate the methodolgies proposed in this site with goal-oriented investing. Taking advantage of the once-in-a-lifetime STRIP rates, and judicious whole-life insurance policies 40 years ago, we’ve a maturity ladder that guarantees my wife and l can maintain our current lifestyles to our nineties. No volatilty, no reinvestment risk. Just an annual ‘salary’ that takes care of everything!
How come?
Nominal STRIPS have inflation risk.
If you have a retirement horizon greater than 30 years you have inflation and reinvestment risk.
Whole Life insurance is no viable retirement strategy.
Depends. Rerun your SWR sheet and check if you’re still in danger of running out of money given your current spending and portfolio value.
Great post, as usual.
I’ve been trying to figure out how best to incorporate the current relatively high real TIPS rates into our retirement portfolio. My default has been something like a cross between your half-half and a glidepath, but using TIPS instead of nominal bonds. [Like you, I understand that the whole point of a TIPS ladder is that it is NOT something you model historically, rather it is a real fixed portion around which you can model the rest of your portfolio.]
Any chance you can incorporate TIPS into your SWR sheet? I realize it might be difficult to do it perfectly, but any way to incorporate an average real tips yield (over 20, 25 or 30 years of a TIPS bond ladder, say), even if it simply assumed it stayed fixed “forever” would IMO be very useful.
Yeah, agree.
The problem is that I don’t have historical TIPS returns.
All I can do is the exercise you described. And that you can do with TIPS through supplemental flows. But there’s no easy one-stop solution.
Thanks.
Any thoughts on how to implement a fixed real return on a percentage of assets? A supplemental flow would have to be a fixed amount (else we might create recursion, yes?), and I’m curious about doing a glidepath where the fixed percentage goes down over time while the stock percentage increases.
The way I modeled the TIPS ladder in the SWR sheet is to take out the TIPS ladder from the portfolio principal (E5 in tab “Cash Flow Assist”), then calculate the real payment in the TIPS ladder (PMT formula in Excel) and add those flows in the real cash flow columns (E-I).
Not sure what else there is to do.
Thx.
I was hoping there was some way you could do it as you have with cash (or stocks and bonds and…) “next 10 years” as is there now, but modifying the sheet somehow so that it uses a fixed real return for this “TIPS-cash” even for the “modeled” period, not just the 10 years following.
It would not be perfect, but using such a perpetual “TIPS (i.e. real) yield” – a perfect ladder perpetually rolled over at the identical yield – would be more than close enough for useful modeling analysis. Along the same lines as your explanation of modeling other things that didn’t exist in the past (index funds with very low annual costs, the ability to own gold, …) in recent posts.
The “next 10 years” returns and returns past that is simply to fill in extra return years, so a 1966 retirement cohort can have a 60-year horizon. In no way would I ever propose that the first 10 years of stock or bond return for any retirement cohort are ever fixed.
ERN,
First time posting. I have read and enjoyed your site for years. It has influenced my finance strategy and I mention it to friends as my favorite finance website.
I have a question for you. I am 53, my wife and I are retiring in a year, and I recently used TIPS real yield ~2.3% as an opportunity to change our holdings from 90/10 stock/bond to 70/30. We hold mainly 10 year TIPS. Over the next 10 years we plan to slowly glide to a ~80/20 stock/bond ratio (sell some bonds early if necessary). 10 years from now our bonds will be complete and I plan to reassess our financial plan at that time, putting little concrete planning into beyond 10 years at this point. Do you see any problem with this approach? I figure there will be so much more new information available 10 years from now that will significantly shape our financial planning that making specific plans beyond this time doesn’t provide much value (what is our net worth? Are we still healthy? Still have the same life plans? Is the world still stable? Etc.).
Thanks,
Peter
In terms of the asset allocation, that’s certainly a healthy plan. I can’t tell you how safe this plan is without knowing the withdrawal rate and other parameters, like future cash flows (Social Security, pensions, home sale, etc.), but your plan is certainly a good start.
Hi, new subscriber here. Have you written about tontines before?
Relative to an annuity, tontines are inferior because their payments start very modest and only increase over time as participants die and survivors get proportionally more income.
Also, in the traditional setup (apparently illegal under today’s financial regulations), the issuer (king or emperor in the old days) would get the principal. What a rip-off! I prefer an annuity where the principal is drawn down and benefits the participants with higher payouts.
Have you ever looked at using options strategies as a hedge against SORR as an alternative to the equities/bonds glidepath?
Either just as downside protection or as collars matched to expected withdrawals?
I have recommended the “sell an at-the-money call” idea here; see item #3 here:
https://earlyretirementnow.com/2020/04/22/three-equity-investing-styles-that-did-ok-in-2020/
Long-run simulations are difficult due to data availability. So, don’t expect any SWR simulation anytime soon! 🙂
Also, remember that any method that uses options to protect your assets will cost you, even a collar (long put, short call). My entire options strategy is based on the idea that myopic, overly risk-averse folks are overpaying for downside protection. The only way I’d implement any long-option strategy would be through a tactical strategy to buy protection when the market is calm.
Hello ERN, thank you so much for your blog.
I’m looking for a table I’m almost 100% certain you made – but I can’t find it! It listed time against the probability of losing money for stocks and bonds. It was a great device – really helped pin down the “hold stocks for 5 years” mantra.
It looked something like this:
Year | Chance of Loss (US Treasuries) | Chance of Loss (S&P 500)
1 | 10% | 40%
2 | 5% | 30%
3 | -5% | 20%
…and so on.
Was that your table?
I never published a table like that. Maybe I should. It would make a huge difference if you go from nominal to real returns, by the way. The bond market had some very long flat spots! The closest I came to doing that is an old post from 2016: https://earlyretirementnow.com/2016/05/19/bond-vs-stock-risk/
Love the content, appreciate all the effort you put in. Have you considered a 60/40 designed with BTAL at 40% and 60% SSO or QLD. If more conservative, closer to retirement or retired simply reverse the numbers etc. Play with the percentages and you get the sequencing risk mitigation benefits of uncorrelated assets. You could add the 3rd leg of something like DBMF and take from the BTAL allocation. Would love some feedback.
I haven’t looked carefully enough at BTAL. But if you have an alpha strategy it would be neat to combine the alpha and beta strategies that way. The only problem: I don’t feel SSO, QLD or UPRO or any of the 2x or 3x ETFs are really that useful. Expense ratios eat up a lot of the advantage. Maybe use a 100% portfolio of the beta-neutral ETF, and then you do the equity beta via S&P 500 e-mini futures.
My solution: keep a balanced portfolio and sell 0DTE and 1DTE puts for extra income. See here: https://earlyretirementnow.com/options/
I’m looking at the futures option as you suggested. Like the options selling, but account is smallish so income created would be modest. A foundation of BTAL, DBMF, KMLM, PFMN, PFAA and PFLS, 100% allocation then add the futures contracts on margin.
I started with a small account and learned many important lessons. Now I run my strategy with a sizable account and it’s worth my time. But you likely need at least $110k to get portfolio margin.
Karsten, I would love your feedback on a thought experiment please.
There is a non-zero chance that automation/AI could result in widespread job loss. The stock markets could collapse and not recover ever. (A knee-jerk critique of this could be “This Time Is Different” mentality, and that historically the equity markets always recover. But a scenario could happen, like AI, which drastically changes capitalist society and the markets.) Seems to me, if an early-retiree were to seek insulation from this scenario, then whatever money that is surplus to the required exposure to equities to satisfy his SWR, could reasonably be put into bonds/gold/cash. What do you think?
I don’t see what the concern is. If AI is a huge success then capital becomes really scarce, which is great for my index funds, bad for workers. There will be a huge oversupply of workers, so I will benefit from cheap labor taking care of me as I age.
More likely is a slow transition into AI replacing labor over time. Which is a lot less worrisome.
Thanks for the reply Karsten. But how can index funds do well: index funds are companies which require a consumer base–the consumer base will have drastically depressed income from widespread unemployment.
AI is a positive productivity shock, so it will have a positive impact on GDP, by definition. Your horror scenario of higher productivity creating unemployment and economic collapse is thus impossible. But to your credit, your luddite world view has been around since, well, at least the luddites and likely before then. But it’s a fallacy.
In the worst possible case, when there is boost in GDP but a loss of labor income, there will be a massive boost in capital income, hence my reply about index funds doing well.
But I believe the more likely scenario would be the one where the AI productivity boost raises all boats, just like in every other industrial revolution before. The American worker and consumer will be just OK.
Karsten, you make a good point that financially independent early retirees with capital investments should do fine financially due to rising GDP due to AI. But Tom’s concern about AI caused job losses potentialy undermining consumer demand is valid as well. If it happens slowly enough, there is a decent chance the societal and economic transition to a society where a much smaller percentage of the population need to work to produce societies need, can occur smoothly, but there is reason to believe substantial job losses (e.g. drop in human labor demand of 50% or more) could happen over the next couple to few decades. Before you dismiss this as luddite, watch the YouTube video “Humans Need Not Apply” which makes a compelling case that AI and robots will likely be able to do most jobs better and cheaper than most humans, and that this time really is different. https://youtu.be/7Pq-S557XQU?si=qiJ35ppvgV9PVAIY.
Consider that many of the people expressing this concern are themselves AI experts, unlike the luddites from before, who were not the experts in automation and the industrial revolution.
Something like AI GDP gains funded Universal Basic Income (UBI) may be necessary to prevent severe economic consequences of massive unemployment cause by AI displacing most jobs. An example today would be the Alaska Permanent Fund Dividend, which pays all Alaskan residents some oil and mining dividends.
Without something like that, investors would do well financially, but laborers with little capital investments could be in big trouble and if that large a portion of the population is in trouble, it puts social cohesion at risk also, which can severely negatively impact economies as well.
Again: we should stop mixing up macroeconomic demand and supply shocks. As I said before: AI is a positive technology shock, much like the steam engine, IT, etc. that will make a lot of labor obsolete. But it’s still a positive effect on GDP, which is why we can’t have that horror scenario that’s often portrayed. The fact that AI experts make this case will not improve the credibility. They are apparently economically uneducated just like the luddites.
Please explain how your above scenario does not violate the law of supply and demand? The scenario Tom posited is one which could easily result in mass (50%+) unemployment, which would be expected to drastically reduce demand across large swaths of the market (unless something like UBI replaced wages). With a drastic reduction in demand, supply would normally drop to match even though the cost to manufacture those goods dropped as a result of AI. Huge surplusses don’t do manufacturers any good.
Even worse, mass societal poverty could result in the breakdown of society and thus law and order, which would undermine the stable legal structure markets require to function well.
What am I missing?
You’re missing an education in 1st semester Ph.D. macroeconomics: infinite-horizon neo-classical growth model. I’m not going to provide that here on the blog. I taught it three years in a row at Emory University (2005-2007) and I won’t do it here again because it’s difficult material that requires more than a hobby attitude.
Thus only in a nutshell:
1: Either AI is a positive or negative productivity shock.
2: I figure it’s a positive shock, like the steam engine and IT before.
3: A positive shock will increase GDP
4: We can certainly have a distributional effect. It’s possible that capital owners benefit more from the AI technology shock than workers. Which is why I believe my S&P500 stock portfolio will be just fine.
5: More likely will be an efect where AI lifts all boats, including labor income.
This blog is about finance. I don’t want this discussion to shift toward leftist/Marxist nanny state policies (UBI, etc.) that are sadly shoehorned into the AI discussion. The fact that AI “experts” fall for this UBI fallacy actually shines a very bad light on AI. Such irony: If the experts are gullible enough to fall for such fallacies, maybe their AI innovations are not going to keep up with all the hype.
That’s all I’m going to write about this topic.
Great comment.
Karsten, I agree that those who are financially independent with capital investments might indeed thrive due to rising GDP from AI advancements. However, Tom’s concern about potential AI-driven job losses is crucial. If AI and robots end up displacing a significant portion of the workforce, we could see a dramatic shift in the labor market, possibly leading to widespread unemployment.
The transition to a society where fewer people need to work might happen smoothly if it’s gradual, but there’s also a valid worry that it could occur much faster than we can adapt to. The video ‘Humans Need Not Apply’ makes a strong case that AI could outperform humans in most jobs, signaling a unique challenge that experts are taking seriously.
In this context, something like an AI GDP-funded Universal Basic Income (UBI) might become necessary to maintain economic stability and social cohesion. An example of this concept in action is the Alaska Permanent Fund Dividend, which provides residents with a share of oil and mining revenues.
This potential shift raises important questions not just about the economy, but also about access to educational resources. For instance, as people seek to reskill and adapt to new job markets, the best audiobook service could play a vital role in helping them learn on the go, making education more accessible in this rapidly changing world.
Well, isn’t that meta, ironic, and just a bit humorous :-;
A plagiarizing (weak AI assisted) spambot is taking my “job” (I don’t really consider blog commenting a job, just in case that wasn’t clear from context) of blog commenting to comment on AI/robots taking jobs in order to advertise a random website.
Yeah, now that you mention it, it sounds AI-generated. Very good eyes, John!!!
What’s more disturbing: did the AI inject that Marxist UBI idea or is that a function of entering the “right” question?
Please see my other comment again about the faulty luddite logic.
I have nothing against the Alaska Permeant Fund. But for that, the government needs to have net positive assets. Our federal government is 30+ trillion dollars in debt.
Hi Mr ERN, is it possible to share your experience and strategies on preferred stock. What role the preferred stock can play in retirement phase? Thanks!
It’s on my to-do list. I like preferreds. But a caveat: it’s not because they miraculously solve the Sequence Risk problem. See my parts 29,30,31 of the series.
Thanks. I also like to hear your thoughts on SPYI. It uses call options to generate 12% yield. Too good to be true for long term?
A strategy like that will eventually drag down the principal. So, your initial yield sounds high, but a long enough drawdown will give you cash flow problems. In general, this fund will underperform the S&P500 as it has YTD so far, i.e., +18.49% for SPY and +13.64% for SPYI.
That said, the fund is less volatile and drawdowns are likely cushioned by the call writing. The real test comes when we go through a 2007/8 episode, where the SPYI would drop a little bit less (that’s good for Sequence Risk) but then the SPY would recover very rapidly, and the SPYI’s recovery is terribly hampered due to the call writing (terrible from a Sequence Risk perspective).
One use case I am considering for TIPS ladder in early retirement is to provide a bridge with social security income at 70. The advantage is that it provide a simple mental model of having a guaranteed income for life adjusted for inflation by the same counterparty. The rest of the retirement income is using withdrawals from the portfolio and with a variable withdrawal rate (CAP based or other).
Yes, very good points: One could defer and max out Social Security (a really nice, fairly priced, true inflation-adjusted annuity) and use a TIPS ladder to make up for the difference early in retirement.
That’s how I’ve modeled my 2-tier needs–the bridge to SSI, then a smaller SSI supplement. You can go out 30 years on a TIPS ladder to see the cost today, then if you taper down the TIPS over the years you know with a very high probability that you’ll do better as your portfolio gets a higher equity share (by spending down the bonds at maturity). Then for years 30+ you can factor in an annuity, using the 30-yr TIPS real yield to bring it back to today’s dollars. Even if not deployed, I find this to be a good way to model the portfolio drawdown–a conservative calculation to convince yourself or partner that you have enough. Lots of Bogleheads seem to like this. A subset promote a liability-matching portfolio: cover the basic needs with guaranteed income (TIPS ladder, SSI, pension, etc), and “you’ve won.” Anything else is gravy. I view a lot of Big ERN’s analysis to be maximizing the gravy–not selling your funds short, either for greater current income, more funds for the next generation/charity, or some of both.
Very interesting analysis, and one I’ve been awaiting since you mentioned it in both an earlier blog post and a blog comment. Thanks! Would you consider an enhancement to the Safety First “Light” scenario to better match either the typical use case for Safety First or an apples to apples comparison to your Safety First Light example?
By typical, I mean Safety First is usually used to provide an income floor, for instance only to cover essential expenses (or a decent percentage of essential expenses), and invest the rest in the market to increase expected returns. As you point out, few, if any, retirees would be willing to tie up all their investable assets in an annuity or TIPS, so the 100% Safety First scenario is almost purely theoretical. So, the typical use case would definitely be closer to your Safety First Light scenario.
It’s a safe bet as you pointed out that someone interested in Safety First should first maximize Social Security, typically by deferring (individual or member of couple with higher Primary Insurance Amount) until age 70. So, they would only be needing reliable income to cover the gap between maximized Social Security and essential expenses – which tends to drop by 1% real per year on average according to David Blanchett’s retirement spending smile research (though either hybrid LTC insurance or a self-insurance reserve for medical and care expenses in the last few years of life would be prudent). Of course, depending on how early someone retires, even maximized Social Security may not be that much (lots of zeros in the 35 year average). If you stuck with your 50 year old couple scenario, Social Security might still be reasonable as they may have ~30 years of SS earnings to average into the 35 years SS calculates.
By apples to apples, the closest comparable outcome for Safety First Light would be replacing only the bond portion of an allocation with reliable income sources, and leaving 100% of the rest in equity to maintain the same equity allocation for comparison purposes in the same scenario. So, since you chose 75% equity / 25% bonds for your light scenario, switching it to 75% equity / 25% annuity (joint survivor, maybe with a 2%-3% COLA to hedge targeted inflation, if not actual) rather than switching the allocation for comparison to 50/50 as that would lower the expected performance, to keep the comparison more apples to apples .
Without one or both of the above scenario adjustments, the Safety First (even “Light”) comparison feels a bit like a straw man comparison (comparing against scenarios that either are unlikely to ever be attractive to retirees, and thus not what people actually do when they use Safety First, or an unfair comparison because the comparison scenario did not use the same equity allocation).
Thoughts? Thanks.
“replacing only the bond portion of an allocation with reliable income sources, and leaving 100% of the rest in equity to maintain the same equity allocation for comparison purposes in the same scenario.”
I tried that too. 100% equities plus the annuity will do slightly worse. The peak failsafe withdrawal amount would have been closer to 80-85% stocks, small bond allocation and then the annuity for the floor.
Talk about overkill. You can tell you are a weird academic who has a difficult time relating to others.
If you can’t tell by your website’s traffic, nobody really cares.
I certainly have more respect for a weird academic who provides innovative and useful content than playground bullies trying to belittle others to make themselves feel better.
I don’t know if Jerry is a bully, but I couldn’t resist commenting on a bizarre personal attack. And in hindsight, replying to Jerry’s comment is probably a waste of my time.
Yeah, and Part 61 wasn’t even that academic. He should read some of the earlier parts… 🙂
Thanks for the encouraging words, Chris!
LOL! Jerry came here to see another print of “4%-5%” but instead saw that he quit work too early. Instead of addressing the pending calamity that he created for himself has decided to attack the messenger.
Yeah, I think Jerry has difficulties relating to others. But since he interacts so little with others, nobody ever told him.
Wow, sorry you wasted your time on my post. Those are 10 minutes you will never get back. I still consider it a compliment to be called academic.
Very interesting. I read through it twice. I wonder how the Safety First vs. Simple Glidepath would have performed and compared in other less than ideal time periods to start retirement, e.g. 1937, 1966, 2000 (almost 25 years worth of data for Jan 2000 retirees) ?
Haven’t done those cohorts yet. I suspect the results are the same though, i.e., a GP and Safety First will do better than the fixed allocation. Between Safety First and GP, there might be different winners in each cohort, though.
Firstly, a huge thank you for your writings. I first “met” you on a podcast about 6 weeks ago, then went back and read your entire blog in order!
My question: Imagine you’re in accumulation and calculate you can consume $50K/year with 0% failure rate over 30 years. Then a year later your portfolio has experienced poor returns, and the toolkit now says $46K/year. (even when referring to the Equity Drawdown table, there are still scenarios where the SCR drops in dollar terms.)
Conceptually we’re saying, “if returns from today onwards look like the Great Depression, you can spend $46K.” That’s generally valid, but the notion that we just had a poor year and will see an *incremental* Great Depression-style weakness from that lower starting point seems much too conservative.
Would it instead be valid to think about your SWR as the maximum rate ever calculated during accumulation? Since markets trend upwards, logically the SWR should consistently grow (assuming you haven’t made withdrawals; keep the same horizon, porfolio composition, final value target, etc.) If so, it removes a lot of potential anxiety – with a market decline I don’t have to feel like I’m losing ground.
If we already saw poor returns it’s unlikely that we tag on another Great Depression. We should condition our SWR to market parameters and then use a higher SWR, conditional on today’s CAPE and/or S&P 500 drawdown. My Google Sheet has those calculations.
“Would it instead be valid to think about your SWR as the maximum rate ever calculated during accumulation? ”
No I would not say that.
Hi Karsten, after following your blog for years, I’m finally writing my first comment. Over the past few months, I’ve been thinking about a retirement strategy that looks like the Safety First “Light”. Similar to commenter Joe above, I live in a place where sovereign real bonds are very attractive. However, in Brazil’s case, the yields are even higher (currently 6.3%+ over the entire curve), the maximum tax after 2 years is 15%, and our Treasury Direct program recently started offering a very interesting product. It is based on Robert C. Merton and Arun Muralidhar’s SeLFIES (https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3548319).
In short, we can buy ultra-long-bonds (up to 2084) which pay real monthly coupons for 20 years. Current yields are historically attractive (even the stock market struggles to beat inflation-adjusted 6%), and that’s why I’ve been considering locking in a floor that covers basically essential expenses over the next decades, even though I have no intention of retiring soon. If I shift about half my portfolio to this instrument, I’d be able to build a ladder which starts paying in 2035, and keeps going until 2084.
I’m 35 now, and I do intend to keep working for a long time, even after the payments start, but I think guaranteeing a basic income would be freeing in many aspects of life. That also means that I’d probably be able to focus the remaining half of the portfolio in US/global stocks, as well as new deposits, which should probably keep coming – maybe even increase if I decide to take a riskier entrepreneurial career path; who knows? I could also account for any remaining longevity risk by buying longer bonds as they become available.
However, what has been holding me was precisely knowing that 100% stocks is the way to go for most during accumulation phase. I’m not sure if this opportunity would be an exception worth considering, given current US Shiller CAPE and the attractive local yields. In any case, the investments are liquid after 90 days, so they would even be available in case I need or some unmissable opportunity arises, and MTM offers another way to profit when the curve calms down. I frequently sell stocks up to the monthly tax-free limit, so rebalancing wouldn’t imply on heavy taxes right now, even though local stock market is close to ATH in local currency. Finally, I know Brazilian yields are higher for a reason, but government real bonds are probably one of the safest local places to be invested on if things get tougher, because they are more likely to potentially perform an inflationary pseudo-default than actually declining to pay, due to the political consequences of the second choice. In any case, about half my portfolio would be abroad right away, and that proportion could only grow with new deposits.
Basically, I see this as guaranteeing I beat the main game, and then I’d be able to give full attention to the rewarding side quests. I’m really trying to figure out if there are any alarming blind spots I could be missing. You are the best thinker I know of when it comes to retirement planning, so it would be great to hear your thoughts!
I’m very US-centric. I am not familiar with the Brazilian inflation-adjusted bond market. 6.3% real sounds like a real steal. The risk, of course, would be government default and/or manipulation of the CPI numbers. Basically, Brazil could go the route of Venezuela. If you ask Elon Musk, he would agree that Brazil is already moving in that direction, i.e., restrictions to freedom of speech/information. I can see how the 6.3% real yield seems attractive, but I’d still keep a sizable reserve in USD-denominated assets just in case. Ideally US total stock market.
Thank you so much for all the valuable content!!
Just a quick question
If the safe withdrawal rate (SWR) of around 3.25% for a 60-year retirement horizon is considered safe, the premise is that my portfolio would not deplete by the end of the 60 years. At the same time, due to the long duration, the withdrawal rate cannot reach 4% without significantly increasing the risk.
Considering the current 30-year Treasury yield of approximately 4.6%, what if I allocate all my assets into 30-year bonds in the first 30 years and withdraw around 4.6% annually? Although there wouldn’t be portfolio growth during this period, the principal would remain intact by the end of the 30 years. Then, starting in the second 30 years, I could switch to Karsten Jeske’s withdrawal strategy. Since the time horizon at that point would only be 30 years, the safe withdrawal rate would theoretically be higher.
Would this approach be more conservative, safe, and feasible compared to a 70% stock / 30% bond allocation where the withdrawal rate has to remain lower (due to the longer time horizon)?
4.6% nominal. So, your $46,000 annual withdrawals from a $1m initial portfolio will slowly melt away due to inflation. Then after 30 years you’d also have a portfolio that’s only about 1/2 of the purchasing power.
Thank you do much for the kind reply!
Solve my big Q in mind!
Thanks again for all the effort on your blog.
You bet!
Hello Karsten!
After years of trolling the Internet digesting opinions and analysis, I used your post series to generate my family’s annuity strategy when we early retired three years ago at age 40. Huge thank you for all the quality analysis and thought work you have made public over the years.
I’ve tried to verify that the following isn’t yet available in your existing posts, but there is a lot to review and Google / I am not spotting it.
My question is the following. As our fixed / inflation proofed withdrawal of our annuity (based on CAPE ratio at the time) has so far performed spectacularly – is there any time horizon at which point we might reconsider our withdrawal rate and perhaps increase it?
My instinct and what I’ve told my wife is “we can never adjust this withdrawal upwards as we don’t know what sequence of returns we are actually on”. But I have wondered if we could back test our withdrawal strategy against historical hypothetical retirement dates and compare returns, then form new risk estimates for modifying forward withdrawals?
My primary concern with this concept would be that there may just not be enough data to make good decisions. Back testing already has somewhat sparse data and then if you also impose constraints on Cape ratio and sequence of returns for the first n years, probably there isn’t much data left to look at?
Do you view this entire line of questioning as simply falling under your flexible withdrawal rate strategies? I’m aiming for something that is a bit more discreet with maybe only one adjustment point. Perhaps say at the 5 to 10-year Mark based upon returns to date.
Thank you for your time,
Scott
You should constantly reassess the portfolio sustainability. Or at least once a year. If the portfolio does well and/or you’ve run your horizon down enough you will definitively be able to increase withdrawals.
Hi!
Hi! First of all congratulations for your incredible work which Is a great help for all of us!!
I would like to ask you this: i am invested in VWCE ( so i also have risk/opportunity of change, mainly dollari but not only) and in area Euro bonds (both ETF, named XGLE and single bonds,mainly euro next generation) so for bonds i dont have change exposure
Are your charts vaild for me too in particular SW rates and if not now do they change?
Second question: which Is the fail safe Perpetual withdrawal rate that can keep 100% of the initial portfolio for ever? My asset allocation Is 40% International stocks and 60% european bonds. Thank you really so much!!!!
My rates are calibrated to US investors. I can’t say anything definitive about other countries because I don’t have the return data (stocks, bonds, CPI) for any other countries.
Sorry i forgot to write that i live in Italy
Thank you anyway! Just a consideration, i live in Italy which is zona Euro, a low inflation environment euro next gen bonds are AA+ bonds and for stocks i don t use Italian stocks but international stocks ( so mainly USA stocks because i use etf Vanguard VWCE ) do you think i can consider your sws series at least as guide line and maybe beeing a little more conservative? For me 3% real ( that after Italian withdrawal taxes becomes 2%) is enough for my portfolio thank you very much again!
That’s the idea: Yes, most people outside of the US would use that approach.
I found the discussion around longevity risk particularly compelling. It’s a sobering reminder that even strategies designed to minimize risk, like TIPS ladders, can introduce significant vulnerabilities if not planned carefully—especially for couples with above-average health. The life expectancy tables and the probability of outliving a 30-year horizon really put things into perspective.
Exactly: Don’t get fooled by average life expectancy! I was shocked how long the last survivor may live for an above-average healthy couple!
Hello and thank you so much for all the hard work and the transparency! I would very much appreciate your opinion on which SWR you feel one should use. 1) the Failsafe rate in “Paramenters & Main Results” tab for a 0% or 1% fairue rate (currently 3.1%), or 2) the SWR (capital preservation) on the CAPE-based rule tab, or 3) the Target Withdrawal rate (which includes supplement flows) on the CAPE-based Rule tab? I get it depends on how conservative you want to be 1) is the failsafe, 2) is CAPE with no supplemental and 3) is CAPE with supplemental. But which do you use or which would you recommend to measure readiness for retirement.
Thanks!!
You use the one that’s appropriate for your situation:
1: You need flat withdrawals? use the 0% or 1% SWR
2: You want rough capital preservation but can stomach some vol? Use the CAPE-based baseline.
3: Like 2, but you have cash flows and/or want to (partially) deplete funds? Then use the adjusted CAPE-based.
Ok, that makes sense. Just to confirm, does #1, the failsafe rate with either 0%or 1% failure, assume the assets are drawdown to zero? Or does it change by our inputs around the assets we want to have at the end?
Thanks again!!
You set the parameter (cell B24 in the main parameter tab). 0% is asset drawdown, or whatever you set.
Hi Karsten,
Thank you very much for sharing your expertise. I’m a couple years from retiring (at 66) and after decades of learning how to invest, I’m doing the crash course on how to spend. Your posts – and the very helpful toolbox (and the cashflow utility!) – have been extremely informative.
Given that SRR over the first 10-15 years is an overwhelming factor in retirement success, and that glidepaths are generally supportive, my naive question is this: Why isn’t simply purchasing laddered bonds/TIPs to completely fund the first 10-15 years of retirement spend, without rebalancing, an effective strategy? You touch on this, but I think the data is or a fixed allocation. Presuming no rebalancing, this approach eliminates equity sales during the period of SRR concern while forcing a glide path toward equities (that could continue if bond haven’t been depleted).
Using “case study” scenarios, this seems to work for the “bad” years. Am I missing a critical downside?
Thanks,
kent
To hedge 15y of spending, you’d set aside close to 60% of your portfolio in unproductive low-return assets, like TIPS.
If stocks goes through a major bear market, your remaining 40% of the portfolio may have trouble fully recovering after 15 years, even when not subject to withdrawals. There have been bear markets where it took 10-15 years to just recover the old CPI-adjusted high.
So, if you start with $1,000,000, you hedge the first 15y of retirement with a TIPS ladder that costs you, say, $500,000. Then after 5 years your equity portfolio is just barely recovered, back to $500k, but now need to withdraw $40k from that (8%) and make it last another 15y (traditional retirement) or even 45y (early retirement). Doesn’t work.
In this hypothetical, if you took less of your portfolio (for a GP or bond tent), and that bear market came, you’d have more assets in equities riding down that bear market, and if at 15 years you’re barely back to breakeven, then 5-8 years earlier you’re withdrawing from equities at depressed values. In this scenario, aren’t your better locking in the low 2.5% real TIPS yield than living through the negative returns on the equities you need to draw from?
Well, I showed the 1929 cohort simulations. The GP did better.
Insightful as always! I did not read all the comments, so apologies if this has already been discussed: in the light hedge scenarios, have you explored allocations other than 50/50 into the hedges? Is there an optimal percentage, or amount to dedicate to partial immunization / duration matching. Thank you
Well, after I’ve done 100/0, 0/100 and 50/50, I’d suppose that everything in between will likely generate a weighted outcome. But no, I haven’t done a more granular study.
Thanks! So if I’m following, you think the linear interpolation would be a decent approximation for what looks like a concave function from the 3 data points (meaning the SWR under 50/50 is greater than the SWR under 0/100 with no hedge and both being greater than 100/0 under reasonable assumptions of current rates)?
Seems like an almost perfectly linear function to me:
TIPS% Failsafe
0% 70596
50% 71096
100% 71595
Note: the half/half is in the middle between 100T annuity and 100% TIPS.
Hello – first of all thanks for the SWR Toolbox worksheet! I’m doing my own modeling, so it’s been helpful.
I’m confused by how you did the lifespan modeling. You’re using the period tables, which are underestimates due to healthcare advancements. Given how young some of us are, those advancements could be as large as that from selecting excellent health. Is there some reason not to use the cohort tables?
Expanding my life expectancy from 95 to 105 will not have a huge impact on initial spending rates. But, yes, I warn people to not use their lifetime expectation but go well above the expected value, especially for joint life expectancy.
Big ERN, can you remind us which setting you are using in the spreadsheet for the slope and intercept? 1.5 and 0.5 or 1.75 and 0.5? Thanks for the response and any added color here. Thanks!!
1.75% and 0.50
Hello Big ERN, my wife and I just FIREd this year. Our situation is unique and wanted to get a perspective about our portfolio. Here are our details:
1. We have a portfolio of about 1.16M
2. Our paid off rental homes generate a cashflow of about $18000 per year after expenses
3. We spend approximately $30000 per year, so we only need about $12000 from the portfolio per year
4. She is 36 and I am 39, so we have many decades ahead of us (or, we hope at least!)
Our current portfolio is as follows:
85% large cap (mostly S&P 500 index and some VTI)
15% fixed income (VMFXX) – Should we swap this for short term bonds or something else?
Do you think the equity % is fine in our situation since our withdrawal rate is so low?
Any insights would be appreciated! Thanks!
$12k out of $1.16m is just a bit more than a 1% WR. So this looks safe and you can certainly stomach a high equity share.
Dear Karsten,
I really appreciate your work and opinions here and found a similarly interesting research article recently on the same theme:
“The Only Other Spending Rule Article You Will Ever Need” by Stefan Sharkansky (link below)
https://www.tandfonline.com/doi/full/10.1080/0015198X.2025.2541567#d1e115
He compares to the 4% rule and GK guard rails, and utilized a TIPS ladder for the bond portion of a retirement plan and single broad based US market index fund for the stock portion, “amortized” to spend down based on market conditions, but trying to spend as much of it as possible during one’s lifetime. He models with 30 years but says you can tailor it to your preference of ladder amount and ladder timeline of course.
Notably, it was clear in his Figure 6 that someone’s “worst case withdrawal” may be significantly under 4% (~$28,000 on $1,000,000 for the bottom 10%ile worst year) give the variable nature, but it’s not clear how many years in a row that typically lasts for. I’m assuming it would last for roughly as long as the respective stock market decline trough lasts for. (But you can also model this more specifically on his website with his calculator for this approach at https://www.thebestthird.com and see based on different bad years)
Like you mentioned, perhaps one could even take the CAPE into account for the amortization formula and instead use a returns factor more aligned with the historical returns based on the current CAPE. (I was mystified by this “formula” at first, but its seems a relatively easy Excel input: Microsoft Excel expression PMT(d,n,1,0,1)
For instance, to amortize a $1,000,000 equities portfolio and 40 year plan at 6% expected real growth (and repeat each year with new value)
=PMT(0.06, 40, 1,000,000, 0, 1) which started somewhere around an initial withdrawal of $62,699
This approach is particularly appealing to me with the psychological certainly of the TIPS ladder floor and simplicity of the single stock fund. However, like you noted above, it may underperform the glide path in the 1929 bear market, perhaps because you are not rebalancing into the lower prices of stocks at the bottom?
The amortization is an interesting way to flexibly spend down one’s money instead of tending towards leaving a lot left over, however, it can lead in the worst case to a few years of spending ~2.8% per his figure 6. (But seems to bounce back once the market recovers in some simulations on his site)
I am curious if you think this is another “gimmick” so to speak, or if there is some real value in this approach (TIPS floor of desired amount, and amortized stock fund). Particularly if someone just wanted to make the TIPS ladder as a form of guaranteed income equity glide path, i.e. maybe a 15 year or so TIPS ladder during SORR?
Appreciate your thoughts and commentary,
Matt
I cannot speak for Karsten, of course.
But I would think if you are looking for an alternative to the bond portion of a portfolio, annuities would be a better choice than TIPS for a couple reasons:
1) Efficiency – annuities benefit from mortality credits, whereas TIPS cannot.
2) TIPS are limited to 30 years, so unsuitable for FIRE (early retirement) for most RE planning horizons.
I can’t take credit for the concept – that goes to Wade Pfau, here: https://www.advisorperspectives.com/articles/2015/08/04/why-bond-funds-don-t-belong-in-retirement-portfolios, where he says: “My simulations showed that the efficient frontier for retirement income generally consists of combinations of stocks and income annuities. Perhaps surprisingly, bond funds did not make it to the frontier; they do not serve a useful role in the optimal retirement income portfolio.”
This may be true for retirements without a bequest motive. If you like to leave a sizable bequest, you can certainly keep bonds+stocks and forego annuities.
Remember: Pfau is a financial advisor and caters to that crowd. They love, love, love annuities because of the higher fees for them.
Regarding Wade Pfau, he is not a practicing advisor, but rather a retirement researcher, professor/teacher, Ph.D. in economics (like you), though he is the research director for an advisory firm which is compensated in a sufficient variety of ways, which should make them roughly neutral towards whether a client wants to invest in stocks and bonds or buy annuities. Also, in the research in question, Wade found SPIAs to be the efficient form of annuities, whereas the annuities with typically excessive fees are variable annuities, so I am not quick to dismiss his research as conflicted. He is also co-developer of a questionnaire which helps retirees figure out their own preferences for or against annuities.
Regarding his research conclusion, I’d encourage you to read his full article I linked above and/or the research paper he referenced in that article and see what you think of his detailed research. His conclusion is:
“When retirement is short, partial annuitization leads to a smaller legacy (though in the case of short retirement, both approaches still support a pretty reasonable legacy). For longer retirements, partial annuitization offers sound spending support while also fortifying a larger legacy. It is a more efficient retirement income strategy, and that is why income annuities serve as a viable replacement for bonds in a retirement income portfolio.”
The efficiency he references is due to mortality credits, which cannot be duplicated by an individual who needs to plan for the longest they reasonably may live rather than their (shorter) life expectancy.
I have listened to a lot of Wade Pfau and generally agreed with you, but he seems to be willing to promote some variable annuities and permanent life insurance policies in the last couple of years. It got to the point that I wondered where his loyalties lied anymore. He did have caveats about past issues with them, but those caveats seemed pretty weak.
But it does seem like there can be a place in ones plan for SPIAs. I did some modeling of them versus 10-year treasuries in Karsten’s Toolbox, and they produced results as you would expect (break points around life expectancy). So maybe a good hedge against longevity risk; even more so if you aren’t prioritizing leaving an inheritance. I’m leaving the option open for us in case we find social security isn’t providing enough longevity risk protection.
I’d be surprised if Wade promoted any *specific* products, annuities or otherwise, as I’ve always heard him be extremely careful to disclaim endorsing any specific products, though he talks about the tradeoffs of different types of financial products. I once heard him answer a question about a specific product, only because it was unique in its offering, but then he xplicitly disclaimed ny endorsement of it.
I believe as a Ph.D. researcher, his loyalties are to whatever unbiased research shows – even if it goes against conventional wisdom. He’s very well published in peer reviewed journals, so his research is well vetted – far more than most sources of financial advice.
I tend to think like you regarding annuities – SPIA only if delaying Social Security to 70 doesn’t provide enough longevity insurance, but I do think he raises interesting questions about the efficiency of SPIAs (especially low or no commission ones) as a bond alternative.
He did not promote any specific products from named insurance companies. I too would not expect that from him. He was just going through the different types of annuities/insurance products (variable, index, deferred, whole life, etc) and talking about the benefits of each. He wasn’t as cautious on them as I expected he would be.
I think some level of healthy skepticism is required even when looking at PhD research. Sometimes they are getting funding from certain parts of industry that might influence the direction of the research or the tone of the reporting. I do agree that Wade tends to be pretty neutral, though.
But that skepticism lead me to run some number through the Toolbox. I think if you are going to calculate your SWR based on an assumption of living past the average life expectancy, any bond allocation you had planned is probably better replaced by SPIAs. In that respect Wade’s analysis on annuities makes sense to me.
All fair points. Though I think, at least in part, he is objrctively reflecting pros and cons of some financial product categories that developed predatory practices in the past, even though those practices are no longer prevalent. Still need to watch for high fees on variable annuities and if lots of annuity riders, but I believe at least some of his analysis has taken into account typical fee structures when determining relative ROIs of alternate instruments.
Thanks for confirming. Wade Pfau is definitely in the circle: he manages money and sells stuff to clients. So, take the annuity and life insurance recommendation with a grain of salt.
Just to clarify one point – Wade Pfau does not personally sell investments (he has said so on the Retire With Style podcast). He has the IA designation only as a precaution because he researches and talks about investment categories, and is a principal at a company that does sell.
Still fair point to take with a grain of salt due to potential conflict of interest.
It’s a distinction without a difference. He owns the company. His company sells products. So, he effectively sells products.
If he said what you claim that’s actually quite troubling. Because you can research and talk about investments all the time without the IA designation. I’ve done so for decades. Only when you sell stuff you need the IA designation.
Pfau is principal at McLean Asset Management. Both he and his firm are registered with FINRA. So, he’s certainly in the business. So, he’s an insider and his firm has stuff to sell.
With regards of the central claim “more efficient than nominal bonds” I’m highly skeptical because it’s impossible to simulate the performance during the Great Depression and 1970s-80s. I’ve written here and elsewhere that I generally like the idea of annuities for short retirements and for people with a zero final net worth target. Most people in the FIRE community should avoid annuities.
> he’s the only employee performing asset management duties.
How did you arrive at that conclusion? This is a genuine question. I may be missing how to read additional information on FINRAs website. I looked up McLean Asset Management on FINRAs brokercheck and found 16 registered individuals (including Wade), all of whom are registered as Investment Advisors. And my understanding of his role at McLean Asset Management is that he is the research director.
I understand why it would not be possible to simulate during the Great Depression (good point). At least I think I do (no SPIAs or available rates to test).
Why would it not be possible to simulate during the 70s and 80s?
> I generally like the idea of annuities for short retirements
By short, do you mean delaying buying annuities until remaining life expectancy is relatively low to get higher return rates? If not, what did you mean?
Thanks.
Thanks for pointing that out. You’re right. Item 5.B.1: there are 17 employees performing investment advisory functions. I thus revised my comment. (My initial comment relied on misreading one section in the ADV form where it said 1 employee, but that was only at one specific location, not the form overall.)
The idea is still the same: He’s the principal of the firm and benefits if his employees push products on clients that yield a higher fee in the short-term than a simple bond fund. So, I see a slight conflict of interest.
If anyone has SPIA quotes from the 1960s, please let me know, so we can back-test this.
Correct. I mean traditional retirees should certainly check out the SPIA. If you’re young, you should go with a standard 60/40 to 75/25 portfolio. You should certainly revisit the SPIA later in retirement when your remaining horizon is short enough.
Beyond age and gender, SPIA payout rates are based on current interest rates (assuming your basic joint life SPIA with immediate payout from a highly rated insurance co). So couldn’t you make pretty reasonable estimates for what the payout rate would be for various points in time?
True. I could look into that. But it’s not high on my priorities list. Maybe someone else wants to tackle this?!
Fair point that as a principal (I say “a” rather than “the” because McLean’s website lists 5 principals, and he is the only non-managing principal), he has a slight conflict of interest.
The oldest annuity quote history I could find is https://www.immediateannuities.com/annuity-shopper/as-archive.html, which only goes as far back as 1986, unfortunately.
Thanks.
Thanks for the link! Very helpful!
The PMT formula with varying expected returns is just the CAPE-based rule I prose in Parts 18 and 54. I find this approach much superior to a fixed calibrated equity expected return.
Sure, there’s the TIPS piece. But we have very little return data on TIPS. They started only in 1997. TIPS would have been better than nominal bonds in the 1970/80s (if they had been around), but far, far worse in the Great Depression. It’s a tradeoff.
Hello Karsten, I find your site the most useful resource on the Internet with respect to retirement funding, even though I live in the UK. Thank you for sharing your incredibly detailed analysis.
I have a question for you regarding annuities. In the UK we can buy uncapped inflation linked annuities from our pension funds at rates between 5% and 5.3%. That’s for a healthy 65 year old, the annuity rate varying with where we live. I find these rates quite an attractive proposition at present considering the high CAPE.
What are your thoughts on this? Would a 5% inflation linked annuity for a 65 year old be attractive from your US perspective? At least for part of retirement income?
The UK has historically suffered from higher inflation than the US too.
If that means you can hand over $100k now and receive $5,300 per year and that is adjusted for CPI inflation for life, I would find that a killer deal. I wouldn’t transform my entire net worth, of course, but my bond portion, about 25% of my financial net worth would go in there.
And the usual disclaimers: i would do this only if the pension funds are in good health and there is a government insurance program to guarantee payments if your (private) pension fund ever goes bust.
Thanks for your thoughts. The annuity rates available in the UK do seem to be very reasonable at the moment. A 65 year old could put half their money into an inflation linked annuity, the other half into stocks drawn down at a very prudent 3% and still achieve a >4% SWR, with a very high likelihood of a significant legacy. The trade off is of course a lower legacy than would likely be achieved without the annuity.
There are 6 annuity providers in the UK and the market is heavily regulated and reasonably competetive. Annuities are 100% protected, without a cap, by a fund that all financial service providers contribute to and the fund has a government backstop. As far as I am aware there has never been a default on an annuity in payment.
I guess only question is tax? Stocks being more tax efficient than the annuity might change how you tax the 4% swr.
Income taken from UK pension funds are subject to income tax. Taxation rates are the same regardless of whether that income is derived from stock dividends, bond interest, capital gains or annuities.
UK pension funds are tax deferred accounts. Income tax relief given on contributions and tax paid on payments out. There are essentially 2 options for taking benefits from a UK pension. The first is to remain invested in stocks and bonds and draw an income from these investments. There is no tax to pay on the investments themselves. Not on the income they generate nor on capital gains. Just income tax on withdrawals from. The other option is to sell some or all of the stocks/bonds and buy 1 or more annuities. Or a combination of drawing an income from part of the stock/bond portfolio and annuity purchase with part of the portfolio.
Ok didn’t realise you were only referring to income from the pension fund and drawing from annuity. Thought you had some in your discretionary account.
Yes, pensions only. We can purchase annuities from general investment accounts and tax advantaged accounts called ISAs, but the market is more specialized, not as developed and annuity rates not as good. These annuities, called Purchased life annuities (PLAs), would be subject to tax and so it would not usually be sensible to purchase from a tax advantaged account. Buying an inflation linked bond ladder would very often work out better value than buying a PLA and almost certainly if the funds came from a ISA account.
Thanks for explaining! Annuities seem to be a good option for at least a portion of the nest egg. I would never go 100% annuity, of course.
I found a way to estimate the annuity payout rates for past time periods using the past interest rates. However, we would need actuary tables of each time period to be most accurate. That said, I’m thinking we’d prefer using today’s actuary tables if we wanted to model SWR for us against historical market returns. Plus, it would be more conservative using today’s tables since it would produce lower annuity payout rates.
Thanks! Probably you estimated Annuity% = a + b x InterestRate + e, or some variation. The problem is that annuity tables are changing over time, but it’s better than nothing. If you want to share more details, please let me know.
Not exactly, but practically yes. It is the sum product of the annual discount rate times the probability payout will occur (owner is still alive that year). The sum is done over the life of the annuity. In practice, it is linear with an r-squared > 0.99 between 2% and 17%. For a 65 year old couple, the payout vs interest rate equation is:
PayOut = 0.67 * interest rate + 0.036. So when interest rates are 5%, the payout would be estimated at 6.95%. (FYI: I used the lifetime tables in your SWR Toolbox to calculate.)
According to Wade Pfau’s article on the topic from 2015 (https://retirementresearcher.com/annuity-pricing-sensitivity/), the interest that the payout rate equation correlates to is the 30-year treasury for a 65-year old couple. Actual payout rate correlate to 10 basis point lower treasury rate (3.1% vs 3.2%). It appears to change based on the life expectancy of the owner(s). A 65-year old male’s individual annuity payout would be correlated closer to the 10-year treasury (about 20 basis points higher).
So possible to evaluate for some specific scenarios (assuming age(s) and gender(s)); but would be complicated to make a flexible option (modifiable ages, genders, individual/joint) in the SWR Toolbox.