One question I’ve gotten from readers a few times over the years is whether the participation in a so-called Employee Stock Purchase Plan (ESPP) is worthwhile.
A little bit of background: some corporations offer their employees to buy stocks of their company at a discount of up to 15%. There are some strings attached, though. For example, there are often minimum holding periods, anywhere between a few months and up to two years. The discount is also taxed as ordinary income, though the subsequent capital gains may qualify for treatment as long-term gains.
If you can liquidate the stocks right away and pocket the discount, then participating is likely a no-brainer. Take the money out of the ESPP and invest it in a low-cost index fund. It’s a nice boost to your contributions in your taxable account after you’ve maxed out all your other tax-advantaged options. 15% adjusted by your marginal income tax rate – federal and state. That would still be more than 10% for most people! Pretty sweet!
But what should you do if there’s a minimum holding period? During that time, part of your portfolio is now concentrated in one single corporation. The opposite of diversification. So, it’s a tradeoff: You get the discount but you also take on additional risk. Is it still worthwhile? This is an inherently quantitative question. Without putting hard numbers behind this we can talk about this until the cows come home. The only way to answer this question is through a quantitative exercise. And it turns out, the numbers look like it’s indeed worthwhile to participate in an ESPP, especially if you can get the full 15% discount, the maximum allowed under federal law.
Recently, there’s been some discussion in the FIRE community about a controversial post written by Sam, a.k.a. “Financial Samurai,” claiming that in light of the current record-low bond yields, specifically, the sub-1% yield on the 10-year Treasury bond, we now all have to scale back our early retirement safe withdrawal rates to… wait for it… only 0.5%! Of course, I’m one of the more cautious and conservative planners in the FIRE community, see my Safe Withdrawal Rate Series, but even I would not push people to less than 3%, even in light of today’s expensive asset valuations.
A lot of people – online and offline – have been asking about my opinion on the economy. When will the recession be over? Is the recession over already? How does does the recession stack up with other events in the past? What are the risks going forward?
What’s my assumption for rebalancing the portfolio?
In the simulations throughout the entire series, I’ve always assumed that the investor rebalances the portfolio every month back to the target weights. And those target weights can be fixed, for example, 60% stocks and 40% bonds, or they can be moving targets like in a glidepath scenario (see Part 19 and Part 20).
In fact, assuming monthly rebalancing is the numerically most convenient assumption. I would never have to keep track of the various individual portfolio positions (stocks, bonds, cash, gold, etc.) over time, but only the aggregate portfolio value. If the portfolio is rebalanced back to the target weights every month I can simply track the portfolio value over time by applying the weighted asset return every month.
But there are some obstacles to rebalancing every single month:
It’s might be too much work. Maybe not necessarily the trading itself but keeping track of the different accounts and calculating the aggregate stock and bond weights, potentially making adjustments for taxable accounts, tax-free and tax-deferred accounts, etc.
It might involve transaction costs. Even in today’s world with zero commission trades for ETFs, you’d still have to bear the cost of the bid-ask spreads every time you trade.
Even if you hold your assets in mutual funds (no explicit trading costs) there might be short-term trading restrictions prohibited you from selling and then buying (or vice versa) too frequently.
It might be tax-inefficient. If an asset has appreciated too much you might have to sell more of it than your current retirement budget to bring the asset weight back to target. But that would mean you’ll have an unnecessarily high tax bill that year. Of course, this tax issue could be avoided by doing the rebalancing trades in the tax-advantaged accounts, not in the taxable brokerage accounts.
And finally and maybe most importantly, there might be a rationale for less-than-monthly rebalancing: it might have an impact on your Sequence of Return Risk. So, especially that last point piqued my interest because anything that might impact the safety of my withdrawal strategy is worth studying.
So, on the menu today are the following questions:
Under what conditions will less-frequent rebalancing do better or worse than monthly rebalancing and why?
How much of a difference would it make if we were to rebalance our portfolio less frequently?
Could the “right” rebalance strategy solve or at least alleviate the Sequence Risk problem?
Welcome back to a new installment of the Safe Withdrawal Series! If you’re a first-time reader, please check out the main landing page of the series for recommendations about how to approach the 38-part series!
I’ve been mulling over an interesting question I keep getting:
Is there a time when we can stop worrying about Sequence Risk?
In other words, when is the worst over? When are we out of the woods, so to say? A lot of people are quick throwing around numbers like 10 years. I would normally resist giving a specific time frame. The 10-year horizon indeed has some empirical validity, but I also want to point out a big logical flaw in that calculation. Nevertheless, in today’s post, I want to present three different modeling approaches to shed light on the question. And yes, I’ll also explain what the heck that Mandelbrot title picture has to do with that! 🙂 Let’s take a look…
One question that I frequently get – in the comments section, via email and in-person – is whether the continued shift away from active stock picking and into passive index investing is all going to create one big, scary bubble. Will this all end in tears? As a member of the FIRE community and a lifelong true believer in passive indexing, it definitely piqued my interest when I heard that I’m (partially) responsible for increasing market inefficiencies and dislocations and potentially even a bubble.
The issue of the “passive investing bubble” bubbles up, so to say, with great regularity. An example is the August 2019 Bloomberg piece “The Big Short’s Michael Burry Sees a Bubble in Passive Investing” likening the current state of the equity market to the crazy CDO market right before the 2008/9 meltdown. Well, that definitely got everyone’s attention! Especially during the slow months in the summer when there isn’t much else going on and financial journalists have to come up with some eye-catching headline!
Long story short, I find that this a bunch of mumbo-jumbo. And instead of replying via email about 10 times a year I just decided to write a blog post about this topic, so I can point to this post in the future if there are people still wondering about my views. That saves me a lot of time and I get to distribute my view to a larger audience, just in case other readers had this same question. And I get into the details a bit more than in a short email reply.
So, why am I not too worried about this shift to passive indexing? Let’s take a look…
Welcome back to another post centered around Put Option Writing. Today we got a real treat because my blogging buddy, fellow option trader and frequent commenter “Spintwig” offered to do a guest post to perform an independent review of my trading strategy. If you don’t know Spintwig, he also retired in 2018 (at age 30!!!) from a career in IT and now writes about FIRE and options strategies at his blog. He does a lot of interesting and important work, including careful and comprehensive back-tests of different option trading strategies, i.e., different underlying assets, different Deltas, different horizons (days to expiration), etc. I highly recommend you check out his work if you’re interested in option writing!
Oh, and following the guest post, I’ll also give a quick update on how my portfolio did during the crazy, scary volatility last week! Stay tuned!
Over to you Mr. Spintwig…
Thank you BigERN for the opportunity to peer review your options strategy and publically share the results with you and your readers. I’ve relied on your research in my own journey to and through FIRE and I’m happy to be able to add to the discussion and body of research.
A few years ago I stumbled upon BigERN’s blog as I was researching safe-withdrawal-rate topics. Among the material was a novel idea: selling put options on the S&P 500 index could mitigate sequence-of-return risk.
Welcome back to another post dealing with an investing strategy that’s central to our own retirement strategy here in the ERN household. Just a bit of background, about 35% of our financial net worth is currently invested in this strategy. But it accounts for more than 50% of our taxable assets, so for our early retirement cash flow planning, this is really serious business. This puts food on the table in the ERN household!
If you’re not familiar with this strategy, I’ve written about the topic of option writing to generate (retirement) income in general and my personal approach here:
The first three links are more about the general philosophy and the last link, Part 3, is about how I’ve been running the strategy most recently. The strategy involves writing (=selling/shorting) put options on the S&P 500 index with a little bit of leverage. And one can also keep the majority of the account in income-producing assets (bond funds, preferred stocks) to generate additional cash flow. Sweet!
In light of the recent market volatility, of course, it would be a good time to do an update on my strategy because I’ve gotten a lot of questions on how that strategy has been holding up during the bear market. Did it blow up? You are all a bunch of rubbernecks, aren’t you? 🙂
Long story short, my strategy did pretty well so far this year. Not just despite but even because of the volatility spike. Let’s take a look…
Well, that didn’t take very long! On August 18, the S&P 500 and Price Index finally set a new record high. The Total Return Index (dividends reinvested) had already reached its new all-time-high on August 10. So, we know for sure that this is a new Bull Market and it started after the March 23 Bear Market Low!
May 11, 2020
The stock market is still well below its February all-time-high, but it’s holding up remarkably well considering how poorly the economy is doing right now:
20+ million jobs lost according to the BLS payroll employment data,
30+ million jobs lost according to the sum of weekly unemployment claims since March,
-4.8% GDP growth in the first quarter (annualized rate) and possibly a 10% drop quarter-on-quarter in Q3, which would be reported as a 34% drop annualized!
And a whole host of other economic indicators that look so bad, you’d have to go back to the Great Depression to find similar readings
Actually, “holding up” is a bit of an understatement when you look at the stock market as of the Friday, May 8 close:
The S&P 500 TR index rallied 31% since the March 23 low!
We’ve recovered more than half of the drop peak to trough!
Since April 8, we’re no longer 20% below the recent all-time-high, which is often quoted as the cutoff for the Bear Market!
Does that mean the Bear market is over now? I certainly hope so! Whether the Bear Market is over and a new Bull Market might have started already obviously depends on the definition of Bull vs. Bear. What is that definition of Bull vs. Bear anyway? Different people have different definitions, some more sensible than others. And it gets more complicated: even if we do agree on a sensible definition, there could still be uncertainty over what’s the state of the market right now because some criteria cannot designate the state of the world in real-time but only after the fact. There’s a confirmation lag! So, we could be in a sort of a bull/bear-limbo state right now! How is that possible???
So many questions! Let’s take a look at how I think about Bull vs. Bear…
Simple (indexing) beats complicated active investing
Well, after unloading on some of the fancy complicated investing styles, I just like to point out the select few of them that indeed performed relatively well in 2020. At least better than the index. So, for the record, I’d also like to write about three examples where…
Complicated beats simple index investing
And most importantly, I’m not pulling some “Monday Morning Quarterback” nonsense telling you that if you could have sold your airline stocks in February and replaced them with stocks for video conferencing makers you could have done really well. Well, duh, very few people other than U.S. Senators had that kind of inside information back in February! Rather, I want to write about some of the deviations from simple indexing that were mentioned here on the blog in my posts and/or in the comments. Before the crisis!