Welcome to a new installment of the Safe Withdrawal Rate Series, dealing with Bucket Strategies. This is one approach that’s often considered a viable solution to the dreaded Sequence Risk Problem. Simply keep buckets of assets with different risk characteristics designated to cover expenses during different time windows of your retirement. Specifically, keep one or more buckets with low-risk assets to hedge the first few years of retirement. And – poof – Sequence Risk evaporates, just like that! Sounds too good to be true, right? And it likely is. Long story short, while there are certain parts of the bucket strategy that can indeed partially alleviate the risk of retirement bust, bucket strategies are by no means a solution to Sequence Risk. Let’s take a look at the details…
In my post two weeks ago I outlined my approach to retirement planning: In light of significant uncertainty in retirement, I like to do a more careful, robust, and scientific analysis. Not because I could ever undoany of the existing uncertainties but because I don’t want to add even more uncertainties through “winging it” in retirement.
But how much detail is really required? I can already hear objections like “you can never know your future spending month-by-month, so why go through all this careful analysis with a monthly withdrawal frequency?” To which I like to answer: Well, maybe that’s the part where you can indeed use the “wing it” approach! So, today I want to go through a few case studies and learn how much of a difference it would make in my safe withdrawal strategy simulations if we a) carefully model the whole shebang in great detail, or b) just wing it and use a rough average estimate for the spending path. For example…
Does the intra-year distribution of withdrawals matter? In other words, how much of a difference does the withdrawal frequency make: monthly vs. quarterly vs. annual?
What if there are fluctuations in my annual withdrawals around the baseline average budget, due to home repairs, health expenses, etc.?
What if those fluctuations have an upward bias?
What if there is a slow (upward) creep in withdrawals?
What about nursing home expenses later in retirement?
Where can I safely wing it? And which are the ones I should worry about? Let’s take a look…
Welcome back to another post in the Safe Withdrawal Rate Series. For a quick intro and a summary of the series, please refer to the new landing page.
Before I get started, though, you probably noticed that I have been offline for a while. Important business to take care of! The ERN family summer vacation. We spent 3 weeks in the Colorado Rockies and the Black Hills in South Dakota (with short stints in Nebraska and Wyoming) for hiking and sightseeing. Then another almost 2 weeks in Gainesville, GA by Lake Lanier with the in-laws. We flew back in early August and after a short “vacation from the vacation”, I’m now back in business again.
So, back to today’s post. People in the FIRE and personal finance blogging community – readers and fellow bloggers alike – often tell me that while they enjoy my writings here, they wonder if I haven’t gone a little too far into the rabbit hole of quantitative analysis. Why measure safe withdrawal rates down to multiple significant digits? Why do all of this careful analysis if there’s so much uncertainty? Market uncertainty, policy uncertainty, personal uncertainty, model uncertainty! Why not just wing it? I always try to give a short reply to defend my quantitative approach and out of the many different mental and written notes I’ve taken over the years I created this post for your enjoyment and for my convenience to refer to if I get this question again next week.
Specifically, I want to propose at least three reasons for being diligent and precise not despite, but precisely because of retirement uncertainties. And, by the way, I will keep today’s post relatively lean in terms of simulations and calculations, and rather try to make this more of a philosophical exercise. So, if you’re one of the quant-skeptics I hope you keep reading because I can promise you that we don’t have to get too deep into the (quant) weeds. So, let’s take a look at my top three reasons to get the math right…
Time flies! I can’t believe I already had my 3-year FIRE anniversary last month! Time to reflect and think back on the first three years of early retirement: travel, moving, “market timing”, dealing with the shutdown, and some other exciting news in the ERN retirement life. Let’s take a look…
We all heard about stealth wealth, i.e., being wealthy without being flashy! Live below your means! There are blog posts about it (Physician on FIRE, Retirement Manifesto, and many more). A large part of The Millionaire Next Door book is about Stealth Wealth. We certainly have been practicing that principle while accumulating wealth, and especially now that we live our comfortable life in early retirement.
But we never overdid the stealth wealth either. In other words, when I announced my retirement in 2018, not a single relative, friend, or colleague blurted out “Yeah, you’re such a cheapskate, no wonder you accumulated seven figures!” Quite the opposite, people wondered how we were able to save and accumulate so much without looking cheap to the outside world. Very simple, we were frugal, but we were able to hide that frugality very well. In other words, we were practicing…
Stealth Frugality = frugality without looking and acting like a miser!
And Stealth Frugality doesn’t rule out Stealth Wealth. It’s more of an extension, a less extreme form of stealth wealth. Being a math wonk, let me make the point with the diagram below. If we plot on the x-axis the perception of wealth and on the y-axis the reality, then really everything above the 45-degree line, i.e., reality > perception, is stealth wealth of sorts. But the trick is to move out of that top-left corner (act poor, big bank account) and a little bit more to the right. Without dropping too close to the x-axis and certainly not all the way to the lower right corner (=Keeping-up-with-the-Joneses, drowning in debt). In other words, Stealth Frugality involves spending wisely without breaking the bank, i.e., try to find some spending categories to splurge on that follow a flatter path than the Minus-45-degree line!
So, why and how did we practice Stealth Frugality? Let’s take a look…
One of my earliest blog posts back in 2016 detailed my thought process for skipping the emergency fund. Back then, while we were still accumulating and saving for early retirement, our entire seven-figure equity index fund portfolio served as our emergency fund. We never kept more than $1,000, maybe $2,000 in a checking account. We’d simply used the credit card float and/or the Home Equity Line of Credit (HELOC) if any larger expenses came up that exceeded my monthly cash flow, e.g., car and home repairs, medical bills, etc.
So, again, the idea is that if you are a practitioner of the FIRE movement and you save and invest aggressively just put all your money in an equity index fund and be done. It’s not crazy at all to simply invest your emergency fund in stocks! And I repeat it again in case people misunderstand (intentionally or unintentionally) my point here, I most definitely advocate stashing a large pile of money. I simply advocate for moving all that money into an investment with high expected returns, ideally equities, instead of letting the money languish in a money market account at 0.03% interest. Please refrain from quoting the strawman sob stories about people who couldn’t afford their roof or car repair because they live paycheck to paycheck.
But a lot has happened since. We’ve had the 2020 recession and bear market and massive equity market volatility. Many financial experts, bloggers, and podcasters started spreading the “you need x months worth of expenses stashed away in a savings/money market account” mantra again. Have I changed my opinion? Heck no! Quite the opposite! The 2020 recession is a perfect example of the lunacy of the emergency fund invested in a money market account. Let me explain why…
Welcome back to a new installment of the options series! In the discussion following the previous post (Part 6), a reader suggested the following: In recent history, the index has never lost more than 50% over the span of one year. Then why not simply write (=short) a put option, about one year out with a strike 50+% below today’s index level? Make it extra-safe and use a strike 60% below today’s index!
So, let’s take a look at the following scenario where we short a put option on the S&P 500 index slightly more than a year out and with a strike about 60% below the current index level:
Trading date: 4/30/2021
Index level at inception: 4,181.17
Strike: 1,700 (=59.2% below the index)
Option premium: $11.50
Multiplier: 100x (so, we receive $1,150 per short contract, minus about $1.50 in commission)
In other words, as a percentage of the initial margin, we can generate about 26% return over about 13.5 months. Annualized that’s still slightly above 23%! Even if we put down $15,000 instead of the bare minimum initial margin, we’re still looking at about 6.8% annualized return. If that’s a truly bulletproof and 100% safe return that’s nothing to sneeze at. A 6.8% safe return certainly beats the 0.1% safe return in a money market, right? Does that mean we have solved that pesky Sequence Risk problem?
Here are a few reasons to be skeptical about this strategy…
Welcome back to another installment of the Safe Withdrawal Rate Series. In the previous installment, Part 44, I went through a number of general tax planning ideas, and I promised another post to introduce an Excel Sheet, I created to help me with my tax planning. There were numerous reader requests a long time ago when I ran the withdrawal strategy case studies (2017-2018) to publish not just the Safe Withdrawal Rate calculations but also the tax planning Excel Sheet. Well, I never published those Excel sheets because a) they were custom-tailored to those particular case studies, b) they potentially included personal information of the case study volunteers and c) they were created “for my eyes only” so I couldn’t really publish them without a massive effort to explain and document what exactly I’m doing there.
But now (with a three-year delay!) I’ve finally come around to creating something from scratch I feel comfortable publishing for a broader audience. It’s not a Google Sheet, but an MS Excel Sheet, more on that later. It’s probably still not a universally applicable tool. And most importantly, it’s a tool that still requires a lot of Excel Spreadsheet mastery. It will not spit out “the” optimal tax strategy, it will only help me (and maybe you) find that optimal tax strategy. A lot of handiwork is still necessary! Much more handiwork than with Safe Withdrawal Sheet (and even that is already a handful!).
So, I like to go through a simple case study to show how this sheet works and showcase how you can “hack” your withdrawal tax optimization strategy in that one specific case. Even aside from tax optimization, the sheet helps me gauge what’s the average effective tax rate throughout retirement, to help me figure out how much of a gross-up I have to apply to translate a net-of-tax retirement budget into a pre-tax withdrawal percentage.
I can’t foresee what exact tax challenges you might face, but with my tool, I would have been able to handle what came across my desk so far, both in my personal finances and the case studies I’ve done so far.
Welcome to a new installment about trading options. Alongside my work on Safe Withdrawal Rates, this is my other passion. In fact, on a day-to-day basis, I probably think about shorting S&P 500 put option much more than about Safe Withdrawal Rates. In any case, one of the most frequent questions I’ve been getting related to my options trading strategy is, how do you even get started with this strategy when you have a smaller-size account? Trading CBOE SPX options, with a multiplier of 100x on the underlying S&P index, even one single contract will have a notional exposure of roughly $400,000. I don’t recommend trading that without at least about $100,000 or better $125,000 or more in margin cushion.
How would one implement this without committing such a large chunk of money?
My options trading buddy Mr. Spintwig who already published another guest post in this series offered to shed some light on this question. He ran some simulations for my strategy using some of the other “option options” (pardon the pun), i.e., implementing my strategy not with the SPX index options but with different vehicles with a smaller multiple than the currently pretty massive 100x SPX contract. For example, the options on S&P 500 E-mini futures are certainly a slightly smaller alternative with a multiplier of only 50. And there are some even smaller-size contract alternatives, but my concern has always been that the transaction costs will likely eat up a good chunk of the strategy’s returns.
In any case, I’ll stop babbling. Mr. Spintwig has the numbers, so please take over…
The readers have spoken and I listened! A lot of folks have been asking for an easier way to digest the Safe Withdrawal Rate research on my site. It has now grown to 44 parts and even with the new landing page, it must still seem like a daunting task to navigate all the different facets of retirement planning. So, I’ve thought long and hard about a more accessible method to convey the complicated subject matter of advanced retirement withdrawal strategies.
I can now announce that I’ve decided to – get ready for this – publish the entire Safe Withdrawal Rate Series on TikTok! I will split up the series, 44 posts and 100,000+ words so far into easy-to-digest bits and pieces. Each post in the Series will be made up of between 5 to 20 TikTok videos, each around 45 to 60 seconds long. I’ll kill two birds with one stone, 1) venture into new markets and meet new people in this exciting new medium, and 2) provide better access to my research for the folks with attention-span challenges. These days, who wants to read 5,000-word blog posts with charts and tables anymore, right?