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 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?
It’s tax season in the U.S. right now! Even though that deadline has just been pushed back to May 17, taxes are on everybody’s mind, so this is a good time to write about the topic in the context of the Safe Withdrawal Rate Series. Until now, I haven’t written all that much about taxes and the main reasons are:
While I do have a combined 6 letters behind my name (Ph.D. & CFA), I’m missing the three letters “CPA” to write anything truly authoritative about the topic.
My primary focus is on getting the Safe Withdrawal Rate right. It’s the first issue everyone should worry about. I did some case studies years ago for early retirees and some of them could actually raise their SWR to more than 5% if they do their accounting for future cash flows right. That’s 25% better than the naïve 4% Rule. If you start with a tax plan that’s already somewhat OK and close to optimal, I doubt that you can squeeze out another 25% in after-tax withdrawals through a truly “optimal” tax plan. Hence my approach: get your SWR right and factor in the tax optimization plan afterward to make sure you squeeze maybe another percent or two in the after-tax numbers! (And likewise, if you have a 60-year horizon and not much in the way of supplemental cash flows and you’re looking at a 3.25%, maybe a 3.5% withdrawal rate, you’re not going to “tax-hack” yourself to a 4% withdrawal rate either!)
Taxes are very personal and it’s difficult to give any generalized advice. As much as I would like to create a spreadsheet like the Google Sheet to simulate safe withdrawal rates (See Part 28 for the details) where you plug in your numbers and the sheet spits out a detailed plan, it’s not so trivial. Very likely, the tax analysis would have to be more custom-tailored! And just to be sure, my Google SWR simulation sheet isn’t trivial either! 🙂
But of course, even if you first do your SWR analysis in before-tax terms, you will want to know how much of a haircut you need to apply to calculate your after-tax retirement budget. Some retirees can indeed make over $110,000 a year and don’t owe any federal tax as I showed in my post in 2019 (“How much can we earn in retirement without paying federal income taxes?“). And in the same post, I showed that to get to a 5% average tax you’ll likely need a $150k annual retirement budget. So, it’s a fair assumption that most of us in the FIRE community will likely get away paying less than 5% of our retirement budget in federal taxes. Add another 0-5% or so for most state tax formulas, and you will likely stay below 10% effective/average tax rate.
But I get the message: because we can’t completely ignore taxes, I wrote today’s post to talk about the general ideas and principles in retirement tax planning. In at least one additional future post (maybe two, maybe three) I will also do a few case studies to see the general principles in action. At that point, I will also include the Excel Sheet I use to perform the tax planning analysis because a lot of readers asked for that tool when I published the Case Studies 3+ years ago! And as I warned before: it’s not as simple as just putting your parameters and Excel automatically spits out your plan. It involves a bit more human input and analysis, stay tuned!
But before we even get to the messy parts, let’s take a look at some general principles…
A while ago I wrote about the challenge of designing pre-retirement equity/bond glidepaths (“What’s wrong with Target Date Funds?“). In a nutshell, the main weakness of Target Date Funds (TDFs) for folks planning an early retirement is that if you have a short horizon and a large savings rate then the “industry standard” TDF is probably useless. 10 years before retirement, the TDF has likely shifted too far out of equities, likely below 70%!
The problem is that the traditional glidepaths are calibrated to the traditional retiree (who would have guessed???) with a sizable nest egg ten years away from retirement. In that case, you want to hedge against the possibility of a bear market so close to retirement from which you might have trouble recovering due to the relatively small contributions of “only” 10-15% of your income. But people planning early retirement with a small initial net worth and a massive 50+% savings rates should clearly take more risk to get their portfolio off the ground.
In any case, back then I mentioned that I had some additional material about glidepaths toward retirement for the FIRE community, to be published at a later date, which is today!
Why is this post part of the Safe Withdrawal Rate Series? First, today’s post is a natural extension of the FIRE glidepath posts (Part 19, Part 20) in this series. Moreover, the majority of readers of the series are not necessarily retired yet. Many seek guidance during the last few years before retirement. In fact, one of the most frequent questions I have been getting is that people who are almost retired and still holding 100% equities wonder how they are supposed to transition to a less aggressive allocation, say 75% stocks and 25% bonds at the start of retirement. Should you do a gradual transition? Or keep the allocation at 100% equities and then rapidly (cold-turkey?) shift to a more cautious allocation upon retirement?
In late January, I wrote about my thoughts on the crazy wild ride in GameStop and some other meme stocks. Now might be a good time to do an update to talk about some of the other things I learned. For example, how a short-interest ratio of more than 100% is surely disconcerting but it’s not quite as scary as it’s often portrayed if you do your math right – which seems to be a luxury good these days!
Last week on Thursday we got a new snapshot on how the economy is doing. The Bureau of Economic Analysis released the quarterly Gross Domestic Product (GDP) numbers that day and the headline number came out as +4%. So the economy grew at an annualized rate of 4% that quarter or about 1% quarter-over-quarter. Not bad! Considering the uncertainty about growth going forward after the blockbuster 33.4% third quarter growth number it’s reassuring that we kept some of the upward momentum in the fourth quarter.
But just to be sure, there is still a lot of economic pain and uncertainty out there. You ask two different people and you will hear two different opinions on how the economy is going. Unless, of course, they are economists and you will hear three different opinions, as the joke goes.
Since I wrote my post about the Q3 GDP release three months ago and it was quite popular, I thought it would be a good idea to write another update. Is the recession finally over? How much of the pandemic-induced loss has the economy recovered? Do we have to worry about a renewed drop in the economy? Let’s take a look..
Update (February 8, 2021): Well, there you have it, GameStop is back closer to reality at around $60 as of today. It lost 80+% from the peak value. Who would have guessed that?!
January 30, 2021
Wow, what a week! I was reminded again why I prefer to be an index investor (for the most part). I don’t have to live through the wild price moves as we saw in GameStop (GME) and the other “meme stocks”. And I don’t have to worry about trading restrictions. But it was entertaining to watch the drama, stocks going up by 100+% in one day and seeing short-seller hedge funds being driven to the brink of ruin. The media certainly loved this story of David vs. Goliath; a mob of Reddit users in the “Wall Street Bets” (WSB) group vs. the powerful finance establishment! My blogging buddy Retire in Progress wrote a nice post about the GameStop Short Squeeze. But I also wanted to share some of my own thoughts. Let’s take a look…
Happy New Year, everyone! And welcome to a new installment of the Safe Withdrawal Rate Series. Today I like to write about the One More Year Syndrome(OMYS) – the fear of retirement and the decision to just work another year. What I find intriguing about OMYS is that procrastination normally works the other way around. You opt for the fun and easy stuff and promise yourself to do the hard work tomorrow. Only to repeat that charade again tomorrow and postpone the unpleasant tasks to the day after tomorrow. And so on.
But why procrastinate a fun-filled early retirement and keep working? Physician on FIRE and Fritz at The Retirement Manifesto have written about their rationales. The number one reason is that you grow your nest egg and put your retirement finances on a better footing. That was certainly my main rationale, too. I could have retired comfortably in 2017, probably even in 2016 but I delayed that decision until 2018.
So, qualitatively it’s obvious. But can we quantify by how much the OMYS improves your retirement security? Is it worth the additional year in the workforce? How can we incorporate OMYS in the Big ERN Google Safe Withdrawal Simulation Sheet? Is it possible that OMYS will boost your retirement health so substantially that it’s not as irrational as it’s sometimes made? Let’s take a look…