The Ultimate Guide to Safe Withdrawal Rates – Part 21: Why we will not have a mortgage in early retirement

Welcome back to the newest installment in our Safe Withdrawal Rate Series! If you are new to our site please go back to Part 1 to start from the beginning. And there are quite a few new visitors these days. That’s because our small blog is one of the finalists in the “Blog of the Year” category at the upcoming 2017 Plutus Awards. How awesome is that? Thank you to all of our faithful readers and followers for supporting and nominating Early Retirement Now!

But back to the topic at hand. It’s been on my mind for a long time. It’s relevant to our own situation and it’s come up in discussions on other blogs, in our case study series and in numerous questions and comments here on the ERN blog:

Should we have a mortgage in Early Retirement?

The case for having a mortgage is pretty simple: You can get a 30-year mortgage for about 4% right now. Probably even slightly below 4% when you shop around. Equities will certainly beat that nominal rate of return over the next 30 years. Open and shut case! End of the discussion, right? Well, not so fast! As we have seen in our posts on Sequence of Return Risk (Part 14 and Part 15), the average return is less relevant than the sequence of returns. Having a mortgage in retirement will exacerbate your sequence of return risk because you are frontloading your withdrawals early on during retirement to pay for the mortgage; not just interest but also principal payments. In other words, if we are unlucky and experience low returns early during our retirement (the definition of sequence risk) we’d withdraw more shares when equity prices are down. The definition of sequence risk!

How badly will a mortgage mess with sequence risk and safe withdrawal rates? That’s the topic for today’s post…Read More »

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The Ultimate Guide to Safe Withdrawal Rates – Part 20: More Thoughts on Equity Glidepaths

Welcome back to the 20th installment of the Safe Withdrawal Rate series. Check out Part 1 to jump to the beginning of the series and for links to the other parts! This is a follow-up from last week’s post on equity glidepaths to address a few more open questions:

  1. Some more details on the mechanics of the glidepath and why it’s so successful in smoothing out Sequence of Return Risk.
  2. Additional calculations requested by readers last week: shorter horizons, other glidepaths, etc.
  3. Why are my results so different from the Michael Kitces and Wade Pfau research? Hint: Historical Simulations vs. Monte Carlo Simulations.

So, let’s get to work …

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The Ultimate Guide to Safe Withdrawal Rates – Part 19: Equity Glidepaths in Retirement

One of the most requested topics for our Safe Withdrawal Rate Series (see here to start at Part 1 of our series) has been how to optimally model a dynamic stock/bond allocation in retirement. Of course, as a mostly passive investor, I prefer to not get too much into actively and tactically timing the equity share. But strategically and deterministically shifting between stocks and bonds along a “glidepath” in retirement might be something to consider!

This topic also ties very nicely into the discussion I had with Jonathan and Brad in the ChooseFI podcast episode on Sequence of Return Risk. In the podcast, I hinted at some of my ongoing research on designing glidepaths that could potentially alleviate, albeit not eliminate, Sequence Risk. I also hinted at the benefits of glidepaths in Part 13 (a simple glidepath captures all the benefits of the much more cumbersome “Prime Harvesting” method) and Part 16 (a glidepath seems like a good and robust way of dealing with a Jack Bogle 4% equity return scenario for the next 10 years).

The idea behind a glidepath is that if we start with a relatively low equity weight and then move up the equity allocation over time we effectively take our withdrawals mostly out of the bond portion of the portfolio during the first few years. If the equity market were to go down during this time, we’d avoid selling our equities at rock bottom prices. That should help with Sequence of Return Risk!

GlidepathPlot
Static Asset Allocation vs. Glidepath in (early) retirement. 80% static equities vs. a glidepath going from 60% to 100%.

So, will a glidepath eliminate or at least alleviate Sequence Risk? How much exactly can we benefit from this glidepath approach? For that, we’d have to run some simulations…
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The Ultimate Guide to Safe Withdrawal Rates – Part 18: Flexibility and the Mechanics of CAPE-Based Rules

Welcome back to the newest installment of the Safe Withdrawal Rate Series. To go back and start from the beginning, please check out Part 1 of the series with links to all the other parts as well.

Today’s post is a follow-up on some of the items we discussed in the ChooseFI podcast a few weeks ago. How do we react to a drop in the portfolio value early on during our retirement? Recall, it’s easy not to worry too much about market volatility when you are still saving for retirement. As I pointed out in the Sequence of Return Risk posts (SWR series Part 14 and Part 15), savers can benefit from a market drop early during the accumulation phase if the market bounces back eventually. Thanks to the Dollar Cost Averaging effect, you buy the most shares when prices are down and then reap the gains during the next bull market. That has helped the ERN family portfolio tremendously in the accumulation phase in 2001 and 2008/9.

But retirees should be more nervous about a market downturn. Remember, when it comes to Sequence of Return Risk, there is a zero-sum game between the saver and the retiree! A market drop early on helps the saver and thus has to hurt the retiree. What should the retiree do, then? The standard advice to early retirees (or any retiree for that matter) is to “be flexible!” Great advice! But flexible how? We are all flexible around here. I have yet to meet a single person who claims to be completely inflexible! “Being flexible” without specifics is utterly useless advice. It’s a qualitative answer to an inherently quantitative problem. If the portfolio is down by, say, 30% since the start of our retirement, then what? Cut the withdrawal by 30%? Keep withdrawals the same? Or something in between?

How flexible do I have to be to limit the risk of running out of money?

That’s today’s post: Using dynamic withdrawal rate strategies, specifically CAPE-based withdrawal rules, to deal with the sequence of returns risk…

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The Ultimate Guide to Safe Withdrawal Rates – Part 17: More on Social Security and Pensions (and why we should call the 4% Rule the “4% Rule of Thumb”)

Welcome back to our series on Safe Withdrawal Rates. This is already the 17th installment! See Part 1 here and make sure you also check out the Social Science Research Network Working Paper we posted on the topic, now with 2,000+ downloads!

In any case, if you have followed the series so far you must have noticed that we are no fans of the 4% Rule and much of what we posted here dealt with the “4%” portion of the 4% Rule. For example, in Part 3 of this series we show that when equities are as expensive as today (Shiller CAPE > 20), failure rates of the 4% Rule have been unacceptably high in historical simulations.

But I think I missed this really important point:

The only thing more offensive than the “4%” part is the word “Rule”

That’s because the word “Rule” makes it sound as though the 4% is some sort of a scientific or mathematical constant. But it’s not. It ain’t scripture either, even though it’s often portrayed that way! There is no one-size-fits-all solution for withdrawals in retirement. With today’s lofty equity valuations and measly bond yields, a 3.25% to 3.50% initial withdrawal rate would be much more prudent. But there is another element that creates just as much variation in SWRs: Different assumptions about Social Security and/or pension benefits: The benefit level, the number of years before benefits kick in, how much of a haircut you want to assign to account for the risk of potential future benefit cuts, etc. and they all create so much variation in personal SWRs that the whole notion of a safe withdrawal rate “Rule” is even more absurd. The 4% Rule should be called the 4% Rule of Thumb because 4% is merely a starting point:

SWR = 4% Rule of Thumb

+/- adjustments for equity/bond valuations

+/- adjustments for idiosyncratic factors, e.g. age, Social Security, pensions, etc.

How much of a difference do these idiosyncratic/personal factors make? A huge difference! A prime example is the case study I worked on over at the ChooseFI podcast: a couple in their early 50s expects pretty generous Social Security benefits after a long career and probably wouldn’t have to worry too much about future benefit cuts. If they both wait until age 70 to claim benefits and are able to reduce their withdrawals from their portfolio dollar for dollar once Social Security kicks in, their Safe Withdrawal Rate estimate goes up from a measly 3.5% to somewhere around 4.5% or even 4.75%. Instead of saving 28.6x annual expenses, they’d need only 22.2x or even 21.1x. That’s a difference of several $100k!

How to quickly and easily gauge the impact of future cash flows from Social Security or pensions on the SWR is the topic of today’s post!Read More »

The ERN Family Early Retirement Capital Preservation Plan

Fritz at The Retirement Manifesto suggested we start a series covering how different FIRE bloggers plan to implement their drawdown strategy. I realize we are a bit late to the party given how many fellow bloggers have already contributed:

The Anchor: Physician on FIRE: Our Drawdown Plan in Early Retirement

Link 1: The Retirement Manifesto: Our Retirement Investment Drawdown Strategy

Link 2: OthalaFehu: Retirement Master Plan

Link 3: Plan Invest Escape (PIE): Planning for Success: Drawdown versus Wealth Preservation in Early Retirement

Link 4: Freedom is Groovy: Freedom is Groovy

Link 5: The Green Swan: The Green Swan

Link 6: My Curiosity Lab: Show Me The Money: My Retirement Drawdown Plan

Link 7: Cracking Retirement: Our Drawdown Strategy

Link 8: The Financial Journeyman: Early Retirement Portfolio & Plan

Link 9: Retire By 40: Our Unusual Retirement Withdrawal Strategy

Link 10: Early Retirement Now:  The ERN Family Early Retirement Captial Preservation Plan (This will land you back in this post. Make sure you don’t end up in an infinite loop! 🙂 )

Link 11: 39 Months: Mr. 39 Months Drawdown Plan

Link 12:  7 Circles:  Drawdown Strategy – Joining The Chain Gang

Link 13:  Retirement Starts Today:  What’s Your Retirement Withdrawal Strategy?

Link 14: Ms. Liz Money Matters: How I’ll fund my retirement

Link 15a: Dads Dollars Debts:  DDD Drawdown Part 1: Living With A Pension

Link 15b: Dads Dollars Debts:  DDD Drawdown Plan Part 2: Retire at 48?

Link 16: Penny & Rich: Rich’s Retirement Plan

Link 17:  Atypical Life:  Our Retirement Drawdown Strategy

Link 18:  New Retirement: 5 Steps For Defining Your Retirement Drawdown Strategy

Link 19:  Maximize Your Money: Practical Retirement Withdrawal Strategies Are Important

Link 20:  ChooseFI:  The Retirement Manifesto – Drawdown Strategy Podcast

So, better late than never: here’s the ERN family contribution. To begin, we are intentionally not calling this a drawdown plan. We will draw from our investments but hopefully never significantly draw them down. So, we are more in the PIE camp, trying to maintain our capital. Even if we were comfortable with leaving nothing to our heirs and charitable causes in 60 years, the drawdown over 60 years would be so small (especially early on, think of this as the initial amortization in a 60-year mortgage!) that we might as well plan for capital preservation rather than drawdown.

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The Ultimate Guide to Safe Withdrawal Rates – Part 16: Early Retirement in a Low-Return World (and why we don’t worry about Jack Bogle’s return prediction)

A while ago I read that Jack Bogle predicts that equities will return only 4% over the next decade. And that already includes dividends and it’s nominal, not real! People call me pessimistic with my equity return assumption for stocks, but good old Jack takes it down another notch. Here’s the quote, reproduced on CNBC:

“Just for mathematical reasons, the dividend yield is 2 percent, a little under 2 percent in fact, and the long-term dividend yield on stocks is pretty close to 4 … the earnings growth on stocks has been a little over 5, that’s going to be a very tough target in the future so let’s call it 4 … 4 and 2 percent give you a 6 percent investment return, but then you have to take … the valuations in the market. …You take that 6 percent return and maybe knock it off a couple of points perhaps for a lower valuation, slightly lower valuation over a decade and you’re talking about a 4 percent nominal return on stocks. And that’s low, lower than history. History is around 6 and a half.”

Wow! That’s a bummer: 4% nominal means about 2% real with a generally agreed upon 2% annual inflation rate. Or another way to look at this return prediction: If we assume that equities pay around 2% in dividend yield, then the equity price index will go up by only the rate of inflation. For ten years!

Everyone in the FIRE community should take notice. If you’re still in the accumulation phase you’ll likely need longer to reach FIRE. If you’re already retired and apply the good old 4% Rule then a Bogle-style scenario will likely put some strain on your portfolio. So, in today’s post let’s look at what the Bogle scenario means for Safe Withdrawal Rates in Early Retirement.

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The Ultimate Guide to Safe Withdrawal Rates – Part 15: More Thoughts on Sequence of Return Risk

Welcome back to our Safe Withdrawal Rate Series! Last week’s post on Sequence of Return Risk (SRR) got too long and I had to defer some more fun facts to this week’s post. Again, to set the stage, I can’t stress enough how important Sequence of Return Risk is for retirement savers. In fact, after doing all this research on safe withdrawal rates (start series here, and also check out our SSRN research paper) if someone asked me for the top three reasons a retirement withdrawal strategy fails I’d go with:

  1. Sequence of Return Risk,
  2. Sequence of Return Risk,
  3. and let’s not forget that pesky Sequence of Return Risk!

Huh? Isn’t that lame? Surely, low average returns throughout retirement ought to be included in that list, right? Or even top that list, right? That’s what I thought, too. Until I looked at the data! Let’s get rolling and look at some more SRR fun facts.Read More »

The Ultimate Guide to Safe Withdrawal Rates – Part 14: Sequence of Return Risk

This is a long overdue post considering how much we’ve written about safe withdrawal rates already. Sequence of Return Risk, sometimes also called Sequence Risk, is the scourge of early retirement. Or any retirement for that matter. So, here we go, finally, we have a designated post on this topic for our Safe Withdrawal Rate series (check here to go to the first post and also make sure you download Big Ern’s SSRN working paper on the topic).

Besides, in case you haven’t heard it, yours truly, Big Ern, was asked by Jonathan and Brad at ChooseFI to be an occasional contributor to their awesome Financial Independence podcast. Specifically, I’ll be the in-house expert on everything related to safe withdrawal rates. And that’s alongside an A-plus-rated team of experts: real estate guru Coach Carson, tax expert The Wealthy Accountant, and business guru Alan Donegan from PopUp Business School! How awesome is that? Because Sequence of Return Risk is something we’ll cover in the podcast soon as part of a crowdsourced case study, I thought it would be a good time to have a go-to reference post on the topic here on our blog. So, once again, make sure you head over to the ChooseFI podcast:

-> ChooseFI Podcast <-

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The Ultimate Guide to Safe Withdrawal Rates – Part 13: Dynamic Stock-Bond Allocation through Prime Harvesting

Welcome back to the Safe Withdrawal Rate series. 13 installments already! As requested by many readers, both in the comments section and via email, I wanted to look into one intriguing method, called “Prime Harvesting” (PH) to dynamically shift the stock vs. bond allocation during retirement. Where does this post fit into the big picture? Recall that parts 1-8 of our series dealt with fixed withdrawals and fixed asset allocation (same % stocks and bonds throughout retirement). Make sure you check out our SSRN working paper, now downloaded over 1,000 times!

Parts 9-11 dealt with how to adjust the withdrawal amounts while keeping the asset allocation fixed (Guyton-Klinger, VPW, CAPE-based rules, etc.). Prime Harvesting does something completely different: Keep the withdrawal amount constant, but use a dynamic stock/bond asset allocation to (hopefully) squeeze out some extra withdrawal wiggle room; the Northwest corner in the diagram below. Almost uncharted territory in our series!

SWR-Part13-Chart3
13 parts of Safe Withdrawal Rate research and where they all fit in.

Eventually, of course, we like to move to that Northeast corner: Dynamic withdrawals and Dynamic Asset Allocation. But let’s take it one step at a time! Let’s see what this Prime Harvesting is all about.

Let’s get cranking!Read More »