How often should we rebalance our portfolio? – SWR Series Part 39

August 5, 2020

In the 3+ years, while working on the Safe Withdrawal Rate Series, I regularly get this question:

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:

  1. 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.
  2. 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.
  3. 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.
  4. 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?

Let’s take a look… Continue reading “How often should we rebalance our portfolio? – SWR Series Part 39”

When Can We Stop Worrying about Sequence Risk? – SWR Series Part 38

July 15, 2020

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…

Continue reading “When Can We Stop Worrying about Sequence Risk? – SWR Series Part 38”

Dealing with a Bear Market in Retirement – SWR Series Part 37

March 25, 2020

In my post last week, I looked at how the 2020 Bear Market will impact folks saving for (early) retirement. But I deferred my recommendations on how current retirees will optimally adjust to the new realities. So, here we go, a new installment of the Safe Withdrawal Series, now 37 posts strong!

Nothing I write here today should be shocking news to people who have read the other 36 parts, but having it all summarized in one place plus some new simulations and perspectives is certainly a worthwhile exercise. In a nutshell, I argue that if you’ve done your homework before you retired, not even a bear market, not even this bear market will derail your retirement. Depending on what approach people chose, some retirees might even increase their spending target now.

Let’s take a look…

Continue reading “Dealing with a Bear Market in Retirement – SWR Series Part 37”

Safe Withdrawal Math with Real Estate Investments – SWR Series Part 36

Welcome to another installment of the Safe Withdrawal Rate Series. This one has been requested by a lot of folks: Let’s not restrict our safe withdrawal calculations to paper assets only, i.e., stocks, bonds, cash, etc. Lots of us in the early retirement community, yours truly included, have at least a portion of our portfolios allocated to real estate. What impact does that have on our safe withdrawal rate? How will I even model real estate investments in the context of Safe Withdrawal and Safe Consumption calculations? So many questions! So let’s take a look at how I like to tackle rental real estate investments and why I think they could play an important role in hedging against Sequence Risk and rasing our safe withdrawal rate…

Continue reading “Safe Withdrawal Math with Real Estate Investments – SWR Series Part 36”

Asset Location: Do Bonds Really Belong in Retirement Accounts? – SWR Series Part 35

Welcome back to another installment of the Safe Withdrawal Rate Series. This one is about taxes. Amazing, how after 30+ installments in the series, I have written conspicuously little about taxes. Sure, I’ve done some Case Studies where, among many other issues, I delved into the tax planning, most recently in the Case Study for Becky and Stephen. But I’ve never written much about taxes and tax planning in the context of the Series.

There are two reasons why I kept the tax discussion on such a low burner: First, my background: If I had an accounting Ph.D. and CPA instead of an economics Ph.D. and a CFA charter, I would have written a whole lot more about taxes! Second, pinning down the Safe Withdrawal strategy and the safe withdrawal rate is my main concern. Most (early) retirees will have extremely low tax liabilities as I outlined in a post last year. You’d have to try pretty hard to pay more than a 5% federal effective tax rate in retirement. So, as long as you stay away from anything clearly irresponsible on the tax planning side, you’re fine. Don’t stress out over taxes in retirement unless you have a really, really large nest egg and taxable income deep into the six-figures during retirement.

But you don’t want to leave any money on the table either. So, I still want to write about taxes if I encounter something that captures my attention. And I came across a topic that’s most definitely interesting from a withdrawal strategy perspective: Asset Location (as opposed to Asset Allocation).

Imagine you target a particular asset allocation, say 60% stocks and 40% bonds. Or 70/30, or 80/20, or whatever suits your needs the best. How should we allocate that across the different account types? If we put all the different accounts into three major buckets…

  1. Taxable, i.e., your standard taxable brokerage account: Interest, dividends and realized capital gains are taxable every year they show up on your 1099 tax form. But you don’t have to pay taxes on capital gains until you realize them.
  2. Tax-deferred, i.e., your 401(k) or your Traditional IRA. Your account grows tax-free until you actually withdraw the money (or roll it over to a Roth). So, so can realize as much in interest income, dividends, capital gains along the way, as long as you keep the money inside the account.
  3. Tax-free, i.e., your Roth IRA or your HSA. The money grows tax-free and you can withdraw tax-free as well.

… then where do we put our bonds and where do we put our stocks? It would be easy, though likely not optimal to simply keep that same asset allocation in all three types of accounts. But is there a better way to allocate your stock vs. bond allocation?

Sure, there is! One of the oldest pieces of “conventional wisdom” investment advice I can remember is this:

“Keep stocks in a taxable account and bonds in your tax-advantaged accounts.”

Or more generally:

“Keep the relatively tax-efficient investments in a taxable account and relatively tax-inefficient investments in a tax-advantaged account.”

Most stocks would be considered more tax-efficient than bonds because a) dividends and capital gains are taxed at a lower rate than interest income and b) you can defer capital gains until you actually withdraw your money, which is a huge tax-advantage (more on that later).

So, it appears that we should ideally load up the taxable account with stocks and the tax-advantaged accounts with bonds. Hmmm, but that doesn’t sound quite right, does it? Why would I want to “waste” the limited shelf space I have in my tax-advantaged accounts with low-return bonds while I expose my high-return stocks to dividend and capital gains taxes? So, it would be completely rational to be skeptical about this common-sense advice!

So who’s right? Conventional wisdom or the skeptics? Long story short: they’re both wrong! You can easily construct examples where either conventional wisdom or the skeptics prevail. So neither side should claim that their recommendation is universally applicable. The asset location decision depends on…

  1. Your expected rates of return,
  2. Your expected tax rates,
  3. Your investment horizon. Yup, you heard that right, it’s possible that you want to go either one way or the other depending on the horizon. Though, this is not really a separate case but really only a result of asset allocation drift. Accounting for that, we’re back to the two cases, but more on that later!

Let’s look at the details…

Continue reading “Asset Location: Do Bonds Really Belong in Retirement Accounts? – SWR Series Part 35”

Using Gold as a Hedge against Sequence Risk – SWR Series Part 34

Happy New Year! It’s time for another installment in the Safe Withdrawal Series! Here’s a topic that I’ve thought about for a while and that was also requested dozens, maybe even hundreds of times from commenters: What about gold? Gold has been a safe haven asset for many decades (Centuries? Millenials???) and it should have the potential to hedge against Sequence of Return Risk. And I recently found this article on Yahoo Finance: “The world’s super-rich are hoarding physical gold“. Maybe it’s just click-bait. Yahoo Finance must have lowered its standards substantially because they even (re-)published one of my articles last year. 🙂

But seriously, in light of the recent runup in gold prices, rising interest by the world’s super-rich and the many requests by readers, I’ve finally gotten around to studying this subject in the context of Sequence Risk. Let’s take a look at how useful gold would be as a hedge against running out of money in retirement…
Continue reading “Using Gold as a Hedge against Sequence Risk – SWR Series Part 34”

How to Calculate Your Safe Withdrawal Rate without using Simulations – SWR Series Part 33

It’s time for a new post in the Safe Withdrawal Rate Series. It’s been a while, I know! This is a post I’ve been mulling over for a long time and a recent suggestion from a reader made me revisit my notes again. Why not calculate sustainable withdrawal based on how accountants or actuaries work. No simulations necessary! Neither historical nor Monte Carlo simulations! And here’s the kicker: you run this SWR calculation with all the data you’re going to assemble to use my Google SWR Sheet already. No extra work necessary! So, what do we have to do? Very simple:

  1. Take stock of all of your asset and liabilities today
  2. Take stock of all of your future expected cash flows: both positive (Social Security, Pensions, etc.) and negative (health expenses, kids’ college expenses, etc.).

This is essentially the information that you’d already need to know when doing a Safe Withdrawal Rate analysis, specifically, the inputs for the Safe Withdrawal Google Sheet, see Part 28 of this series!

So, how do you calculate a safe withdrawal rate without simulating anything? Very simple, use Net Present Value (NPV) calculations to transform all future cash flows (Social Security, Pensions, annuities, etc.) into today’s values, so you will end up with an adjusted net worth that takes into account not just your current assets and liabilities but also all of the future flows. And again, those future flows can be positive (Social Security, pensions) or negative (setting aside money for health expenses, nursing homes, etc.)

Once we have this “adjusted net worth” we can simply do a “reverse NPV calculation” to determine what retirement budget will exactly match our net worth. And that’s a sustainable retirement budget the way an actuary or an accountant would likely compute it.

Before everybody gets too excited, though, let me state the obvious: I would not recommend relying exclusively on this one approach and you’ll need to rely on simulations after all – more on the disadvantages below. But I certainly like the simplicity and some of the information we can gather from this approach!

Let’s take a look…
Continue reading “How to Calculate Your Safe Withdrawal Rate without using Simulations – SWR Series Part 33”

A Safe Withdrawal Rate Case Study for Becky and Stephen

What? A new case study? I know, I had promised myself to wind down the Case Study Series I ran in 2017/18 after “only” 10 installments. It was a lot of work and a lot of back and forth via email. It takes forever! I mean F-O-R-E-V-E-R! But then again, there’s always a reason to make an exception to the rule! Jonathan and Brad from the ChooseFI Podcast had a very interesting guest on their show this week (episode 152). Becky talked about her experience of a late start in getting her and her husband’s finances in order. They started at around age 50 and became Financially Independent (FI) in their early 60s and retired a year ago. I should also mention that Becky recently started her own blog, appropriately labeled Started At 50, writing about her path to FI and RE so make sure you check that out, too.

In any case, Jonathan and Brad asked me to look at Becky’s numbers because I must be some sort of an expert on Safe Withdrawal Strategies in the FIRE community. I chatted with Jonathan and Brad about my case study results the other day and this conversation should come out as this week’s Friday Roundup episode. Because there’s only so much time we had on the podcast and I didn’t get to talk about everything I had prepared, I thought I should write up my notes and share them here. Heck, with all of that effort already spent, I might as well make a blog post out of it, right? That’s what we have on the menu for today… Continue reading “A Safe Withdrawal Rate Case Study for Becky and Stephen”

You are a Pension Fund of One (or Two) – SWR Series Part 32

Before we get to the business part of today’s post, again, let me thank everybody who nominated my blog for this year’s Plutus Awards! We got into the final five in two categories: “Best Financial Independence/Early Retirement Blog” and “Best Series: Blog, Podcast, or Video.” We’ll find out at FinCon next week on Friday who will win! But let’s not forget that there’s also the People’s Choice Award. I never even actively encouraged anyone to vote for me yet – I never thought I’d have a chance anyway. But it looks like the ERN blog is among the top 10 contenders as of August 28, see screenshot below! How awesome is that? If you haven’t cast a vote yet, please consider heading over to the Plutus Award page…

https://www.plutusawards.com/nominate/?pc=earlyretirementnow.com

… to nominate the ERN blog for that category. All you need is to enter your name and email address. The blog URL is already pre-filled! 🙂

SWR-Part32-PlutusAward01
Source: PlutusFoundation.org

But let’s get to the really important business. Safe Withdrawal Strategy business! The other day I was browsing on Amazon to look for the book “The Simple Path to Running a Pension Fund” and couldn’t find anything. Maybe Jim Collins is working on that right now? Or Mr. Money Mustache might have a blog post on the “simple math” or wait, I mean the “shockingly simple math” of running a pension fund? Duh’uh! Of course, there is no such simple path/simple math! Because it’s no simple task. Lots of people are involved in running a pension fund. And we’re not just talking about the operational people; customer service reps, lawyers, etc. There would also be a bunch of highly-trained investment professionals taking care of the portfolio. When I worked in the asset management industry I talked to them frequently because a lot of our clients were indeed pension funds. 

And I realize that – strictly speaking – I’m actually running a pension fund right now. For a married couple like us, it has only two beneficiaries, my wife and myself. I could count our daughter as beneficiary #3 because she’ll get some money for the first two decades or her life, but strictly speaking, she’s more of a “residual claimant” who’s going to get most of the “leftovers” when Mrs. ERN and I are gone. All of us in the FIRE community are running our own little one-person or two-person pension funds. And of course, in a lot of ways, running these small-potato pension funds is a lot easier than what the big guys (and gals) are doing. We don’t need fancy buildings, lawyers, customer reps, etc. But that’s the bureaucracy side. How about the mathematical and financial aspects? I’ve obviously written about how decumulating assets in retirement is clearly more complicated than accumulating assets while working (see Part 27 of this series – Why is Retirement Harder than Saving for Retirement?) but I was surprised how my DIY pension fund faces math/finance challenges greater than even a large pension fund. So, here are seven reasons why I think my personal pension fund is a heck of a lot more challenging than a corporate or public pension fund…

Continue reading “You are a Pension Fund of One (or Two) – SWR Series Part 32”

The Safe Withdrawal Rate Series: A Guide for First-Time Readers

We’re back home in Washington State after our epic 2019 Summer Tour. Four months on the road, mostly in Europe with a quick visit in Morocco for a week! In early August, while traveling I almost fell out of my chair (or was it my bed?) when I read that my little blog is nominated for not one but two (!) Plutus Awards this year. “Best Financial Independence/Early Retirement Blog” and my work on the Safe Withdrawal Rate research was nominated in the “Best Series: Blog, Podcast, or Video” category, how awesome is that? So, please accept my deep gratitude: thanks to everyone who took the time to submit a ballot and nominate my blog! I’m very humbled and honored. Whether it’s a Plutus Award nomination or just a friendly comment or email, thanks for supporting my work here! It always makes my day! 🙂

Plutus2019_011Plutus2019_021

Talking about the Safe Withdrawal Rate Series, I often get feedback like this one, let me paraphrase:

“The entire series is obviously very helpful but also a bit intimidating. As a first-time reader, where should you even start?”

I hear you! I totally hear you! So, I wrote a new “landing page” for the Series that has a summary of all 31 posts, grouped by major topic and also a few suggestions for readers what to read depending on preferences and where you are with your early retirement planning. There are two ways to get to this new summary page:

1: Click this new link:

https://earlyretirementnow.com/safe-withdrawal-rate-series

2: Even easier, when you’re anywhere on the ERN blog webpage, simply go to the top of the page and click the new menu option “Safe Withdrawal Rate Series” – see below!

NewMenuSWR1

So, if you get a chance, please check out that new landing page and let me know what you think! And please continue sharing the SWR Series everywhere people discuss safe withdrawal rates, ideally using that new landing page link! Many thanks in advance!

Continue reading “The Safe Withdrawal Rate Series: A Guide for First-Time Readers”