Welcome, everyone, to another installment of the Safe Withdrawal Rate Series! See here for Part 1, but make sure you also check out Part 26: Ten things the “Makers” of the 4% Rule don’t want you to know for a more high-level, less technical intro to my views on Safe Withdrawal Strategies! Today’s topic is something that has come up frequently in reader inquiries, whether through email or in the blog post comments. Let me paraphrase what people normally write:
“Here’s how I can guarantee my withdrawal strategy won’t fail: I simply hold a portfolio with a high enough yield! Now the regular cash flow covers my expenses. Or at least enough of my expenses that I never have to worry much about Sequence Risk, i.e., liquidating principal at depressed prices.”
I’ve seen several of those in the last few weeks and it’s a nice “excuse” to write a blog post about this very important topic. So, what do you think I normally reply? Want to take a guess? It’s one of the two below:
A: Oh, my God, you got me there. This is indeed the solution to once and for all, totally and completely eliminate Sequence Risk! I will immediately take down my Safe Withdrawal series and live happily ever after.
B: Your suggestion sounds really good in theory but there are serious flaws with this method in practice. It will likely be no solution to Sequence Risk. And in the worst case, your “solution” may even exacerbate Sequence Risk!
Anyone? Of course, it’s option B. It sounds like a great idea in theory but it has very serious flaws once you look at the numbers in detail. Let’s take a look…
I hope everybody checked out the ChooseFI Roundup episode in early January, where I talked with Jonathan and Brad about the recent stock market volatility. They invited me for a short appearance on their Friday show after reading my piece from two weeks ago. That post was on how the recent stock market volatility will probably not obliterate the FIRE community. One issue that came up is the potential for people on their FIRE path to actually benefit (!) from the drop in the stock market. How can one possibly benefit from a drop in the stock market? It’s certainly not a guarantee. It depends on the personal circumstances and on the nature of the stock market drop! Generally speaking:
How permanent or how transitory is the drop in the market? If your portfolio dropped because one of the equity or bond holdings went bankrupt (or you were a victim of the OptionSellers meltdown) then that’s not something to cheer about. It’s about as permanent as it gets. Not good for the investor! But frequently, the market drops without much of a change in fundamentals. Be it a “flash crash” that reverses within a few hours or even minutes or the (likely) overreaction of the stock market drop in December, one could argue that since nothing (or not much) changed in the fundamentals (GDP growth, earnings growth, etc.) the drop may be only temporary and will eventually revert to the mean. Or even during a recession (the definition of weaker fundamentals!) stocks often overreact on the downside and then stage a strong comeback, i.e., return expectations going forward could be higher than long-term average returns. In other words, that paper loss you see now could be at least cushioned by higher returns on your additional savings going forward. And if this admittedly uncertain advantage of higher expected returns is large enough and over time more than offsets the paper loss then we could be looking at a net gain.
How far along are you on your path to FIRE? The further along you are the more damage a bear market will cause even if you can expect a bounce in future expected returns from a transitory shock to the market. On the other hand, if you’re just starting out saving for retirement and all you lost is a few hundred or thousand bucks in your 401k/IRA and you still got 10-15 years ahead of you then you might benefit from the drop!
So, in other words, if the loss in your existing portfolio is offset by enough of a rise in future expected returns, then a drop in the stock market can be a net positive. Seems pretty obvious from a qualitative point of view. But quantitatively? How early is early along the FIRE journey? How much of a rise in expected returns do we need to make this work? Even if there isn’t a net benefit, how much of the paper loss is at least cushioned by higher future returns? These are all inherently quantitative questions. This blog post is an attempt to shine some light on the math behind the tradeoffs…
Happy New Year! Geez, are you all glad that 2018 is over? What a rough fourth quarter! It started quite harmlessly with Suze Orman poking fun at the FIRE movement. Not a big deal, we hit back and even had some fun with it. But the quarter ended with Mr. Market taking our stock portfolio to the woodshed. The S&P500 Total Return Index (dividends reinvested) was down 19.36% at some point (closing value Oct 3 to closing on Dec 24, total return). Not only was the fourth quarter brutal on your stock portfolio, but the FIRE movement has also become the target of continued ridicule. It looks like FIRE critics have come up with some cool and creative new acronyms:
FIRE = Foolish Idealist Returns to Employer (MarketWatch)
Right around the time when I wrote my options selling update a few weeks ago was when everyone in the option seller circles talked about the blowup of OptionSellers.com. Option Sellers, LLC was a Tampa, Florida based Registered Investment Adviser and CTA (Commodity Trading Adviser). They managed money for 290 clients. Considering the minimum investment was $250,000 and most investors likely had more money with them, I’d surmise that they were managing around $150m. On November 15, 2018, they informed their investors that not only was all their money lost but that clients would likely owe more money. Wow, let that sink in: they had a loss of more than 100% and clients are left with debts they have to cover now! Bad news for the clients who invested all their money with OptionSellers!
A failure of a small obscure adviser probably would have stayed under the radar but the co-founder published a tearful apology video, confessing that all customer accounts were wiped out “by a rogue wave.” The movie was since taken down – probably the lawyers didn’t like the idea of this kind of mea culpa so much – but it’s still available on YouTube. The story went viral (or at least as viral as something as obscure as options trading can go) and was then picked up even by the national news media, including the Wall Street Journal, CNBC and many others.
Quite intriguingly, their strategy imploded over the span of just a few trading days. And just to be sure, this wasn’t fraud a la Bernie Madoff but investors actually lost their money “fair and square” if there is such a thing. Is this something all option sellers should worry about? Yes, if you are as reckless as Option Sellers. If you had bothered to check what these clowns were doing it was clear that this debacle was all but unavoidable. Let’s take a look at what they did and the five obvious mistakes that lead to the meltdown…
Homeless no more: We just bought a house last month! Over the internet! Well, not entirely over the internet because we actually toured houses in person the old-fashioned way. With a real estate agent, more on that below. But we eventually closed the transaction while we were on our epic trip through Asia this Fall! All the “paperwork” was done electronically! One reason we were able to pull this off was that we paid for the house in full. Applying for a mortgage would have required a lot more paperwork and notarized signatures. Probably not something you can accomplish while traveling in Southeast Asia! And just in case you don’t remember, we outline the reasons for not getting a mortgage while in early retirement in Part 21 of the Safe Withdrawal Series!
In any case, where did we buy, what and why? Let’s take a look…
Picture credit: Pixabay(this is not our new home!)
October was a scary month for stocks: the worst monthly S&P 500 return in seven years! And November is off to a volatile start as well! We haven’t even seen a real correction yet but apparently, the drop was bad enough for me to got inquiries from friends and former colleagues asking how I’m doing with our portfolio and if (and when?) I’m going to come back to the office again! Sorry, not anytime soon! As I detailed in the post two weeks ago, we are not too concerned about one month of bad returns early in retirement.
Some friends and readers of this blog were specifically concerned that my options trading strategy might have been hit badly by the wild swings. After all, I’m doing this with a little bit more than 2x leverage and with the market down about 7% does that mean we lost more than 14%? Of course not! To all the rubbernecks out there who suspect we had a bad car wreck in our portfolio last month, I’m happy to report that we actually made a small profit with this strategy in October! And continued to do so in November! How awesome is that!? Well, there were a few close calls but I was able to escape any major damage. It took some HoudiniSkills (or luck???), hence the title image of escape artist Harry Houdini (Picture Credit: Lomography).
Wow, did you see the big stock market move in October? The worst monthly S&P 500 performance since 2011! When you’re still working and contributing to your retirement savings it’s easy to lean back and relax: you can buy equities at discount prices and you buy more shares for the same amount of savings when prices are down, a.k.a. dollar-cost-averaging. Now that we’re retired things are different. Sequence Risk creates the opposite effect of dollar-cost-averaging: you deplete your money faster while the portfolio is down. I have been writing about this theme for almost two years now and now it looks like I might become my very own poster child of Sequence Risk.
So, are we worried having retired at (or close to) the peak of the market? Well, take a look at the title image: an ERN family selfie while vacationing in Angkor Wat (Siem Reap, Cambodia) in October. It doesn’t look like we’re too concerned about the stock market! And here are a few reasons why…
Unless your internet was out or you’ve been living under a rock for a few weeks you must have heard about the earthquake created by the Suze Orman interview on Paula Pant’s Afford Anything podcast. Lots of people have weighed in already. I participated in a few discussions here and there on Twitter and on other blogs but I also have a few things to say that can’t be distilled into a short tweet or blog comment. So here’s a short blog post with my thoughts.
Well, you can’t blame her for beating around the bush; Suze started the podcast proclaiming that she hates the FIRE movement. And the reaction in our community was swift. And brutal! Suze Orman was called a buffoon and worse names. She just doesn’t get what we are all about in the FIRE movement! OK, let’s congratulate ourselves on what the royal smackdown we gave the Matriarch of Money… Are we done patting ourselves on the back? Great, so let’s face reality again. Sorry to tell you all, but we merely convinced the folks who need no more convincing, i.e., other members in the FIRE community. And I have the concern that, wait for it…
…to a neutral observer, Suze Orman won the argument!
The average reader/viewer who’s never heard about the FIRE movement walks away with the impression that the great money expert Suze Orman just schooled a bunch of uneducated financial clowns. Sadly, people might get the false impression that early retirement requires such an insurmountable large pile of cash that it’s not even worth trying to pursue FIRE. I’m not saying that this is true because nothing could be farther from the truth but it might be the perception to a lot of people unfamiliar with FIRE. To me, it sounded like Suze wanted to ruffle some feathers and that’s why she approached Paula and volunteered to go on the podcast! Did she use us to get herself into the spotlight and sell her strange “work until you’re 70” narrative again?
So, we got a lot of work ahead of us dealing with the Suzes of the world! Notice I’m using the plural here. Most of us are probably not famous enough to talk to Suze in person. But we are still going to encounter a lot Suze lookalikes in our lives; relatives, friends, neighbors, colleagues etc. who have an equally unrealistic and bombastic “you need at least a gazillion dollars to retire early” mentality. Here are a few suggestions on how to discuss FIRE when encountering a skeptic like Suze…
Whole Life Insurance has a bad reputation in the FIRE community! Does anyone here have a Whole Life Insurance (WLI) policy? Anyone? It seems so toxic that even if anyone had a WLI policy they’d be afraid to admit it for fear of ridicule. I only recently “came out of the closet” when I was chatting with folks at the April CampFI over lunch and the topic came up. People were astonished: Huh? Big ERN has a WLI policy? And his wife, too? Isn’t WLI only for naïve and unsophisticated folks that fall for the insurance salespeople’s pitches? Sometimes! But just like many all other issues in personal finance, there’s rarely a simple, clear-cut and universally applicable recommendation. I would argue that WLI is not a bad option if certain conditions are satisfied! And it’s a loooong laundry list of issues to consider and conditions to satisfy. I came up with no less than ten things to consider and in an absolutely shameful, “clickbaity” kind of way, I call them the Ten Commandments of Whole Life Insurance.