Timing Leverage in Retirement – SWR Series Part 52

March 21, 2022 – Last year in Part 49 of the Safe Withdrawal Series, I wrote a post about using leverage in retirement, and in today’s post, I like to explore some additional issues. 

A quick recap, the appeal of using leverage in retirement is that we would borrow against the portfolio instead of liquidating assets. Nice! That might help with Sequence Risk if we avoid liquidating assets at temporarily depressed prices. There could also be a tax advantage in that we keep deferring the realization of taxable capital gains, potentially until we bequeath our assets to our daughter who can then use the “step-up basis” for complete forgiveness of all of our accumulated capital gains. That’s the famous “buy, borrow, die” approach popular with high-net-worth folks.

The gist of the post last year: Not so fast! Leverage could potentially even exacerbate Sequence Risk if you are unlucky and retire right before a bad market event that’s deep enough (like the Great Depression) or long enough (like the 1965-1982 stagflation episode) to compromise the portfolio so badly that the margin loan becomes unsustainable relative to the underwater portfolio.

One solution proposed by several readers: instead of always borrowing against the portfolio, maybe we should carefully time when we use leverage. For example, borrow only when the stock market is down “far enough” and use withdrawals from the portfolio otherwise. And if the market is doing well again, potentially pay back the loan again! Sounds like a reasonable and intuitive plan. But I want to put that to the test with some real simulations. Let’s take a look at the details… 

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Retirement in a High-Inflation Environment – SWR Series Part 51

February 28, 2022 – What a difference a year makes! In late 2020, only about 16 months ago, I felt the urge to comment on the then-fashionable discussion of how low inflation would impact retirees. See Part 41 – Can we raise our Safe Withdrawal Rate when inflation is low? of my SWR Series. Feels like a lifetime ago, doesn’t it?

The takeaway back then: don’t get distracted by high-frequency economic fluctuations. Low inflation doesn’t necessarily mean we can all raise our safe withdrawal rates. Certainly not one-for-one. There is neither empirical nor theoretical economic backing for materially changing your retirement strategy.

Only a little more than a year later the tide has turned. We’re now facing the highest inflation readings in about 40 years. 7.5% CPI and potentially 8% year-over-year once the BLS releases the February figure in mid-March. So, people asked me if my inflation views are symmetric, i.e., high inflation is also a non-event? As I signaled in my inflation post last month, I’m not too worried. Here’s why…

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Inflation at 7%! Here’s why I’m not running for the hills (yet)!

January 13, 2022 – According to the most recent inflation numbers that came out yesterday (1/13), CPI inflation is now running at 7% year-over-year. From September to December, we saw a 2.2% increase, which is a 9.1% annualized rate. And it’s not all energy and food inflation. The core CPI is also elevated at 5.5% year-over-year.

What do I make of this? How persistent or transitory is this inflation bump? Should we adjust our portfolio? Or our safe withdrawal rate? Here’s a short note with my thoughts…

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Ten things the “Makers” of the FIRE movement don’t want you to know – SWR Series Part 50

January 3, 2022 – Happy New Year, everybody. I hope you had a relaxing and healthy Christmas and a good start to the New Year!

Last month was the 5th anniversary of the Safe Withdrawal Rate Series! In December 2016, I published the first part of that series. I had material for maybe four or five parts but one thing led to another and with new ideas, most of them due to reader feedback, the series took off. It’s been running for 5 years and I obviously opened a bottle of bubbly last month to celebrate.

So, what’s the deal with the title then? Very simple: Blogging 101. You need a catchy title! I might have called the post “What I’ve learned in 5 years and 50 posts” or something along those lines. But to shake things up and get everybody’s attention, this is the title I went with. Think of this post as a natural extension of Part 26 “Ten things the “Makers” of the 4% Rule don’t want you to know” or the equally “tongue-in-cheek” posts “How to ‘Lie’ with Personal Finance” – Part 1 and Part 2.

So, after 5 years, 50 posts, what have I learned? What do I think others in the FIRE community are missing? What can you learn from my series that you may not have seen elsewhere? Let’s take a look…

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Low-Cost Leverage: The “Box Spread” Trade

December 9, 2021 – Last month, I published Part 49 of my Safe Withdrawal Rate Series, dealing with leverage in retirement. In that post, I surmised that the cheapest form of leverage likely comes in the form of a margin loan in an Interactive Brokers (IB) account. If you have the IB Pro account you have access to loan rates tied to the Federal Funds Rate plus a tiered spread ranging from 0.3% to 1.5%. Though, the really low rates don’t start until your loan reaches at least $3,000,000. For more manageable loan amounts that the average retail investor would use, we’re looking at a higher spread: 1.50% spread for the first $100,000 and 1.00% over the Fed Funds Rate for the next $900k. With the current effective Fed Funds Rate at around between 0.08% and 0.10%, that’s a very competitive rate. Certainly better than a Home Equity Line Of Credit (HELOC).

In the comments section, though, a reader brought up an idea for an even lower-cost method for borrowing against your assets: an exotic options trade called a “box spread”. I had heard of this trade before but never put much thought into it. And I certainly didn’t put any money into that idea. But just for fun, I researched this trade some more and even initiated one box spread trade on Monday, essentially issuing a synthetic $20,000 zero-coupon bond maturing in December 2026 at a very competitive interest rate, significantly lower what you’d get from IB.

So, in today’s post, I like to go through the basics of the Box Spread, how to implement it and how this trade could in fact give us a cheaper form of leverage than even the rock-bottom rates from IB. Let’s take a look at the details…

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Using Leverage in Retirement – SWR Series Part 49

November 16, 2021 – My Safe Withdrawal Series has grown to almost 50 parts. After nearly 5 years of researching this topic and writing and speaking about it, a comprehensive solution to Sequence Risk is still elusive. So today I like to write about another potential “fix” of Sequence Risk headache: Instead of selling assets in retirement, why not simply borrow against your portfolio? And pay back the loan when the market eventually recovers, 30 years down the road! You see, if Sequence Risk is the result of selling assets at depressed values during an extended bear market, then leverage could be the potential solution because you delay the liquidation of assets until you find a more opportune time. And since the market has always gone up over a long enough investing window (e.g., 30+ years), you might be able to avoid running out of money. Sweet!

Using margin loans to fund your cash flow needs certainly sounds scary, but it’s quite common among high-net-worth households. In July, the Wall Street Journal featured this widely-cited article: Buy, Borrow, Die: How Rich Americans Live Off Their Paper Wealth. It details how high-net-worth folks borrow against their highly appreciated assets. This approach has tax and estate-planning benefits; you defer capital gains taxes and potentially even eliminate them altogether by either deferring the tax event indefinitely or by using the step-up basis when your heirs inherit the assets. Sweet!

So, is leverage a panacea then? Using leverage cautiously and sparingly, you may indeed hedge a portion of your Sequence Risk and thus increase your safe withdrawal rate. But too much leverage might backfire and will even exacerbate Sequence Risk. Let’s take a look at the details…

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Passive income through option writing: Part 9 – 2016-2021 backtest: Guest Post by “Spintwig”

November 10, 2021 – Welcome to a new post in the Put Option Writing Series. My blogging buddy Spintwig volunteered to perform another backtest simulation. If you remember from Part 5, he simulated selling 5-delta and 10-delta put options going back to 2018. He now added 18 more months of returns to go back to September 2016. In the end, I will also compare my live results with the simulated returns and point out why my live trading achieved even slightly better results.

Mr. Spintwig, please take over…

* * *

Thank you BigERN (can I call you Dr. K?) for another opportunity to collaborate and add to the body of research that supports what is colloquially known as the “BigERN strategy.”

Part 8 of the options trading series is a 2021 update that discusses, among other things, premium capture, annualized return and the idea of lowering leverage while increasing delta.

Let’s throw some data at the idea of trading a higher delta at a lower leverage target and see how metrics like premium capture, CAGR, and max drawdown are impacted. As an added bonus, I’ve obtained SPX data that can facilitate a Sept 2016 start date for this strategy. This gives us an additional 18 months of history vs the SPY data that was used in Part 5.

For the benchmark, we’ll use total return (i.e. dividends reinvested) buy/hold SPY (S&P 500) and IEF (10Y US Treasuries), rebalanced annually, in the following configurations:

  • 100 SPY / 0 IEF
  • 80 SPY / 20 IEF
  • 60 SPY / 40 IEF

Let’s dive in…

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2022 FI Chautauqua in Ecuador

October 27, 2021 – Hi Everybody! Not a big blog post today, just a quick announcement: I will be heading to the 2022 Chautauqua in Ecuador as one of the invited speakers. The event will span an entire week: June 18-25 in 2022. So, if you want to spend a fun-filled week in a beautiful location with an opportunity to interact with like-minded FI and FIRE enthusiasts and four awesome FIRE thought leaders please consider joining us there!

Here are more details…

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Passive income through option writing: Part 8 – A 2021 Update

October 18, 2021 – After three posts in a row about safe withdrawal rates, parts 46, 47, and 48 of the series, let’s make sure we have the right level of diversity here. Welcome to a new installment of the option writing series! I wanted to give a brief update on several different fronts:

  1. A quick YTD performance update.
  2. How does the option selling strategy fit into my overall portfolio? Is this a 100% fixed income strategy because that’s where I hold the margin cash? Or a 100% equity strategy because I trade puts on margin on top of that? Or maybe even a 200+% equity strategy because I use somewhere around 2x to 2.5x leverage?
  3. By popular demand: Big ERN’s “super-secret sauce” for accounting for the intra-day adjustments of the Options Greeks. This is a timely topic because the Interactive Brokers values for the SPX Put Options seem to be wildly off the mark, especially for options close to expiration. So, you have to get your hands dirty and calculate your own options Greeks, especially the Delta estimates.
  4. There’s one slight change in the strategy I recently made: I trade fewer contracts but with a higher Delta thus reducing my leverage and the possibility of extreme tail-risk events.

Let’s dive right in…

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Retirement Bucket Strategies: Cheap Gimmick or the Solution to Sequence Risk? – SWR Series Part 48

September 14, 2021 – 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…

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