Tag: Asset Allocation

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…

Continue reading “Retirement Bucket Strategies: Cheap Gimmick or the Solution to Sequence Risk? – SWR Series Part 48” →

Passive income through option writing: Part 7 – Careful when shorting long-dated options!

May 3, 2021

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!

12-month rolling S&P 500 index returns (price index only, not total returns!).

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
  • Expiration: 6/16/2022
  • 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)
  • Initial Margin: $4,400, maintenance margin: $4,000

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…

Continue reading “Passive income through option writing: Part 7 – Careful when shorting long-dated options!” →

Passive income through option writing: Part 6 – A 2018-2021 backtest with different contract sizes: Guest Post by “Spintwig”

All parts of this series:

* * *

April 21, 2021

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…

Continue reading “Passive income through option writing: Part 6 – A 2018-2021 backtest with different contract sizes: Guest Post by “Spintwig”” →

Q4 2020 GDP Update: Are we on track for a sustained economic recovery?

February 1, 2021

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..

Continue reading “Q4 2020 GDP Update: Are we on track for a sustained economic recovery?” →

How to Beat the Stock Market

December 9, 2020

Right at the start, let me point out that, no, I’ve not gone to the bad side! I will not try to sell any actively-managed funds here. If you’re a part of the passive investing crowd, which is a large portion of the FIRE community, you might find the title a bit “click-baity.” Because the thought process of the average passive investor would go like this:

  1. Underperforming the VTSAX is a non-starter. That’s highly undesirable. The only assets we’d ever consider are those with an expected return equal to or larger than the VTSAX!
  2. But the problem is that due to efficient markets, nobody can beat the market!
  3. If we intersect the two sets above, i.e., constrain ourselves to what’s both desirable and feasible we’re left with the VTSAX (or whatever close substitute you might pick, e.g., FSKAX from Fidelity).

Beat the market diagram01
A very one-dimensional view of the world: How most folks in the FIRE community justify passive investing

That line of reasoning has some advantages: it has probably convinced a lot of folks to get rid of their irrational fear of the stock market and many have benefited from low-cost index investing instead of wasting money on actively-managed funds. My concern here is that I think that this thought process of “nobody can beat the market” is overly simplistic and (literally) one-dimensional. Of course, there are ways to beat the market! Here are eight ideas I can think of… Continue reading “How to Beat the Stock Market” →

What’s wrong with Target Date Funds?

November 9, 2020

Amazingly, after 4+ years of blogging and 200 posts, I haven’t written anything about Target Date Funds (TDFs). For some folks, they are certainly a neat tool. Your fund provider automatically allocates your regular retirement contributions to a portfolio that they deem appropriate for your age and/or the number of years you’re away from your retirement date. It’s a hands-off approach for people who don’t want to think about their asset allocation and simply outsource that task to a fund manager.

But I think not all is well in the TDF world. People planning for FIRE should stay away from TDFs. But even for traditional retirees, there are some unpleasant features. Let’s take a look…

Continue reading “What’s wrong with Target Date Funds?” →

What to make of that Q3 U.S. GDP number?

October 29, 2020

Today’s GDP release for the third quarter came in at 33.1%. Not a typo. After the disastrous second-quarter number of -31.4%, the worst quarterly number on record we now got the best quarterly reading on record. What’s going on here? What do I make of that number? Are we out of the woods now? I’m putting on my economist’s hat for today and share my thoughts in a short post. Let’s take a look…

Continue reading “What to make of that Q3 U.S. GDP number?” →

Can we raise our Safe Withdrawal Rate when inflation is low? – SWR Series Part 41

October 26, 2020

A few weeks ago I wrote the post “Do we really have to lower our Safe Withdrawal Rate to 0.5% now?” about the pretty ridiculous claim that the Safe Withdrawal Rate should go all the way down to just 0.5%, in light of today’s ultra-low interest rates. The claim was transparently false and it was great fun to debunk it. But recently I came across another proclamation of the type “We have to rethink the Safe Withdrawal Rate” – this time proposing to raise it all the way up to 5% and even 5.5%! Well, count me a skeptic on this one, too. Though I’d have to tread a bit more cautiously here because the 5.5% SWR claim doesn’t come from some random internet troll but from the “Father of the 4% Rule” himself, Bill Bengen. He’s been doing the rounds recently advocating for a 5% and even 5.5% Safe Withdrawal Rate:

  • In September in a piece he wrote for FA-mag with a recommendation to raise the SWR to 5%.
  • On October 1, the same article, reprinted almost verbatim under a different title in the same magazine: “Choosing The Highest Safe Withdrawal Rate At Retirement”
  • On October 13 on Michael Kitces’ podcast, Bengen made another explicit SWR recommendation: “[I]n a very low inflation environment like we have now, if we had modest stocks, I wouldn’t be recommending 4.5%, I’d probably be recommending 5.25%, 5.5%” It’s not clear what made him raise the SWR by another 0.25-0.50%, though.

And the whole discussion was quickly picked up in the personal finance  and FIRE community:

The main rationale for increasing the SWR: inflation has been really tame recently and will stay subdued over the coming years and even decades. That’s his forecast, not mine! Hence, Bengen makes the case that we’d have to make smaller “cost-of-living adjustments” (COLA) to our withdrawals. Smaller future aggregate withdrawals afford you larger initial withdrawals, according to Bengen. But as you might have guessed, the calculations that justify the significantly higher withdrawal rate don’t appear so convincing once look at the details…

Continue reading “Can we raise our Safe Withdrawal Rate when inflation is low? – SWR Series Part 41” →

Should we preserve our capital and only consume the dividends in retirement? – SWR Series Part 40

October 14, 2020

Welcome to a new installment of the Safe Withdrawal Rate Series!  40 Parts already! If this is the first time you encounter this series, I recommend you check out the landing page here to find your way around. 

Today’s post is about a question I’ve encountered quite a few times recently. If Sequence of Return Risk means that you face the danger of retirement ruin from liquidating (equity) shares during a down market early during retirement, why not avoid touching your principal altogether and simply live off the dividends only in retirement? Sounds reasonable, right?

But by solving the “running out of money” problem we create a bunch of new questions, such as:

  • Will the principal keep up with inflation over a typical retirement horizon?
  • Will your dividend payments keep up with inflation over time?
  • How much volatility in the dividend payments would you have to expect?

So, in other words, the “dividend only” strategy – simple as it may seem – is somewhat more complicated than your good old Trinity-style 4% Rule simulations. In the Trinity Study, failure means you run out of money before the end of the retirement horizon – simple as that. With the dividend-only approach, failure can come in many different shapes. For example, you may not run out of money but the volatility of dividends could be too high and/or you face deep and multi-year (or even multi-decade!) long drawdowns in dividend income and/or you have to live like a miser early on because the dividend yield is so low. All those are failures of sorts, too. Then, how good or how bad is this dividend-only approach? Let’s take a look…

Continue reading “Should we preserve our capital and only consume the dividends in retirement? – SWR Series Part 40” →

Is an Employee Stock Purchase Plan (ESPP) better than a Retirement Account?

September 23, 2020

In last week’s post, I showed that if you have access to an Employee Stock Purchase Plans (ESPP) offering the full 15% maximum discount you can justify prioritizing the ESPP over an index fund investment in a taxable account, despite the higher risk. But I didn’t answer another important question: would you want to prioritize your ESPP even over retirement savings accounts? 

If your company match is 50% or even 100%, well, then you get a quick guaranteed 50% or 100% return, much higher than any ESPP discount you can expect. The retirement plan with such a high matching percentage easily mops the floor with that puny 15% ESPP discount. But what about the 401(k) contributions after the match? Should we forego those and invest in the ESPP instead? Is the ESPP better than a Roth IRA?

Well, it all depends on your personal situation, specifically, your tax and benefit parameters. So, that’s the question for today: How do we determine priorities across the different savings vehicles? Under what conditions would we forego the 401(k) contributions beyond the company match and invest in the ESPP instead?

Let’s take a closer look: Continue reading “Is an Employee Stock Purchase Plan (ESPP) better than a Retirement Account?” →