Eight Lessons After Eight Weeks Of Early Retirement

Eight weeks of retirement already! Actually, a little bit more by the time this goes online, but it was exactly eight weeks when I started writing this. Early retirement is a lot more than number crunching and safe withdrawal simulations, so today it’s time to reflect on the first two months of Early Retirement. Everybody’s experience will be different and here’s what have I learned, what surprised me and what didn’t surprise me…

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Here’s an idea for a new ETF

Actually, not one ETF, but two! Or more! How can there be a need for a new ETF? Aren’t there enough already? Earlier this year, Motley Fool argued there are too many ETFs (1,929 at that time, probably over 2,000 by now) and they are covering pretty much every thinkable (and unthinkable) benchmark. Soon we might have more ETFs than publicly traded equities in the U.S., how crazy is that??? Why would I propose a new ETF that doesn’t already exist?

Here’s some background. I’m an index investor at heart and I like tax optimization. For so many years now, I’ve held equity index ETFs and Mutual Funds in both taxable accounts and tax-deferred accounts (both retirement and deferred compensation at work). It’s so painful to see the dividend payments in the taxable accounts getting taxed every year. Sure, it’s only about 1.9% dividend yield in the S&P500 right now but for us, that’s taxed at 15% federal, 10+% state (California!) and 3.8% Obamacare tax, for a total of almost 30% marginal tax! Isn’t there a better way? Sure! Simply put the taxable equity allocation into stocks that pay zero (or close to zero) dividends and keep the high-dividend stocks in the tax-deferred account where they can compound in peace and be taxed only once upon withdrawal rather than every year along the way! So, the two ETFs that I wish existed would exactly replicate the S&P500 if held in equal shares. But individually they’d have non-index weights and one would hold the equities with the lowest dividend yield and the other with the high-yield equities!

Notice that most folks already do this tax optimization across asset classes: Hold the tax-inefficient asset classes (bonds, REITs, etc.) in tax-deferred accounts and equities in taxable accounts. So, why not do this within the equity asset class as well for additional tax efficiency? How much extra after-tax return would we get out of this? Let’s look at the numbers…

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The Ultimate Guide to Safe Withdrawal Rates – Part 3: Equity Valuation

Update: We posted the results from parts 1 through 8 as a Social Science Research Network (SSRN) working paper in pdf format:

Safe Withdrawal Rates: A Guide for Early Retirees (SSRN WP#2920322)

Welcome back to our safe withdrawal rate series! Over the last two weeks, we already posted part 1 (intro and pitfalls of going beyond a 30-year horizon) and part 2 (capital preservation vs. capital depletion). Today’s post deals with yet another early retirement pet peeve: safe withdrawal rates are likely overestimated given today’s expensive equity valuations. We wrote a similar piece about this issue before, but that was based on cFIREsim external simulation data. We prefer to run our own simulations to be able to dig much deeper into this issue.

So, the point we like to make today is that looking at long-term average equity returns to compute safe withdrawal rates might overstate the success probabilities considering that today’s equity valuations are much less attractive than the average during the 1926-current period (Trinity Study) and/or the period going back to 1871 that we use in our SWR study.

Thus, following the Trinity Study too religiously and ignoring equity valuations is a little bit like traveling to Minneapolis, MN and dressing for the average annual temperature (55F high and 37F low, see source, which is 13 and 3 degrees Celsius, respectively). That may work out just fine in April and October when the average temperature is indeed pretty close to that annual average. But if we already know that we’ll visit in January and wear only long sleeves and a light jacket we should be prepared to freeze our butt off because the average low is 8F =-13C! Likewise, be prepared to work with lower withdrawal rates considering that we’re now 7+ years into the post-GFC-recovery with pretty lofty equity valuations.Read More »

The dangers of getting close to retirement: “Yeah, I’ll do that when I’m retired!”

The other day, my wife asked me to take out the trash. My response: “Yeah, I’ll do that when I’m retired!” We both got a pretty good laugh out of that one. After I took out the trash (pre-retirement, obviously), we realized that our planned retirement date, hopefully in early 2018, creates all sorts of inefficiencies; I catch us procrastinating already! YIDTWIR=”Yeah, I’ll do that when I’m retired!” Are they the seven most dangerous words for the approaching-FIRE crowd?

Procrastination is as old as humanity and if there weren’t enough temptations to postpone stuff already, a retirement date in the near future is the mother of all reasons: Procrastination-palooza! Think about how much procrastination an absolutely arbitrary date like January 1 creates: “I’ll quit smoking/go to the gym/work less/work more/etc. in the New Year!” The main reason for New Year’s resolutions is that they give you cover – a guilt-free, chain-smoking, TV-binge-watching couch potato existence between late October and December 31. There is absolutely nothing magical about January 1 but it still creates New Year’s resolutions. And, of course, resolutions are never broken but just postponed to January 1 of the next-next year.

But an upcoming retirement date is different in that you will actually have more time on your hands.Read More »

Passive income through option writing: Part 1

On the path to early retirement (and most likely in early retirement as well), the ERN family will be writing options to generate passive income (in addition to equity and real estate investments, of course). This may be something that people either haven’t heard before or even if they did, they might be turned off by the involvement of derivatives. After we got over our initial aversion against trading exotic instruments like options we found that it’s actually a reliable and profitable strategy to generate passive income. We mentioned this strategy already in a previous post on trading derivatives on the path to FIRE and thought that others might find this interesting too.

Today, in Part 1, we will do a quick intro to cover mostly the conceptual aspects of this strategy. Part 2 will go into how we actually implement our strategy. As a warm up, though, let’s start with a …

Pop Quiz:

Since 2000, the SPY ETF (S&P500 index fund from iShares) returned about 101% (Dec 1999 to August 2016, dividends reinvested), or about 4.3% p.a. What would the return have been if we had participated only when the market went up, i.e., if we had avoided every single down month and received a 0% return during that time?

A: 386% total, 10.0% annualized

B: 1,039% total, 15.7% annualized

C: 2,497% total, 21.6% annualized

D: 3,891% total, 24.8% annualized

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We just went from millionaire to dead-broke with one simple accounting maneuver

We are on the home stretch to early retirement and in about 18 months or so – if everything goes well – we will sell our expensive condo, pay off the mortgage and move to a less expensive location. We might rent a house there or pay for a modest home with cash. One way or another, we should be completely mortgage-free!

Or will we still have a mortgage? How about the “mortgage payments” in the form of our future living expenses in retirement? They increase by the rate of inflation every year! That’s the mother of all mortgage payments! Mortgage mayhem! How do we treat a “mortgage” like that on our balance sheet? Read More »

Top 10 reasons for having an emergency fund – debunked (Part 2)

This is a follow up from our post last week when we couldn’t fit debunking all the arguments for emergency funds into one post. This is also good place the point out some of the great work other bloggers have done on this topic:

Here are our reasons 6-10. Enjoy!Read More »

We just saved $42,000 by not switching to Betterment

There is a popular car insurance commercial featuring someone who “just saved a ton of money by switching to GEICO.” How much is a ton of money? $400? Well, by that measure we just saved more than “100 tons of money” or a whole century worth of car insurance savings. And we didn’t do so by switching, but by not switching our brokerage account. Ka-Ching, how easy was that?Read More »

The Great Bond Diversification Myth

Bonds diversify your equity portfolio risk. Everybody knows that, right? Well, how much diversification potential is there, really? Much less than we thought! (For full disclosure, though, bonds still serve a purpose, but it has nothing to do with diversification!)

Pop Quiz: Over the last 10 years, a portfolio of 80% stocks (U.S. Broad Equity Market) and 20% bonds (U.S. Aggregate Bond Market) had what correlation with the stock market?

A: 0.998

B: 0.857

C: 0.800

D: 0.683

The correct answer is A: the correlation was +0.998, so an 80/20 Stock/Bond portfolio would have been extremely highly correlated with the stock market. We might as well round it up all the way to 1.0 because from a statistical, financial and economic perspective that’s pretty much a perfect correlation. This correlation coefficient is for a broad U.S. stock market ETF (use Vanguard’s US Total Market VTI) vs. a portfolio made up of 80% Vanguard’s VTI and 20% Barclays Aggregate bond index (we used the iShares AGG total returns). Monthly returns are from 07/2006 to 07/2016.Read More »