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”

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”

Who’s Afraid of a Bear Market?

We made it through October, without much volatility this time – what a change compared to last year! We even got to a new all-time high in the S&P 500 in the last few days. When you reach new records, the pessimists come out of the woodworks and declare that “this is the top” and the next bear market must be right around the corner! It’s like clockwork! And if you go to the popular forums and Facebook Groups in the FIRE community, you’ll see people poking fun at the perma-pessimists. Quite appropriately, I think!

Even if we’re at a top, we’ll have another top before too long! Source:,

But why are people still a bit nervous about corrections and bear markets and market crashes? Being retired now, I have to admit I feel at least a little bit uneasy right now. Why’s that? If I wanted to quantify how afraid I am of something I’d do so as follows: Fear depends on both the probability and the magnitude of something scary happening:     FEAR = The probability of something scary  TIMES  the magnitude of something scary

In my recent post My thoughts on the “Upcoming Recession” I wrote about the probability part. I personally don’t think that the economy is at the brink of a major slowdown (yet) and with the economic growth trend, still intact the stock market will likely chug along. This all looks like a mid-cycle, temporary soft spot.

What makes me nervous about the bear market prospect, though, is the magnitude part; the fact that IF a bear market were to occur (however unlikely that may be) we’d most definitely go through some anxiety for a while. That’s true for all retirees and even folks close to retirement. Probably not so much for everybody just starting out in their accumulation phase, see the post “How can a drop in the stock market possibly be good for investors?” from earlier this year.

Quite intriguingly, though, if you look around in the FIRE community I get the sense that people minimize how scary a bear market will be if it were to start today. And the thought process is:

  1. The market will always recover (see the chart above)
  2. Most bear markets last only about one to two years

It sounds like the bear has really lost its teeth! So, why am I not convinced? There are multiple problems with that line of thinking. That 1-2 years estimate wildly underestimates how long it takes to recover from a bear market.  If you do the math right a bear market will appear a lot scarier than it’s commonly portrayed. Let’s see why…

Continue reading “Who’s Afraid of a Bear Market?”

How To “Lie” With Personal Finance – Part 2 (Homeownership Edition)

Remember the blog post from a few months ago, How To “Lie” With Personal Finance? I got a fresh set of four new “lies” today! Again, just for the record, that other post and today’s post should be understood as a way to spot the lies and misunderstandings in the personal finance world, not a manual to manufacture those lies. Of course!

This one is about the rent vs. homeownership debate. Is homeownership a wise financial decision? I’m not going to answer this question here. It’s a calculation that’s highly dependent on personal factors. I lean toward homeownership over renting but that’s because of our idiosyncratic personal preferences – our ideal early retirement lifestyle involves having a stable home base in a good school district. For us personally, the monetary side of homeownership has also worked out pretty well (“My best investment ever: Homeownership?!”) and I like to hedge against Sequence Risk in early retirement by taking a small chunk of our net worth – just under 10% – and “investing” it in an asset that lowers our mandatory expenses because we don’t have to pay rent. But I can certainly see how some other folks, whether retired or not, would prefer to rent. I certainly don’t want to talk anyone out of renting. But on the web, you sometimes read pretty nonsensical arguments against homeownership. And just for balance, there’s also a prominent lie in favor of homeownership. This is going to be interesting; let’s take a look… Continue reading “How To “Lie” With Personal Finance – Part 2 (Homeownership Edition)”

Stuck With a High-Expense-Ratio Fund? Here’s a Google Sheet to Weigh the Pros and Cons of Dumping that “Stinker” in Your Portfolio!

This is a question that’s been on my mind for a while, partially out of curiosity and also because it’s been raised by readers a few times: Suppose you didn’t get the “memo” on passive investing early enough in your life and you now have some high-expense-ratio funds in our portfolio. So, is it too late to switch to a low-cost fund now? Maybe you’re lucky and your funds are actively-managed and they actually beat the broad index reliably. Good for you, but more often than not people are unhappy with the performance of their high-fee funds and like to switch to a low-fee, passively-managed index mutual fund at Fidelity, Schwab or Vanguard. Or move to one of the many index ETFs. Fees will be in the low single-digit basis points, around 0% to 0.015% for some of the Fidelity index funds and around 0.035% for the “Admiral Shares” Vanguard funds. Of course, if this is a fund in a tax-advantaged account where you can just switch between funds without any tax consequences you should just do so if you have that option. But the story gets a lot more complicated in a taxable account! We now have to weigh the pros and cons of switching to a low-cost fund:

Pro: You get rid of that “stinker” mutual fund and replace it with a low-fee, or even zero-fee index fund and eliminate the drag from the high expense ratio. We could be talking about a 0.5% difference in fees and maybe as much as 1.0 or 1.5%. And that’s every year! This can accumulate to a very large pile of cash over time!

Cons: You may have to realize capital gains today. There is a tax inefficiency from having to realize capital gains before you actually need the money in retirement. And this inefficiency takes two forms:

1) for most of you, there’s a good chance that marginal tax rates will be lower in the future, especially in retirement. Your high income right now might put you into a high marginal tax bracket (both Federal and State), while in retirement you might face much lower (or potentially zero) marginal rates. It’s best to defer capital gains until then!

2) even if your future projected tax rate is the same, there’s a potential inefficiency due to realizing capital gains twice; once today when switching to the new fund and once in the future when liquidating that fund in retirement, thus compounding the drag from taxes. It’s best to defer capital gains and pay taxes only once in retirement.

So, depending on how much in built-in capital gains you have right now, how much you can lower your expense ratio and what your current and projected future tax rates are, it may be optimal or suboptimal to dump that high-expense fund. In other words, it is the choice between two evils: The one evil is the drag from the high expense ratio and the other is the drag from tax inefficiency. Which one outweighs the other? Hard to tell, unless you put some numbers in a spreadsheet and do a proper “horse race.” And that’s what we do here today. Let’s take a look…

Continue reading “Stuck With a High-Expense-Ratio Fund? Here’s a Google Sheet to Weigh the Pros and Cons of Dumping that “Stinker” in Your Portfolio!”

My thoughts on the “Upcoming Recession”

“The recession is near!” Headlines like that have become more common recently. And I’m not talking about those ridiculous “sponsored posts” on Yahoo-Finance (“Reclusive millionaire’s warning: get out of cash now”) but the actual news; the Yield Curve inverted recently and then you add the “Trade War” and weakness abroad and everybody gets nervous. Even the U.S. Federal Reserve is nervous enough to start lowering rates again; one cut already in July and another 0.25% cut likely coming tomorrow! So, will the longest-running economic expansion end of “old age” soon and cause a sizable market correction? Or a bear market? Or a market crash? Should we even care? Since lots of readers have asked me to weigh in on those issues I thought this might be a good time to write a post on this.

First of all, hell yes, we should care. If the economy really goes South and the stock market with it, that would be detrimental for retirees and even folks well before retirement. Fortunately, despite all those bad headlines, I’m still sleeping well at night. Sure, the outlook has worsened since earlier this year and I am a bit more worried about the market now compared to before. But I’m still not too concerned in absolute terms. And my view is mostly based on economic fundamentals. Notice how that view is different from some places in the FIRE community where “no worries” has become something of a mantra. The standard applause line there is that “the market always recovers, so we don’t have to worry about a bear market!” But that’s really a strawman argument. Nobody ever argued that we’ll have a recession and a permanent bear market that we’ll never recover from! The stock market is tied to macroeconomic fundamentals and as long as the economy grows we can be confident that the market keeps delivering. But eventually getting back to the old peak is a pretty lame criterion. Why? Let’s look at the chart below from my post earlier this year, but updated to 9/13/2019. It plots the real (inflation-adjusted) total-return performance (dividends reinvested) of the S&P 500 since 2000.

Real, CPI-adjusted S&P500 total return (dividends reinvested) 12/31/1999 to September 2019 (month-to-date). I also marked the 2000-2002 and 2007-2009 peaks and troughs and how the index would have performed with an assumed 6% p.a. trend return.

Of course, the market recovers eventually. But it may take a while! The index didn’t reach the 2000 peak until 2013. And a zero-percent real return over 13 years is a pretty lousy goal. Or here is another way to look at the chart: Let’s start at the peak in 2000 and assume the 2001 and 2007-2009 recessions had never happened and the index had instead advanced at 6% per year (even a little bit less than the long-term average). We’d be 50+% richer today. Don’t tell me recessions and bear markets don’t matter! Also, we did catch up to the 2007 peak plus 6% growth, but even that took about 10 years. So, yes absolutely, recessions and bear markets matter because of what they can do to our retirement plans, compliments of Sequence of Return Risk.

I’m just pointing this out to stress that I’m not categorically unconcerned about a recession. I just don’t see enough evidence yet to run for the hills. Let’s take a look at the details… Continue reading “My thoughts on the “Upcoming Recession””

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…

… 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! 🙂


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”

Can a Rising Equity Glidepath Save the 4% Safe Withdrawal Rate Over a 60 Year Retirement? (Guest Post by Dr. David Graham)

Welcome back to another guest post. Dr. David Graham, over at FIPhysician has been on a roll. His spike in productivity has been the perfect “hedge” against my drop in productivity while traveling this summer, so when he offered me to write a follow-up on his very well-received guest post a few weeks ago, I was all for it. This current post is about adding a “glidepath” to your retirement portfolio and how and why this would change the success prospects over a 60-year retirement horizon. Over to you, Dr. Graham…

In my last post, I show a 4% Safe Withdrawal Rate (SWR) is actually NOT safe over 60-years (assumptions, assumptions). A more conservative 3.25% SWR does ok. On the other hand, if the asset allocation is increased from 60/40 to 90/10 stock to bond ratio, a 4% SWR thrives again. ERN advises, however, that a 90/10 portfolio sets you up for even more Sequence of Return Risk (SORR). SORR describes the long-term detrimental effects initial negative market returns have on overall portfolio success. Even if the stock market eventually recovers, selling part of your equity portfolio at rock-bottom prices can lead to premature failure of the withdrawal strategy.

What protects from SORR yet permits a higher SWR? A rising equity glidepath is one possibility. Let’s look at the details…

Continue reading “Can a Rising Equity Glidepath Save the 4% Safe Withdrawal Rate Over a 60 Year Retirement? (Guest Post by Dr. David Graham)”

A Different Way to Plan Retirement – Guest Post on “Monte Carlo” Simulations by “Gasem”

Today we have another guest post, this time by our long-time reader “Gasem.” I’m sure most of you who have looked through the comments section here and at a number of other blogs would have noticed his comments. They are always highly insightful. He’s also a prolific writer on his own blog MD on FIRE, which I highly recommend. And if you’re not a Gasem-fan yet, I suggest you check out the What’s Up Next? podcast episode earlier this year where he was featured together with Susan from FIIdeas and VagabondMD

In any case, we had a discussion about using Monte Carlo Simulations to gauge safe withdrawal rates following David Graham’s guest post two weeks ago. And Gasem volunteered to write a guest post here detailing his approach measuring retirement risks. So without further ado, Dr. “Gasem,” please take over…

David Graham recently wrote a great post on this site regarding the 4% rule. What is the 4% rule really? You save 25x your yearly need and put it at some risk in a portfolio and then try to extract 30 years of value from the portfolio by extracting 4%/yr. 25x is the target (initial) principal. You have to inflation-adjust the withdrawal, and then you risk the principal at some interest rate above inflation. Let’s say you have 1M, you pull out 4% above inflation (and SORR doesn’t eat your lunch) you will preserve your capital and thus still have 1M 25 years later. You can re-retire for another 25 years on that 1M (capital preservation!) and still pull out 4%. So if inflation is 2% you need to make 6% on your money to run this money machine. 6% is the leverage on your future, That’s the “math” behind the 4% projection.

What’s the problem you say? The problem is volatility. The problem is the market can not guarantee 6% return and 2% inflation. Return is all over the map as is inflation. One year you may make 12%, the next year lose 20%. One year inflation maybe 2% and 5 years later 13% (1979). If you’re lucky it’ll work out you tell yourself, probably will work out, I read it on the internet! So what’s the probability? That’s where “Monte Carlo Simulations” come in. Let’s take a look… Continue reading “A Different Way to Plan Retirement – Guest Post on “Monte Carlo” Simulations by “Gasem””