“Do not trust any statistic you did not fake yourself” (Winston Churchill)
There is a classic book called “How to lie with Statistics” that I read many, many years ago (actually decades ago!) as a college student. If you’re ever looking for an inexpensive but fun and impactful present for a young student/graduate with the hidden agenda of getting that person interested in math and statistics, this is the one! The book taught me to take with a grain of salt pretty much anything and everything number-related. Anywhere! Whether it’s in the news or in the Personal Finance blogging world and even (particularly?!) in academia. I’m not sure if I was already a severely suspicious (paranoid?) person before reading this or the book turned me into the person I’m today. So, inspired by that book, I thought it would be a nice idea to write a blog post about the different ways numbers are misrepresented in the FIRE/Personal Finance arena. And just to be sure, this post is not to be understood as a manual for fudging numbers, but – in the spirit of the “How to Lie With Statistics” classic – serves as a manual on how to spot the personal finance “lies” out there!
And there’s a lot of material! Probably enough for at least one more followup post, so for today’s post, I look at just four different way of how quantitative financial issues are frequently fudged in the personal finance world. And a side note about the slightly attention-grabbing title I used here: Well, I put the word “Lie” in quotation marks to show to the faint-hearted that this is a bit tongue-in-cheek. I could have written, “fudge the numbers” or “Enron-accounting” or “How we delude ourselves in personal finance,” or something like that. Also, Hanlon’s Razor (“don’t attribute to malice what can be explained by incompetence”) comes to mind here, but I’m not sure if those faint-hearted folks feel that incompetence is a significantly more benign explanation than malice.
So, let’s look at some of my favorite examples of how people lie to themselves (and others) in the realm of personal finance…
From 2017 until early 2018 I ran a series of ten case studies for readers who volunteered to open their books and serve a real-world safe withdrawal rate guineapigs. The second case study in July 2017 was for Captain Ron (not his real name) who was planning to FIRE and enjoy early retirement with his wife on a sailboat! That title picture you see up there, that’s their actual boat! Sounds like a great adventure, not just the financial aspects but also the lifestyle changes are daunting! So, how did that all go? Captain Ron just sent me an update on how life has been, so Ron, please take over the wheel…
We retired in September 2017 as planned and are really enjoying life. Financially things are great and we have adjusted to the sailing life, but that first year of cruising was a surprisingly difficult transition. More on that later.
Update 8/22/2019: The 10Y-2Y spread inverted very briefly during the day on 8/14, but finished the day at +0.01%. Am I worried now? Certainly more worried than in April when I wrote this piece. The ISM-PMI index is around 51 – that’s also weaker but not weak enough to worry; everything above 50 is still called expansionary, only below 45 it’s a serious warning sign. Unemployment claims are still very low, which is a good sign. So, this is still “only” a mixed bag. Consistent with a false alarm a la 1998. But the probability of worse things to come has certainly gone up!
Well, there you have it: The Yield Curve inverted last month. Finally! Starting on March 22 and throughout much of last week, short-term interest rates (e.g., the 3 months bills) yielded slightly more than the bond market bellwether, the 10-year Treasury bond.
People in finance and economics view this with some concern because history has told us that an inverted yield curve is a pretty reliable recession indicator. And I made this point in my post in February 2018: The yield curve shape, especially the slope between longer-term yields (10 years) and the short end (e.g., 2-year yields) is one of my three favorite macro indicators:
Also notice that I usually look at the 10-year vs. 2-year yield rather than 3-month spread and that made a bit of a difference recently, more on a little bit that later. But in any case, since I went on the record about the importance of the yield curve and now got several reader requests to comment on this issue, here’s an update: in a nutshell, I’m not yet worried and here are eight reasons why…
Welcome to the follow-up to the follow-up post on the “Yield Illusion.” Again, here’s the context: a few weeks ago, I wrote a post (SWR Series Part 29) on why I don’t believe that chasing higher yields is necessarily a good hedge against Sequence of Return Risk. A very well-received post! It was picked up by CanIRetireYet.com as one of their Best of the Web in February, it was featured on RockstarFinance on Monday, and we had a great discussion in the comments section. So I wrote a follow-up post on Monday (SWR Part 30) and since that post was running way too long already, here’s some more material that got cut; some more thoughts on my asset class outlook, international vs. U.S. stocks, dividend vs. value stocks, and more. So let’s get rolling…
Welcome to a new installment of the Safe Withdrawal Series! The last post on the Yield Illusion (Part 29) was definitely a discussion starter! 140 comments and counting! Just as a quick recap, fellow bloggers at Millenial Revolution claim that the solution to Sequence Risk is to simply invest in a portfolio with a high dividend yield. Use the dividend income to pay for your retirement budget, sit back and relax until the market recovers (it always does, right?!) and, boo-yah, we’ve solved the whole Sequence Risk issue! Right? Wrong! As I showed in my last post, it’s not that simple. The Yield Shield would have been an unmitigated failure if applied during and after the 2008/9 Great Recession. So, not only did the Yield Shield not solve Sequence Risk. The Yield Shield made it worse! And, as promised, here’s a followup post to deal with some of the open issues, including:
A more detailed look at the reasons for the Yield Shield Failure over the past 10 years (attribution analysis).
Past performance is no guarantee for future returns. How confident am I that the Yield Shield will fail again in the future?
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)
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…