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The Ultimate Guide to Safe Withdrawal Rates – Part 5: Cost-of-Living Adjustments

Welcome back to the Safe Withdrawal Rate Series. Last week we wrote about how Social Security can impact the SWR estimates. Even under the most optimistic assumption (no changes to the Social Security benefits formula), we didn’t think that the 4% withdrawal rate is safe.

But how about tinkering with the inflation adjustments, also called Cost-of-Living adjustments (COLA)? I often hear that one way to save the 4% rule in periods when the stock market doesn’t cooperate is to not do inflation adjustments for a few years. Or simply utilize the fact that we all potentially spend less (in real terms) as we age! How much can we push the initial withdrawal rate in that case?

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With a declining real withdrawal rate, we can afford higher initial withdrawals!

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The Ultimate Guide to Safe Withdrawal Rates – Part 4: Social Security and Pensions

After a one-week hiatus over the holidays when we wrote about a lighter topic (dealing with debt, booze, and cigarettes, go figure), let’s return to the safe withdrawal rate topic. We’ve already looked at:

  • the sustainable withdrawal rates over 30 vs. 60-year windows (part 1),
  • capital depletion vs. preservation (part 2)
  • and the current expensive equity valuations (part 3).

The bad news was that after all that number-crunching, the sensible safe withdrawal rate with an acceptable success rate melted down all the way to 3.25%. So much for the 4% safe withdrawal rate! That 25x annual spending target for retirement savings just went up to 1/0.0325=30.77 times. Ouch! Sorry for being a Grinch right around Christmas time!

But not all is lost! Social Security to the rescue! We could afford lower withdrawals later in retirement and, in turn, scale up the initial withdrawals a bit, see chart below. How much? We have to get the simulation engine out again!

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With Social Security (and/or a pension) later during retirement, we can afford higher initial withdrawal rates!

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

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 Celius, 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 »

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My Interview on the Physician on FIRE blog!

My interactions with medical doctors normally involve the question “on a scale from 0 to 10, how much pain do you feel?” So, I was relieved when my blogging friend Physician of FIRE invited me over to answer questions about blogging, personal finance, and life in general as part of his “Christopher Guest Post” series. But given Dr. PoF’s strange fascination with “spinal taps” and the number 11, I was a bit nervous at first:

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Coming soon to a hospital near you?!

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Housing Choices in Early Retirement: Rent vs. Own 

One of the idiosyncrasies of the ERN family early retirement plan is that it involves a relocation. It’s not that we don’t like our current location. But even with our nest egg solidly in the seven figures we likely couldn’t afford to retire here comfortably because of the insanely high housing costs. The state income tax rates are also unpleasantly high. So, if everything goes well we will relocate to another state with low or no income tax and lower housing costs.

The options we consider:

  1. Own a house, mortgage-free
  2. Own a house, plus mortgage. But what term: 30-years or 15-years?
  3. Rent a house or apartment, long-term
  4. Nomadic lifestyle: have no fixed residence, move from place to place with light luggage

Ok, I have to admit, I threw in that last option just for fun. Some people can pull it off (GoCurryCracker), but I doubt that the nomadic lifestyle is for us. I like to have a home base! The way I can tell is that as much as we love to travel, it’s always nice to come back home to sleep in our own bed. Even if I know I have to head back to the office the next day. Seriously!

Quantifying the tradeoffs

We can write as much as we want about the pros and cons of renting vs. owning, but in the end, it all boils down to the numerical assumptions, especially the rental yield (annual rent divided by purchase price):

  • If we can rent a house for only 5% p.a. of the purchase price or less it’s likely a no-brainer to rent. The opportunity cost of our money tied up in a house plus the depreciation and taxes would be too large. Unless, of course, we factor in huge property appreciation. But our baseline assumption is that property values appreciate with the rate of inflation. The last time folks were budgeting outsized returns in housing it didn’t end so well, remember 2008/9? So, renting can be much smarter than owning, see some examples at 10!Rocks and Millenial Revolution.
  • If the annual rent is 10% or more of the purchase price, it’s almost a slam dunk to buy.

Somewhere in between has to be the sweet spot. Let’s check where’s that crossover point in the rental yield!Read More »

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Why would anyone have a mortgage and a bond portfolio?

We are homeowners with a pretty sizeable mortgage but we also accumulated a nice retirement nest egg, which is actually many times larger that our mortgage. Even our taxable investments are several times larger than the mortgage. Still, we don’t pay off the mortgage because we like the benefit of leverage. We have a liability with a low interest rate and assets with a much higher expected rate of return, so our overall expected rate of return is higher than without a mortgage. Our friend FinanciaLibre did some nice number crunching on this topic recently and we agree wholeheartedly.

Moreover, if you follow our blog you’ll also remember that we take a pretty dim view on bonds:

So, personally, we skip the bond allocation altogether. Others have written about this, too, check Physician on Fire’s 2-part guest post here and here. In light of all of this, here’s one question that occurred to us:

Why would anybody have a 30-year mortgage at about 3.50% and a bond portfolio currently paying around 1.8 to maybe 2.5% interest for safe government bonds?

Leverage works only when the asset has a higher expected return than the liability!
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Cash Management in Early Retirement

Less than two years away from early retirement, we wonder how much cash (if any?) we’d like to hold in a money market account. As many of you might have heard, we currently run a very tight ship with our cash management. We have no emergency fund – our entire portfolio is our emergency fund! But that’s easy to do while the paychecks are still rolling in and we maintain a 60% savings rate. Early retirement will be very different. How would we handle the cash withdrawals in retirement? How do we react to market fluctuations?

In the FIRE community, I often read that the solution (maybe even the panacea) for an equity bear market is to keep a certain percentage of the portfolio in cash (money market account) to sustain cash flows through a bear market. And we should point out that we are not the only ones thinking about this, as evidenced by recent popular posts on the PIE blog and on Retirement Manifesto (also check out the really cool infographic) dealing with this subject. Two to three years worth of expenses (presumably 5-10% of the portfolio) seem to be the numbers floating around (examples: 5% cash allocation for the PIE blog, The Retirement Manifesto recommends 2-3 years, ThinkSaveRetire uses 3 years), obviously calibrated to roughly correspond to the length of the average bear market.

How much of a difference does a cash cushion really make?

How big is the opportunity cost of holding cash when there isn’t a bear market?Read More »

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Shorting an inverse ETF? A bad idea! (Or: Why “Beta-Slippage” isn’t alpha)

A while back, I came across an interesting blog post. A guest writer on the White Coat Investor blog put forward an intriguing, almost too good to be true, money-making scheme. Unfortunately, it is too good to be true. It works neither in practice nor in theory. The more I looked into this subject, the more flaws I found with the analysis and I thought people might find it useful when I share my notes here.

It would have been so nice to announce here – with great fanfare – that, yes, there is a way to consistently beat the stock market. But it wasn’t meant to be. Oh, well, sometimes it’s just as insightful to understand why things don’t work!Read More »

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Five Fishy Finance Phrases Deserving Diabolical Deaths

Halloween is around the corner, as evidenced by the annual return of the “Pumpkin Spice Latte” at Starbucks and 5-pound bags of sweet stuff at the grocery store! That’s also a good time to stab through the heart and kill with a silver bullet all those scary senseless finance myths, truisms, and falsehoods. Every time I hear one of the phrases below I suffer a mini heart attack. I hope people would stop saying those.Read More »