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.

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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””

Another Option Strategy Failure: Why it’s “Nickels in Front of a Steamroller” and not “Benjamins in Front of a Baby Stroller!”

My little blog here may be mostly known for the Safe Withdrawal Rate Series. But I’m surprised how many people share my other passion: options trading. Both here on the blog and at FinCon last weekend lots of fans of the blog asked me when I’m going to write something about derivatives again. Wait no more! I have been thinking about this one for a while; it’s another cautionary tale about markets going haywire and unsuspecting and unsophisticated investors are caught in between. And then they realize the “safe” and “conservative” strategy marketed by their financial adviser can blow up in their face!

The Wall Street Journal came out with a pretty detailed article (subscribers only) a few weeks ago, but the story has been around for a while. See, for example, on WealthManagement.com or SeekingAlpha.com. And this time it’s not some obscure small shop in Florida that got into trouble. No, it’s one of the big fish: UBS!  Their so-called “Yield Enhancement Strategy (YES),” marketed as a conservative and low-risk strategy to risk-averse investors with mostly bonds in their portfolio, racked up heavy losses late last year. Well, at least people weren’t completely wiped out like the poor sobs in the OptionSellers mess. But a purported 20% loss (about $1b) is still a hard pill to swallow for investors that were told that this is completely safe. Sure, if you were 100% invested in the S&P500 last year and lost 20%, then yeah at least you knew what you’re getting into. But for the average mom-and-pop muni bond investor, a 20% loss is pretty epic. And not in a good way!

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Headlines from around the web. Source: Wealth Management, Wall Street Journal, Seeking Alpha

Of course, looking at the low-yield environment right now – in some places we even have a negative-yield environment – I don’t blame investors for shopping around for higher yields. But be aware of the charlatans. If they tell you that higher yields come with no side effects run away! There is always a catch with a higher yield! Even if it’s your trusted personal wealth advisor at a shop as famous as UBS!!! This yield enhancement strategy involved a risky options trading strategy. With 5x leverage! And most of the investors didn’t even know what they were getting into unless they had read the pages with the fine print! So, let’s do a post-mortem for this strategy. What were they doing and how and why did this go so horribly wrong?

Continue reading “Another Option Strategy Failure: Why it’s “Nickels in Front of a Steamroller” and not “Benjamins in Front of a Baby Stroller!””

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…

https://www.plutusawards.com/nominate/?pc=earlyretirementnow.com

… 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! 🙂

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Source: PlutusFoundation.org

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”

The Safe Withdrawal Rate Series: A Guide for First-Time Readers

We’re back home in Washington State after our epic 2019 Summer Tour. Four months on the road, mostly in Europe with a quick visit in Morocco for a week! In early August, while traveling I almost fell out of my chair (or was it my bed?) when I read that my little blog is nominated for not one but two (!) Plutus Awards this year. “Best Financial Independence/Early Retirement Blog” and my work on the Safe Withdrawal Rate research was nominated in the “Best Series: Blog, Podcast, or Video” category, how awesome is that? So, please accept my deep gratitude: thanks to everyone who took the time to submit a ballot and nominate my blog! I’m very humbled and honored. Whether it’s a Plutus Award nomination or just a friendly comment or email, thanks for supporting my work here! It always makes my day! 🙂

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Talking about the Safe Withdrawal Rate Series, I often get feedback like this one, let me paraphrase:

“The entire series is obviously very helpful but also a bit intimidating. As a first-time reader, where should you even start?”

I hear you! I totally hear you! So, I wrote a new “landing page” for the Series that has a summary of all 31 posts, grouped by major topic and also a few suggestions for readers what to read depending on preferences and where you are with your early retirement planning. There are two ways to get to this new summary page:

1: Click this new link:

https://earlyretirementnow.com/safe-withdrawal-rate-series

2: Even easier, when you’re anywhere on the ERN blog webpage, simply go to the top of the page and click the new menu option “Safe Withdrawal Rate Series” – see below!

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So, if you get a chance, please check out that new landing page and let me know what you think! And please continue sharing the SWR Series everywhere people discuss safe withdrawal rates, ideally using that new landing page link! Many thanks in advance!

Continue reading “The Safe Withdrawal Rate Series: A Guide for First-Time Readers”

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””

Does A 4% Withdrawal Rate Survive a 60-Year Retirement? (Guest Post by Dr. David Graham)

You might have noticed that I haven’t published any guest posts for a while. I even explicitly state on my contact page that I’m no longer interested in publishing any guest posts. But every once in a while you make an exception to the rule. David Graham, actually, Dr. David Graham (FIPhysician), has been on a roll with a bunch of top-notch guest posts on other personal finance blogs; first writing for the White Coat Investor blog on Roth Conversions, then two guest posts on Physician on FIRE, first on Asset Location in Retirement, and then on Buffer Stock and Bucket Strategies to alleviate Sequence Risk in retirement. All really important topics! And after sending a few emails back and forth with the good Dr. Graham we agreed on a topic for him to publish a guest post here on the ERN blog, Instead of using backward-looking historical return windows, as I would normally do in my SWR Series, why not check the sustainability of the 4% Rule with forward-looking return projections? Vanguard and a lot of financial companies publish those every year. Sounds like an interesting exercise! So, without further ado, please take over Dr. Graham…

As we all know, ERN is the man when it comes to Safe Withdrawal Rate (SWR) and FIRE. Reading between the lines, he has a different opinion on SWRs for a 60-year retirement vs. a more traditional 30-year plan. Obviously, using only historical data, it is more difficult to study SWR with rolling 60-year stock and bond returns than 30-year periods. Nevertheless, FIRE often subscribes to the 4% rule despite a prolonged period of income demands on the accumulated nest egg. In order to further understanding of the 4% rule over a longer than usual planned retirement, let’s visualize the 4% rule over a 60-year period and see what we can learn. Continue reading “Does A 4% Withdrawal Rate Survive a 60-Year Retirement? (Guest Post by Dr. David Graham)”

My thoughts on Small-Cap and Value Stocks

People have often asked me what I think about value and small-cap equity portfolios. So, this is a post I always wanted to write but kept postponing because I never knew how to best frame it. But now I have the perfect excuse to write it; last week, I listened to the ChooseFI podcast and they had Paul Merriman as a guest in episode 130. Paul Merriman is one of the big proponents of small-cap and value stocks. Of course, they talked about a variety of topics and I thoroughly enjoyed most of the discussion. I’m completely on the same page with Paul, Jonathan and Brad on a wide range of issues. For example:

  • Choose index funds over actively managed funds
  • Take emotions, especially fear and greed out of investment decisions
  • Young investors benefit from Dollar Cost Averaging. Specifically, a market crash early in your investing life can even be beneficial, at least under specific assumptions, as I wrote earlier this year in “How can a drop in the stock market possibly be good for investors?
  • Young investors shouldn’t even think about bonds in the portfolio when starting out. Use 100% equities, use as much risk as possible.

But there’s one thing I vehemently disagreed with! Paul Merriman seems to suggest that by using a “better” or “smarter” equity allocation, specifically, overweighting the value and small-cap styles – both domestically and internationally – we can increase our expected return by two full percentage points a year. And just to be sure, this is not stock picking but simply asset class/style picking, all implemented with passive ETFs. Two percentage points of extra return? Let that sink in! 2% a year can compound to a large sum over the years and then you retire and you get extra 50% of withdrawals when you add 2 percentage points to your 4% safe withdrawal rate. Pretty impressive! There’s only one problem: Merriman’s recommended portfolio didn’t return those two extra percentage points over the past few decades. And there are good reasons to believe that you will not gather those 2% extra returns going forward either. Let me explain why… Continue reading “My thoughts on Small-Cap and Value Stocks”