April 14, 2023
Welcome to a new installment of the Safe Withdrawal Rate Series. Please check out the SWR landing page for a summary of and a link to the other posts.
Today’s topic is homeownership. I’ve already made the case that not just rental properties but even homeownership can be a great tool in building assets (“See that house over there? It’s an investment!“). But what if you are already retired? What are some of the benefits of homeownership in the context of (early) retirement? Does homeownership reduce Sequence Risk? Do homeowners enjoy a lower inflation rate in retirement? If so, by how much can homeowners raise their safe withdrawal rate? How do we properly account for homeownership (with and without a mortgage) in the SWR simulation toolkit?
Lots of questions! Let’s take a look…
Continue reading “Accounting for Homeownership in (Early) Retirement– SWR Series Part 57” →
March 16, 2023
After the tumultuous year 2022, it looked like 2023 was off to a great start. But banks threw a monkey wrench into the machine, with the S&P almost erasing the impressive YTD gains, several bank failures, and the prospect of a worldwide banking crisis that all changed. So folks contacted me and asked me if I could weigh in on this and some other issues.
Here are some of my musings about bank failures, government failures, moral hazard, and why the FDIC should eliminate the $250k limit and simply insure all deposits…
Continue reading “March 2023 Market and Moral Hazard Musings” →
March 10, 2023
After seven years of blogging in the personal finance and FIRE community, I realize that there’s one type of post I’ve always avoided: How to explain FIRE to a complete newbie. Until now, I’ve outsourced that task and simply referred to the Links Page. But where’s a good overview, all in a simple and comprehensive post to give a one-stop overview of what FIRE is and how one can pull it off? I’ve come across a lot of good information, but it’s all in bits and pieces and here and there. I’m not going to dump a reading/listening list of 20 different posts/shows on 18 different blogs/podcasts on someone new to the community. And my Safe Withdrawal Rate Series? Great stuff. But it’s also the deep end of the pool, and I would likely scare away any new recruits. That series is targeted at folks already retired or nearing early retirement.
So how would I explain or even pitch FIRE to someone new to the community? Let’s take a look…
Continue reading “The Basics of FIRE” →
February 6, 2023
Welcome to another installment of my Safe Withdrawal Rate Series. See the landing page of this series here for an intro and a summary of all posts I’ve written so far. On the menu today is an issue that will impact most retirees: we all likely receive supplemental cash flows in retirement, such as corporate or government pensions, Social Security, etc. Some retirees opt for an annuity, i.e., transform part of their assets into a guaranteed, lifelong cash flow.
Of course, if you are a long-time reader of my blog and my SWR series you may wonder why I would write a new post about this. In my SWR simulation toolkit (see Part 28), there is a feature that allows you to model those supplemental cash flows and study how they would impact your safe withdrawal rate calculations. True, but there are still plenty of unanswered questions. For example: how do I evaluate and weigh the pros and cons of different options, like starting Social Security at age 62 vs. 67 vs. 70 or receiving a pension vs. a lump sum?
Also, you might want to perform those calculations separately from the safe withdrawal rate analysis, from a purely actuarial point of view. For example, we may want to calculate net present values (NPVs) and/or internal rates of returns (IRRs) of the different options before us. Clearly, NPV and IRR calculations are relatively simple, especially with the help of Excel and its built-in functions (NPV, PV, RATE, IRR, XIRR etc.). However, the uncertain lifespan over which you will receive benefits complicates the NPV and IRR calculations. How do we factor an uncertain lifespan into the NPV calculations? Should I just calculate the NPV of the cash flows up to an estimate of my life expectancy? Unfortunately, the actuarially correct way is more complicated. But Big ERN to the rescue, I have another Google Sheet to help with that, and I share that free tool with you.
Let’s take a look…
Continue reading “Evaluating Annuities, Pensions, and Social Security – SWR Series Part 56” →
January 25, 2023
Welcome to another part of my Safe Withdrawal Rate Series. Today’s topic: Bucket Strategies in retirement. As you know, my blogging buddy Fritz Gilbert has written extensively on this topic at his Retirement Manifesto blog, for example:
And likewise, I have written about my skepticism of bucket strategies in Part 48 of the series: “Retirement Bucket Strategies: Cheap Gimmick or the Solution to Sequence Risk?”
Fritz’s most recent post on the Bucket Strategy started a lively back-and-forth on Twitter, and it seemed appropriate to pursue a more detailed discussion with more than 280 characters per answer in a “fight of the titans” blog post. So if you haven’t done so already, please check out our awesome discussion over on Fritz’s blog:
Is The Bucket Strategy A Cheap Gimmick?
The response was overwhelmingly positive, and we decided to craft a follow-up post here on my blog. We came up with two new questions, and we also need to address two major themes from the comments section in Part 1, specifically, the role of simplicity and behavioral biases in retirement planning.
So, let’s take a look…
Continue reading “Discussing Retirement Bucket Strategies with Fritz Gilbert – SWR Series Part 55” →
December 7, 2022
The number one story in the crypto world this year (or decade? or century?) must be the FTX crypto platform collapse. It’s mindblowing how quickly FTX went from one of the largest crypto exchanges with a 150-second Superbowl commercial in February 2022, naming rights to sports arenas, numerous A-list celebrity endorsements, etc., to become the pariah of the financial world in just one short week in November 2022.
And likewise, FTX’s founder Sam Bankman Fried (SBF), went from a modern-day J.P. Morgan to Bernie Madoff 2.0. Is it even appropriate to compare SBF with Bernie Madoff? Isn’t that a bit of an insult? You bet! It’s an insult to the late Bernie Madoff! Along several dimensions, the FTX collapse is actually more outrageous than Bernie’s decadelong Ponzi Scheme. Let’s take a look at why…
Continue reading “A Post-Mortem for a Crypto Exchange: Is FTX worse than Bernie Madoff?” →
November 2, 2022
In my post three weeks ago, I happily declared that the 4% Rule works again, thanks to the much more attractive equity and bond valuations. It’s always fun to deliver pleasant news. But keep in mind, everyone, that this refers to today’s retirees with their slightly depleted portfolios. But how about the folks who were unlucky enough to retire earlier this year in January 2022, when equities were at their all-time high? That cohort is off to a bad start, to put it mildly. Of course, it’s too early to tell what should have been the appropriate safe withdrawal rate for that cohort. We’re only less than a year into a multi-decade retirement. My recommendation back then would have been that due to the wildly expensive equity valuations and low bond yields one should have treaded a bit more cautiously. Maybe do 3.50-3.75% for a 30-year traditional retirement and 3.25% for a 50 or 60-year early retirement. And maybe raise that a little bit again depending on your personal circumstances, especially if you expect large supplemental cash flows from pensions and Social Security later in retirement, see my Google Simulation sheet (Part 28 of my SWR Series). Also notice also that with my estimates, I’m a bit more aggressive than the widely-cited Morningstar study recommending a 3.3% safe withdrawal rate for a 30-year retirement.
But recently, I’ve come across some rumblings that put into question all this cautious retirement planning. The reasoning goes as follows: First, the year 2000 retirement cohort actually did reasonably well with the 4% Rule. Second, the Shiller CAPE at the peak of the Dot-Com bubble was higher than in 2022. Bingo! The 4% Rule should do really well and even better for the 2022 cohort, right? I’m not so sure. That line of reasoning is flawed, for (at least) two reasons: First, the pre-Dot-Com-Crash retirement cohort experience wasn’t as pleasant as some people want to make it now. And second, I actually believe that the fundamentals in late 2021 and early 2022 were not very attractive at all. In fact, in some crucial dimensions, they were significantly worse than at the height of the Dot-Com bubble. Hence today’s post with the slightly scary and ominous title. Two days late for Halloween, I know.
Let’s take a look…
Continue reading “Could 2022 be worse than 2001?” →
October 12, 2022
As promised in the “Building a Better CAPE Ratio” post last week, here’s an update on how I like to use the CAPE ratio calculations in the context of my Safe Withdrawal Rate Research. I have studied CAPE-based withdrawal rates in the past (see Part 11, Part 18, Part 24, Part 25) and what I like about this approach is that we get guidance in setting the initial and then also subsequent withdrawal rates based on economic fundamentals. That’s a lot more scientific than the unconditional, naive 4% Rule. In today’s post, I want to specifically address a few recurring questions I’ve been getting about the CAPE and safe withdrawal rates:
- Can a retiree factor in supplemental cash flows like Social Security, pensions, etc. when calculating a dynamic CAPE-based withdrawal rate, just like you’d do in the SWR simulation tool Google Sheet (see Part 28 for more details)? Likewise, is it possible to raise the CAPE-based withdrawal rate if the retiree is happy with (partially) depleting the portfolio? You bet! I will show you how to implement those adjustments in the CAPE calculations. Most importantly, I updated my SWR Simulation Google Sheet to do all the messy calculations for you!
- With the recent market downturn, how much can we raise our CAPE-based dynamic withdrawal rate when we take into account the slightly better-looking equity valuations? Absolutely! It looks like, the 4% Rule might work again! Depending on your personal circumstances you might even be able to push the withdrawal rate to way above 4%, closer to 5%!
- What are the pros and cons of using a 100% equity portfolio and setting the withdrawal rate equal to the CAPE yield?
Let’s take a look…
Continue reading “The 4% Rule Works Again! An Update on Dynamic Withdrawal Rates based on the Shiller CAPE – SWR Series Part 54” →
October 5, 2022
After a bit of a hiatus from the blog – thanks to our ambitious summer travel schedule – it’s time for another post. Over the years, I’ve gotten a lot of questions about the Shiller CAPE Ratio and if it’s still relevant. If you’re a regular reader of my blog, you’ll likely be familiar with the CAPE concept, but just as a refresher, Prof. Robert Shiller, economist and Nobel Laureate, came up with the cool idea of calculating a Price-Earnings (PE) ratio based not just on 1-year trailing earnings, which can be very volatile, but on a longer-term average to iron out the corporate earnings fluctuations over the business cycle. Hence the name Cyclically-Adjusted Price Earnings (CAPE) Ratio. If we use a 10-year moving average of inflation-adjusted earnings as the denominator in the PE ratio, we get a measure of market valuations that’s more informative in many instances. For example, historically, the CAPE ratio has been significantly negatively correlated with subsequent equity returns. It’s not useful for the very short-term equity outlook, but over longer horizons, say 10+ years, the CAPE ratio has been highly informative. Especially retirees should take notice because your retirement success hinges a lot on those first 10 or so retirement years due to Sequence of Return Risk. In fact, all failures of the 4% Rule occurred when the CAPE was above 20! A high initial CAPE ratio signals that retirees should probably be more cautious with their withdrawal rate!
But the CAPE has been elevated for such a long time, people wonder if this measure is still relevant. In the comments section, people ask me all the time what kind of adjustments I would perform to “fix” the CAPE. Can we make the Shiller CAPE more comparable over time, to account for different corporate tax environments and stock buybacks and/or dividend payout ratios over the decades? Yes, I will present my ideas here today. And even better, I will post regular updates (potentially daily!) in my Google Drive for everyone to access for free.
So, what do I find? The adjustments certainly lower the CAPE, but don’t get your hopes too high. Even after the adjustments, the CAPE is still a bit elevated today! Let’s take a look at the details…
Continue reading “Building a Better CAPE Ratio” →
July 5, 2022
Over the last few decades, we’ve become accustomed to a negative correlation between stocks and U.S. Treasury bonds. Bonds used to serve as a great diversifier against macroeconomic risk. Specifically, the last four downturns in 1991, 2001, 2007-2009, and 2020 were all so-called “demand-side” recessions where the drop in GDP went hand-in-hand with lower inflation because a drop in demand also lowered price pressures. The Federal Reserve then lowered interest rates, which lifted bonds. This helped tremendously with hedging against the sharp declines in your stock portfolio. And in the last two recessions, central banks even deployed asset purchase programs to further bolster the returns of long-duration nominal government bonds. Sweet!
Well, just when people start treating a statistical artifact as the next Law of Thermodynamics, the whole correlation collapses. Bonds got hammered in 2022, right around the time when stocks dropped! At one point, intermediate (10Y) Treasury bonds had a worse drawdown than even the S&P 500 index. So much for diversification!
So, is the worst over now for bonds? Maybe not. The future for nominal bonds looks uncertain. We are supposed to believe that with relatively modest rate hikes, to 3.4% by the end of this year and 3.8% by the end of 2023, as predicted by the median FOMC member at the June 14/15, 2022 meeting, inflation will miraculously come under control. As I wrote in my last post, that doesn’t quite pass the smell test because it violates the Taylor Principle. The Wall Street Journal quipped, “The Cost of Wishful Thinking on Inflation Is Going Up Too”. I’m not saying that it’s impossible for inflation to subside easily, but at least we should be prepared for some significant upside risk on inflation and interest rates. Watch out for the July 13 CPI release, everybody!
So, trying to avoid nominal bonds, how do we accomplish derisking and diversification? Here are ten suggestions…
Continue reading “Hedging Against Inflation and Monetary Policy Risk” →