Ask Big Ern: A Safe Withdrawal Rate Case Study for “Captain Ron”

A month ago, I did a case study for a fellow FIRE planner (“John Smith”) and the reception was awesome. So why not do more of those? Without even asking for volunteers, I already got two more fellow FIRE planners who contacted me via email and shared their financial parameters. Today’s case study is for “Captain Ron” and, of course, Ron isn’t his real name, though he is indeed a Captain. Not the “Captain Ron” from the 1992 movie, but just a captain. More on that later!


Why are case studies so exciting? One of the most important lessons I learned from my Safe Withdrawal Rate research (jump to Part 1 of the series here) is that the safe withdrawal calculations are best performed on a one-by-one basis. As we pointed out in our post last week, a withdrawal rate strategy should respond to market factors like equity valuations and bond yields as well as personal factors like age, retirement horizon, and expectations about pension and Social Security benefits. Further complicating the whole calculation is also the fact that we all have different distributions of assets over taxable, tax-deferred and tax-exempt accounts. So, let’s take a closer look at Captain Ron’s situation…

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The Ultimate Guide to Safe Withdrawal Rates – Part 17: More on Social Security and Pensions (and why we should call the 4% Rule the “4% Rule of Thumb”)

Welcome back to our series on Safe Withdrawal Rates. This is already the 17th installment! See Part 1 here and make sure you also check out the Social Science Research Network Working Paper we posted on the topic, now with 2,000+ downloads!

In any case, if you have followed the series so far you must have noticed that we are no fans of the 4% Rule and much of what we posted here dealt with the “4%” portion of the 4% Rule. For example, in Part 3 of this series we show that when equities are as expensive as today (Shiller CAPE > 20), failure rates of the 4% Rule have been unacceptably high in historical simulations.

But I think I missed this really important point:

The only thing more offensive than the “4%” part is the word “Rule”

That’s because the word “Rule” makes it sound as though the 4% is some sort of a scientific or mathematical constant. But it’s not. It ain’t scripture either, even though it’s often portrayed that way! There is no one-size-fits-all solution for withdrawals in retirement. With today’s lofty equity valuations and measly bond yields, a 3.25% to 3.50% initial withdrawal rate would be much more prudent. But there is another element that creates just as much variation in SWRs: Different assumptions about Social Security and/or pension benefits: The benefit level, the number of years before benefits kick in, how much of a haircut you want to assign to account for the risk of potential future benefit cuts, etc. and they all create so much variation in personal SWRs that the whole notion of a safe withdrawal rate “Rule” is even more absurd. The 4% Rule should be called the 4% Rule of Thumb because 4% is merely a starting point:

SWR = 4% Rule of Thumb

+/- adjustments for equity/bond valuations

+/- adjustments for idiosyncratic factors, e.g. age, Social Security, pensions, etc.

How much of a difference do these idiosyncratic/personal factors make? A huge difference! A prime example is the case study I worked on over at the ChooseFI podcast: a couple in their early 50s expects pretty generous Social Security benefits after a long career and probably wouldn’t have to worry too much about future benefit cuts. If they both wait until age 70 to claim benefits and are able to reduce their withdrawals from their portfolio dollar for dollar once Social Security kicks in, their Safe Withdrawal Rate estimate goes up from a measly 3.5% to somewhere around 4.5% or even 4.75%. Instead of saving 28.6x annual expenses, they’d need only 22.2x or even 21.1x. That’s a difference of several $100k!

How to quickly and easily gauge the impact of future cash flows from Social Security or pensions on the SWR is the topic of today’s post!Read More »

We are so skewed!

Note that I didn’t say “screwed” but skewed. Well, it wouldn’t have made a difference because today’s post is about how we get screwed by skewness. 

But I’m getting ahead of myself. The other day I asked myself why would anyone buy lottery tickets? The return profile is atrocious! The average payout is probably only about 50% of the money raised. In a hypothetical lottery with a one in a million chance for a $500,000 prize and a ticket price of $1.00, your expected return is -50% in one week, which means essentially -100% compounded over a year. The standard deviation is $500, so 50,000% relative to the $1 investment. And that’s on a weekly basis, which translates into over 360,000% annualized. What’s worse, that jackpot payout is usually stretched over many years or decades with a much lower lump-sum payment. And it’s subject to income taxes, so the after-tax return is even bleaker! If Vanguard or Fidelity or Schwab offered a mutual fund with return stats like that everybody involved would be facing federal indictments!

Then why not invest the lottery ticket money in stocks? No one can tell me that they’re afraid of equity risk (about 10-15% annualized) when they buy lottery tickets with 360,000% annualized risk. Nowadays you can buy stocks or equity mutual funds in very small amounts. Our 529 account has a $25 minimum investment and you can buy single stocks on Robinhood. Then what’s the appeal of a lottery? In one word: Skewness, see the Wikipedia definition. In particular, positive skewness!

Positive Skewness: higher probability of large positive outcomes (e.g. lottery). Negative skewness: higher probability of large negative outcomes (e.g. stock market). Source: Wikipedia

Positive Skewness means that the likelihood of large positive outliers is much higher than that of large negative outliers. Case in point, a lottery ticket: Your worst return is -$1, or whatever the price of the lottery ticket may be.  The largest positive outlier might be in the hundreds of millions. Read More »

Good and Bad Reasons to Love the Mortgage Interest Deduction

Welcome back to the Early Retirement Now blog! I hope everybody had a safe and relaxing Fourth of July holiday. And if you don’t live in the U.S. and had to go to work yesterday we hope you had a nice Fourth of July, too! We are currently on vacation in Paris and I am sure even here I smelled some barbecue in the air yesterday, so folks seem to celebrate worldwide!

In any case, as we detailed last week, we plan to rent during early retirement, at least in the beginning. But even if and when we buy a house we’d likely pay cash and forego the mortgage deduction. Won’t we miss the deduction? Probably not! We found a few reasons to really appreciate this tax deduction but also two very bad reasons. Let’s start with the bad reasons!Read More »

The ERN Family Early Retirement Capital Preservation Plan

Fritz at The Retirement Manifesto suggested we start a series covering how different FIRE bloggers plan to implement their drawdown strategy. I realize we are a bit late to the party given how many fellow bloggers have already contributed:

The Anchor: Physician on FIRE: Our Drawdown Plan in Early Retirement

Link 1: The Retirement Manifesto: Our Retirement Investment Drawdown Strategy

Link 2: OthalaFehu: Retirement Master Plan

Link 3: Plan Invest Escape (PIE): Planning for Success: Drawdown versus Wealth Preservation in Early Retirement

Link 4: Freedom is Groovy: Freedom is Groovy

Link 5: The Green Swan: The Green Swan

Link 6: My Curiosity Lab: Show Me The Money: My Retirement Drawdown Plan

Link 7: Cracking Retirement: Our Drawdown Strategy

Link 8: The Financial Journeyman: Early Retirement Portfolio & Plan

Link 9: Retire By 40: Our Unusual Retirement Withdrawal Strategy

Link 10: Early Retirement Now:  The ERN Family Early Retirement Captial Preservation Plan (This will land you back in this post. Make sure you don’t end up in an infinite loop! 🙂 )

Link 11: 39 Months: Mr. 39 Months Drawdown Plan

Link 12:  7 Circles:  Drawdown Strategy – Joining The Chain Gang

Link 13:  Retirement Starts Today:  What’s Your Retirement Withdrawal Strategy?

Link 14: Ms. Liz Money Matters: How I’ll fund my retirement

Link 15a: Dads Dollars Debts:  DDD Drawdown Part 1: Living With A Pension

Link 15b: Dads Dollars Debts:  DDD Drawdown Plan Part 2: Retire at 48?

Link 16: Penny & Rich: Rich’s Retirement Plan

So, better late than never: here’s the ERN family contribution. To begin, we are intentionally not calling this a drawdown plan. We will draw from our investments but hopefully never significantly draw them down. So, we are more in the PIE camp, trying to maintain our capital. Even if we were comfortable with leaving nothing to our heirs and charitable causes in 60 years, the drawdown over 60 years would be so small (especially early on, think of this as the initial amortization in a 60-year mortgage!) that we might as well plan for capital preservation rather than drawdown.

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Good Advice vs. Feel-Good Advice

Surfing around in the personal finance blogging and podcast world, there is no shortage of advice. Mostly good advice and some not so good advice. Oftentimes, advice that may be appropriate for some or even most investors would be completely inappropriate for others due to different risk aversion attitudes, investment horizons, and so on.

Occasionally, however, I come across examples of truly and irredeemably bad advice. Recommendations that are suboptimal under any and all circumstances I can think of, irrespective of the preferences and parameters of the individual. What’s worse, the financial experts spreading this nonsense do so not because of ignorance or incompetence. Rather, they are fully aware of the suboptimality and against better knowledge spread something that’s less than ideal. And the rationale? It may not be good advice but it’s feel-good advice. Let’s take a look at the two examples of feel-good advice I recently came across:

  1. The debt snowball: While paying down multiple credit cards, start with a card that has the lowest balance, even if that’s not the highest interest debt. Achieving a “win” of paying off one debt in full is more important than paying down all debts as fast as possible.
  2. Keeping an emergency fund in a money market account while still having credit card debt: Apparently, cash sitting around in a money-market account, earnings essentially zero interest is more important than tackling high-interest credit card debt.

In both cases, the rationale is that it makes you feel good. The “easy win” of completely paying down one debt or the sense of accomplishment of a having a $1,000 cash cushion certainly feels good.  Of course, those two measures probably make you feel better than the status quo, i.e., not tackling your debt at all or not having any savings at all. But wouldn’t the average person feel even better if they knew a faster way to get out of debt? Does anyone else find this troublesome? Do the financial gurus view their readers and listeners as a bunch of feeble financial fruitcakes? Is this some sort of personal finance edition of “You Can’t Handle The Truth” with Jack Nicholson / Colonel Jessup?Read More »

The Ultimate Guide to Safe Withdrawal Rates – Part 16: Early Retirement in a Low-Return World (and why we don’t worry about Jack Bogle’s return prediction)

A while ago I read that Jack Bogle predicts that equities will return only 4% over the next decade. And that already includes dividends and it’s nominal, not real! People call me pessimistic with my equity return assumption for stocks, but good old Jack takes it down another notch. Here’s the quote, reproduced on CNBC:

“Just for mathematical reasons, the dividend yield is 2 percent, a little under 2 percent in fact, and the long-term dividend yield on stocks is pretty close to 4 … the earnings growth on stocks has been a little over 5, that’s going to be a very tough target in the future so let’s call it 4 … 4 and 2 percent give you a 6 percent investment return, but then you have to take … the valuations in the market. …You take that 6 percent return and maybe knock it off a couple of points perhaps for a lower valuation, slightly lower valuation over a decade and you’re talking about a 4 percent nominal return on stocks. And that’s low, lower than history. History is around 6 and a half.”

Wow! That’s a bummer: 4% nominal means about 2% real with a generally agreed upon 2% annual inflation rate. Or another way to look at this return prediction: If we assume that equities pay around 2% in dividend yield, then the equity price index will go up by only the rate of inflation. For ten years!

Everyone in the FIRE community should take notice. If you’re still in the accumulation phase you’ll likely need longer to reach FIRE. If you’re already retired and apply the good old 4% Rule then a Bogle-style scenario will likely put some strain on your portfolio. So, in today’s post let’s look at what the Bogle scenario means for Safe Withdrawal Rates in Early Retirement.

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The Other Student Loan Crisis: Half of Parent Cosigners Facing a Shaky Retirement

[It’s a pleasure to introduce Laur (Lauren) Davidson today. Laur is a senior at the University of Pennsylvania majoring in English and Communications. She wants to build a portfolio as a freelance writer and agreed to write a guest post for us – perfect timing because the ERN family is on vacation this week! The post is on a very timely topic: student loans and how they threaten even the parents’ finances if they cosigned their kids’ private student loans. Take it over from here, Laur!]

Half of Parent Cosigners Facing a Shaky Retirement

By Laur Davidson, a soon-to-be graduated freelance writer for hire

The sheer magnitude of the mountainous $1.4 trillion of debt weighing down 44 million Americans is rightfully grabbing headlines as a looming financial crisis. The devastating economic and social impact of student loan debt on borrowers, their families, the communities in which they live and the nation is well documented. Less known, but no less devastating is the impact student loan debt is having on well-intentioned parents who are suffering financially for having helped their students by cosigning their private educational loans. With the number of students unable to repay their private loans increasing each year, more and more parents are having to rethink their retirement plans.

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The Ultimate Guide to Safe Withdrawal Rates – Part 15: More Thoughts on Sequence of Return Risk

Welcome back to our Safe Withdrawal Rate Series! Last week’s post on Sequence of Return Risk (SRR) got too long and I had to defer some more fun facts to this week’s post. Again, to set the stage, I can’t stress enough how important Sequence of Return Risk is for retirement savers. In fact, after doing all this research on safe withdrawal rates (start series here, and also check out our SSRN research paper) if someone asked me for the top three reasons a retirement withdrawal strategy fails I’d go with:

  1. Sequence of Return Risk,
  2. Sequence of Return Risk,
  3. and let’s not forget that pesky Sequence of Return Risk!

Huh? Isn’t that lame? Surely, low average returns throughout retirement ought to be included in that list, right? Or even top that list, right? That’s what I thought, too. Until I looked at the data! Let’s get rolling and look at some more SRR fun facts.Read More »