According to the most recent inflation numbers that came out yesterday (1/13), CPI inflation is now running at 7% year-over-year. From September to December we saw a 2.2% increase, which is a 9.1% annualized rate. And it’s not all energy and food inflation. The core CPI is also elevated at 5.5% year-over-year.
What do I make of this? How persistent or transitory is this inflation bump? Should we adjust our portfolio? Or our safe withdrawal rate? Here’s a short note with my thoughts…
Last month, I published Part 49 of my Safe Withdrawal Rate Series, dealing with leverage in retirement. In that post, I surmised that the cheapest form of leverage likely comes in the form of a margin loan in an Interactive Brokers (IB) account. If you have the IB Pro account you have access to loan rates tied to the Federal Funds Rate plus a tiered spread ranging from 0.3% to 1.5%. Though, the really low rates don’t start until your loan reaches at least $3,000,000. For more manageable loan amounts that the average retail investor would use, we’re looking at a higher spread: 1.50% spread for the first $100,000 and 1.00% over the Fed Funds Rate for the next $900k. With the current effective Fed Funds Rate at around between 0.08% and 0.10%, that’s a very competitive rate. Certainly better than a Home Equity Line Of Credit (HELOC).
In the comments section, though, a reader brought up an idea for an even lower-cost method for borrowing against your assets: an exotic options trade called a “box spread”. I had heard of this trade before but never put much thought into it. And I certainly didn’t put any money into that idea. But just for fun, I researched this trade some more and even initiated one box spread trade on Monday, essentially issuing a synthetic $20,000 zero-coupon bond maturing in December 2026 at a very competitive interest rate, significantly lower what you’d get from IB.
So, in today’s post, I like to go through the basics of the Box Spread, how to implement it and how this trade could in fact give us a cheaper form of leverage than even the rock-bottom rates from IB. Let’s take a look at the details…
Welcome back to another post dealing with an investing strategy that’s central to our own retirement strategy here in the ERN household. Just a bit of background, about 35% of our financial net worth is currently invested in this strategy. But it accounts for more than 50% of our taxable assets, so for our early retirement cash flow planning, this is really serious business. This puts food on the table in the ERN household!
If you’re not familiar with this strategy, I’ve written about the topic of option writing to generate (retirement) income in general and my personal approach here:
The first three links are more about the general philosophy and the last link, Part 3, is about how I’ve been running the strategy most recently. The strategy involves writing (=selling/shorting) put options on the S&P 500 index with a little bit of leverage. And one can also keep the majority of the account in income-producing assets (bond funds, preferred stocks) to generate additional cash flow. Sweet!
In light of the recent market volatility, of course, it would be a good time to do an update on my strategy because I’ve gotten a lot of questions on how that strategy has been holding up during the bear market. Did it blow up? You are all a bunch of rubbernecks, aren’t you? 🙂
Long story short, my strategy did pretty well so far this year. Not just despite but even because of the volatility spike. Let’s take a look…
Well, it is a Bear Market as of this week! We dipped well below the -20% line on March 12 due to the awful 10% meltdown that day. But we also recovered very nicely on Friday the 13th, of all days!!! I’m putting together some notes about my thoughts. To be published on Wednesday, March 18. Stay tuned! Good luck everybody! Stay invested! 🙂
Original Post (3/4/2020)
Volatility is back! Did it feel a little bit like a bear market last week? Actually, that wasn’t even a bear market, only a correction so far. Hence the title picture with the Koala “Bear,” which is not a bear at all but a marsupial. But it still felt like a mini-bear-market, didn’t it?
So, I thought it’s a good time to write a response to some of the questions I’ve been getting over the last few days:
How bad is this event compared to other corrections? How long will this last?
Should I sell my stocks now?
Is this a good buying opportunity?
How did some of the “exotic” investment styles fare during this volatile time (Yield Shield, Merriman’s Small-Cap Value)?
What does this all mean for my retirement plans?
Did your leveraged option writing strategy blow up already?
I’m still running that same strategy but it definitely evolved quite a bit over time. This might be a good time to write a quick update on what I’m doing and what I’ve changed since then. And for everyone who’s wondering what’s the use of this: I’m planning a future post on how selling options may help with Sequence Risk, so this is all very, very relevant even for folks in the FIRE crowd!
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…
Last year in December we noticed that one of our Municipal Bond mutual funds had short-term losses. That’s not a huge surprise after the post-election bond yield surge and hence it was time to harvest those losses. If you’re not familiar with Tax Loss Harvesting, we wrote two earlier posts on the topic, one dealing with the general concept and one dealing with the implementation. In any case, after we sold the underwater tax lots, where do we put the money? For 30 days we can’t invest in the same fund (or different fund with identical benchmark) or we’d run afoul with the IRS wash-sale rule. There was one asset class that we had never owned but had definitely been on our radar screen for a while. Finally, we took the plunge and invested in… drumroll …