Can we raise our Safe Withdrawal Rate when inflation is low? – SWR Series Part 41

October 26, 2020

A few weeks ago I wrote the post “Do we really have to lower our Safe Withdrawal Rate to 0.5% now?” about the pretty ridiculous claim that the Safe Withdrawal Rate should go all the way down to just 0.5%, in light of today’s ultra-low interest rates. The claim was transparently false and it was great fun to debunk it. But recently I came across another proclamation of the type “We have to rethink the Safe Withdrawal Rate” – this time proposing to raise it all the way up to 5% and even 5.5%! Well, count me a skeptic on this one, too. Though I’d have to tread a bit more cautiously here because the 5.5% SWR claim doesn’t come from some random internet troll but from the “Father of the 4% Rule” himself, Bill Bengen. He’s been doing the rounds recently advocating for a 5% and even 5.5% Safe Withdrawal Rate:

  • In September in a piece he wrote for FA-mag with a recommendation to raise the SWR to 5%.
  • On October 1, the same article, reprinted almost verbatim under a different title in the same magazine: “Choosing The Highest Safe Withdrawal Rate At Retirement”
  • On October 13 on Michael Kitces’ podcast, Bengen made another explicit SWR recommendation: “[I]n a very low inflation environment like we have now, if we had modest stocks, I wouldn’t be recommending 4.5%, I’d probably be recommending 5.25%, 5.5%” It’s not clear what made him raise the SWR by another 0.25-0.50%, though.

And the whole discussion was quickly picked up in the personal finance  and FIRE community:

The main rationale for increasing the SWR: inflation has been really tame recently and will stay subdued over the coming years and even decades. That’s his forecast, not mine! Hence, Bengen makes the case that we’d have to make smaller “cost-of-living adjustments” (COLA) to our withdrawals. Smaller future aggregate withdrawals afford you larger initial withdrawals, according to Bengen. But as you might have guessed, the calculations that justify the significantly higher withdrawal rate don’t appear so convincing once look at the details…

Continue reading “Can we raise our Safe Withdrawal Rate when inflation is low? – SWR Series Part 41”

Should we preserve our capital and only consume the dividends in retirement? – SWR Series Part 40

October 14, 2020

Welcome to a new installment of the Safe Withdrawal Rate Series!  40 Parts already! If this is the first time you encounter this series, I recommend you check out the landing page here to find your way around. 

Today’s post is about a question I’ve encountered quite a few times recently. If Sequence of Return Risk means that you face the danger of retirement ruin from liquidating (equity) shares during a down market early during retirement, why not avoid touching your principal altogether and simply live off the dividends only in retirement? Sounds reasonable, right?

But by solving the “running out of money” problem we create a bunch of new questions, such as:

  • Will the principal keep up with inflation over a typical retirement horizon?
  • Will your dividend payments keep up with inflation over time?
  • How much volatility in the dividend payments would you have to expect?

So, in other words, the “dividend only” strategy – simple as it may seem – is somewhat more complicated than your good old Trinity-style 4% Rule simulations. In the Trinity Study, failure means you run out of money before the end of the retirement horizon – simple as that. With the dividend-only approach, failure can come in many different shapes. For example, you may not run out of money but the volatility of dividends could be too high and/or you face deep and multi-year (or even multi-decade!) long drawdowns in dividend income and/or you have to live like a miser early on because the dividend yield is so low. All those are failures of sorts, too. Then, how good or how bad is this dividend-only approach? Let’s take a look…

Continue reading “Should we preserve our capital and only consume the dividends in retirement? – SWR Series Part 40”

Do we really have to lower our Safe Withdrawal Rate to 0.5% now?

August 31, 2020

Recently, there’s been some discussion in the FIRE community about a controversial post written by Sam, a.k.a. “Financial Samurai,” claiming that in light of the current record-low bond yields, specifically, the sub-1% yield on the 10-year Treasury bond, we now all have to scale back our early retirement safe withdrawal rates to… wait for it… only 0.5%! Of course, I’m one of the more cautious and conservative planners in the FIRE community, see my Safe Withdrawal Rate Series, but even I would not push people to less than 3%, even in light of today’s expensive asset valuations.

So, 0.5% seems a bit crazy low to me. What’s going on here? It’s pretty simple; the 0.5% number relies on several mathematical, financial and just plain logical flaws. Let’s unpack them all… Continue reading “Do we really have to lower our Safe Withdrawal Rate to 0.5% now?”

How often should we rebalance our portfolio? – SWR Series Part 39

August 5, 2020

In the 3+ years, while working on the Safe Withdrawal Rate Series, I regularly get this question:

What’s my assumption for rebalancing the portfolio?

In the simulations throughout the entire series, I’ve always assumed that the investor rebalances the portfolio every month back to the target weights. And those target weights can be fixed, for example, 60% stocks and 40% bonds, or they can be moving targets like in a glidepath scenario (see Part 19 and Part 20).

In fact, assuming monthly rebalancing is the numerically most convenient assumption. I would never have to keep track of the various individual portfolio positions (stocks, bonds, cash, gold, etc.) over time, but only the aggregate portfolio value. If the portfolio is rebalanced back to the target weights every month I can simply track the portfolio value over time by applying the weighted asset return every month.

But there are some obstacles to rebalancing every single month:

  1. It’s might be too much work. Maybe not necessarily the trading itself but keeping track of the different accounts and calculating the aggregate stock and bond weights, potentially making adjustments for taxable accounts, tax-free and tax-deferred accounts, etc.
  2. It might involve transaction costs. Even in today’s world with zero commission trades for ETFs, you’d still have to bear the cost of the bid-ask spreads every time you trade.
  3. Even if you hold your assets in mutual funds (no explicit trading costs) there might be short-term trading restrictions prohibited you from selling and then buying (or vice versa) too frequently.
  4. It might be tax-inefficient. If an asset has appreciated too much you might have to sell more of it than your current retirement budget to bring the asset weight back to target. But that would mean you’ll have an unnecessarily high tax bill that year. Of course, this tax issue could be avoided by doing the rebalancing trades in the tax-advantaged accounts, not in the taxable brokerage accounts.

And finally and maybe most importantly, there might be a rationale for less-than-monthly rebalancing: it might have an impact on your Sequence of Return Risk. So, especially that last point piqued my interest because anything that might impact the safety of my withdrawal strategy is worth studying.

So, on the menu today are the following questions:

  • Under what conditions will less-frequent rebalancing do better or worse than monthly rebalancing and why?
  • How much of a difference would it make if we were to rebalance our portfolio less frequently?
  • Could the “right” rebalance strategy solve or at least alleviate the Sequence Risk problem?

Let’s take a look… Continue reading “How often should we rebalance our portfolio? – SWR Series Part 39”

When Can We Stop Worrying about Sequence Risk? – SWR Series Part 38

July 15, 2020

Welcome back to a new installment of the Safe Withdrawal Series! If you’re a first-time reader, please check out the main landing page of the series for recommendations about how to approach the 38-part series!

I’ve been mulling over an interesting question I keep getting:

Is there a time when we can stop worrying about Sequence Risk?

In other words, when is the worst over? When are we out of the woods, so to say? A lot of people are quick throwing around numbers like 10 years. I would normally resist giving a specific time frame. The 10-year horizon indeed has some empirical validity, but I also want to point out a big logical flaw in that calculation. Nevertheless, in today’s post, I want to present three different modeling approaches to shed light on the question. And yes, I’ll also explain what the heck that Mandelbrot title picture has to do with that! 🙂 Let’s take a look…

Continue reading “When Can We Stop Worrying about Sequence Risk? – SWR Series Part 38”

Some Financial Lessons from the First Quarter of 2020 (incl. Jack Bogle’s Revenge)

April 8, 2020

Wow, we made it through the first quarter of 2020. Seemed like an eternity! Remember January 2020? Suleimani Drone strike and an almost-war with Iran? Australian Wildfires? February? The Super Bowl, the impeachment trial? Even early March: Super Tuesday (March 3). It all feels like years ago! All those daily 100-point S&P 500 and 1,000-point Dow Jones moves took a toll. They make you age in dog years, I guess!

Time to look back and reflect. Let’s take a look at a few lessons I learned… Continue reading “Some Financial Lessons from the First Quarter of 2020 (incl. Jack Bogle’s Revenge)”

Dealing with a Bear Market in Retirement – SWR Series Part 37

March 25, 2020

In my post last week, I looked at how the 2020 Bear Market will impact folks saving for (early) retirement. But I deferred my recommendations on how current retirees will optimally adjust to the new realities. So, here we go, a new installment of the Safe Withdrawal Series, now 37 posts strong!

Nothing I write here today should be shocking news to people who have read the other 36 parts, but having it all summarized in one place plus some new simulations and perspectives is certainly a worthwhile exercise. In a nutshell, I argue that if you’ve done your homework before you retired, not even a bear market, not even this bear market will derail your retirement. Depending on what approach people chose, some retirees might even increase their spending target now.

Let’s take a look…

Continue reading “Dealing with a Bear Market in Retirement – SWR Series Part 37”

Safe Withdrawal Math with Real Estate Investments – SWR Series Part 36

Welcome to another installment of the Safe Withdrawal Rate Series. This one has been requested by a lot of folks: Let’s not restrict our safe withdrawal calculations to paper assets only, i.e., stocks, bonds, cash, etc. Lots of us in the early retirement community, yours truly included, have at least a portion of our portfolios allocated to real estate. What impact does that have on our safe withdrawal rate? How will I even model real estate investments in the context of Safe Withdrawal and Safe Consumption calculations? So many questions! So let’s take a look at how I like to tackle rental real estate investments and why I think they could play an important role in hedging against Sequence Risk and rasing our safe withdrawal rate…

Continue reading “Safe Withdrawal Math with Real Estate Investments – SWR Series Part 36”

Asset Location: Do Bonds Really Belong in Retirement Accounts? – SWR Series Part 35

Welcome back to another installment of the Safe Withdrawal Rate Series. This one is about taxes. Amazing, how after 30+ installments in the series, I have written conspicuously little about taxes. Sure, I’ve done some Case Studies where, among many other issues, I delved into the tax planning, most recently in the Case Study for Becky and Stephen. But I’ve never written much about taxes and tax planning in the context of the Series.

There are two reasons why I kept the tax discussion on such a low burner: First, my background: If I had an accounting Ph.D. and CPA instead of an economics Ph.D. and a CFA charter, I would have written a whole lot more about taxes! Second, pinning down the Safe Withdrawal strategy and the safe withdrawal rate is my main concern. Most (early) retirees will have extremely low tax liabilities as I outlined in a post last year. You’d have to try pretty hard to pay more than a 5% federal effective tax rate in retirement. So, as long as you stay away from anything clearly irresponsible on the tax planning side, you’re fine. Don’t stress out over taxes in retirement unless you have a really, really large nest egg and taxable income deep into the six-figures during retirement.

But you don’t want to leave any money on the table either. So, I still want to write about taxes if I encounter something that captures my attention. And I came across a topic that’s most definitely interesting from a withdrawal strategy perspective: Asset Location (as opposed to Asset Allocation).

Imagine you target a particular asset allocation, say 60% stocks and 40% bonds. Or 70/30, or 80/20, or whatever suits your needs the best. How should we allocate that across the different account types? If we put all the different accounts into three major buckets…

  1. Taxable, i.e., your standard taxable brokerage account: Interest, dividends and realized capital gains are taxable every year they show up on your 1099 tax form. But you don’t have to pay taxes on capital gains until you realize them.
  2. Tax-deferred, i.e., your 401(k) or your Traditional IRA. Your account grows tax-free until you actually withdraw the money (or roll it over to a Roth). So, so can realize as much in interest income, dividends, capital gains along the way, as long as you keep the money inside the account.
  3. Tax-free, i.e., your Roth IRA or your HSA. The money grows tax-free and you can withdraw tax-free as well.

… then where do we put our bonds and where do we put our stocks? It would be easy, though likely not optimal to simply keep that same asset allocation in all three types of accounts. But is there a better way to allocate your stock vs. bond allocation?

Sure, there is! One of the oldest pieces of “conventional wisdom” investment advice I can remember is this:

“Keep stocks in a taxable account and bonds in your tax-advantaged accounts.”

Or more generally:

“Keep the relatively tax-efficient investments in a taxable account and relatively tax-inefficient investments in a tax-advantaged account.”

Most stocks would be considered more tax-efficient than bonds because a) dividends and capital gains are taxed at a lower rate than interest income and b) you can defer capital gains until you actually withdraw your money, which is a huge tax-advantage (more on that later).

So, it appears that we should ideally load up the taxable account with stocks and the tax-advantaged accounts with bonds. Hmmm, but that doesn’t sound quite right, does it? Why would I want to “waste” the limited shelf space I have in my tax-advantaged accounts with low-return bonds while I expose my high-return stocks to dividend and capital gains taxes? So, it would be completely rational to be skeptical about this common-sense advice!

So who’s right? Conventional wisdom or the skeptics? Long story short: they’re both wrong! You can easily construct examples where either conventional wisdom or the skeptics prevail. So neither side should claim that their recommendation is universally applicable. The asset location decision depends on…

  1. Your expected rates of return,
  2. Your expected tax rates,
  3. Your investment horizon. Yup, you heard that right, it’s possible that you want to go either one way or the other depending on the horizon. Though, this is not really a separate case but really only a result of asset allocation drift. Accounting for that, we’re back to the two cases, but more on that later!

Let’s look at the details…

Continue reading “Asset Location: Do Bonds Really Belong in Retirement Accounts? – SWR Series Part 35”

Using Gold as a Hedge against Sequence Risk – SWR Series Part 34

Happy New Year! It’s time for another installment in the Safe Withdrawal Series! Here’s a topic that I’ve thought about for a while and that was also requested dozens, maybe even hundreds of times from commenters: What about gold? Gold has been a safe haven asset for many decades (Centuries? Millenials???) and it should have the potential to hedge against Sequence of Return Risk. And I recently found this article on Yahoo Finance: “The world’s super-rich are hoarding physical gold“. Maybe it’s just click-bait. Yahoo Finance must have lowered its standards substantially because they even (re-)published one of my articles last year. 🙂

But seriously, in light of the recent runup in gold prices, rising interest by the world’s super-rich and the many requests by readers, I’ve finally gotten around to studying this subject in the context of Sequence Risk. Let’s take a look at how useful gold would be as a hedge against running out of money in retirement…
Continue reading “Using Gold as a Hedge against Sequence Risk – SWR Series Part 34”