The Effect of “One More Year” – SWR Series Part 42

January 13, 2021

Happy New Year, everyone! And welcome to a new installment of the Safe Withdrawal Rate Series. Today I like to write about the One More Year Syndrome (OMYS) – the fear of retirement and the decision to just work another year. What I find intriguing about OMYS is that procrastination normally works the other way around. You opt for the fun and easy stuff and promise yourself to do the hard work tomorrow. Only to repeat that charade again tomorrow and postpone the unpleasant tasks to the day after tomorrow. And so on. 

But why procrastinate a fun-filled early retirement and keep working? Physician on FIRE and Fritz at The Retirement Manifesto have written about their rationales. The number one reason is that you grow your nest egg and put your retirement finances on a better footing. That was certainly my main rationale, too. I could have retired comfortably in 2017, probably even in 2016 but I delayed that decision until 2018.

So, qualitatively it’s obvious. But can we quantify by how much the OMYS improves your retirement security? Is it worth the additional year in the workforce? How can we incorporate OMYS in the Big ERN Google Safe Withdrawal Simulation Sheet? Is it possible that OMYS will boost your retirement health so substantially that it’s not as irrational as it’s sometimes made? Let’s take a look…

Continue reading “The Effect of “One More Year” – SWR Series Part 42″

How to Beat the Stock Market

December 9, 2020

Right at the start, let me point out that, no, I’ve not gone to the bad side! I will not try to sell any actively-managed funds here. If you’re a part of the passive investing crowd, which is a large portion of the FIRE community, you might find the title a bit “click-baity.” Because the thought process of the average passive investor would go like this:

  1. Underperforming the VTSAX is a non-starter. That’s highly undesirable. The only assets we’d ever consider are those with an expected return equal to or larger than the VTSAX!
  2. But the problem is that due to efficient markets, nobody can beat the market!
  3. If we intersect the two sets above, i.e., constrain ourselves to what’s both desirable and feasible we’re left with the VTSAX (or whatever close substitute you might pick, e.g., FSKAX from Fidelity).
Beat the market diagram01
A very one-dimensional view of the world: How most folks in the FIRE community justify passive investing

That line of reasoning has some advantages: it has probably convinced a lot of folks to get rid of their irrational fear of the stock market and many have benefited from low-cost index investing instead of wasting money on actively-managed funds. My concern here is that I think that this thought process of “nobody can beat the market” is overly simplistic and (literally) one-dimensional. Of course, there are ways to beat the market! Here are eight ideas I can think of… Continue reading “How to Beat the Stock Market”

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”

Passive income through option writing: Part 5 – A 2018-2020 backtest: Guest Post by “Spintwig” (plus a quick update on last week’s volatility)

June 17, 2020

Welcome back to another post centered around Put Option Writing. Today we got a real treat because my blogging buddy, fellow option trader and frequent commenter “Spintwig” offered to do a guest post to perform an independent review of my trading strategy. If you don’t know Spintwig, he also retired in 2018 (at age 30!!!) from a career in IT and now writes about FIRE and options strategies at his blog. He does a lot of interesting and important work, including careful and comprehensive back-tests of different option trading strategies, i.e., different underlying assets, different Deltas, different horizons (days to expiration), etc. I highly recommend you check out his work if you’re interested in option writing!

Oh, and following the guest post, I’ll also give a quick update on how my portfolio did during the crazy,  scary volatility last week! Stay tuned!

Over to you Mr. Spintwig…

 

Thank you BigERN for the opportunity to peer review your options strategy and publically share the results with you and your readers. I’ve relied on your research in my own journey to and through FIRE and I’m happy to be able to add to the discussion and body of research.

A few years ago I stumbled upon BigERN’s blog as I was researching safe-withdrawal-rate topics. Among the material was a novel idea: selling put options on the S&P 500 index could mitigate sequence-of-return risk.

The concept was straightforward but I wanted to know if there was an optimal approach or if it could be applied to other indices and have similar results. Would it be advantageous to replace a traditional buy-and-hold portfolio with an options trading strategy? Unfortunately, there were no definitive or trustworthy answers to this question on the internet so I set out to do my own research and publish what I find. Continue reading “Passive income through option writing: Part 5 – A 2018-2020 backtest: Guest Post by “Spintwig” (plus a quick update on last week’s volatility)”

Three Equity Investing Styles that did OK in 2020

April 22, 2020

Recently, I wrote a post endorsing the simple Bogleheads approach: invest in passive index ETFs. Everything else is just mumbo-jumbo, window-dressing and people not understanding the (mostly) efficient market nature of the stock market. In other words…

Simple (indexing) beats complicated active investing

Well, after unloading on some of the fancy complicated investing styles, I just like to point out the select few of them that indeed performed relatively well in 2020. At least better than the index. So, for the record, I’d also like to write about three examples where…

Complicated beats simple index investing

And most importantly, I’m not pulling some “Monday Morning Quarterback” nonsense telling you that if you could have sold your airline stocks in February and replaced them with stocks for video conferencing makers you could have done really well. Well, duh, very few people other than U.S. Senators had that kind of inside information back in February! Rather, I want to write about some of the deviations from simple indexing that were mentioned here on the blog in my posts and/or in the comments. Before the crisis!

Let’s take a look:

Continue reading “Three Equity Investing Styles that did OK in 2020”

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”