Welcome to a new installment of the Safe Withdrawal Rate Series, dealing with Bucket Strategies. This is one approach that’s often considered a viable solution to the dreaded Sequence Risk Problem. Simply keep buckets of assets with different risk characteristics designated to cover expenses during different time windows of your retirement. Specifically, keep one or more buckets with low-risk assets to hedge the first few years of retirement. And – poof – Sequence Risk evaporates, just like that! Sounds too good to be true, right? And it likely is. Long story short, while there are certain parts of the bucket strategy that can indeed partially alleviate the risk of retirement bust, bucket strategies are by no means a solution to Sequence Risk. Let’s take a look at the details…
In my post two weeks ago I outlined my approach to retirement planning: In light of significant uncertainty in retirement, I like to do a more careful, robust, and scientific analysis. Not because I could ever undoany of the existing uncertainties but because I don’t want to add even more uncertainties through “winging it” in retirement.
But how much detail is really required? I can already hear objections like “you can never know your future spending month-by-month, so why go through all this careful analysis with a monthly withdrawal frequency?” To which I like to answer: Well, maybe that’s the part where you can indeed use the “wing it” approach! So, today I want to go through a few case studies and learn how much of a difference it would make in my safe withdrawal strategy simulations if we a) carefully model the whole shebang in great detail, or b) just wing it and use a rough average estimate for the spending path. For example…
Does the intra-year distribution of withdrawals matter? In other words, how much of a difference does the withdrawal frequency make: monthly vs. quarterly vs. annual?
What if there are fluctuations in my annual withdrawals around the baseline average budget, due to home repairs, health expenses, etc.?
What if those fluctuations have an upward bias?
What if there is a slow (upward) creep in withdrawals?
What about nursing home expenses later in retirement?
Where can I safely wing it? And which are the ones I should worry about? Let’s take a look…
Welcome back to another post in the Safe Withdrawal Rate Series. For a quick intro and a summary of the series, please refer to the new landing page.
Before I get started, though, you probably noticed that I have been offline for a while. Important business to take care of! The ERN family summer vacation. We spent 3 weeks in the Colorado Rockies and the Black Hills in South Dakota (with short stints in Nebraska and Wyoming) for hiking and sightseeing. Then another almost 2 weeks in Gainesville, GA by Lake Lanier with the in-laws. We flew back in early August and after a short “vacation from the vacation”, I’m now back in business again.
So, back to today’s post. People in the FIRE and personal finance blogging community – readers and fellow bloggers alike – often tell me that while they enjoy my writings here, they wonder if I haven’t gone a little too far into the rabbit hole of quantitative analysis. Why measure safe withdrawal rates down to multiple significant digits? Why do all of this careful analysis if there’s so much uncertainty? Market uncertainty, policy uncertainty, personal uncertainty, model uncertainty! Why not just wing it? I always try to give a short reply to defend my quantitative approach and out of the many different mental and written notes I’ve taken over the years I created this post for your enjoyment and for my convenience to refer to if I get this question again next week.
Specifically, I want to propose at least three reasons for being diligent and precise not despite, but precisely because of retirement uncertainties. And, by the way, I will keep today’s post relatively lean in terms of simulations and calculations, and rather try to make this more of a philosophical exercise. So, if you’re one of the quant-skeptics I hope you keep reading because I can promise you that we don’t have to get too deep into the (quant) weeds. So, let’s take a look at my top three reasons to get the math right…
One of my earliest blog posts back in 2016 detailed my thought process for skipping the emergency fund. Back then, while we were still accumulating and saving for early retirement, our entire seven-figure equity index fund portfolio served as our emergency fund. We never kept more than $1,000, maybe $2,000 in a checking account. We’d simply used the credit card float and/or the Home Equity Line of Credit (HELOC) if any larger expenses came up that exceeded my monthly cash flow, e.g., car and home repairs, medical bills, etc.
So, again, the idea is that if you are a practitioner of the FIRE movement and you save and invest aggressively just put all your money in an equity index fund and be done. It’s not crazy at all to simply invest your emergency fund in stocks! And I repeat it again in case people misunderstand (intentionally or unintentionally) my point here, I most definitely advocate stashing a large pile of money. I simply advocate for moving all that money into an investment with high expected returns, ideally equities, instead of letting the money languish in a money market account at 0.03% interest. Please refrain from quoting the strawman sob stories about people who couldn’t afford their roof or car repair because they live paycheck to paycheck.
But a lot has happened since. We’ve had the 2020 recession and bear market and massive equity market volatility. Many financial experts, bloggers, and podcasters started spreading the “you need x months worth of expenses stashed away in a savings/money market account” mantra again. Have I changed my opinion? Heck no! Quite the opposite! The 2020 recession is a perfect example of the lunacy of the emergency fund invested in a money market account. Let me explain why…
Welcome back to a new installment of the options series! In the discussion following the previous post (Part 6), a reader suggested the following: In recent history, the index has never lost more than 50% over the span of one year. Then why not simply write (=short) a put option, about one year out with a strike 50+% below today’s index level? Make it extra-safe and use a strike 60% below today’s index!
So, let’s take a look at the following scenario where we short a put option on the S&P 500 index slightly more than a year out and with a strike about 60% below the current index level:
Trading date: 4/30/2021
Index level at inception: 4,181.17
Strike: 1,700 (=59.2% below the index)
Option premium: $11.50
Multiplier: 100x (so, we receive $1,150 per short contract, minus about $1.50 in commission)
In other words, as a percentage of the initial margin, we can generate about 26% return over about 13.5 months. Annualized that’s still slightly above 23%! Even if we put down $15,000 instead of the bare minimum initial margin, we’re still looking at about 6.8% annualized return. If that’s a truly bulletproof and 100% safe return that’s nothing to sneeze at. A 6.8% safe return certainly beats the 0.1% safe return in a money market, right? Does that mean we have solved that pesky Sequence Risk problem?
Here are a few reasons to be skeptical about this strategy…
Welcome to a new installment about trading options. Alongside my work on Safe Withdrawal Rates, this is my other passion. In fact, on a day-to-day basis, I probably think about shorting S&P 500 put option much more than about Safe Withdrawal Rates. In any case, one of the most frequent questions I’ve been getting related to my options trading strategy is, how do you even get started with this strategy when you have a smaller-size account? Trading CBOE SPX options, with a multiplier of 100x on the underlying S&P index, even one single contract will have a notional exposure of roughly $400,000. I don’t recommend trading that without at least about $100,000 or better $125,000 or more in margin cushion.
How would one implement this without committing such a large chunk of money?
My options trading buddy Mr. Spintwig who already published another guest post in this series offered to shed some light on this question. He ran some simulations for my strategy using some of the other “option options” (pardon the pun), i.e., implementing my strategy not with the SPX index options but with different vehicles with a smaller multiple than the currently pretty massive 100x SPX contract. For example, the options on S&P 500 E-mini futures are certainly a slightly smaller alternative with a multiplier of only 50. And there are some even smaller-size contract alternatives, but my concern has always been that the transaction costs will likely eat up a good chunk of the strategy’s returns.
In any case, I’ll stop babbling. Mr. Spintwig has the numbers, so please take over…
The readers have spoken and I listened! A lot of folks have been asking for an easier way to digest the Safe Withdrawal Rate research on my site. It has now grown to 44 parts and even with the new landing page, it must still seem like a daunting task to navigate all the different facets of retirement planning. So, I’ve thought long and hard about a more accessible method to convey the complicated subject matter of advanced retirement withdrawal strategies.
I can now announce that I’ve decided to – get ready for this – publish the entire Safe Withdrawal Rate Series on TikTok! I will split up the series, 44 posts and 100,000+ words so far into easy-to-digest bits and pieces. Each post in the Series will be made up of between 5 to 20 TikTok videos, each around 45 to 60 seconds long. I’ll kill two birds with one stone, 1) venture into new markets and meet new people in this exciting new medium, and 2) provide better access to my research for the folks with attention-span challenges. These days, who wants to read 5,000-word blog posts with charts and tables anymore, right?
A while ago I wrote about the challenge of designing pre-retirement equity/bond glidepaths (“What’s wrong with Target Date Funds?“). In a nutshell, the main weakness of Target Date Funds (TDFs) for folks planning an early retirement is that if you have a short horizon and a large savings rate then the “industry standard” TDF is probably useless. 10 years before retirement, the TDF has likely shifted too far out of equities, likely below 70%!
The problem is that the traditional glidepaths are calibrated to the traditional retiree (who would have guessed???) with a sizable nest egg ten years away from retirement. In that case, you want to hedge against the possibility of a bear market so close to retirement from which you might have trouble recovering due to the relatively small contributions of “only” 10-15% of your income. But people planning early retirement with a small initial net worth and a massive 50+% savings rates should clearly take more risk to get their portfolio off the ground.
In any case, back then I mentioned that I had some additional material about glidepaths toward retirement for the FIRE community, to be published at a later date, which is today!
Why is this post part of the Safe Withdrawal Rate Series? First, today’s post is a natural extension of the FIRE glidepath posts (Part 19, Part 20) in this series. Moreover, the majority of readers of the series are not necessarily retired yet. Many seek guidance during the last few years before retirement. In fact, one of the most frequent questions I have been getting is that people who are almost retired and still holding 100% equities wonder how they are supposed to transition to a less aggressive allocation, say 75% stocks and 25% bonds at the start of retirement. Should you do a gradual transition? Or keep the allocation at 100% equities and then rapidly (cold-turkey?) shift to a more cautious allocation upon retirement?
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…
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:
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!
But the problem is that due to efficient markets, nobody can beat the market!
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).
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”→