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:
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…
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…
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.
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:
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.
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.
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.
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?
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…
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 ITnd 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.
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!
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.
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?
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…