The_Importance_Of_Always_Thinking_Ahead
00:00:00.000 | Hello everybody, it's Sam from Financial Samurai. And in this episode, I want to talk about
00:00:04.800 | the Financial Samurai safe withdrawal rate formula. And that formula is the 10-year bond yield
00:00:12.640 | times 80% equals the safe withdrawal rate in retirement. So if the 10-year bond yield is at 1%,
00:00:18.400 | you're going to withdraw 0.8%. And when the 10-year bond yield is at 2%, you withdraw at a 1.6%
00:00:27.040 | rate. And the formula is very simple. And it's predicated on the fact that the 10-year bond
00:00:32.080 | yield tells us a lot of things. It tells us a lot of things about the future of inflation,
00:00:37.440 | for example. So if inflationary pressure is building, if we expect inflation to explode,
00:00:43.120 | the 10-year bond yield should go up to help dampen inflation, and vice versa. The 10-year bond yield
00:00:49.840 | also tells us about equity risk premium, the risk-free rate of return, and what we can expect
00:00:57.360 | for stocks and bonds and other risk asset classes in the future. Because everything is relative to
00:01:03.040 | a risk-free rate of return. You wouldn't invest any money in anything if it didn't provide you
00:01:08.880 | a risk premium. So what is that risk premium that you require to take risk? Now, if there's no risk
00:01:16.720 | premium, then you would just invest it in a risk-free asset. And that risk-free asset is
00:01:21.280 | the 10-year bond yield. So for example, the 10-year bond yield today is about 1.3%. What
00:01:28.640 | kind of equity risk premium do you require to invest in stocks, which historically have gone
00:01:35.040 | up by about 10% a year, but tend to correct by 10% every couple of years, and 30% every
00:01:41.760 | three to five years. So what is that equity risk premium ERP you require to take on that risk?
00:01:48.240 | It's kind of different for everyone. There are mathematical models that calculate it over time.
00:01:53.440 | But a simple calculation is, well, if stocks are expected to return 10%, and the risk-free rate is
00:01:59.760 | 1.3%, then the equity risk premium is 10% minus 1.3%, and that's 8.7%. Very simplified, but that's
00:02:09.040 | how you should think about things. So the 10-year bond yield is the number one economic metric that
00:02:15.280 | I follow, that all of y'all should follow, that will tell us a huge story about so many things,
00:02:22.000 | if you understand basic economics and finance. So back in August 2020, remember that time period?
00:02:29.280 | We're about four months into lockdowns. Things were looking up, but there was still a lot of
00:02:34.960 | uncertainty. I came out with a post called "The Proper Safe Withdrawal Rate," colon,
00:02:39.680 | "The 4% Rule is Outdated." And the reason why I think it's outdated is because the 4% rule came
00:02:46.160 | out in the 1990s when the 10-year bond yield was over 5%. It was at 5% or 6%. So of course,
00:02:52.160 | a 4% safe withdrawal rate is safe. That's lower than the risk-free rate of return. Therefore,
00:02:59.040 | a logical conclusion to carry on this type of thinking is to say, "Well, 4% was 80% of where
00:03:06.480 | the 10-year bond yield was at the time, let's say at 5%. So let's carry on that formula." So I came
00:03:11.840 | up with the Financial Samurai Safe Withdrawal Rate formula of the 10-year bond yield times 80%
00:03:17.840 | equals your safe withdrawal rate in retirement. Very logical. You don't need to have a PhD in
00:03:23.520 | economics or finance or be a pontificator researcher of retirement to come up with this
00:03:29.840 | formula. But hey, nobody came up with this formula and nobody connected these dots,
00:03:33.920 | so I took it as my own. And what ensued was a lot of hysteria. Seriously, hysteria, folks.
00:03:41.920 | Take a look at my post, "The Proper Safe Withdrawal Rate," "4% Rule is Outdated."
00:03:46.560 | There are over 370 comments, and more than half of them are people saying, "That is a
00:03:52.400 | ridiculous rule. That is way too conservative. What are you talking about, Sam? You should be
00:03:59.280 | banned from the internet." I don't know. It's pretty crazy. I haven't encountered so much
00:04:05.040 | vitriol for suggesting people be more conservative in retirement, at least for the initial one,
00:04:11.760 | two, three years. After a lifetime of saving and earning money, it is very, very weird,
00:04:18.720 | very difficult to start spending more money, to start spending down your capital.
00:04:24.240 | I'm telling you, folks, because I'm living it right now. I could not spend down capital for
00:04:29.760 | the life of me for the first several years. And even today, it just feels so painful to spend down
00:04:36.400 | capital, which is why I'm trying to generate more passive income and just live off the income and
00:04:44.000 | not touch principle. And it's also why I've spent time since the beginning of the pandemic trying
00:04:49.200 | to make some more money online, because it's very hard to lose capital, as we saw in March 2020.
00:04:55.280 | And it's even harder to spend down that capital for some people. And so look, I understand where
00:05:01.120 | part of the hysteria came from, because when the 10-year bond yield was at 0.7% in August 2020,
00:05:09.520 | my formula, the Financial Samurai Safe Withdrawal Rate formula, indicated that you should withdraw
00:05:14.560 | at a 0.5% rate. Now, 0.5% is unheard of. It is so small that people were starting to freak out
00:05:24.320 | because they flipped the formula around and said, "Well, wait, does that mean I need to now accumulate
00:05:30.160 | 200 times my annual expenses before I can declare financial independence or retire?"
00:05:35.440 | Well, for that moment in time, that one-month moment in time, the answer is yes. But as we know,
00:05:43.520 | the 10-year bond yield and the markets, they're dynamic. They change every single day. So in 2021,
00:05:51.200 | the 10-year bond yield started going up and it reached a high of about 1.75% as the economy
00:05:57.840 | roared back. Earnings in 2021 for the S&P 500 are estimated to rebound by over 45% from 2020.
00:06:07.280 | So as you can see, there's hope now. There's inflation building up. The 10-year bond yield
00:06:12.160 | has gone up. Now, it's gone back down to 1.3%. My formula is dynamic because our lives are
00:06:17.840 | dynamic. They change every single day and week and month and year. You might be single, living in a
00:06:26.560 | van one day and then you might have three kids and you want to buy a bigger house.
00:06:30.800 | You might be happily married another day and you might get divorced another week. Life is
00:06:36.560 | unpredictable. We think we're in control. We have our plan, but things generally don't always go
00:06:42.880 | according to plan. So a formula is just that. It's a guide. It helps you think logically about risk
00:06:49.680 | and returns and spending money and saving money. And a guide is meant to guide you. It doesn't say,
00:06:57.440 | "Look, this is exactly what you have to do," but it's meant to guide you towards the right
00:07:02.240 | direction because if the direction is correct, sooner or later you're going to get there.
00:07:06.960 | If you're feeling down, just remember this Chinese proverb. It's one of my favorites.
00:07:12.320 | So one of the things I discovered while writing the post on do-it-yourself investing, which I
00:07:18.400 | highly advocate, which I've been discussing since I started Financial Samurai in 2009,
00:07:23.280 | and the second post on reasons why you might want to hire a financial advisor or investment manager
00:07:29.760 | or robo-advisor is that future returns could be coming down. And if future returns on risk assets
00:07:38.560 | like stocks and bonds are coming down, then paying a 1% financial advisory fee is going to feel even
00:07:45.840 | more egregious. And one of the reasons why I came up with the Financial Samurai safe withdrawal
00:07:51.600 | rate formula in retirement is because I believe that returns for risk assets will likely come down
00:07:58.800 | in the future. Whether that's true or not, nobody really knows, but that's what I believe.
00:08:04.160 | And given that's what I believe, it is only logical to lower your safe withdrawal rate in
00:08:10.240 | retirement. Really logical, but a lot of people were very angry at this belief. Just read the
00:08:15.600 | comments. It's not me. Just read the comments. I always try to be very level-headed and logical,
00:08:20.560 | but just read the comments and you'll see. So it was with great relief, maybe, maybe a little joy
00:08:27.760 | that Vanguard, one of the largest money managers in the world, came out with something in August
00:08:35.280 | 2021, a full year after I came up with my Financial Samurai safe withdrawal rate formula.
00:08:42.160 | They came out with their 10-year median forecast for US stocks, US bonds, and inflation using their
00:08:52.000 | "Vanguard Capital Markets Model" registered trademark. It's their financial simulation
00:08:58.400 | engine to forecast future performance by analyzing historical data that drive asset returns.
00:09:05.120 | So if you don't want to believe me, who thinks about things way ahead, then let's think about,
00:09:11.840 | maybe believe in Vanguard. So the historical returns for US stocks, according to them,
00:09:16.240 | is 10.37%. For US bonds, 5.3%. And inflation, 2.87%. That's historical average returns.
00:09:25.600 | Their model now predicts 4.02% future returns for US stocks, 1.31% future returns for US bonds,
00:09:37.360 | and 1.58% future return for inflation. So Vanguard is forecasting more than a 60%
00:09:45.440 | decline in returns for stocks, bonds, and inflation. And I like that inflation number,
00:09:50.800 | 1.58%, because since I started Financial Samurai, I've been talking about a permanently lower
00:09:57.440 | inflationary environment. Why? Because we're getting smarter. Technology is connecting us
00:10:02.720 | more. We're learning from our mistakes. We have global central coordinated banks. All of these
00:10:08.880 | things help us combat global inflation, and we're becoming a smaller world. We're exporting
00:10:15.120 | deflation. Well, China and India are exporting deflation. All that good stuff is allowing us to
00:10:20.160 | control inflation better. So any kind of rising inflationary expectations, I think they're just
00:10:26.800 | temporary. They're just temporary. We're structurally going down, folks. Just look at the
00:10:30.720 | 10-year bond yield again. Since the 1980s, the late 1980s, the 10-year bond yield has been going
00:10:37.360 | down, down, down, which is one of the reasons why I believe real estate is going to continue going
00:10:43.680 | up, up, up, because there's an implicit tailwind due to low mortgage rates. When it comes to
00:10:50.560 | managing your money, it's always better to be a little bit conservative if you already have the
00:10:56.640 | money. If you are in retirement, or you've decided you have accumulated a large enough financial nut
00:11:03.360 | to be free, the last thing you want to do is take excess risk, lose lots of your money, and have to
00:11:09.440 | go back to work at a job you disliked. At the same time, if you are a financial samurai, you need to
00:11:16.560 | be flexible in thought and understand that everything is yin-yang in finance. There are no
00:11:23.360 | absolutes. So if you start getting angry at things, my beliefs, someone else's beliefs,
00:11:29.760 | question your rigidity of thought, and maybe try to see the other person's point of view. If you
00:11:36.320 | can be flexible in thought while having your beliefs, I think it's going to go a lot better
00:11:41.920 | for you in the long run. Not only will your finances probably be better, you're probably
00:11:46.640 | also going to be a less stressed and happier person as a result, right? Because at the end
00:11:50.240 | of the day, this is about using money to achieve happiness and do the things that you want to do.
00:11:56.160 | And there's another thing I personally realized, and that is I continue to write and talk about
00:12:02.080 | things that are in the future. And so when things are in the future, I think most people just aren't
00:12:09.040 | able to think about the future or grasp these concepts in the present. And then there's a lot
00:12:15.840 | of discomfort, and there's a lot of anger. And I'm not trying to make you folks angry, folks.
00:12:21.200 | I'm trying to help you guys think forward into the future, what things could be like. And that way,
00:12:28.000 | you can kind of get ahead of things. You can asset allocate your capital towards these long-term
00:12:33.680 | investment trends and benefit. There is no downside to thinking ahead and planning ahead.
00:12:40.080 | Anybody who tells you otherwise is being lazy, because thinking ahead is free. It is so free,
00:12:47.600 | we should do it for a little bit of time every day. Why not create pre-mortem situations so you
00:12:53.440 | know what to do in case bad things happen or good things happen. Let me tell you a final story about
00:12:59.760 | a friend, my son, and tennis. In 2017, I decided to coach high school tennis. I thought it would
00:13:07.120 | be fun because I enjoy teaching, I enjoy writing, I enjoy interacting with people. I had been out
00:13:12.080 | of the workforce since 2012. I thought it'd be good to get into some type of community again.
00:13:17.440 | And so my friend said, "Why the hell would you want to teach high school tennis to a bunch of
00:13:23.120 | boys? The pay is $1,000 a month, you got to shuttle them around. Sounds like a pain in the ass."
00:13:29.840 | Well, I told him, "I like to coach. I love being part of a community." And I was expecting a son.
00:13:35.520 | And as a new father, you just don't know what to do. But as a new father, I was always hearing
00:13:42.560 | stories about how it's very difficult to manage teenage boys. So I thought, what better way to
00:13:48.640 | understand teenage boys than to be the coach of 12 teenage boys on a high school tennis team.
00:13:55.040 | I wanted to learn how they would deal with authority, how I should speak to these boys,
00:14:00.960 | what are their interests, how do they interact with each other, and what type of conflicts
00:14:05.760 | happen. And my friend was like, "Oh, okay, you're crazy." And I told him, "Well, I'd be crazy not
00:14:11.280 | to plan ahead, because I don't know what I'm doing. I'm a new father." So please, folks,
00:14:16.480 | plan ahead, use opportunities to think ahead. And if you see something that seems out of left field
00:14:22.880 | on Financial Samurai or on this podcast, don't get angry. Just think, "Well, maybe Sam is thinking
00:14:28.960 | ahead." And maybe sometimes these things do come true. Thanks so much for listening to this latest
00:14:34.800 | episode. If you enjoyed this episode or this podcast overall, share it with your friends.
00:14:39.920 | Please leave a positive review. It keeps me motivated to keep on going, because I sure am
00:14:45.040 | a terrible monetizer of this podcast, because I haven't reached out to anybody to help sponsor it.
00:14:50.080 | So thanks so much and keep thinking forward.