How Much $ Do You Need to Retire? Does the 4% Rule Work in 2024?

00:00:00.000 | Imagine retiring early and living comfortably for decades

00:00:03.840 | without running out of money.

00:00:05.300 | Sounds like a dream, right?

00:00:06.560 | Well, today we're gonna demystify the secrets

00:00:09.560 | of smart retirement planning that go far beyond

00:00:12.640 | the commonly touted 4% rule.

00:00:14.400 | Whether you're aiming for early retirement

00:00:16.440 | or just wanna secure a worry-free future,

00:00:19.200 | these strategies will help you navigate the complexities

00:00:22.020 | of safe withdrawal rates and market risks.

00:00:24.440 | I'm Chris Hutchins, and today I'm joined by Karsten

00:00:26.980 | from Early Retirement Now.

00:00:28.540 | And big favor before we jump in

00:00:30.400 | is to give us a quick thumbs up

00:00:31.780 | to help others find this channel.

00:00:33.460 | And if you're new here and you wanna keep upgrading

00:00:35.620 | your life, money, and travel, consider subscribing.

00:00:38.380 | You say that people can't afford not to retire early.

00:00:43.140 | Is that message really for everyone?

00:00:45.220 | Hopefully not for everybody, right?

00:00:46.800 | You want some really productive people

00:00:48.880 | to keep working forever, right?

00:00:50.560 | You want the Warren Buffetts and I mean, Charlie Munger,

00:00:53.680 | I think he was over 90 and still working when he passed away.

00:00:56.940 | So we need those people too.

00:00:58.280 | So, but for, yeah, for most folks,

00:01:02.520 | I think early retirement is a great concept

00:01:06.200 | and it is attainable and achievable.

00:01:09.860 | And so that's why that's by my little byline there

00:01:13.780 | on my blog that you should recognize

00:01:17.580 | that you have this opportunity cost

00:01:19.040 | like going to the office every day,

00:01:20.200 | you miss so much in terms of family time.

00:01:23.920 | And at some point you accumulate enough assets,

00:01:28.480 | then the opportunity cost goes the other way around

00:01:31.000 | from what we normally learn it in economics, right?

00:01:33.460 | Opportunity cost means you want to do fun stuff.

00:01:36.080 | You have the missed opportunity cost of your salary.

00:01:41.040 | If you have a lot of money,

00:01:42.120 | I think it's the other way around.

00:01:43.300 | Keep going to work and getting more promotions

00:01:46.760 | and bigger gadgets, bigger houses, bigger cars.

00:01:50.380 | At some point, the opportunity cost

00:01:51.600 | goes the other way around, right?

00:01:52.640 | You miss out on life.

00:01:54.360 | But that's where this idea comes from.

00:01:55.940 | You can't afford not to retire early.

00:01:57.520 | At some point, you should consider this opportunity cost

00:02:01.360 | and spend more time with loved ones,

00:02:03.060 | travel more, have more relaxed time.

00:02:05.780 | - A lot of the criticisms

00:02:07.360 | of the financial independence movement

00:02:08.940 | have kind of said, you know, that's great,

00:02:10.560 | but only if you have a high salary

00:02:12.280 | and only if you can do all these things.

00:02:13.980 | So do you think it's really attainable

00:02:17.640 | for the average employee in a company?

00:02:21.940 | - Obviously, if you look at what would be the ideal setting

00:02:25.480 | for somebody to achieve FIRE, right,

00:02:27.480 | it would be a married couple, no kids,

00:02:30.700 | very high salaries, professional salaries,

00:02:33.280 | say doctors, lawyers, engineers,

00:02:35.400 | finance professionals, accountants,

00:02:37.480 | live in a low-cost area and have no student loan debt.

00:02:43.440 | So that would be the ideal setting.

00:02:45.740 | I think those people should probably make it very easily.

00:02:49.740 | And somebody who would have a very challenging time

00:02:52.860 | would be single, income family, lots of kids,

00:02:56.080 | high cost of living area.

00:03:01.040 | So they would find it more challenging.

00:03:02.400 | But nobody's always at the extremes, right?

00:03:05.040 | So for example, my personal example is,

00:03:08.080 | yeah, I was in a very high-paying industry

00:03:09.940 | and a very high-paying job in finance.

00:03:12.240 | I had little to no student loan debt, so that was good.

00:03:18.820 | But we had a single family,

00:03:21.660 | so we had a single-income family,

00:03:23.860 | so my wife didn't work once we had our daughter,

00:03:26.700 | and we lived in a high-cost of living area.

00:03:28.740 | So we checked off some of the boxes

00:03:30.480 | and we didn't check off some of the other boxes.

00:03:34.280 | I think even if you are somewhere in between,

00:03:36.400 | between the ideal and the not-so-ideal extreme,

00:03:39.060 | you can still make it.

00:03:40.020 | I mean, I did it, and there are lots of people

00:03:42.360 | who achieved FIRE and FIRE

00:03:46.280 | without ever earning six figures.

00:03:49.900 | And I mean, if they can make it,

00:03:52.900 | it's a lot more attainable.

00:03:55.400 | And I think, yeah, I understand there are some challenges,

00:03:59.560 | but I think also a lot of the criticism of FIRE and FIRE

00:04:03.980 | is it's a little bit of coping, right?

00:04:05.940 | It's easier to make excuses

00:04:08.240 | than to get your act together and do it, right?

00:04:12.020 | Because that's going to be a long path, right?

00:04:13.700 | It's going to be a 10 to 15-year path to get your finances

00:04:16.560 | in order and accumulate enough.

00:04:19.860 | And it's very easy to just fall back and say,

00:04:23.120 | "Well, only the very rich people can do it,"

00:04:25.320 | and I throw up my hands and I'm not going to do it, so.

00:04:28.580 | - I'm not going to walk through the process for that.

00:04:30.940 | I've done an episode on financial independence.

00:04:34.240 | We'll put it in the show notes.

00:04:35.620 | But when you talk to most people

00:04:37.700 | about how to think about this,

00:04:39.060 | the most common rule or rule of thumb is the 4% rule,

00:04:43.020 | which is like, how do you know if you can do this?

00:04:45.580 | And it's that, oh, well, if you have enough assets

00:04:47.860 | that you can live off 4%, you're all set.

00:04:50.220 | What do you think people get wrong

00:04:51.580 | if they rely on something so simple?

00:04:53.620 | - So I think a 4% rule is a good guideline.

00:04:58.620 | If you are starting out and say you have zero assets

00:05:03.500 | and you're starting on this path

00:05:05.060 | and you think maybe 10, 15, 20 years down the road,

00:05:10.540 | you are going to need, say, $80,000 a year

00:05:15.540 | to live comfortably, yeah,

00:05:18.180 | and then you can say it's times 25,

00:05:20.020 | which is the equivalent of the 4% rule, right?

00:05:22.820 | One divided by 25 is 0.04, is 4%.

00:05:26.180 | That's where that comes from.

00:05:27.820 | So this rule of 25X, so if you have $2 million,

00:05:31.020 | you should be able to roughly retire at that time.

00:05:36.020 | It's obviously just the rule of thumb, right?

00:05:38.980 | So this should not be generalized, right?

00:05:40.860 | We should not all wear the same shoe size

00:05:44.260 | and it's gonna be too tight for some

00:05:46.940 | and too big for others.

00:05:49.260 | And the reason why this 4% rule has gotten such fame

00:05:54.260 | is obviously it's a round number, right?

00:05:59.260 | And the actual results,

00:06:02.300 | if you look at some of the extreme cases

00:06:05.140 | that you could have, say somebody who is really young,

00:06:07.460 | who has a much longer horizon,

00:06:09.780 | yeah, you probably have to go down

00:06:11.020 | to something like 3%, right?

00:06:13.180 | And somebody who is really close to social security, right,

00:06:16.580 | who maybe only has to bridge a little bit of time

00:06:19.260 | until they have some other cash flows coming in,

00:06:22.420 | you could maybe go to 5%, right?

00:06:24.580 | So then people say, well, you know,

00:06:26.100 | this big range of 3% to 5%, 4% is right in the middle.

00:06:30.820 | It's a nice round number.

00:06:34.220 | And then the 3% and the 5%,

00:06:36.300 | hey, it's just a percent difference, right?

00:06:37.820 | What is it really?

00:06:39.340 | So 4% seems to be this nice, precise, and round number.

00:06:44.380 | Of course, the problem with that

00:06:45.580 | is the range from 3% to 5% is not a 2% difference, right?

00:06:50.580 | To go from, say, a $60,000 a year budget

00:06:55.060 | to $100,000 a year budget,

00:06:57.980 | say on a $2 million nest egg,

00:07:00.820 | that's not a 2% difference, right?

00:07:02.260 | To go from 60% to 100%, that's a 66% difference.

00:07:05.860 | So this is a really wide range, right?

00:07:08.580 | So if somebody says, yeah, it's 4%,

00:07:10.300 | but it could be anywhere between 3% and 5%,

00:07:12.260 | that's like saying the weather forecast,

00:07:14.580 | it could be anywhere between freezing

00:07:16.980 | and heatwave tomorrow, and that's obviously true,

00:07:20.460 | but it's really a useless forecast

00:07:22.940 | in terms of doing actually something concrete.

00:07:27.140 | So my point is that the 4% rule,

00:07:32.020 | my problem is not so much with the 4% number,

00:07:35.820 | but it's about the word rule, right?

00:07:37.580 | It shouldn't be a rule, it's a rule of thumb.

00:07:40.140 | Your actual number should be more custom-fitted,

00:07:44.340 | and it should be custom-fitted,

00:07:46.660 | taking into account your personal parameters, your age,

00:07:50.860 | whether you would like to leave a bequest,

00:07:53.060 | whether you would like to make major contributions.

00:07:57.620 | Say, if you have kids,

00:07:58.820 | do you want to help them with down payment

00:08:00.700 | in college later in life?

00:08:03.500 | Do you want them to also start from scratch,

00:08:05.900 | or do you want to help them a little bit, right?

00:08:08.420 | Whether you have supplemental cash flows

00:08:10.500 | later in retirement,

00:08:11.700 | whether you, when and how much social security you expect,

00:08:15.100 | do you have any kind of government pension,

00:08:16.700 | military pension, corporate pension that kicks in later?

00:08:21.020 | So all of that could make really huge differences

00:08:23.660 | in your calculations, right?

00:08:25.780 | And so this is why you get this wide window.

00:08:29.020 | I have done safe withdrawal case studies for people,

00:08:33.780 | and they can range anywhere from somewhere in the 3% range

00:08:39.020 | to all the way to 6-plus percent,

00:08:41.380 | and that is such a wide range,

00:08:43.860 | tells you that you should take

00:08:46.780 | your personal parameters in account.

00:08:49.660 | And the other thing you have to take into account

00:08:51.180 | is also where are asset markets today, right?

00:08:53.980 | If you're retiring at the bottom of a recession

00:08:58.260 | and a bear market,

00:08:59.740 | you can probably be a little bit more aggressive

00:09:02.900 | because, well, if the market is already down 30%, 40%,

00:09:06.660 | the probability that we tag on another Great Depression

00:09:10.060 | or global financial crisis

00:09:12.540 | on top of what we already dropped is very unlikely.

00:09:15.940 | So you can probably factor in that

00:09:19.820 | you don't need to go by the historical worst-case scenarios,

00:09:23.260 | which would normally traditionally get you to that 4%.

00:09:26.860 | Well, then, yes, absolutely, you can also do a 6% rule

00:09:29.300 | or even more than 6%.

00:09:31.340 | So depending on where you are in the market cycle,

00:09:33.660 | you should also adjust that.

00:09:35.340 | And so just taking one number and running with that,

00:09:40.340 | that seems really inappropriate,

00:09:44.060 | and that's really my little niche on my blog

00:09:47.220 | where I look into what can we learn

00:09:51.700 | and what can we put into our safe withdrawal analysis

00:09:57.060 | that factors in some of these idiosyncratic

00:10:01.500 | personal parameters,

00:10:02.580 | and then also looking at what the market tells us,

00:10:06.500 | how much we can withdraw at any point.

00:10:08.700 | - So we'll link to the whole series

00:10:10.620 | because I don't actually know if you know

00:10:12.220 | how many words it is, but 60-plus posts,

00:10:15.380 | you know, it's basically a book at this point,

00:10:17.340 | if not multiple. - Right, right, right.

00:10:19.340 | - We won't cover it all,

00:10:20.740 | but I wanna double-click a little bit.

00:10:22.940 | It sounds like what I heard you say might be one,

00:10:27.060 | 3%, if anything, is probably a really safe number,

00:10:31.100 | but very conservative for lots of people.

00:10:35.900 | When you start to try to dial in what this is,

00:10:38.540 | how much does longevity matter?

00:10:40.420 | Was the 4% rule designed to last for 100 years,

00:10:44.420 | or is it much more timeframe-sensitive?

00:10:47.500 | - So the 4% rule, the original papers,

00:10:50.100 | they had a 30-year retirement horizon,

00:10:52.740 | and then what people did was,

00:10:57.100 | well, so the initial 4% rule,

00:11:00.140 | a success would have been if you run out of money

00:11:02.700 | after exactly 30 years,

00:11:03.900 | or you're running on fumes towards the end,

00:11:06.420 | and you have basically one cent left after 30 years,

00:11:08.940 | that would have been called a success, right?

00:11:11.180 | So we can already see what kind of problems that creates

00:11:13.580 | if we extrapolate and make this a longer horizon.

00:11:16.820 | So if we take longer horizons,

00:11:20.260 | we probably have to withdraw a little bit less.

00:11:22.820 | Now, some people who are not very good at math,

00:11:26.700 | they would say, well, if you have a 60-year horizon,

00:11:28.820 | does that mean you cannot do only 2%?

00:11:31.460 | And fortunately, that's not the case, right?

00:11:35.820 | You can do much, much more than 2%.

00:11:40.180 | So it's probably somewhere in the range.

00:11:41.500 | You go from 4% to maybe 3.25%, right?

00:11:44.580 | So basically, the just very basic safe withdrawal analysis

00:11:50.580 | is something that I could take a 60/40 portfolio,

00:11:52.700 | a 75/25 portfolio,

00:11:55.020 | and look at how you would have fared

00:11:57.420 | during the Great Depression.

00:11:59.140 | Yeah, the good news is it would have lasted for 60 years

00:12:03.820 | if you go down into the maybe the low 3%.

00:12:07.860 | It's much better than 4% divided by two,

00:12:11.740 | but it is definitely much less.

00:12:13.540 | And I thought, and this was actually one of the reasons

00:12:16.260 | that enticed me to write my series.

00:12:18.620 | I saw that there was a lot of misinformation out there

00:12:22.340 | in the FIRE community where people said,

00:12:24.500 | oh yeah, I mean, most of the time you last for 30 years,

00:12:27.900 | and most of the historical cohorts

00:12:30.900 | actually ended up with more money than they started with.

00:12:34.500 | And well, if you still have the same amount of money

00:12:37.460 | after 30 years, you just tag on another 30 years,

00:12:39.980 | and boom, 4% rule can be extrapolated indefinitely.

00:12:44.300 | But yeah, I mean, the problem is that,

00:12:46.260 | I mean, this is obviously something

00:12:48.140 | of an amortization exercise, right?

00:12:49.980 | And if you expand the horizon,

00:12:51.780 | then obviously something happens to the payment, right?

00:12:53.900 | The question is, is there really a big impact

00:12:57.180 | or a small impact?

00:12:58.340 | And it's obviously much more optimistic

00:13:02.900 | than just having to half your payout

00:13:05.820 | if you double the horizon, but it is a noticeable impact

00:13:09.220 | if you go from 30 years to 40 years to 50 years to 60 years.

00:13:13.300 | And again, it may not quite show up

00:13:17.260 | in terms of the percentage of that going from 4% to 3.2%.

00:13:22.260 | And again, this is not a 0.8% decrease in your budget,

00:13:26.180 | it's a 20% decrease in your budget.

00:13:28.540 | So it's better than a 50% drop,

00:13:31.460 | but it is a noticeable drop, right?

00:13:32.900 | And this drop, you can track it.

00:13:35.580 | If you go from 30 to 40 to 50 to 60,

00:13:38.660 | you go from four to go and fill in

00:13:41.820 | basically the steps in between.

00:13:43.620 | So there is an impact of longevity.

00:13:46.620 | And it's important enough

00:13:51.260 | that we really should take it into account.

00:13:53.980 | You can't just say, well, it works over 30 years.

00:13:57.380 | I crossed my fingers, it also works over 60 years.

00:13:59.780 | That would be really financial malpractice doing that.

00:14:03.260 | - And you've done a lot of testing with this.

00:14:05.540 | Are you testing kind of more historical data

00:14:08.980 | or are you also testing kind of modeled out

00:14:11.220 | Monte Carlo future simulations?

00:14:13.260 | - So I've done both.

00:14:14.780 | On my blog, it's mostly historical simulations

00:14:18.740 | and I've justified that in my blog.

00:14:23.260 | I also like Monte Carlo in some way

00:14:26.140 | because now you can say we can run more simulations.

00:14:30.700 | Obviously, the problem with Monte Carlo

00:14:34.620 | is there's always a bit of a garbage in,

00:14:36.060 | garbage out proposition.

00:14:38.660 | Of course, as I said, there's this hybrid method

00:14:40.780 | where you basically do the,

00:14:43.140 | you draw returns from the actual history,

00:14:48.140 | but then not just month by month,

00:14:51.460 | but really blocks of data.

00:14:52.900 | So you can solve some of the problems there.

00:14:55.740 | But I personally prefer to just use historical data.

00:15:00.260 | - How can the average person

00:15:01.780 | who doesn't have that expertise

00:15:04.060 | start to model out what a reasonable number is for them?

00:15:06.900 | - So first of all, you don't need to understand

00:15:08.620 | all the underlying details.

00:15:11.340 | That's why I did the hard work.

00:15:13.140 | So people don't have to, right?

00:15:14.540 | So it's like if I'm sitting in an airplane,

00:15:17.260 | I don't have to understand all the mechanics

00:15:19.740 | that keeps that airplane afloat.

00:15:22.620 | There's some people that thought about that for me

00:15:25.300 | and I just enjoy the ride.

00:15:26.820 | And it's almost as simple as that

00:15:31.020 | for people who want to plan their retirement.

00:15:34.180 | And again, as I said before,

00:15:35.980 | you have to do this as a personalized exercise, right?

00:15:39.580 | Because everybody's parameters are different.

00:15:42.380 | So on my blog, I have a Google sheet.

00:15:45.740 | So I have a blog post and in the blog post,

00:15:48.020 | I go through basically as a manual

00:15:52.540 | how I would use my retirement simulation tool.

00:15:58.580 | And basically what you can do

00:15:59.580 | is you can put in your own parameters,

00:16:02.340 | your portfolio allocation, and then you can calculate,

00:16:06.100 | well, how would your personal retirement have fared

00:16:09.740 | in all the possible historical retirement cohorts

00:16:14.060 | since the 1870s?

00:16:16.140 | If you think that everything before, say the 1920s,

00:16:18.700 | that is so outdated and you can obviously ignore that

00:16:23.140 | and only look at what would have been the results,

00:16:25.500 | say post Great Depression.

00:16:30.420 | And so anyway, so you can then do

00:16:33.540 | your personalized retirement analysis

00:16:36.700 | with your personal parameters.

00:16:39.900 | What is your retirement horizon?

00:16:42.220 | What kind of future cash flows do you expect?

00:16:45.900 | What kind of cash flows are they?

00:16:47.740 | Are they inflation adjusted, right?

00:16:49.940 | Is it something like social security

00:16:51.660 | where you get a certain amount at a certain time

00:16:54.300 | and then that also goes up with inflation?

00:16:56.580 | It could be something like supplemental cash flows

00:16:59.020 | like many corporate pensions are not inflation adjusted.

00:17:03.220 | So that would be some amount,

00:17:04.700 | but then that would be eaten away over time by inflation.

00:17:08.420 | So there would be ways to model that.

00:17:10.140 | You can hack your retirement

00:17:12.300 | and your retirement planning tool,

00:17:14.580 | probably in a way that no financial planner

00:17:19.580 | or no other free tool that you can find on the web

00:17:23.340 | would be able to do.

00:17:24.460 | And so you can do this

00:17:26.500 | and then you can do it multiple different ways.

00:17:28.740 | You can check what would be the one level payout

00:17:33.500 | over my entire retirement horizon

00:17:36.140 | that would have still survived the entire horizon.

00:17:40.660 | And then by the way, surviving means

00:17:43.580 | you can specify that too, right?

00:17:46.660 | So you can specify, are you okay with depleting your money

00:17:50.780 | versus having X percent left of your nest egg at the end?

00:17:55.660 | So imagine you have a big quest motive

00:17:58.020 | and you want to leave certain percentage of your nest egg

00:18:00.900 | to your kids or to charity.

00:18:03.220 | A lot of my blog posts

00:18:04.980 | were taken straight out of this tool.

00:18:08.740 | And I mean, so some very serious,

00:18:11.980 | very serious retirement planning research

00:18:17.300 | came out of just using that tool.

00:18:19.020 | But I mean, it is really usable

00:18:21.420 | for just regular retail investors.

00:18:23.620 | And it might seem a little bit intimidating

00:18:27.860 | when you first look at it.

00:18:28.860 | But yeah, I mean, I have my,

00:18:31.180 | I think it's part 28 of my series

00:18:33.100 | where I go through what all the different features are.

00:18:36.180 | And then there's two buddies of mine,

00:18:38.140 | they run a podcast, Two Sides of Fi.

00:18:40.780 | I think they have done two or so videos

00:18:44.420 | on how they would use it.

00:18:45.740 | And I think it's something like 30 minutes each.

00:18:48.020 | And if you just watch these videos,

00:18:49.900 | so you're pretty much off and ready to go

00:18:51.980 | and you can probably use 99% of all the features

00:18:54.980 | of that free tool.

00:18:57.300 | - It is free, so anyone can go get it.

00:19:00.020 | And it's been really interesting

00:19:02.100 | to see a lot of the nuance of,

00:19:05.100 | here's what a reasonable withdrawal rate would be

00:19:08.540 | and at different confidence intervals.

00:19:11.380 | But one of the things you said earlier

00:19:13.140 | was it really matters

00:19:14.180 | when in the market's current situation you are.

00:19:17.500 | And you've talked a lot about the sequence of return risk,

00:19:20.300 | which maybe you could explain a little bit

00:19:22.700 | and talk about how to even figure out where you're at

00:19:26.060 | and how that should affect your plan.

00:19:28.780 | - So sequence of return risk means that

00:19:30.980 | if you are a retiree

00:19:32.820 | and you are taking money out of your portfolio,

00:19:35.580 | you face some different challenges

00:19:38.420 | from say a buy and hold investor, right?

00:19:41.500 | So imagine you're a buy and hold investor,

00:19:43.620 | you put your money in the stock market today

00:19:46.700 | and then in 30 years,

00:19:48.020 | you finally open that letter from Fidelity or Vanguard

00:19:52.260 | and you see what's in there.

00:19:54.500 | And it doesn't really matter

00:19:57.940 | how the market performed along the way.

00:20:00.740 | The only thing that matters is your average return

00:20:03.340 | over those 30 years, right?

00:20:05.460 | So that determines uniquely

00:20:08.860 | what the final outcome would be, right?

00:20:11.580 | So imagine you had something like a 10% average return

00:20:14.700 | between now and the end point.

00:20:18.780 | And it doesn't matter if you had poor returns first

00:20:21.420 | and then very good returns later on or vice versa.

00:20:25.620 | And that's true for buy and hold investors,

00:20:29.620 | but it's not so much true for people

00:20:31.940 | who are either taking money out of the portfolio

00:20:34.620 | or putting money into the portfolio.

00:20:36.060 | That's actually the flip side of this.

00:20:38.060 | And I've written about this in parts 14 and 15 of the series

00:20:42.220 | where I drill into the intuition

00:20:45.820 | and the mechanics of what a sequence of return risk is.

00:20:50.820 | And so it turns out that for retirees,

00:20:54.620 | it's not so much important what the average return is

00:20:58.460 | over your 30-year retirement horizon.

00:21:00.980 | In fact, I have one chart somewhere floating around

00:21:04.900 | on my blog where I showed what,

00:21:06.620 | well, what were the failures of the 4% rule?

00:21:09.780 | What explains the failure of the 4% rule?

00:21:12.900 | And I can get you some example where the 4% rule failed,

00:21:16.340 | even though the buy and hold return

00:21:19.700 | from beginning to the end of the retirement,

00:21:23.100 | something like, I think, from 1968 to 1998,

00:21:27.700 | I think a 75% stock, 25% bond portfolio

00:21:32.380 | would have had a return of somewhere around in the high 5%

00:21:35.220 | or even low 6% in real terms, inflation adjusted.

00:21:39.740 | Yet the 4% rule still failed.

00:21:42.300 | And the reason for that is if you have very poor returns

00:21:44.940 | early on and you withdraw money along the way

00:21:48.700 | on the bottom of the market,

00:21:50.420 | or even close to the bottom of the market,

00:21:52.500 | you are taking so much money out of the portfolio

00:21:54.940 | in terms of number of shares that you sell,

00:21:57.820 | that even if the market then recovers subsequently,

00:22:00.780 | you have compromised your portfolio so badly

00:22:03.100 | that even with a subsequent recovery,

00:22:06.020 | your portfolio still runs out.

00:22:07.500 | So it's essentially, it's the opposite of dollar cost averaging.

00:22:11.260 | Because we're all familiar with dollar cost averaging

00:22:13.660 | and we tell people, "Oh, yeah, you don't have to be afraid

00:22:17.140 | if the market goes down and you put money in."

00:22:19.700 | Because the nice thing is if the market goes down,

00:22:22.620 | you're buying more shares.

00:22:24.540 | And then if the market subsequently recovers,

00:22:28.220 | then those additional shares are going to look even better

00:22:33.180 | in your portfolio, right?

00:22:34.100 | Because you don't buy by the number of shares,

00:22:37.060 | but by the money that you put in, right?

00:22:39.140 | And you're buying more shares if the market is low.

00:22:42.540 | And people are amazed.

00:22:44.740 | So this is obviously a feature

00:22:47.300 | during your accumulation period.

00:22:49.380 | And everybody is, once they find out about this

00:22:53.140 | and they think, "Oh, this is the best ever."

00:22:56.300 | Problem is this exact same feature hurts you

00:22:59.820 | if you're in retirement.

00:23:02.020 | Because now if the market is down,

00:23:04.780 | you are selling more shares of your portfolio

00:23:08.700 | because prices are down.

00:23:10.820 | And so this is the flip side of dollar cost averaging.

00:23:15.220 | And that could actually wipe you out,

00:23:17.620 | even though the returns

00:23:19.460 | over the entire 30-year return history wasn't even so bad

00:23:24.100 | or it might've been really good even.

00:23:25.700 | So in fact, none of the failures of the 4% rule

00:23:29.740 | are because the average return was so low.

00:23:32.300 | Every single failure of the 4% rule,

00:23:35.460 | you had returns that on average would have been enough

00:23:38.940 | to sustain a 4% rule,

00:23:40.380 | but it's because of the sequence of return

00:23:43.340 | that you had very bad returns early on.

00:23:45.900 | And then the subsequent recovery was too late.

00:23:49.060 | You had already depleted your portfolio so badly

00:23:51.180 | that there was no hope at that point.

00:23:55.300 | So that's what sequence of return means.

00:23:57.580 | It's exactly what the name says.

00:24:00.180 | It matters in which sequence

00:24:02.020 | the good and bad returns come in.

00:24:03.780 | - So for example, in the $2 million nest egg

00:24:07.060 | that 4% would say, "Oh, I can take $80,000 a year out."

00:24:11.580 | If the first year you retire,

00:24:13.340 | the market's down 35% and you start taking 80,000 out,

00:24:18.340 | you're actually taking out more than 6% of your portfolio.

00:24:22.540 | And if you do that three, four years in a row

00:24:24.860 | while the market's down, even if the market recovers,

00:24:28.780 | it's gonna make it really tough to get back there.

00:24:30.900 | - Exactly, exactly, yeah.

00:24:32.940 | - And so what should we do about that?

00:24:36.180 | 'Cause obviously we can't predict the future.

00:24:39.140 | Are there ways to know where we're at now

00:24:42.260 | and whether that should affect,

00:24:43.900 | are we likely to be there in the future or ways to react?

00:24:48.900 | - So short of becoming a market timer

00:24:52.540 | and either knowing or predicting when the market drops,

00:24:58.300 | there's relatively little we can do about it.

00:25:01.660 | So the reason why I've written so much

00:25:06.220 | about safe withdrawal rates

00:25:07.300 | is that there is no easy solution, right?

00:25:09.260 | And some of the blog posts I wrote would be,

00:25:12.220 | "Well, somebody pointed out to me,

00:25:14.260 | "well, can't we just do such and such?

00:25:17.260 | "And would that solve sequence of return risk?"

00:25:20.580 | And a lot of the proposed solutions

00:25:26.300 | are actually not really valid.

00:25:28.380 | So people have said,

00:25:29.220 | "Well, couldn't we just do something like,

00:25:32.660 | "well, we set up a portfolio

00:25:34.300 | "that has a dividend yield of 4%, right?

00:25:37.220 | "Boom, we're done.

00:25:38.260 | "We never dig into the principle

00:25:40.940 | "'cause the dividends are now so high

00:25:43.700 | "that they pay out the 4%

00:25:46.700 | "and we never even have to sell shares when they're down.

00:25:50.540 | "So boom, there we solve our sequence of return risk."

00:25:53.540 | Well, the problem with that is,

00:25:54.460 | well, first of all, dividends can be cut, right?

00:25:56.380 | So, and they have been.

00:25:58.500 | Dividends, even if they are not cut,

00:26:01.540 | they could be depleted away by inflation.

00:26:03.940 | So if you look at, say, even S&P 500,

00:26:07.020 | you look at the dividend income

00:26:08.660 | of one representative share in the S&P 500.

00:26:12.580 | Yeah, it had some, it grew a lot, the dividend income,

00:26:16.180 | but it also had some very nasty drawdowns.

00:26:18.380 | And then during those drawdowns,

00:26:19.780 | either you consume less

00:26:21.340 | or then you do have to dig into your principle

00:26:24.820 | to make up the difference.

00:26:26.020 | And then by the way,

00:26:26.860 | the S&P 500 hasn't yielded 4% for a long time.

00:26:29.860 | So you have to supplement your S&P 500 portfolio

00:26:32.940 | with a lot of other stuff that is very high yielding

00:26:36.500 | and potentially very risky,

00:26:38.020 | something like high yield bonds or preferred shares.

00:26:41.860 | So I checked that one out.

00:26:43.180 | And so that doesn't really work.

00:26:45.780 | At least it doesn't work reliably.

00:26:48.940 | So the one thing that I propose

00:26:51.980 | that maybe doesn't solve sequence of return risk,

00:26:56.500 | but at least it takes a little bit the edge off

00:26:59.140 | is that when you retire,

00:27:01.900 | you're a little bit more cautious

00:27:03.260 | with your stock bond allocation.

00:27:05.580 | So instead of being 75% or 80% stocks,

00:27:10.580 | maybe you start out at 60% stocks, 40% bonds.

00:27:16.780 | You know, the good old 60/40, right?

00:27:18.460 | This might not be a bad starting point,

00:27:22.620 | especially today, right?

00:27:23.620 | Because we are recording this in early July.

00:27:25.820 | So 10-year bonds are again in the mid 4% in their yields.

00:27:30.820 | I haven't checked it this morning,

00:27:32.180 | but it was something like 4.48.

00:27:34.500 | - I just pulled it up.

00:27:35.740 | - Yeah, so right in the mid fours.

00:27:37.500 | And it's not a bad yield for a relatively safe investment.

00:27:44.220 | And so you start a little bit more on the cautious side,

00:27:49.220 | but remember, we also have

00:27:51.500 | a very long retirement horizon, right?

00:27:53.500 | And even at that 4.5%,

00:27:56.780 | after you take out inflation, maybe 2% to 2.5%,

00:27:59.740 | a bond itself has a little bit of a lean real return

00:28:03.900 | of maybe 2% to 2.25% right now.

00:28:07.260 | So you need equities obviously in the long run.

00:28:09.460 | And the way you do that is while you start very cautiously,

00:28:12.460 | but then you shift into higher equities

00:28:15.540 | later in retirement.

00:28:16.460 | So that's called a reverse glide path, right?

00:28:19.180 | Because we know the glide path

00:28:21.420 | is the glide path into retirement

00:28:23.300 | where you go from high equities, low bonds,

00:28:26.140 | into more bonds and less equity.

00:28:29.540 | And quite amazingly, this reverse glide path

00:28:32.860 | where in retirement you shift out of bonds

00:28:35.020 | and back into equities,

00:28:36.660 | it actually helps you at least very partially

00:28:40.540 | with the sequence of return.

00:28:42.300 | So for example, I've had some case studies

00:28:45.820 | where maybe over a long horizon,

00:28:49.660 | you had something like a 3.4% safe withdrawal rate

00:28:54.100 | with a 75/25 portfolio.

00:28:58.500 | You can maybe raise it from 3.4% to 3.6%.

00:29:03.020 | Again, you don't go all the way from 3.4% to 4%,

00:29:05.980 | but at least you cover maybe a third of the distance

00:29:09.700 | to go back to 4% with this reverse glide path.

00:29:13.180 | And so I'm not the inventor of this,

00:29:16.580 | but I've definitely done a lot of research on that.

00:29:18.980 | So it's a guy called Michael Kitsis

00:29:21.980 | has proposed this weight file,

00:29:24.420 | who is a very big name in the retirement planning community.

00:29:27.820 | So they have written about this extensively.

00:29:29.660 | I have written about this.

00:29:30.980 | So that is actually one route that you can do

00:29:34.580 | to maybe not solve sequence of returns,

00:29:36.900 | but you can alleviate a little bit

00:29:38.780 | because, well, you take off what...

00:29:42.740 | Because your retirement success

00:29:46.260 | so much depends on the first five to 10 years

00:29:49.340 | of returns early in your retirement.

00:29:52.460 | Maybe you take a little bit less risk early on,

00:29:54.980 | but then you shift into higher risk assets

00:29:57.100 | again later in retirement.

00:29:58.620 | So that seems to work.

00:29:59.900 | Not much else really works.

00:30:03.740 | There are some other proposals

00:30:05.460 | where you follow something like a market timing strategy.

00:30:09.500 | You do some kind of a momentum trend following strategy.

00:30:13.540 | I haven't published anything on that,

00:30:15.620 | but I think that's gonna be my next blog post

00:30:18.220 | where I look into that.

00:30:19.140 | That's probably gonna be part 62.

00:30:21.060 | It solves some of the problems,

00:30:25.540 | but it also creates some other issues.

00:30:28.180 | So it's like squeezing a balloon almost, right?

00:30:30.020 | So you fix this problem,

00:30:31.460 | but then the balloon blows up on the other edge.

00:30:35.700 | And there were a few cases

00:30:37.140 | where a sequence of return risk

00:30:41.180 | wasn't that big of a problem,

00:30:42.940 | but then using that momentum strategy,

00:30:44.900 | suddenly it became a problem in that episode.

00:30:48.180 | But I mean, this is something that people have proposed.

00:30:50.580 | I am a little bit skeptical

00:30:52.660 | that this momentum and trend following

00:30:55.260 | is gonna work reliably.

00:30:57.020 | Again, I want to point it out.

00:31:01.260 | Yeah, but I mean, apart from that,

00:31:02.580 | I mean, the only thing you can really do

00:31:04.540 | is be more cautious with your withdrawal rate, right?

00:31:09.540 | Take a withdrawal rate that in the beginning

00:31:13.660 | might be a little bit leaner.

00:31:15.060 | And then obviously chances are

00:31:18.060 | you did not retire at the worst possible time,

00:31:21.380 | and then you would eventually walk up

00:31:23.580 | your retirement withdrawals.

00:31:25.700 | And by the way, this is what we do

00:31:30.180 | in many other aspects of life too, right?

00:31:33.140 | I mean, when I fly somewhere and I go to the airport,

00:31:37.700 | I plan my departure time at home when I go to the airport

00:31:42.700 | to set the probability of missing the plane to 0%, right?

00:31:47.500 | I mean, there's nothing I can do about missed connections.

00:31:50.540 | If you fly through Chicago in the winter

00:31:53.740 | or Atlanta in the summer,

00:31:55.340 | you might miss a connection

00:31:56.500 | because of thunderstorms or snowstorms.

00:31:59.100 | But at least the part that is in my control,

00:32:02.900 | right, I have this asymmetric risk profile

00:32:07.900 | wasting some time at the airport.

00:32:10.620 | Yeah, okay, I can deal with that.

00:32:12.140 | Missing a plane and missing a vacation,

00:32:14.900 | missing a cruise, missing a birthday,

00:32:16.940 | missing a wedding, missing a funeral,

00:32:19.260 | that would be a very one-sided risk.

00:32:25.180 | And I view it the same in retirement, right?

00:32:28.820 | I probably over-accumulated assets

00:32:32.460 | and I could have in hindsight retired a little bit earlier,

00:32:35.140 | but I think the risk is asymmetric

00:32:40.020 | and I would rather accumulate a little bit more

00:32:42.860 | and retire a little bit later,

00:32:44.580 | but then retire in comfort and without worry

00:32:48.340 | that I run out of money.

00:32:50.100 | And so, yeah, I mean, the best way to deal

00:32:54.220 | with sequence of return risk

00:32:55.420 | is to simply be a little bit more cautious

00:32:59.580 | on your withdrawal rate in the beginning.

00:33:02.100 | - Now, you mentioned that in the first five to 10 years

00:33:04.540 | are kind of the most important

00:33:06.140 | when it comes to sequence of returns.

00:33:08.780 | If you had a strategy where you said,

00:33:10.820 | "Hey, I wanna retire when I'm,"

00:33:12.940 | let's pick an age, 45, 50, it doesn't matter.

00:33:15.780 | And you said, "But if when I decide I'm gonna retire,

00:33:19.540 | "I'm willing to say this is a bad time,

00:33:24.460 | "the market's not great,

00:33:25.700 | "I could work a little extra in those first five years."

00:33:28.980 | Could that level of flexibility

00:33:31.580 | give you the ability to actually retire a little earlier

00:33:34.660 | knowing that if something happened

00:33:36.420 | in those first few five, 10 years, you could change?

00:33:39.420 | - Basically, we're talking about flexibility, right?

00:33:40.940 | Can't I just be flexible and either consume less

00:33:44.620 | or work a little bit more?

00:33:46.580 | And I say, yes, absolutely you can and you should be,

00:33:51.780 | but make sure that maybe you model that too, right?

00:33:56.180 | And the way you can model that in my tool is,

00:33:58.620 | well, yeah, maybe for the first five years,

00:34:02.620 | you still model something like a side gig,

00:34:05.380 | and then you can see how much of a difference

00:34:07.780 | does that make in my safe withdrawal analysis.

00:34:11.020 | I mean, there's some people who say,

00:34:12.300 | "Yeah, if you are just more flexible,

00:34:16.020 | "you could raise your safe withdrawal rate

00:34:18.260 | "to 5.5% from 4%."

00:34:21.060 | And I say, "Well, are you sure you wanna do that?"

00:34:23.900 | Because if you look at what your rule,

00:34:26.660 | what your "flexibility rule" would have created is,

00:34:29.820 | yeah, in the beginning, you withdraw 5.5%,

00:34:32.940 | and then something bad happens in the market,

00:34:34.740 | and then you go down to something like 2.75.

00:34:38.260 | You have to cut your spending by half and say,

00:34:41.740 | "Well, you only do the necessary stuff and everything else.

00:34:44.260 | "Either you don't spend

00:34:45.300 | "or you have to supplement with a job."

00:34:47.580 | And then the problem is people misunderstand

00:34:51.580 | that this spending cut or the side gig

00:34:56.580 | has to last for only as long as the bear market lasts,

00:34:59.540 | but it doesn't, right?

00:35:00.420 | Because your portfolio might be taken down so badly,

00:35:03.740 | even now we are back in a bull market,

00:35:05.940 | but your portfolio is still in a bear market, unfortunately,

00:35:09.300 | and it's still underwater.

00:35:11.340 | So this flexibility might last longer

00:35:14.740 | than you are comfortable with, right?

00:35:16.180 | So what I always call this is, again,

00:35:18.860 | you take one failure

00:35:23.220 | and you replace it with another failure, right?

00:35:24.780 | The failure of the 4% rule is,

00:35:26.540 | well, you run out of money after 27 years,

00:35:29.500 | and you almost create a worse failure

00:35:32.460 | by now all the pain starts very early on,

00:35:36.700 | and you have to go back to work,

00:35:39.900 | you have to cut your expenses, right?

00:35:41.620 | You are young and you have all of this drive,

00:35:43.700 | and now I want to travel, and I want to do this and that,

00:35:46.940 | and I want to volunteer more.

00:35:48.580 | And now you have to put this on ice again,

00:35:50.260 | and I have to put this on hold again.

00:35:52.460 | And so I think that would be a failure of sorts too.

00:35:56.860 | It wouldn't be quite as dramatic

00:35:58.340 | as running out of money at age 81,

00:36:02.020 | but it would still be impactful for a lot of people,

00:36:05.140 | it would be impactful for me.

00:36:06.500 | So, and again, I would say that

00:36:08.740 | if you have this flexibility, sure,

00:36:11.620 | model that flexibility and maybe stretch the flexibility

00:36:15.380 | for as long as you're comfortable.

00:36:17.060 | And if you say, you know, I could work on the side,

00:36:19.820 | I could do some consulting, maybe two or three years,

00:36:23.060 | but after two or three years, it really gets old,

00:36:26.460 | and then I want to go back into retirement.

00:36:28.140 | So what difference would this two to three years

00:36:30.980 | really make in my safe withdrawal analysis?

00:36:33.420 | And what I found is it's, yeah, it makes a difference,

00:36:35.500 | but it's not a huge difference, right?

00:36:37.540 | So be careful about it, because if some people say,

00:36:42.100 | oh, you have to be flexible,

00:36:43.900 | and then you can raise your safe withdrawal rate

00:36:46.260 | from 4% to 5.5.

00:36:48.620 | First of all, it wasn't 4% to begin with, right?

00:36:51.020 | So even over a 30 year, I think it's something like 3.8,

00:36:54.700 | because they were at the 4% rate, there were a few failures.

00:36:58.380 | So if you want to make it a 0%, it's maybe 3.8.

00:37:01.420 | So you can't just take it from 3.8 to 5.5

00:37:04.060 | and expect that the flexibility

00:37:06.980 | is going to be completely painless.

00:37:08.540 | It's actually the flexibility potentially

00:37:10.900 | would be quite impactful.

00:37:14.700 | And I wouldn't say it would ruin your retirement,

00:37:17.740 | but it would come close to ruining your retirement,

00:37:21.260 | because the flexibility, the length of the spending cuts

00:37:26.260 | and/or side gigs that you have to do in retirement,

00:37:31.620 | and the depth might be so painful

00:37:34.660 | that it might not be very palatable.

00:37:37.580 | The other problem is, obviously, right?

00:37:39.620 | I mean, if you look at, well, when were these times

00:37:44.100 | when you needed to go back to work in the past?

00:37:47.140 | It would have been, say, you have a labor market

00:37:50.380 | like in 1932, when you had 25% unemployment rate,

00:37:55.180 | or I think even in the '80s,

00:37:57.380 | we had double-digit unemployment.

00:37:59.900 | So it's usually not the best time to go look for a site.

00:38:03.940 | Maybe it's easier for some people than others.

00:38:06.340 | But yeah, so it's this whole flexibility solution

00:38:11.340 | to a sequence of returners.

00:38:13.820 | It raises more problems than it really answers, in my view.

00:38:17.740 | - I never thought about the fact that looking for extra work

00:38:21.260 | when the market is down 40% is probably not an ideal time,

00:38:24.660 | but is there any way, without predicting the future,

00:38:28.060 | that we could adjust our withdrawal rate

00:38:32.100 | based on current market conditions,

00:38:34.140 | whether we feel like it's over- or under-priced?

00:38:36.220 | - This is also something I found somewhere on the web,

00:38:38.180 | where people look at the Shiller-Kape ratio.

00:38:40.260 | So Kape ratio stands

00:38:41.740 | for a cyclically-adjusted price-earnings ratio.

00:38:44.340 | So if we are stock investors,

00:38:46.820 | we probably heard about a price-earnings ratio, right?

00:38:49.660 | Our problem is, if you look at the,

00:38:52.140 | just the price-earnings ratio,

00:38:53.900 | and you can do this with backward-looking earnings

00:38:56.180 | or forward-looking earnings forecasts,

00:39:00.260 | the price-earnings ratio is not really the best indicator

00:39:03.900 | for future returns.

00:39:06.340 | And that's just because sometimes the market

00:39:08.260 | gets a little bit ahead of itself and then keeps going up.

00:39:11.180 | And then, so some of the best returns

00:39:13.700 | happened when the price-earnings ratio

00:39:15.980 | was actually quite unattractive and vice versa.

00:39:19.660 | And so what Shiller proposed is that,

00:39:23.740 | so we take a longer-term view of,

00:39:29.180 | we look at the last 10 years of earnings of the S&P 500,

00:39:34.100 | and then we also do inflation adjustment, right?

00:39:38.300 | Because these are usually nominal numbers.

00:39:40.540 | And then we look at today's index

00:39:43.260 | over this average earnings over the last 10 years.

00:39:46.140 | And the reason for that is,

00:39:47.300 | sometimes the market fluctuates,

00:39:49.060 | but at least on the earnings side,

00:39:51.860 | we take longer-term averages,

00:39:53.460 | because, well, sometimes during recessions,

00:39:55.660 | earnings temporarily could actually become negative, right?

00:39:58.300 | Because then what is a price-earnings ratio

00:40:00.100 | if earnings were negative, right?

00:40:01.300 | That's not that meaningful.

00:40:03.700 | But if we take 10-year averages,

00:40:05.500 | at least we know that this is a little bit more stable.

00:40:08.180 | And what Shiller basically said,

00:40:11.380 | yeah, I mean, you can deviate from long-term averages,

00:40:15.180 | but eventually markets are gonna catch up again

00:40:18.540 | with earnings.

00:40:20.660 | And so looking at the Shiller CAPE,

00:40:25.820 | that, too, is not really a good predictor of next month

00:40:30.420 | or even next year S&P 500 returns,

00:40:33.540 | but it is a relatively reliable predictor

00:40:37.660 | of, say, the next 10-year returns, okay?

00:40:41.100 | So there is a pretty noticeable correlation

00:40:44.020 | between the CAPE ratio and 10-year returns.

00:40:48.020 | And, well, guess what?

00:40:48.860 | 10-year returns is roughly the horizon

00:40:52.780 | that matters for retirees.

00:40:55.140 | So it's a natural extension

00:40:59.260 | that we, as retirement researchers,

00:41:01.540 | should look at the CAPE ratio

00:41:03.180 | and let that educate us

00:41:05.580 | in determining what should be the right safe withdrawal rate.

00:41:08.260 | And then if stocks are very expensive,

00:41:11.300 | so that means the CAPE ratio is high,

00:41:13.500 | or the earnings yield,

00:41:14.620 | which is one over the CAPE ratio, is very low,

00:41:17.460 | then we should also take back a little bit

00:41:19.180 | our safe withdrawal rate.

00:41:21.140 | So now, basically, what you created

00:41:22.740 | is a method for doing retirement withdrawal planning

00:41:27.740 | that gets rid of some of this headache

00:41:34.380 | that you pointed out earlier, right?

00:41:35.980 | You start with a 4% withdrawal rate.

00:41:38.860 | The market drops by X percent,

00:41:41.020 | and now, suddenly, you are withdrawing 6%, right?

00:41:43.540 | And you ask yourself, "Well, the market is down.

00:41:45.820 | Okay, yeah, maybe I could withdraw a little bit more,

00:41:48.420 | but is it really a good idea

00:41:49.580 | to withdraw 6% instead of 4%?"

00:41:53.220 | So the nice thing about these CAPE-based

00:41:57.220 | safe withdrawal rate rules

00:41:59.900 | would be that you have a way to fine-tune

00:42:04.580 | and make dynamic your safe withdrawal rates

00:42:09.140 | because you would respond to market conditions.

00:42:13.900 | The nice thing, though,

00:42:14.740 | if you look at this more valuation-based approach

00:42:17.820 | from the CAPE ratio,

00:42:18.900 | so imagine the market goes down

00:42:20.580 | by a certain number of percent.

00:42:22.260 | Your portfolio is down.

00:42:24.140 | But because the market is down,

00:42:25.660 | now the earnings yield also looks a little bit better.

00:42:29.660 | So your percentage withdrawal rate goes up,

00:42:34.180 | and your portfolio is down.

00:42:35.820 | So the net effect is that, yeah,

00:42:38.180 | you're still going to withdraw less,

00:42:40.140 | but not really one-for-one.

00:42:42.500 | Maybe you withdraw 10% less.

00:42:45.460 | So, and this would be a way to at least systematically

00:42:49.540 | and dynamically adjust your withdrawals.

00:42:52.700 | So there is a way to basically rethink,

00:42:56.700 | well, yeah, I mean, the market is down already so much.

00:42:58.860 | I can now, I don't have to withdraw 4%

00:43:03.860 | of that decimated portfolio.

00:43:05.260 | I can withdraw a little bit more than 4% now.

00:43:07.540 | And you can do that in a systematic way,

00:43:09.460 | and it's, especially for somebody

00:43:12.100 | with a finance background,

00:43:14.620 | that's something that actually makes a lot of sense.

00:43:17.700 | And also gets rid of this problem, right?

00:43:20.620 | So for the math geeks,

00:43:22.900 | if you wonder about the Bellman principle of optimality,

00:43:26.020 | right, so that actually would satisfy

00:43:28.460 | this Bellman principle of optimality

00:43:30.420 | in the sense that if your portfolio is down by X%,

00:43:35.380 | and now you basically re-optimize,

00:43:38.340 | and your behavior would be no different

00:43:40.900 | from somebody who just retired

00:43:43.620 | with that portfolio level at that time.

00:43:46.420 | So you would both withdraw the same.

00:43:48.300 | Whereas if you do the 4% rule, right,

00:43:50.860 | you withdraw now 6% of your decimated portfolio.

00:43:54.020 | If somebody else retired with that same portfolio level

00:43:57.260 | and used the 4% rule, they would withdraw only 4%.

00:44:00.980 | So mathematically, that doesn't really make a lot of sense

00:44:04.020 | that you both have the same portfolio level,

00:44:06.660 | the same age, the same retirement horizon.

00:44:08.940 | You just retired at different times.

00:44:11.260 | And the one guy withdraw 6%, and one guy withdraw 4%,

00:44:15.220 | it can't both be optimal.

00:44:17.220 | Whereas this method that creates a withdrawal rate

00:44:22.220 | that's purely based on market condition and nothing else,

00:44:27.220 | I think that's a mathematically sound,

00:44:30.580 | and also I think financially sound method.

00:44:32.860 | So, and by the way,

00:44:34.140 | this is something that you can also model

00:44:35.700 | with my spreadsheet.

00:44:37.180 | So there's this, you can use the CAPE-based safe withdrawals.

00:44:42.180 | But so as a caveat, it again generates this headache, right?

00:44:47.820 | It creates failures.

00:44:51.500 | You never fail in terms of running out of money,

00:44:55.220 | but you would potentially fail in the sense that, yeah,

00:44:58.420 | if you retire at the wrong time,

00:44:59.980 | you might have to cut your withdrawals very substantially

00:45:04.140 | for long periods of time.

00:45:06.140 | So it's not a panacea,

00:45:08.980 | but it's something that if you have a little bit

00:45:11.780 | of flexibility with your spending,

00:45:13.420 | you should definitely consider.

00:45:15.660 | - Is an option to just take a look

00:45:17.500 | at the kind of CAPE-Shiller ratio now and say,

00:45:20.820 | oh, it's high or low.

00:45:23.460 | Maybe I should just be a little bit more aggressive

00:45:26.260 | or conservative before retirement,

00:45:28.020 | maybe work another year or not.

00:45:29.940 | - Right.

00:45:30.780 | And so right now the Shiller-CAPE ratio,

00:45:34.020 | if you look at Shiller's webpage, it's in the 30s,

00:45:38.780 | I think it's something like 33,

00:45:40.900 | and it's extremely high by historical comparison.

00:45:45.500 | It's not as high as right before the dot-com crash,

00:45:48.380 | but I mean, we are talking about as high

00:45:51.220 | as before the 1929 crash.

00:45:53.300 | So if, I'm not saying that the 1929 crash has to repeat,

00:45:57.700 | but I mean, we are definitely now in an environment

00:46:00.620 | that looks exactly like some of the past market peaks.

00:46:05.620 | And so I, again, I would say this is now the time

00:46:10.260 | to be a little bit more cautious.

00:46:12.100 | And by the way, I also freely admit

00:46:15.980 | you should also do the opposite, right?

00:46:17.780 | So for example, when we were close to the market bottom

00:46:20.980 | in October, 2022, I wrote a blog post where I said,

00:46:25.660 | well, now is actually the market is down so much

00:46:28.460 | and the CAPE ratio looks very attractive again,

00:46:31.180 | now is the time to raise your withdrawal rate.

00:46:33.780 | And actually 4% rule works again, that was back then.

00:46:37.860 | Now I would probably be a little bit more cautious

00:46:40.220 | because we definitely market looks a little bit overvalued.

00:46:45.220 | And again, I do this on my, in this Google sheet,

00:46:50.980 | you can look at, well, what were the safe withdrawal rates

00:46:56.300 | and what were the probabilities of running out of money,

00:46:58.780 | say for a fixed withdrawal rate, like the 4% rule.

00:47:03.820 | Well, the 4% rule normally works if the CAPE is below 20.

00:47:07.340 | And if the CAPE is above 20,

00:47:09.060 | then the probability of running out of money

00:47:13.220 | is a lot higher than what you would deduce

00:47:15.740 | from the Trinity study, for example.

00:47:18.620 | So these are all things that I report

00:47:22.340 | in this Google spreadsheet exactly for that reason, right?

00:47:25.420 | You want to look at market valuations

00:47:27.860 | and then conditional on market valuations,

00:47:31.300 | you potentially get very different safe withdrawal rates,

00:47:35.820 | right?

00:47:37.420 | The safe withdrawal rate could be 3.8% if the CAPE is high,

00:47:42.420 | and it could be as high as 5% or 5.5%

00:47:45.660 | if the CAPE is really low.

00:47:46.740 | But as you said, definitely take into account

00:47:49.660 | where the market is.

00:47:50.900 | And we are recording this in July,

00:47:52.500 | but if somebody looks at this maybe three years down the road

00:47:55.500 | and we have very different CAPE ratios,

00:47:57.140 | you definitely want to make adjustments for that.

00:48:00.660 | - This might be what you were referring to with Post 62,

00:48:04.780 | but if you adopt a strategy of starting your retirement

00:48:09.780 | at a kind of more reverse glide path approach,

00:48:15.060 | and one, two years in, you see a big market correction,

00:48:20.060 | can you increase or I guess decrease the failure rate

00:48:25.060 | and increase the success rate by at that moment

00:48:28.820 | shifting from fixed income to equities

00:48:32.100 | and increasing the stock allocation?

00:48:34.900 | - Right, and you could do that.

00:48:38.820 | And if you are smart enough or lucky enough

00:48:42.380 | and you grab exactly the market bottom,

00:48:45.020 | you would look really good at that time.

00:48:47.900 | Now, nobody knows exactly how deep we're going to fall,

00:48:51.260 | and so in that sense, this is why I like the glide path

00:48:56.260 | because it takes a little bit the emotion out of it.

00:48:58.900 | You do it slowly over time.

00:49:01.340 | And what that would do is

00:49:02.500 | if you really have a bad bear market early on,

00:49:06.300 | it would almost work like, well, by shifting the weight,

00:49:11.180 | you're probably going to effectively

00:49:13.100 | when you look at the portfolio every month

00:49:14.700 | and you take money out,

00:49:16.140 | it's you would potentially take mostly money out of bonds

00:49:21.020 | and you would potentially already shift money from bonds

00:49:24.180 | into equities on top of that.

00:49:26.060 | So you wouldn't be,

00:49:26.900 | so not only would you not take money out of stocks

00:49:29.820 | that are being hammered and potentially beaten down

00:49:32.900 | and this overreaction on the downside,

00:49:34.940 | like we saw in March of 2009

00:49:38.060 | when everybody thought the world is going to end.

00:49:40.100 | And so you would already do that,

00:49:45.740 | but you wouldn't pick one particular point when to do that.

00:49:49.220 | You would do this over time.

00:49:50.780 | - And that's just because you're rebalancing the portfolio.

00:49:53.220 | - I've done some simulations on that too.

00:49:55.060 | How often do you rebalance the portfolio?

00:49:57.260 | Should you do it every month?

00:49:58.660 | In my toolkit, I assume that it's every month.

00:50:00.940 | It's actually easier to calculate it that way.

00:50:03.780 | A little technical side note,

00:50:05.420 | but of course in practice, you might not do it every month.

00:50:07.820 | If you do it every second month, every third month,

00:50:10.380 | every year, results are still going to be very similar

00:50:13.980 | to my toolkit results.

00:50:17.260 | If you never rebalance,

00:50:18.820 | then now you might kind of sort of wander off

00:50:22.260 | in some weird direction.

00:50:24.460 | But as long as you at least occasionally rebalance,

00:50:28.300 | that's fine.

00:50:29.980 | But so here's, so you're rebalancing.

00:50:33.260 | Now the question is, what do you rebalance to, right?

00:50:35.780 | In the toolkit, most of the work I do there

00:50:38.700 | is a fixed allocation,

00:50:40.220 | and you specify that fixed allocation.

00:50:42.420 | I have one little feature where you can do a case study

00:50:45.260 | of one particular retirement cohort

00:50:46.940 | and then check how a glide path

00:50:49.660 | would have performed better or worse.

00:50:52.980 | Most of the, not most of,

00:50:54.380 | all of the time when you do a glide path

00:50:56.900 | from less equities, more bonds,

00:50:59.140 | into more equities, less bonds,

00:51:01.220 | you would do better in all of the worst case scenarios.

00:51:04.460 | Of course you do worse if nothing bad happens, right?

00:51:07.060 | If the bull market continues

00:51:09.580 | and continues for another five years,

00:51:11.380 | and you had too little in equities,

00:51:13.580 | you would give up a little bit on the upside,

00:51:15.700 | but you're fine to do that, right?

00:51:17.260 | It's almost like an insurance contract, right?

00:51:18.900 | You pay out if you do well,

00:51:22.060 | but you make a little bit of extra return

00:51:24.940 | when the market is going against you.

00:51:28.820 | So anyways, yeah, so this glide path

00:51:33.180 | has a little bit of this feature.

00:51:34.740 | If the market goes down,

00:51:36.060 | you would actually shift somehow resources

00:51:39.660 | from fixed income to stocks.

00:51:41.460 | And the glide path takes out the emotion

00:51:46.380 | and the market timing in that,

00:51:48.900 | because, well, what if you take your entire bond portfolio

00:51:52.580 | and to plow it all into stocks,

00:51:54.580 | and the stock market is already down by 30%,

00:51:57.500 | and then it goes down another 20%, right?

00:51:59.340 | How would you feel about that?

00:52:01.300 | You, maybe in the long run and in the big picture,

00:52:05.580 | it was still the right move,

00:52:06.820 | but you would probably feel a little bit emotional

00:52:09.380 | that you got that market timing wrong.

00:52:11.420 | So it's better to do it over time in small steps.

00:52:13.740 | You're not gonna get it completely right,

00:52:15.420 | but at least you're not gonna get it

00:52:16.740 | completely wrong either.

00:52:17.980 | So that's the advantage of that glide path.

00:52:21.140 | - To backtrack a little bit,

00:52:22.260 | you talked about and made a lot of references to inflation.

00:52:26.020 | How, when people think about their withdrawal rate,

00:52:29.020 | their early retirement,

00:52:29.980 | how does inflation play a role in all of this?

00:52:32.260 | - Right, so obviously what you want to do

00:52:34.660 | is you want to adjust everything by inflation, right?

00:52:37.580 | Because nothing makes sense

00:52:40.140 | if you look at just nominal numbers.

00:52:42.860 | And so the gold standard that you want to follow

00:52:47.860 | in every single safe withdrawal analysis

00:52:53.620 | is that first of all,

00:52:54.540 | the withdrawals should be adjusted for inflation.

00:52:58.820 | And then also when you look at,

00:53:00.140 | well, what is my final value at time X,

00:53:04.340 | that should also be adjusted for inflation, right?

00:53:06.780 | So obviously it doesn't make a huge difference

00:53:09.860 | if your goal is to deplete your capital.

00:53:14.140 | Well, $0 30 years from now,

00:53:16.740 | it doesn't matter if it's a nominal or real dollars, right?

00:53:20.540 | But if you have a goal of giving a bequest

00:53:24.300 | of a million dollars in 30 years,

00:53:26.780 | it makes a huge difference

00:53:28.300 | whether that is after inflation or before inflation, right?

00:53:33.300 | So everything I do is always inflation adjusted.

00:53:38.300 | So when I say you withdraw a fixed value over time,

00:53:45.020 | that is all inflation adjusted.

00:53:47.500 | And then when you specify,

00:53:48.980 | I would like to keep say 30% of my nest egg after 50 years,

00:53:53.980 | I want to keep that either as a reserve or as a bequest,

00:53:58.100 | then it's also 30% of today's portfolio value

00:54:01.340 | adjusted for inflation.

00:54:02.860 | So inflation adjustments have to be always in there,

00:54:05.500 | otherwise you're comparing apples and oranges.

00:54:07.500 | And I've seen people out there mixing up the two

00:54:11.700 | where they say, oh yeah,

00:54:13.420 | there's a 90% chance that after 30 years,

00:54:16.380 | you still have your original portfolio value.

00:54:20.660 | Problem with that is,

00:54:22.140 | that usually means it's a nominal terms.

00:54:25.500 | And in nominal terms,

00:54:27.260 | the same portfolio value as 30 years ago

00:54:29.980 | could mean anything or nothing, right?

00:54:31.860 | That could mean it's 80% depleted

00:54:34.900 | if those 30 years include the 1970s and '80s

00:54:38.100 | when we had these big inflation shocks.

00:54:40.580 | So as I said, gold standard,

00:54:42.700 | everything has to be inflation adjusted.

00:54:44.740 | - One thing that I've heard a lot of people say,

00:54:47.260 | and I think inflation is actually the answer,

00:54:49.540 | is like, oh wow, if you look,

00:54:50.700 | everything from one month to 30 year treasuries,

00:54:53.460 | you're in the five and a half to four and a half range,

00:54:56.300 | doesn't that solve for the 4% rule?

00:54:59.260 | And is the answer, or the 3.25% or whatever it is,

00:55:04.260 | and is inflation the reason why you can't just rely

00:55:07.380 | on rates right now that happen to be very high

00:55:11.020 | for a long period of time?

00:55:12.580 | - First of all, and again, everything depends on,

00:55:15.900 | so first of all, your horizon

00:55:17.500 | and whether you are willing to deplete your capital, right?

00:55:20.220 | So first of all, treasuries are not inflation adjusted.

00:55:25.100 | So it's actually, you have maybe 5%.

00:55:28.900 | I've seen some CDs in the 5.4, 5.5% range

00:55:33.060 | over one year.

00:55:35.500 | I think 10-year bonds are now down.

00:55:39.340 | We just established that to about four and a half percent.

00:55:42.180 | 30 years are probably also in that range,

00:55:44.380 | maybe a little bit higher.

00:55:45.780 | And again, you have to,

00:55:46.780 | but to take out an inflation estimate, right,

00:55:48.980 | maybe two, two and a half percent,

00:55:51.380 | the real yields of treasuries

00:55:54.780 | would still be a little bit above 2%.

00:55:57.180 | The solution, if you want to completely hedge

00:55:59.500 | against inflation, would be TIPS, right?

00:56:01.300 | Treasury Inflation Protected Securities.

00:56:04.060 | And last time I checked,

00:56:06.420 | they were yielding a little bit over 2%.

00:56:11.260 | Let me check.

00:56:12.460 | It's 2.31 for the 30-year,

00:56:17.460 | 2.31 for 20 years.

00:56:19.860 | So in that sense, if you can get 2.31 over 30 years,

00:56:26.220 | so you do the back of the envelope calculation,

00:56:28.580 | if you want to keep your capital,

00:56:30.700 | you could model a 2.31% withdrawal rate.

00:56:34.980 | It's not quite true because the more near-term TIPS,

00:56:37.660 | they have slightly lower yields,

00:56:38.980 | but it's also close enough, 2.12 to 2.3.

00:56:41.660 | Let's make it two and a quarter percent.

00:56:43.820 | So you could create something like a TIPS ladder, right,

00:56:47.700 | where you buy TIPS with all of the expiration dates

00:56:52.700 | staggered over your retirement horizon.

00:56:55.540 | And then you get real inflation-adjusted returns

00:56:58.820 | of somewhere around 2%.

00:57:00.100 | So it means you could generate a 2%

00:57:03.180 | or two and a quarter percent safe withdrawal rate

00:57:06.500 | with zero risk.

00:57:08.180 | - That also leaves you with your entire principle.

00:57:10.700 | - That leaves you with your entire

00:57:12.340 | inflation-adjusted initial net worth.

00:57:16.500 | So you could do that.

00:57:20.180 | The other thing you could do is,

00:57:21.820 | and I always did that calculation.

00:57:24.700 | So imagine, and this is now boiling down

00:57:27.820 | basically to an amortization calculation, right?

00:57:30.340 | So imagine you have a 2.3% real yield.

00:57:35.340 | Well, how much money can you take out?

00:57:38.260 | So you imagine you think of that as a mortgage, right?

00:57:40.580 | Instead of paying off the mortgage,

00:57:42.140 | you hand over the money and they pay you.

00:57:44.700 | And then after 30 years, the mortgage then is forgiven.

00:57:47.860 | So your money is exhausted

00:57:49.180 | and all you get is a flat payment stream.

00:57:53.900 | It's actually, even with a 1.3% real yield,

00:57:58.260 | you could generate a 4% safe withdrawal rate

00:58:00.980 | and completely wipe out your money after 30 years.

00:58:04.260 | So that's actually quite astonishing, right?

00:58:08.620 | Because the 1.3% return is what pays

00:58:13.620 | only maybe a third of your payment.

00:58:17.020 | And the other part of it

00:58:18.100 | is basically just exhausting your capital, right?

00:58:21.140 | And so the nice thing is that

00:58:23.860 | you need actually relatively low real returns

00:58:28.300 | and fixed safe real returns

00:58:30.460 | to generate already a 4% safe withdrawal rate.

00:58:33.700 | And so I actually wrote about that in part 61 of the series,

00:58:37.780 | which is called Safety First, right?

00:58:39.340 | This is what people understand.

00:58:40.860 | Safety First is, you know what?

00:58:42.820 | Instead of worrying about a 4% withdrawal rate,

00:58:45.500 | why don't I just, instead of investing in stocks,

00:58:48.660 | why don't I just completely hedge my retirement

00:58:52.980 | and put money in safe investment

00:58:55.660 | and just either put it in an annuity.

00:58:58.180 | Problem with an annuity is

00:58:59.620 | it's not inflation adjusted usually,

00:59:02.460 | but say a tips ladder would be

00:59:05.100 | the inflation adjusted method.

00:59:07.940 | And so, yeah, you could say that, yeah,

00:59:11.860 | even with a 1.3% real rate,

00:59:15.020 | you could get a 40% retirement

00:59:18.100 | and a 4% safe withdrawal rate.

00:59:20.620 | Problem is it doesn't work for early retirees, right?

00:59:23.540 | - Yeah, because the maximum duration.

00:59:25.380 | - After 30 years, your money is wiped out, right?

00:59:27.860 | Or you do the 2.3% withdrawal rate,

00:59:30.900 | which seems a little bit lean.

00:59:32.580 | And so, yeah, I mean, this Safety First,

00:59:38.580 | I think it's a viable solution for traditional retirees

00:59:44.300 | who are willing to completely wipe out their portfolio.

00:59:47.060 | And maybe they have,

00:59:47.980 | or it doesn't mean that they don't care about their kids,

00:59:50.420 | but maybe they have already given enough

00:59:53.020 | of a headstart to their kids.

00:59:55.020 | It may be paid for college, paid for home down payments.

00:59:57.820 | And they say, okay, kids, this is all you're gonna get.

01:00:00.140 | Don't expect any retirement.

01:00:01.860 | So you don't expect any bequest and any estate.

01:00:06.860 | We're gonna leave exactly $0

01:00:10.060 | because we're gonna take our money

01:00:12.300 | and transform it into a fixed cashflow.

01:00:14.900 | And that's gonna last us a lifetime.

01:00:17.500 | Yeah, I mean, it would be okay for traditional retirees.

01:00:22.460 | If you retire at age, say, 40,

01:00:24.860 | and the longest you can structure with a TIPS letter

01:00:28.260 | would be up to age 70.

01:00:29.460 | So now at age 70, what do you do?

01:00:31.540 | Maybe you have to set aside some money

01:00:33.580 | that you put in a stock market

01:00:35.020 | and let that grow over 30 years.

01:00:36.420 | And cross your fingers that over the next 30 years,

01:00:39.220 | it actually grows to a big enough portfolio

01:00:41.100 | that then you quote-unquote re-retire.

01:00:43.500 | But then again, so yeah,

01:00:47.300 | now your safe withdrawal rate is no longer 2 point something

01:00:51.420 | or 4% if you use that exhaustion of cap.

01:00:54.540 | It's a little bit less

01:00:55.500 | because you can't take your entire portfolio.

01:00:58.500 | You have to set a little bit aside.

01:01:00.260 | And now you again have some uncertainty built in.

01:01:02.940 | And that uncertainty will reveal itself at age 70

01:01:05.700 | because that's when you re-retire, right?

01:01:09.220 | That's when your TIPS letter is used up.

01:01:12.060 | And you now have to look at, well,

01:01:14.140 | what did my stock portfolio grow to over the last 30 years?

01:01:17.660 | So you can, as for early retirees, it's a real headache.

01:01:21.700 | You can't completely take out the risk

01:01:25.700 | with fixed income security.

01:01:28.100 | And again, it's exactly because of that inflation issue.

01:01:30.900 | You can't just go with the 4.5% yield in the 10 year

01:01:35.740 | or the 4 point something percent in the 30 year.

01:01:38.980 | You have to factor in inflation.

01:01:42.540 | And once you factor in inflation,

01:01:44.260 | some of these fixed income routes look quite unappealing,

01:01:48.620 | I have to admit.

01:01:49.580 | - And you mentioned annuities briefly.

01:01:51.540 | And one of the challenges is a lot of the annuity yields

01:01:54.620 | are nominal yields.

01:01:57.100 | So it sounds great.

01:01:58.900 | Oh, I can get this payment every year

01:02:00.580 | for the rest of my life.

01:02:01.660 | Another problem, even if you could find one that was real

01:02:04.860 | is fees are high.

01:02:06.500 | Have you, if you look at annuities,

01:02:09.020 | have you found any product or package

01:02:10.900 | that's even worth someone looking at or considering?

01:02:13.660 | - Probably the lowest fee, one would be an SPIA,

01:02:16.860 | single premium immediate annuity.

01:02:19.580 | And funny thing is I realized I can even get it

01:02:22.500 | at my age already.

01:02:23.340 | So I'm 50, I turned 50 this year.

01:02:25.820 | I think they can go all the way down to age 40.

01:02:28.660 | You can probably get an annuity already.

01:02:31.580 | And the nice thing about that is

01:02:34.260 | that is such a standard product.

01:02:38.580 | It really only differs by the credit rating

01:02:42.060 | of the insurance company, right?

01:02:44.300 | So if you shop around with all the AAA providers,

01:02:47.980 | you should probably get similar quotes

01:02:52.980 | and you just pick the best one because there's nothing else.

01:02:58.140 | So there's no other bells and whistles.

01:02:59.580 | It just pays as long as you live.

01:03:01.340 | There might be some other issues with some survivor benefits.

01:03:05.620 | It could be a joint survivor.

01:03:07.300 | It could be only single survivor,

01:03:09.260 | but it's such a standard product.

01:03:13.260 | By the way, you can even plan for it, right?

01:03:15.300 | You can plan that on average,

01:03:17.540 | inflation is gonna be 2% over the next 30, 40, 50 years.

01:03:22.260 | And when you get X amount dollars today,

01:03:26.900 | it will slowly dwindle away

01:03:28.940 | from perspective of after inflation.

01:03:33.940 | And maybe you don't transfer everything

01:03:37.980 | into the annuity, right?

01:03:40.020 | You keep a little bit of a reserve.

01:03:41.700 | And then over time,

01:03:42.940 | when you realize that my purchasing power

01:03:45.420 | has been depleted, you buy another annuity.

01:03:48.820 | And so it's possible in general,

01:03:53.820 | but again, because yields are,

01:03:57.900 | they are higher than they were three, four, five years ago,

01:04:00.620 | but they are still not quite as high

01:04:02.820 | that I'm super urgently knocking on annuity providers doors

01:04:07.820 | that I would be interested in buying them.

01:04:11.580 | I would still take my chances

01:04:13.260 | with my stock and bond portfolio,

01:04:16.220 | but if interest rates were a little bit higher,

01:04:18.860 | I would probably start to look into that.

01:04:22.140 | And again, it's never an all or nothing proposition, right?

01:04:25.020 | You could do a partial conversion

01:04:28.380 | of your net worth into annuities

01:04:30.700 | and keep the rest in your 75, 25 portfolio

01:04:35.660 | and run with that.

01:04:36.780 | So again, this is something I wrote about recently

01:04:39.340 | in that part 61.

01:04:42.220 | It's probably something that works well

01:04:44.460 | for traditional retirees

01:04:46.060 | that don't have huge bequest motives.

01:04:50.620 | If you are a young retiree

01:04:53.380 | and you want to keep money as a reserve

01:04:57.100 | for say health emergencies

01:04:59.740 | or helping out your kid or kids,

01:05:02.660 | I would probably still hold on to my portfolio

01:05:05.100 | and not do the annuity round.

01:05:07.380 | - One thing that we didn't touch on,

01:05:08.780 | which is pretty relevant to a safe withdrawal rate

01:05:12.220 | is the tax situation of your portfolio.

01:05:16.060 | So if someone has a $2 million net worth,

01:05:18.940 | that could be a $2 million net worth

01:05:22.580 | that has a cost basis of $100,000

01:05:25.540 | and will be subject to lots of taxes,

01:05:27.820 | or it could be a $2 million net worth

01:05:30.420 | where half of it's in a Roth IRA

01:05:32.100 | with no future taxes at retirement.

01:05:34.620 | How do you think about taxes

01:05:36.620 | as it relates to the current value of that portfolio?

01:05:40.620 | - Taxes are obviously the whole additional layer.

01:05:43.420 | So, and I have to admit in that Google spreadsheet,

01:05:46.740 | I don't model those.

01:05:48.500 | So that means what you take out of that portfolio

01:05:51.340 | is still subject to taxation.

01:05:53.940 | Now, a good news is that in the US,

01:05:56.020 | I think we are pretty blessed in that.

01:05:59.540 | I think if you stay below a certain income threshold,

01:06:03.780 | you can structure your retirement to be almost tax-free.

01:06:08.380 | Maybe not in California because,

01:06:10.940 | but even in California, I mean, I did the math, right?

01:06:13.660 | So I think in California,

01:06:14.940 | I think if you stay somewhere below 60 or $80,000,

01:06:18.420 | it's the really high marginal tax rates don't yet kick in.

01:06:22.740 | And I live in Washington, so I don't have state taxes,

01:06:26.020 | state income taxes, but yes, on the federal level.

01:06:30.260 | So taxation, so adds to the complexity.

01:06:34.260 | First of all is from a cashflow point of view, right?

01:06:37.220 | Lots of people have everything tied up in a 401(k).

01:06:40.460 | Well, how do you access that now?

01:06:42.460 | So hopefully you could do some Roth conversions

01:06:45.420 | and then do that Roth conversion later

01:06:47.620 | over a five-year period.

01:06:49.140 | And then you can take the money out of the Roth.

01:06:52.220 | And yeah, but so the other issue is if you are lucky enough

01:06:58.540 | and you have a lot of money in taxable brokerage accounts

01:07:04.020 | and you have long-term gains that you need to tax,

01:07:08.100 | at least on the federal level,

01:07:09.340 | there are very high exceptions.

01:07:12.860 | So first of all, you have the standard deduction.

01:07:14.580 | And then on top of that,

01:07:15.460 | I think you have something like 79 or $80,000

01:07:18.220 | that a married couple can have in long-term capital gains.

01:07:21.380 | - Looks like for 2024, it's up to $94,059.

01:07:25.980 | - Oh, wow, 94.

01:07:26.820 | I think, yeah, even in 2023, it was already over 80.

01:07:30.500 | Yeah, yeah.

01:07:31.340 | So you have these, if you structure everything

01:07:35.380 | as long-term gains.

01:07:37.700 | And so there are obviously some tax hacks

01:07:42.300 | and I haven't written about those very much

01:07:45.780 | because other people have already done that.

01:07:47.620 | So I think that if other people have already done the job

01:07:51.140 | to do that credibly and to my standards,

01:07:56.140 | and I don't have to redo the math, right?

01:08:01.100 | I think GoQuery Cracker wrote about it.

01:08:04.140 | For example, at some point,

01:08:05.380 | you could do tax gain harvesting, right?

01:08:07.300 | So imagine you have a taxable income

01:08:09.860 | where you are below that threshold, right?

01:08:12.380 | Where you are not even maxing out

01:08:14.980 | all your 0% capital gains.

01:08:18.940 | Well, you could sell some of your tax slots

01:08:23.220 | and then re-buy them again the next day

01:08:25.380 | or even the same day.

01:08:26.300 | You just realize the gains,

01:08:28.380 | fill up the 0% tax bracket.

01:08:30.780 | So you could do that.

01:08:32.820 | You obviously want to probably make sure

01:08:36.420 | that you at least utilize the,

01:08:39.260 | I think now it's $27,700

01:08:42.220 | in standard deduction for married couples,

01:08:45.980 | at least fill that one in with ordinary income.

01:08:48.820 | So if you don't have any other ordinary income,

01:08:51.100 | maybe you use some Roth conversions to fill that one in

01:08:54.500 | because that will create ordinary income.

01:08:57.260 | You might even fill up the 10%

01:08:59.420 | or maybe even the 12% bracket with some Roth conversions.

01:09:03.740 | Yeah, so I personally haven't really modeled

01:09:09.460 | really too much of this tax optimization.

01:09:14.460 | The way I think about it is I have something

01:09:17.300 | like an average tax rate of,

01:09:20.540 | and it's in the single digits,

01:09:22.380 | probably in the low single digits.

01:09:24.060 | And so this is just the drag

01:09:27.020 | that it's basically like an expense

01:09:29.660 | that it's like property taxes for me.

01:09:32.660 | It's probably even in the same ballpark per year.

01:09:36.060 | And I don't really model that any further

01:09:39.660 | as a lot of people in the FIRE community,

01:09:41.660 | I mean, especially if it's married couples,

01:09:44.100 | they will very likely stay below that.

01:09:47.820 | And it's now probably,

01:09:49.220 | I think it's in the $120,000 range

01:09:51.460 | that you can have $120,000 in income.

01:09:55.940 | If you fill up your standard deduction

01:09:59.820 | with ordinary income and the rest

01:10:01.420 | with long-term capital gains,

01:10:02.900 | you can pay zero federal income tax.

01:10:05.180 | And then maybe you go even a little bit above

01:10:07.060 | if you have kids and you can get

01:10:08.380 | the $2,000 tax credit in the US.

01:10:11.620 | So the US tax code is extremely,

01:10:14.940 | extremely friendly toward early retirees.

01:10:18.100 | Unless you really have such a big footprint

01:10:20.740 | where you're early retiree,

01:10:22.380 | but then you also have something

01:10:23.460 | like a $200,000 a year lifestyle,

01:10:26.500 | then probably the tax planning

01:10:28.980 | is becoming a little bit more urgent.

01:10:30.660 | But I've never felt a huge,

01:10:35.140 | huge urge to really stress out

01:10:38.060 | over any of the tax issues.

01:10:40.260 | - It sounds like if you realistically think

01:10:43.020 | your kind of needs each year

01:10:47.300 | in terms of withdrawals from your portfolio,

01:10:49.580 | that would generate income,

01:10:51.220 | not just withdrawals,

01:10:52.180 | but the income on the capital gains

01:10:54.300 | are kind of above the $125,000 mark,

01:10:58.140 | taxes may play an impact more than you think,

01:11:01.500 | but still at the capital gains rates,

01:11:04.140 | not at the income rates,

01:11:05.500 | which can be lower.

01:11:06.980 | Okay, so I mentioned I wanted to talk

01:11:08.140 | a little bit about portfolios.

01:11:09.700 | We talked about the reverse glide path,

01:11:14.500 | which probably explains why target date funds

01:11:17.180 | could be a pretty terrible choice

01:11:19.380 | if they're doing the inverse.

01:11:21.060 | But you could also make a case

01:11:22.980 | often as someone being aggressive,

01:11:25.340 | especially with bonds where they were

01:11:28.020 | prior to the last few years

01:11:30.220 | of being 100% stocks.

01:11:32.060 | How do you think about that allocation

01:11:34.460 | during accumulation,

01:11:36.180 | since we kind of talked about

01:11:37.180 | what it could be in retirement?

01:11:39.300 | - Right, so accumulation,

01:11:41.780 | I have done 100% equities

01:11:44.900 | and it worked for me.

01:11:46.620 | It might be a little bit too volatile for some people,

01:11:50.380 | but pre-retirement glide paths,

01:11:52.260 | how crazy is it to hold 100% equities until retirement?

01:11:55.180 | So that's part 43 of my series.

01:11:57.820 | And so I make the point that

01:12:00.660 | on your accumulation path,

01:12:02.980 | it's defensible to have 100% equities until retirement.

01:12:07.980 | And the nice thing is,

01:12:10.260 | well, of course the problem with that is,

01:12:12.660 | well, what if at your retirement date,

01:12:15.100 | you just are in the middle of a recession

01:12:17.740 | and your portfolio got so clobbered that,

01:12:21.140 | well, suddenly you can't retire anymore.

01:12:23.500 | So that would be the risk.

01:12:24.860 | Remember, maybe at that bottom of the market,

01:12:29.900 | you don't have to apply the 4% rule.

01:12:31.900 | You could probably apply the 6% rule

01:12:33.940 | because the equity valuations are, again, much better.

01:12:37.180 | But even if you say,

01:12:39.820 | well, there's a little bit of risk that

01:12:41.780 | at that target date that I want to retire,

01:12:44.780 | well, maybe my portfolio is really down

01:12:46.940 | and I have a little bit of flexibility about,

01:12:48.980 | well, if I maybe work a year longer,

01:12:52.820 | would that be such a big concern?

01:12:55.820 | Yeah, if you have a little bit of flexibility

01:12:58.540 | in your retirement date,

01:12:59.820 | maybe you could do that 100% equity portfolio.

01:13:04.820 | For example, I had it, right?

01:13:06.300 | So I said, well, if in 2018, when I want to retire,

01:13:10.700 | the market totally evaporates,

01:13:12.460 | well, then I'm just gonna stay another year at my old job.

01:13:15.700 | So it's not the worst thing.

01:13:20.300 | I was actually a good job and liked everybody around me.

01:13:24.100 | So it wasn't terrible.

01:13:25.700 | But of course, there are some people who say that,

01:13:27.420 | yeah, I want to retire after,

01:13:29.660 | say, 20 years of government service,

01:13:31.660 | and I don't want to work a week longer.

01:13:34.180 | And if the market is down at that time,

01:13:36.660 | then that would be a huge problem.

01:13:39.460 | So in that case, yes, absolutely.

01:13:41.180 | You want to do a glide path,

01:13:43.060 | and the glide path would be

01:13:44.700 | just like a target date retirement glide path.

01:13:48.340 | Now, I personally don't like

01:13:49.700 | these traditional target date funds

01:13:52.180 | because they start shifting from 90/10,

01:13:56.380 | 90% stocks, 10% bonds, into something like 50/50,

01:14:01.380 | probably 55% stocks might be still,

01:14:05.300 | some providers would offer that.

01:14:07.340 | The problem with that is you would do that over 20 years.

01:14:10.900 | Well, most people don't even accumulate for 20 years

01:14:13.740 | if they plan fire, right?

01:14:15.740 | So you can't really use the traditional glide path

01:14:19.420 | for target date funds.

01:14:22.620 | So you have to, and I ran some simulations.

01:14:25.820 | Well, how would the optimal glide path look like

01:14:28.620 | for somebody who has a much shorter accumulation period?

01:14:33.620 | And well, it turns out that the shape

01:14:36.460 | of the glide path still is the same.

01:14:38.660 | You start very high equity,

01:14:40.180 | and then you shift into bonds,

01:14:43.140 | and you kind of, at the halfway point,

01:14:45.460 | you start shifting into bonds.

01:14:46.940 | Well, if your accumulation period is only 10 years,

01:14:50.300 | well, you actually start shifting into bonds

01:14:52.140 | five years before retirement.

01:14:54.020 | If your accumulation period is five years,

01:14:56.780 | you would start shifting into bonds

01:14:58.420 | maybe at the two or three year mark.

01:15:02.100 | So it's, qualitatively, it's the same glide path,

01:15:05.620 | but it's compressed.

01:15:07.820 | So it's not, you don't take the last five years

01:15:11.700 | of the target date fund,

01:15:13.060 | where you go, say, from 60% stocks to 50% stocks.

01:15:16.420 | That would be way too conservative

01:15:18.100 | for most early retirees.

01:15:19.700 | So, and actually, I ran some simulations,

01:15:22.300 | and that's actually where I ran

01:15:23.940 | both historical simulations and also Monte Carlo.

01:15:28.620 | And yeah, so I agree.

01:15:31.380 | I think 100% equities is actually not bad.

01:15:33.580 | And so, by the way, in the target date funds

01:15:36.540 | that the big fund companies put out,

01:15:39.460 | it's 90% is the maximum stock.

01:15:41.420 | It's actually, I think it's an ERISA regulation.

01:15:43.900 | You cannot go above 90% stocks.

01:15:46.340 | If you do it yourself, you can definitely do 100%

01:15:50.220 | because you don't have to follow those regulations.

01:15:52.780 | And I actually think 100% is better than 90%.

01:15:56.820 | And so that 10% fixed income,

01:15:59.940 | that's really just a fig leaf for,

01:16:02.660 | so nobody can claim

01:16:04.140 | that you didn't have enough diversification,

01:16:06.020 | and nobody can sue you if somebody's unhappy

01:16:08.460 | with having big losses in their 401(k).

01:16:12.180 | If you're familiar with JL Collins

01:16:16.220 | and all the gang from the personal finance community,

01:16:18.740 | yeah, yeah, I mean, you can take a little bit

01:16:20.460 | of a bear market in between.

01:16:21.740 | You know, market goes up again.

01:16:23.420 | And so, yes, absolutely, 100% equities.

01:16:27.420 | It worked for me personally.

01:16:29.420 | If you have a stomach and an appetite for that,

01:16:32.700 | I recommend it to everybody who listens.

01:16:35.940 | But I also say that if you have concerns

01:16:40.940 | about you don't want to work way past

01:16:43.860 | that planned retirement date,

01:16:45.700 | maybe do a little bit of a glide path into more bonds.

01:16:49.980 | And then I tell people, hey, it's not forever, right?

01:16:52.980 | Because then you can do the reverse glide path again

01:16:55.220 | in retirement.

01:16:56.060 | So you do something that's called,

01:16:58.180 | they call it a bond tent, right?

01:17:00.620 | Because the bond allocation then looks like a tent, right?

01:17:03.700 | It goes up as you go to retirement,

01:17:06.060 | and then it goes down again as you're in retirement.

01:17:08.380 | And it looks like this triangle and a tent.

01:17:11.020 | And that is actually recommended by Kitsis

01:17:15.220 | and Pfau and me, that that seems to be something

01:17:20.220 | that takes a little bit the edge

01:17:22.420 | off of the sequence of return risk, right?

01:17:26.060 | And again, sequence of return risk, right?

01:17:28.980 | It affects both savers and retirees, right?

01:17:32.580 | So the last few years of your accumulation phase,

01:17:37.420 | you also have sequence of return risk.

01:17:39.300 | You don't want to have the really bad returns

01:17:41.620 | towards the end of your accumulation period.

01:17:43.420 | Or if you do, you want to hedge against that a little bit.

01:17:47.700 | You don't want to be 100% equities right around the end

01:17:50.940 | when you have that huge portfolio.

01:17:53.260 | And then on the way out again,

01:17:57.100 | that also helps you with the sequence

01:17:59.900 | of return risk in retirement.

01:18:01.620 | So this is not some voodoo science or anything.

01:18:05.620 | There's actually some economic

01:18:07.220 | and mathematical principles behind that, right?

01:18:09.820 | Because basically what you do

01:18:11.260 | is the glide path into retirement, right?

01:18:14.540 | Why do you start high equities, low bonds?

01:18:18.460 | Because your contributions over your next 40 years,

01:18:21.900 | they are something of a long bond position, right?

01:18:25.020 | So they act, but they are not a long bond position,

01:18:27.620 | but they act like a long bond position, right?

01:18:29.940 | And because you're so overweight with bonds,

01:18:33.100 | you don't want to pile on even more bonds,

01:18:34.780 | so you start with very high equity.

01:18:36.220 | But then as you get closer to your retirement date,

01:18:38.980 | your human capital becomes less and less

01:18:41.700 | and your future incomes and your future contributions

01:18:43.980 | into your nest egg become less and less.

01:18:46.260 | And that's why now you put bonds into your portfolio

01:18:50.620 | because you run out of bonds,

01:18:52.180 | quote unquote, in your human capital.

01:18:53.860 | And the same with your retirement.

01:18:55.220 | Well, what is your retirement?

01:18:56.500 | You're taking money out of your portfolio.

01:18:58.780 | In some way, that's a short bond position, right?

01:19:02.060 | Because it's almost like a liability

01:19:04.660 | you take out of your portfolio every year.

01:19:08.020 | There's some cash flow

01:19:09.100 | and it's relatively certain and predictable.

01:19:13.060 | So it acts like a bond.

01:19:14.820 | And because you take it out of your portfolio,

01:19:17.340 | it acts like a short position in bonds.

01:19:20.780 | And in order to overcome this risk

01:19:23.780 | of having a short bond position,

01:19:25.060 | you want to have more bonds

01:19:26.140 | at the beginning of your retirement.

01:19:27.740 | But then over time, you can phase that out again.

01:19:29.820 | So this explains why you both go into bonds

01:19:33.180 | as you reach retirement

01:19:34.780 | and then out of bonds as you progress in retirement.

01:19:38.220 | So there's some math and some intuition behind it.

01:19:41.100 | It's not just a pure numerical result

01:19:45.060 | and nobody understands why that happens.

01:19:46.740 | There's this very good understanding why that happens.

01:19:49.140 | And it's very intuitive,

01:19:51.620 | which makes me wonder why this has never reached

01:19:55.420 | the target date fund industry,

01:19:57.980 | because basically what that means

01:19:59.500 | in the target date funds post-retirement,

01:20:02.220 | they should go back into equities,

01:20:04.340 | but they actually shift further out of equities

01:20:06.420 | and go more into even shorter term bonds.

01:20:09.940 | And again, I'm not a lawyer or anything.

01:20:13.820 | Maybe there's some regulation that mandates even that,

01:20:17.860 | but definitely the math,

01:20:19.580 | both the empirical results from past simulations

01:20:23.700 | and then also the mathematical and financial intuition

01:20:27.180 | points toward that bond tent.

01:20:29.180 | And it's not done.

01:20:30.460 | Only the one half of the bond tent is done,

01:20:32.780 | but not the other in target date funds,

01:20:34.380 | which is mind-blowing.

01:20:35.660 | - I think we have a version of saying

01:20:39.260 | this thing that we've done for a long time

01:20:41.180 | is actually not right.

01:20:42.620 | So I would imagine there's something with,

01:20:45.140 | oh, yeah, the thing we sold you and we've been,

01:20:47.900 | it's all wrong.

01:20:48.740 | We've got a new way and it's better.

01:20:50.300 | I feel like people would rather keep doing the wrong thing

01:20:52.820 | than admit that there's a better thing

01:20:54.580 | that they didn't know about.

01:20:55.620 | But I don't know, I'm not in charge.

01:20:57.340 | I don't know.

01:20:58.220 | - Yeah, yeah, maybe that's how that comes about, yeah.

01:21:01.220 | - Within the equity position,

01:21:03.180 | we've talked a lot about recessions in the United States.

01:21:05.860 | You've talked a lot about the S&P.

01:21:08.020 | What role does international diversification,

01:21:11.780 | whether it's developed or emerging markets,

01:21:14.020 | have in the way you have equities?

01:21:17.180 | - Right, so I have some international.

01:21:18.980 | I probably have less international

01:21:20.900 | than would have been recommended just by pure market cap.

01:21:24.700 | I think right now US market cap is,

01:21:27.700 | of the US market cap of the overall world market cap

01:21:30.580 | is definitely over 50%.

01:21:32.260 | But I probably have probably closer to 90%

01:21:37.260 | equity allocation is in US domestic equity.

01:21:42.140 | So, and it's just, I always had it that way

01:21:46.820 | and it's hard to move it,

01:21:49.300 | especially because then you realize,

01:21:51.260 | well, what if I move it just at the wrong time?

01:21:54.860 | And, but so far it's actually served me well.

01:21:58.020 | So the nice thing, obviously, that we have in the US

01:22:01.380 | is that we are big enough and important enough

01:22:06.380 | that you can probably get away

01:22:10.500 | with an all US equity portfolio

01:22:13.100 | in the sense there is probably not that much diversification

01:22:16.780 | from international stocks.

01:22:17.980 | And then of course there is diversification, right?

01:22:19.820 | I mean, and you can basically draw

01:22:22.260 | an efficient frontier diagram of past return data

01:22:26.180 | and then you put in international stocks

01:22:28.140 | and then you see that the efficient frontier

01:22:29.820 | expands a little bit.

01:22:31.060 | So that's all really nice and good.

01:22:33.540 | So I agree with that, I don't doubt that.

01:22:35.820 | What I'm saying is that we are very different

01:22:40.220 | from say an investor in New Zealand or Belgium, right?

01:22:43.500 | I mean, if you're in some of these small countries

01:22:46.380 | and you have only domestic stocks,

01:22:48.700 | you really run the risk that your country

01:22:52.260 | goes through some very idiosyncratic crisis

01:22:54.780 | and you could have gotten diversification

01:22:57.980 | from international equities.

01:23:00.820 | But it's also true that every single US recession

01:23:05.540 | and bear market has spread across the world, right?

01:23:08.180 | So on the way down for sure,

01:23:13.180 | every correlation in the equity world

01:23:18.180 | pretty much goes to one, right?

01:23:19.860 | If we have a recession and bear market in the US,

01:23:22.580 | everybody will feel it.

01:23:24.620 | I think the diversification for international stocks

01:23:28.380 | probably comes more from the non-recession times, right?

01:23:32.020 | There were times where the recovery, for example,

01:23:36.500 | out of the dot-com crisis was better abroad.

01:23:39.900 | So part of that had to do with just the stock markets

01:23:43.780 | doing better there.

01:23:44.860 | And part of it was also basically

01:23:46.700 | just an exchange rate effect, right?

01:23:49.780 | So if the dollar depreciates,

01:23:51.660 | you will be better off with the foreign stocks.

01:23:53.780 | It has nothing to do with diversification.

01:23:55.860 | It has more to do with basically currency

01:23:58.460 | and economic diversification.

01:24:01.260 | But I mean, it's definitely true that

01:24:04.420 | when we have bad bear markets in the US,

01:24:08.420 | you have also bad bear markets abroad.

01:24:11.580 | But it's also been true that post-global financial crisis,

01:24:16.300 | the US recovered much better from that.

01:24:18.340 | So Europe had very, very weak

01:24:22.380 | and very disappointing recovery.

01:24:24.220 | Also post-pandemic, lots of Europe has not done very well.

01:24:28.820 | So I've been very happy with my US-centric allocation.

01:24:33.820 | It's in the back of my mind,

01:24:36.260 | should I maybe now that I've done so well

01:24:38.780 | with being US-centric, should I now diversify?

01:24:43.380 | Because at some point,

01:24:44.900 | Europe and rest of the world is going to come back.

01:24:48.260 | I also have to tell you that, so I'm from Europe, right?

01:24:54.220 | I'm from Germany.

01:24:55.540 | And so obviously I'm in the US because I like it better here.

01:24:59.580 | So I think the US economy is a better functioning economy.

01:25:06.060 | And it's more dynamic.

01:25:07.580 | And I think it's better run overall than a lot of Europe.

01:25:12.580 | So I have a little bit of an aversion against Europe

01:25:15.940 | because overall, I think the US is the stronger economy

01:25:20.500 | and has more growth prospects.

01:25:22.380 | Now, of course, as an efficient market proponent,

01:25:25.500 | well, it should be already priced.

01:25:26.740 | And this, by the way, explains why Europe valuations,

01:25:30.020 | price earnings ratios look much more attractive.

01:25:33.180 | It's much cheaper.

01:25:35.260 | It's also, well, it could also be cheaper for a reason,

01:25:39.060 | right, and the reason is that one single stock in the US,

01:25:44.060 | I think somebody did the calculation,

01:25:45.620 | Nvidia is worth more than the entire market capitalization

01:25:50.300 | of most European stock markets, right?

01:25:53.020 | So, and that tells you something,

01:25:56.180 | there's all of the big innovation

01:25:58.020 | and all of the, especially the AI innovation,

01:26:00.780 | that will all come from the US.

01:26:02.620 | And I think this is why everybody

01:26:03.980 | is crowding into the US.

01:26:06.060 | This is why probably I'm also not that,

01:26:08.780 | it's not itching me to diversify.

01:26:13.940 | I have a little bit, maybe 10% non-US stocks,

01:26:17.140 | it's all index funds, by the way.

01:26:19.140 | I, yeah, I have a strong belief

01:26:22.700 | that the US will do very well.

01:26:24.860 | And then again, I mean, nobody else

01:26:26.780 | but US investors should think that way, right?

01:26:28.700 | If you're Canadian, if you're Australian,

01:26:31.500 | if you're from New Zealand,

01:26:33.100 | it should be exactly the other way.

01:26:34.300 | Or you probably have to have at least 50%

01:26:36.100 | of your portfolio should be US stocks.

01:26:38.100 | But we have a great luxury that we can be oblivious

01:26:44.260 | to what's going on abroad.

01:26:46.140 | - Four quick portfolio things we can run through.

01:26:48.220 | I'm curious to get your take.

01:26:49.380 | We talked about rebalancing already, so I'll skip that one.

01:26:52.900 | What's your take on tax loss harvesting?

01:26:54.980 | - Yeah, I mean, tax loss harvesting, I have done it myself.

01:26:58.460 | I think it's a neat tool.

01:27:00.260 | The sad thing is that if you have no gains

01:27:04.660 | to use them as an offset

01:27:06.940 | and you are bound by these $3,000 a year,

01:27:09.740 | so you can write off $3,000 against your ordinary income

01:27:18.100 | from tax loss harvesting.

01:27:19.860 | Some people will argue it's not really worth the hassle

01:27:25.420 | to do that.

01:27:27.660 | For me, personally, because I generate some capital gains,

01:27:32.660 | so I do some options trading,

01:27:34.500 | and that generates both short-term

01:27:37.940 | and long-term capital gains.

01:27:40.020 | So I have done tax loss harvesting,

01:27:41.940 | and it's offsetting some of that income.

01:27:44.780 | And I've used that very heavily.

01:27:46.860 | So I think it's a useful tool.

01:27:48.700 | I've used it, and it brings up a whole other issue.

01:27:53.700 | So for example, a lot of people now

01:27:56.020 | want to do direct indexing, right?

01:27:57.740 | So instead of buying the index fund,

01:27:59.700 | they still do the index, they still do the S&P 500 index,

01:28:02.460 | but they implement the S&P 500 index

01:28:04.660 | with the underlying constituents.

01:28:06.180 | And then you can do a lot more tax loss harvesting.

01:28:09.500 | And yeah, I mean, if you have enough gains to offset,

01:28:13.940 | it might be a really good idea.

01:28:17.300 | And I know your connection

01:28:20.340 | with Wealthfront and everything.

01:28:21.620 | So I can see how, so for some people

01:28:26.580 | with a lot of taxable gains that they want to offset,

01:28:30.820 | that is very useful.

01:28:32.180 | If you don't have a lot of taxable gains

01:28:34.900 | and the $3,000 is all you can really offset every year,

01:28:39.900 | it might be a whole lot of hot air over nothing.

01:28:46.580 | But I mean, definitely for a lot of people,

01:28:50.660 | tax loss harvesting can be super helpful.

01:28:53.260 | - My other criticism of it,

01:28:54.860 | I'm not gonna let my past employer influence my opinions,

01:28:58.940 | is that especially for people who are early retirement,

01:29:03.940 | when you're not actively contributing

01:29:06.940 | to your investment portfolio,

01:29:09.020 | you end up in a place where there aren't a lot of losses.

01:29:11.820 | So my portfolio right now is,

01:29:15.020 | during the pandemic, did a lot of tax loss harvesting.

01:29:19.940 | And so since the floor of the pandemic,

01:29:23.420 | the market's up quite significantly.

01:29:26.140 | I don't have any losses to harvest

01:29:28.060 | because my cost basis is now so, so low.

01:29:31.180 | And the unfortunate thing is I now have this large amount

01:29:34.500 | of carry forward capital losses

01:29:37.140 | that I would need to find a use for.

01:29:39.500 | I actually do have some gains in individual equity positions

01:29:44.380 | that I would like to get out of.

01:29:45.660 | And so it turns out that it's a good opportunity.

01:29:48.740 | But if you're not actively contributing,

01:29:51.420 | if you have a big nest egg already,

01:29:53.780 | the value of tax loss harvesting

01:29:55.660 | diminishes quite significantly.

01:29:58.340 | - Right, right.

01:29:59.220 | One way would be, so for,

01:30:00.740 | I don't know how you do any kind of, so cash management.

01:30:03.580 | So imagine you have $100,000 cash reserve or something.

01:30:07.180 | So there is a new ETF, it's called BOXX, B-O-X-X.

01:30:12.180 | And it does some options trading and it creates,

01:30:16.420 | basically recreates a three-month T-bill,

01:30:19.380 | but the income comes in terms of capital gains

01:30:22.580 | and they don't pay dividends.

01:30:24.940 | So your return would come in terms of capital gains.

01:30:28.300 | So you could create something that looks like

01:30:31.500 | a cash or money market portfolio, but the way,

01:30:35.780 | and then on top of that,

01:30:36.780 | you only get taxed when you realize the gains.

01:30:39.380 | So you could create basically

01:30:41.140 | three-month T-bill interest rates,

01:30:44.100 | but it's only taxed when you sell

01:30:45.860 | and generate gains.

01:30:48.140 | But then when you generate the gains,

01:30:49.700 | they would be capital gains and not ordinary income.

01:30:52.660 | So if you have a lot of stuff to offset,

01:30:56.580 | you could use that to offset something

01:30:58.420 | that would have otherwise been ordinary income taxes.

01:31:01.100 | - Yeah, I actually read the post you wrote

01:31:02.580 | about that strategy.

01:31:04.020 | And in it, you advocated for some people,

01:31:07.780 | it's a better deal to execute yourself.

01:31:10.180 | But if you live in California

01:31:12.100 | and you're in a high state tax bracket,

01:31:14.300 | it's particularly, it's particularly good.

01:31:16.900 | - It's very painful, it's very painful.

01:31:18.780 | Yeah, yeah, I agree there.

01:31:20.100 | - So I haven't looked too much, but I will.

01:31:23.220 | And what about asset location, right?

01:31:25.580 | We talked about allocation,

01:31:26.620 | but do you think very strategically

01:31:29.540 | about where you put all of your assets

01:31:31.780 | across retirement and non-retirement accounts?

01:31:34.100 | Or do you kind of just keep

01:31:35.020 | that same consistent portfolio everywhere?

01:31:37.180 | - I think it's pretty much consistent almost everywhere.

01:31:41.940 | And so I wrote about that, which one is that one?

01:31:46.940 | Asset location, that's part 35.

01:31:50.740 | So do bonds really belong in retirement accounts?

01:31:53.660 | And so it's not a complete slam dunk,

01:31:58.180 | but it used to be, and it's probably now back

01:32:02.060 | to exactly that scenario.

01:32:03.900 | Again, if bonds pay relatively high interest rates,

01:32:07.500 | then probably bonds belong into tax deferred accounts.

01:32:11.740 | And stocks belong into your taxable account, right?

01:32:14.660 | So, and the reason is that you have to,

01:32:19.660 | bonds would be tax efficient in a taxable account.

01:32:24.060 | - Especially, I guess, if you plan to sell those stocks

01:32:27.900 | at a point in time or those index funds

01:32:30.340 | where you can stay under that threshold

01:32:31.900 | at 0% capital gains, then you're really looking good.

01:32:36.300 | - Yeah, I definitely follow that example.

01:32:39.940 | I don't really have a lot of real bonds.

01:32:44.620 | I have preferred shares and I actually do have them

01:32:49.220 | in a taxable account, but they pay ordinary dividends.

01:32:54.220 | So that's taxed at a lower rate than ordinary income.

01:32:58.380 | As we said earlier, during the accumulation phase,

01:33:00.780 | maybe you want to have only stocks anyways,

01:33:04.620 | but even then, well, maybe keep your REITs

01:33:08.740 | very tax inefficient in a tax deferred account

01:33:13.580 | and keep your S&P 500 index funds in your taxable account.

01:33:18.580 | There would still be a little bit

01:33:20.380 | of a tax drag from dividends.

01:33:22.180 | So you just have to live with that.

01:33:26.700 | And then on top of that, right, if we talk about,

01:33:28.460 | so somebody wants to implement a bond tent, right?

01:33:30.980 | Move from stocks into bonds.

01:33:33.100 | Well, you would do that also in your tax deferred accounts

01:33:36.620 | or in your tax advantaged accounts,

01:33:39.500 | because you don't want to have to realize

01:33:42.460 | a lot of capital gains.

01:33:44.140 | And then basically, and then by the way,

01:33:47.180 | you have the bonds in the right place.

01:33:49.500 | So you have the bonds in your tax advantaged accounts

01:33:53.260 | when you want to do that bond tent.

01:33:54.820 | Yeah, I mean, absolutely.

01:33:56.580 | So there is some tweaks you can do

01:34:00.100 | both in the accumulation phase

01:34:01.980 | and then later in retirement that, yeah,

01:34:04.900 | there's some tax efficiency planning to do there, yeah.

01:34:07.820 | - The last one comes back to my wealth front time

01:34:10.060 | where I remember looking at the,

01:34:12.540 | this was not in today's interest rate environment,

01:34:15.020 | but at the interest rates about three,

01:34:17.900 | four or five years ago, interest rates were super low.

01:34:21.180 | And all I could think about was like,

01:34:22.860 | well, we've got a risk score that goes from zero to 10.

01:34:25.300 | Could you get to 11 by taking out a 10% margin loan

01:34:29.620 | and putting it into the portfolio?

01:34:31.700 | You've written a little bit about leverage

01:34:33.420 | and I'm curious if you think,

01:34:35.300 | the historical argument I've heard is,

01:34:38.180 | well, mortgages are fine.

01:34:40.100 | You can leverage real estate

01:34:41.300 | because you don't have any risk of default

01:34:46.180 | because you're locked in,

01:34:47.740 | but in a stock portfolio, there is that risk.

01:34:49.900 | But at a 10, 15% level, there's not really that risk.

01:34:54.740 | Do you think there's a case for juicing the portfolio,

01:34:58.980 | if you will, by adding on a little leverage,

01:35:01.220 | even if it's just leveraging up VTI?

01:35:04.420 | - Right.

01:35:05.260 | Yeah, I agree with that.

01:35:08.340 | Now, the question is,

01:35:09.980 | so the problem with that is that retail investors

01:35:13.540 | might find it a little bit harder to do leverage.

01:35:17.980 | And so you can always do leverage.

01:35:20.740 | If you go and you do leverage through a brokerage account

01:35:24.060 | at Fidelity or TD America or something,

01:35:27.340 | they will charge you margin rates that are so unattractive

01:35:30.220 | that it's not really worth it.

01:35:32.340 | You can go with interactive brokers,

01:35:35.500 | which is a little bit more for sophisticated investors.

01:35:40.500 | So I have my option trading account

01:35:41.980 | with interactive brokers.

01:35:43.220 | That works maybe a little bit better,

01:35:47.820 | but I think margin interest rate is still a little bit high.

01:35:51.420 | I think they do something like

01:35:54.740 | maybe a fed funds rate plus a percent or something like that.

01:35:59.740 | And you can do leverage

01:36:04.300 | through this box spread trade that I mentioned once.

01:36:08.780 | So that would even make the interest

01:36:12.580 | effectively tax-deductible.

01:36:14.700 | So that's a pretty neat way.

01:36:17.900 | So it brings new cash into your account,

01:36:20.020 | and then you take that cash and buy more stocks.

01:36:22.500 | You can definitely do that.

01:36:23.860 | And again, the idea here is that

01:36:26.180 | it goes back to this intuition I told you before, right?

01:36:28.860 | So if you do a glide path optimization,

01:36:32.140 | and I've worked on this,

01:36:33.820 | I've written about it on my blog,

01:36:37.940 | but I did the maximum stock position

01:36:41.900 | would have been 100%.

01:36:44.140 | And the reason why 100% was optimal

01:36:46.500 | was not because 100% is optimal,

01:36:48.300 | it's because I set the upper limit to 100%.

01:36:50.900 | So if you're really young

01:36:52.020 | and you have relatively little in investments,

01:36:55.220 | and you still have enough runway to retirement,

01:36:58.220 | yeah, you could definitely go above 100%.

01:37:01.940 | And as long as you don't do it too crazy,

01:37:03.940 | there seems to be some,

01:37:05.500 | in some bogleheads forum,

01:37:07.060 | there's somebody who wrote this horror story

01:37:09.580 | where as a grad student,

01:37:10.860 | he went into equities with some leverage,

01:37:14.340 | and then the global financial crisis hit.

01:37:16.260 | And I think he lost almost everything.

01:37:19.260 | So bad things can happen if you do leverage.

01:37:21.980 | I think if you do it reasonably

01:37:24.020 | and you do something like 110% equities,

01:37:27.660 | you do a little bit of extra leverage.

01:37:30.500 | I think that mathematically,

01:37:33.380 | it's definitely the right thing to do

01:37:35.980 | from say a lifetime asset allocation point of view.

01:37:40.100 | And I'm not sure everybody has a stomach to do that,

01:37:45.660 | but if you do, you should obviously do that.

01:37:47.460 | I guess the easier thing to do is say,

01:37:50.620 | if you already have a house and a mortgage,

01:37:53.340 | think of the mortgage as almost like leverage.

01:37:55.940 | So instead of paying down,

01:37:57.220 | instead of making accelerated payments on your mortgage,

01:37:59.860 | maybe put everything in the stock market

01:38:02.020 | and then keep 100% equity position,

01:38:04.060 | that's almost already like a equity with leverage,

01:38:07.860 | because you have the mortgage on the side,

01:38:11.220 | it is basically just the money is fungible.

01:38:14.820 | So think of almost the mortgage as the leverage.

01:38:17.780 | But yes, I absolutely agree with that.

01:38:21.860 | And it goes back to this idea,

01:38:23.860 | you already have a lot of bond-like allocation,

01:38:28.860 | which is an implicit allocation,

01:38:30.500 | which are your future contributions into your 401(k)

01:38:34.460 | and, or 401(k) or NASDAQ in general.

01:38:38.500 | And because you have this big bond allocation,

01:38:41.580 | you want to overcome that

01:38:43.060 | and have maybe not just 100% equities,

01:38:46.140 | then it could be 110 or 120% equities.

01:38:48.580 | And then minus 20%, you have some borrowing,

01:38:53.300 | ideally as something like a box spread trade

01:38:56.340 | where you can get, I mean, you can borrow money

01:38:58.820 | at maybe three months treasuries plus 0.3%.

01:39:03.820 | And that stuff is also tax deductible,

01:39:06.660 | which is not really the case with a lot of other things.

01:39:10.580 | - Okay, I think I hit on all the portfolio stuff.

01:39:13.220 | The more you talk about options,

01:39:14.540 | the more it makes me wanna do an entire another conversation

01:39:17.260 | about option strategies,

01:39:18.380 | 'cause you've got a great series there.

01:39:20.740 | We'll punt that for the future and we'll have you back.

01:39:24.980 | As we wrap up, you're kind of one of the people I know

01:39:28.820 | who've gone through this early retirement thing.

01:39:31.540 | What advice do you have for someone

01:39:33.780 | who's still in that accumulation phase

01:39:36.220 | beyond just some of the stuff we talked about now,

01:39:38.660 | maybe more about the life and the mindset

01:39:40.780 | that you've picked up along the way

01:39:42.380 | that you'd like to share?

01:39:43.580 | - As I said earlier, if you're early on

01:39:45.940 | in your accumulation phase, go aggressive.

01:39:50.860 | So 100% equities is not a dirty word.

01:39:55.140 | Also keep up the pace.

01:40:00.180 | So you have to almost rewire your mind.

01:40:02.820 | If equities are at an all-time high, great.

01:40:05.940 | Momentum is working.

01:40:07.740 | I'm going to keep investing

01:40:09.540 | and this thing will keep rolling forever.

01:40:12.740 | And then if equities are down,

01:40:15.180 | then, okay, forget about momentum.

01:40:17.660 | Now we think valuation, right?

01:40:20.340 | So now we say equities are cheap.

01:40:24.220 | So now is a great time to invest too.

01:40:26.060 | So there's always a great time to invest.

01:40:28.700 | And think about that as what we said before, right?

01:40:32.580 | For retirees, it's a real headache.

01:40:34.980 | There could be a bear market around the corner

01:40:38.820 | and you have sequence of returners.

01:40:40.540 | The flip side of that is that actually a recession

01:40:43.980 | and bear market could work okay for savers

01:40:48.980 | because you have dollar cost averaging.

01:40:52.020 | You keep investing through the trough

01:40:54.980 | and you pick up more shares at cheaper prices.

01:40:57.980 | And then when the market retires again,

01:40:59.460 | you look really golden.

01:41:00.300 | I mean, definitely it worked for me twice, right?

01:41:03.300 | Once during the dot-com crash

01:41:05.940 | and once during the global financial crisis.

01:41:08.780 | And so if you are still saving and preparing for retirement

01:41:13.780 | and saving for an accumulating for,

01:41:16.740 | whether it's traditional retirement or early retirement,

01:41:19.580 | don't really sweat the volatility,

01:41:22.140 | don't really sweat valuation so much.

01:41:25.580 | Worry about that later and then you can check out my blog,

01:41:28.020 | but on the way there, just keep plowing money in.

01:41:32.460 | And, but then at the same time,

01:41:35.540 | I also wrote a blog post it's called Stealth Frugality.

01:41:39.860 | So you don't want to overdo this frugality business, right?

01:41:43.740 | I mean, you also want to live a little bit

01:41:45.740 | and don't want to shortchange your fun.

01:41:50.740 | And I mean, it's really fun to live in early retirement,

01:41:55.620 | but you don't want to be too frugal

01:41:59.500 | during the accumulation phase.

01:42:01.140 | And then because you might fall off the wagon

01:42:06.140 | and you might hate it.

01:42:08.700 | So even if it takes you maybe two or three years longer

01:42:12.940 | to reach that early retirement date,

01:42:15.860 | I mean, if the path there is fun,

01:42:19.260 | it's much easier to save for two or three more years.

01:42:23.980 | So keep that in mind.

01:42:26.020 | - And would you say stealth frugality is just,

01:42:28.740 | be frugal where necessary,

01:42:30.540 | but don't be so frugal that everyone knows it

01:42:32.660 | and you don't have fun.

01:42:33.500 | Or how do you think about it?

01:42:34.340 | - Well, people talk behind your back about it

01:42:36.020 | or something, right?

01:42:36.860 | I mean, you want to send some signals.

01:42:38.700 | So I never sweated, for example, going out for coffee,

01:42:41.780 | the work lunches.

01:42:42.780 | So we would go out for lunch

01:42:44.380 | at some of our favorite places in San Francisco.

01:42:48.780 | And so, yeah, it's a little bit extra expense,

01:42:53.020 | but it's also, I value the social interaction

01:42:56.700 | and picking up the gossip around the office

01:43:01.700 | and connecting with people.

01:43:03.380 | And yeah, also making friends

01:43:06.260 | and actually making lifelong friends too.

01:43:09.140 | So don't shortchange your accumulation phase,

01:43:14.020 | make that fun too.

01:43:15.140 | And then retirement will be fun.

01:43:16.940 | - And the last thing,

01:43:17.780 | do you think, one thing about retirement

01:43:20.780 | that because you're in it,

01:43:22.260 | maybe you can help me kind of grab with is,

01:43:26.460 | or maybe you can help me understand is,

01:43:28.780 | I feel like with all this free time in early retirement,

01:43:32.500 | you'd actually have more time to spend.

01:43:34.660 | And so if I look and say, "Oh, right now I spend,"

01:43:37.900 | let's use our old example, $80,000 pre-retirement.

01:43:41.420 | Do you think from all the case studies you've done,

01:43:44.700 | that number should be higher or lower?

01:43:47.140 | Because you've talked about die with zero.

01:43:49.860 | One of Bill Perkins' points

01:43:51.220 | was people in retirement spend less,

01:43:53.300 | but what about people in early retirement?

01:43:55.780 | - So, I mean, obviously people in retirement spend less

01:43:59.300 | because you have this cliff

01:44:00.900 | when people retire at age 65 or 67, right?

01:44:04.820 | So maybe some people slow down already.

01:44:07.740 | Sometimes it's also,

01:44:09.500 | it's basically job-related expenses that you have less of.

01:44:14.140 | So for me, it's probably,

01:44:16.500 | yeah, we probably now might be spending more,

01:44:19.220 | say outside of some of the fixed expenses

01:44:21.780 | that you had in California, right?

01:44:23.100 | A big mortgage.

01:44:25.420 | So that is now gone,

01:44:27.100 | but what you spend on top of the mortgage,

01:44:29.060 | yeah, I mean, you didn't even have time to travel as much.

01:44:32.460 | And so we definitely spend more on travel.

01:44:36.780 | We have to pay out of pocket more for health expenditures.

01:44:40.420 | Yeah, I mean, keep that in mind

01:44:41.860 | that some of that might change.

01:44:44.380 | You might spend less on work clothes and commuting,

01:44:48.780 | but yeah, you have more time to spend money.

01:44:51.540 | You have more bandwidth.

01:44:52.820 | You sit in front of the computer.

01:44:53.940 | Maybe just out of boring, out of boredom,

01:44:57.180 | you check out Amazon and do some therapy shopping.

01:45:01.340 | And so it could be a problem.

01:45:05.700 | I definitely noticed we spend more on certain categories,

01:45:10.140 | but spending less on work clothes and less on the mortgage,

01:45:15.020 | and we have no mortgage right now,

01:45:17.180 | but yeah, it could be a problem for some people.

01:45:21.860 | You should have this guy on the show

01:45:23.540 | as Justin from Root of Good,

01:45:25.620 | so he can tell you more about it.

01:45:27.180 | So he definitely, he has this theory

01:45:29.300 | that he's spending somewhere between $30,000 and $36,000

01:45:34.140 | on a lifestyle that would require a $100,000 salary

01:45:39.140 | for the average middle-class American.

01:45:43.220 | So he can probably tell you that,

01:45:44.940 | no, because you have more time,

01:45:46.540 | you can do more stuff yourself.

01:45:48.100 | You have to outsource less.

01:45:49.460 | You can do more home repairs yourself.

01:45:51.620 | You can do yard maintenance yourself.

01:45:54.980 | So there are definitely going to be different views.

01:45:58.620 | My personal view is, yeah, probably outside of the sum of,

01:46:03.620 | so if we had stayed in San Francisco,

01:46:06.060 | we probably would still have that cost

01:46:08.860 | and maybe a little bit more.

01:46:10.900 | So maybe just purely by numbers, we're spending less now,

01:46:13.940 | but that's because we don't have the mortgage

01:46:16.060 | in San Francisco anymore.

01:46:17.500 | This has been awesome.

01:46:19.340 | Everybody should go check out the series.

01:46:21.580 | If they want to go deeper, we'll link to that.

01:46:23.940 | We'll link to the site.

01:46:25.260 | We'll link to the toolbox and the spreadsheet you built.

01:46:27.540 | Is there anywhere else you want to send anyone

01:46:29.740 | or any parting words you want to share?

01:46:31.740 | Check me out on my webpage.

01:46:33.460 | And we probably have already common audience,

01:46:38.460 | but if you haven't found me yet,

01:46:39.900 | that would be good to check me out.

01:46:42.020 | Early retirement now is where everything is.

01:46:44.020 | Links are in the show notes.

01:46:45.180 | Karsten, thanks for being here.

01:46:47.300 | You bet.

How Much $ Do You Need to Retire? Does the 4% Rule Work in 2024?

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