Hello, everybody. It's Sam from the Financial Samurai Podcast, where I try to help you achieve financial freedom sooner rather than later. The Federal Reserve has finally cut interest rates by 50 basis points, not 25 basis points, and this is the first rate cut since 2020. The new interest rate target is 4.75% to 5%, and the dot plot signals interest rates will be down to 4.25% to 4.5% by the end of 2024 and by another 100 basis points by the end of 2025.

So, December 2025, we could see the Fed funds rate at 3.25% to 3.5%. This rate cut is significant, and there is a lot that this rate cut will do for your money. In the short run, we're talking cuts to credit card interest rates, auto loans. The Fed funds rate is the overnight bank lending rate.

It's the shortest end of the yield curve. Mortgage rates have already come down about 1.5% to 2%. The 10-year bond yield has come down in anticipation of this rate cut. However, given that the Fed has signaled continuous cuts over the next 16, 18 months, we should expect mortgage rates on the long end, the 10-year bond yield, specifically, to fade down as well.

It might fade down to 3% by this time next year. So, I want to first talk about what the Fed rate cut means for the real estate sector. I am bullish on the real estate sector because I think we are heading into a really Goldilocks type of scenario. There is pent up demand.

Many, many people over the past couple of years since the Fed started raising rates and since mortgage rates started going up aggressively have been holding off on buying. One, because they can't afford to, and two, because they think or they thought that higher mortgage rates would depress housing prices.

Well, housing prices have come down in areas where you can build a lot of supply. For example, Austin, Texas or Boise, Idaho, where prices are down 10 to 15% from the peak. But those prices went astronomical during the pandemic. So, it's just a normalization here. There is a structural undersupply of homes.

We're talking millions of homes undersupply in this nation. And it's going to get worse because from 2022 to right now, 2024, builders weren't building because it cost too much to build. So, this is going to be a lag effect. There's going to be undersupply going forward over the next several years.

I don't see how this problem is going to get fixed. Three, you've got declining mortgage rates now, right? They're about 1.5% off from the peak, maybe 2% off from the peak actually. And they're probably going lower. In addition, we're probably going to have a soft economic landing or maybe a mild recession.

A 50 basis point cut is signifying that the Fed sees a slowdown in the economy, specifically in the labor market. And they wouldn't have done 50 if they didn't see a greater slowdown than expected. If it was 25, they'd be like, well, okay, not too bad. But 50, maybe they see a little bit more sense of urgency.

But in a way, that can be good because that shows that the Fed doesn't want to be too far behind the curve. Another positive for real estate is record high stock market wealth, 5,600 plus on the S&P 500. The market has created a tremendous amount of wealth for listeners, for readers of Financial Samurai, for the 60 plus percent Americans who own homes and the 50, what, 5% of Americans who own stock.

So when you have more wealth, you're going to spend it. And we're entering a multi-year Fed rate cut cycle, right? By this time next year, the Fed funds rate could be down another one and a half percentage points. Further, with rates coming down, I see a potential rotation of capital from public equities more to real estate, private real estate, residential real estate, commercial real estate.

There are opportunities to be had specifically in the commercial office real estate market. A lot of bombed out prices trading at 40, 60% discounts to where they were first purchased before the pandemic began. And you are seeing, you are seeing investors make those investments right now. And I think over a 10-year period, it's going to turn out to be quite good for them.

Now that the Fed has cut rates, I think a lot of people are going to start getting off the sideline. Retail buyers, people who don't follow personal finance sites or listen to personal finance podcasts, are thinking to themselves, well, the Fed cuts rate, that means mortgage rates are going down.

However, we all know that the Fed doesn't control mortgage rates. They influence mortgage rates, but mortgage rates are controlled by the bond market. So the mortgage rates have already moved. But what I see happening now is millions and millions of people looking at the headlines, listening to podcasts, watching TV saying, oh, the Fed has cut rates, that means mortgage rates are coming down.

It's now safer to come out and buy. And as a result, I think you're going to see an uptick in demand. But the one thing that's throttling home buying right now, especially during a cyclically slow period of the year, right, second half of the year, fourth quarter specifically, is the election on November 5th, 2024.

People are waiting to figure out who's going to win the presidential election in America so they can better understand where they want to live, for example, or what type of policies the new president will try to implement and how that will affect real estate prices, depending on where you live.

For example, the salt cap deduction of 10,000, maybe that gets eliminated by the next president. And if so, that might create a lot more interest in buying coastal city or more expensive city real estate. Just as an example. Another example is first time home buying subsidy credits, right? $25,000 free money.

What does that mean? Well, that probably means there will be greater demand for first time homes. And that means prices for first time homes, lower cost homes might be going up faster than medium priced homes or higher priced homes. So as an investor, you probably want to invest in first time homes, which would actually make them even more expensive.

So there's all these second knock effect consequences for government policies that we have to think about and that people investors are thinking about until they get greater clarity on who is president, the next president of the United States. Now, what does a Fed rate cut mean for the stock market?

Well, as a stock market investor, you have to compare your potential returns to the risk free rate of return. The risk free rate of return is the 10 year bond yield usually and that is hovering around 3.7%. So that means you wouldn't invest in any risk asset unless it returned potentially greater than 3.7% because you can get that risk free.

Now, in general, lower rates are good for stocks because that means the cost of capital is lower, which means companies can borrow and invest more in their businesses. They can acquire other businesses. It would be more economic activity with a lower hurdle rate, lower interest rate, lower opportunity cost.

More capital will be willing to invest in stocks because the opportunity cost of investing in a risk free asset like a 10 year bond yield is lower. So in other words, let's say the 10 year bond yield was very high. Let's say it was at 50%. You wouldn't invest in anything else that wasn't going to return greater than 50% because 50% is huge just doing nothing and especially if let's say inflation was under 50%.

So this is what stock investors are thinking now. Okay, we're modeling out a decline in the Fed funds rate, a potential decline in long term bond yields. So as a result, we want to look at other asset classes to potentially generate a greater return. The tricky scenario is if the Fed is behind the curve and a recession comes where there are two consecutive quarters of negative GDP growth and the unemployment rate surges from the low 4 percentage point to 5 plus percent in a matter of 6 to 12 months.

If that were to occur, then I expect the stock market, specifically the S&P 500 to go down and we have precedence for this. In the 1990s, the Fed started cutting rates, stock market went down. In 2007, during the most bubblish year of my lifetime at least, the Fed also delivered a half point rate cut on September 18, 2007.

And what transpired then was the global financial crisis, which was the most devastating downturn in our lifetimes. In hindsight, it was clear the Federal Reserve was behind the ball. They had let the housing market bubble to crazy amounts, crazy levels, the stock market was going crazy, a lot of speculation.

And then they were too late to start cutting. And then by the time they started cutting, everything unraveled. Today, things are a little bit better. Actually, they're much better. The corporate balance sheets are much better. Personal balance sheets are much, much better. Just look at the charts on how much home equity there is, how much money is in money market funds, how much lower the gearing is for corporate balance sheets in terms of having less debt.

Profitability is much higher. So I don't think the Fed is as behind as it was back then. It might be a little bit behind, which is okay, but it's nowhere near as behind as it was in late 2007. As a result, I think with a telegraphed declining interest rate environment over the next 16 to 18 months, plus a slowdown in the economy, softer landing, I think equities can do okay.

They are overvalued from a historical KPE ratio, something like 30%. But if earnings can continue to grow over the next 12 months, maybe this current P multiple is not as expensive as it will be in the future. On a relative basis, though, if I had, let's say $10 to invest, I would invest $6, $7 of that into real estate because we have this huge tailwind going on with lower rates.

Look at the publicly traded ETFs and real estate ETFs, as well as real estate companies like Redfin and Zillow. Those stocks are on fire. They are very forward-looking. They are quick to move, whereas residential real estate prices are slow to move, as well as private commercial real estate prices.

Now for public stocks, I would still invest $2 or $3 of the $10 in the S&P 500 or your stocks of choice, because it's a low cost, easy way to gain exposure to the US economy, which is still growing. Despite elevated valuations, historically, the S&P 500 has returned about 10% a year.

Now, maybe the future returns might be lower. 7.8% is what JP Morgan predicts over the next 20 years. And I know they're going to change their forecast next year. Vanguard is even more bearish. They're looking at like 4% to 5% annual returns over the next 10 years for the S&P 500 US equities specifically.

So that's something to consider. However, again, investing in stocks have traditionally shown to be one of the biggest and best wealth creators over the long term at a low cost, and it's very easy to do. And then finally, I would invest the remaining $1 or $2 in private growth companies, specifically venture capital in the AI space.

I'm here in San Francisco. I can't escape AI. I'm going to an AI party tonight. It's just everywhere. And we are seeing real use cases for AI as apps and software and products are being built. So by investing 10% to 20% of new cash flow or your existing portfolio in private growth companies, I think you have a good hedge.

You have a hedge just in case these companies do extremely well in the future. You hear open AI trying to raise something like $6 billion plus at $150 billion valuation at the end of 2024, when they just raised at an $80 billion valuation in February 2024. So that's a huge gain in just 6 to 10 months.

And I don't want to miss out on that. So I'm willing to allocate 10% to 20% of cash flow or existing capital to AI. If AI does great, this capital will do great. If AI turns out to be an overhyped bust, well, the capital will underperform probably the S&P 500.

But at least our children will still have jobs and have purpose and meaning as AI doesn't take over their lives. All right, we've talked about how the Fed funds rate will affect borrowing costs, real estate and stocks. Let's talk about how the Fed funds cuts will affect your safe retirement withdrawal rate.

Back in 2020, during the height of COVID, I introduced the Financial Samurai Dynamic Safe Retirement Withdrawal Rate. And that equals 80% of whatever the 10-year bond yield is at the time. And I came up with that because I look back in the 1990s when the 4% rule was created, and it was created when the 10-year bond yield was between 5 to 6%.

So 4% is 80% of 5 to 6%. So I went with that and I went with that logic. It's an easy way to think about how to withdraw money when you no longer have a day job. Now, when I introduced this, the 10-year bond yield was at about 0.6% because so much capital was fleeing stocks, fleeing real estate at the time to the safety of Treasury bonds, sovereign bonds by the United States government.

If the world was going to hell and the virus was going to eat up and take over and kill everybody, at least we had the safety of Treasury bonds. So as bond prices went up, yields went down. And when I talk about 80% of the 10-year bond yield, that means having a safe retirement withdrawal rate of 0.5% because 0.65% times 80% is about 0.5%.

And when I talked about this, a bunch of people on the internet went apoplectic saying, "This is a ridiculous assumption. 0.5% is way too low. That would require 200 times my annual expenses for me to retire early. Screw you. This is ridiculous. You're a chump." Whatever it is. And a lot of bad words.

It's actually quite interesting how much fire there was. But you have to remember, this is a dynamic safe withdrawal rate. It changes as conditions change, economic conditions change, pandemic, vaccine, whatever. People move on with their lives change. It changes. And what I failed to understand was that people are stuck in this static mindset.

They say, "Oh, 4% roll. Inverse that. 25 times your annual expenses, boom, you can retire with that net worth." But the thing is that is lazy thinking. That's easy thinking because you're like, "Okay, 4% roll. It is what it is." But if you stick with a 4% roll from 40 years ago, when the world is changing, you could get blown up.

You could get left behind. And I don't want you all to get left behind. I want you to make more money than the median person or the average person so you can live a more free life sooner rather than later. So, if you adopted my dynamic safe withdrawal rate, then what you did was you lowered it to 0.5% during the worst of the pandemic.

Instead of 4%, you're at 0.5%. And guess what? You had more capital. You had more safety to protect yourself against the unknown. And if you were so courageous and daring, you could have used that spread, 4% minus 0.5% or 3.5%, and used that extra capital to invest in risk assets like stocks, real estate, or whatever at depressed prices.

And guess what, folks? Four and a half years later, you are much wealthier because of it. And not only did you invest more wisely, calmly, and diligently, your mental health was probably better at that time because you followed a dynamic framework that guided you during uncertain times. And as times got better, you could increase your safe withdrawal rate.

Well, what's interesting to note is that just as the Fed starts its multi-year rate cut cycle, investment houses like JP Morgan, PGIMDC, which I've never heard of, and others are calling for an increase in the safe withdrawal rate from 4% to 5%. How is that logical? Let's think about it.

If interest rates are coming down and the Fed is cutting rates because it fears a recession, that means there is more risk ahead. Slowdown, lose job, whatnot. There's risk there. Second, if interest rates are coming down, that means your risk-free rate of return is coming down. Therefore, you've got to take on more risk.

And if you take on more risk, there's a greater chance you might lose money. You cannot, in a low interest rate environment, generate as much risk-free income to pay for your retirement. That was one of the benefits of higher rates. Savers were rewarded with five, five and a half percent risk-free money.

That was amazing. That was enough to pay for life. But now, with rates going down, not so much. So why would you suggest increasing the safe withdrawal rate? But here's the other point of inconsistency from these investment houses. JP Morgan, for example, is expecting the next 20 years for public equities in the United States to return 7.8% per annum versus the historical 10% per annum return.

Now that's 2.2% decline. While Vanguard is expecting 4% to 5% public equity returns for the next 10 years. And that's 5% to 6% below the historical rate of return of the S&P 500. So if you are expecting lower rates of equity returns and relatively stable to slightly lower bond yield returns, then it is completely counterintuitive and completely illogical to then suggest increasing your safe withdrawal rate in retirement.

Even Bill Begum, the creator of the 4% rule in the mid-1990s, is also revising his recommended safe withdrawal rate up. He told Barron's that in his upcoming book he may endorse a rate very close to 5%. Now, I was trying to think why Bill would raise his recommended safe withdrawal rate by 25%, right, 4% to 5%.

And I realized it's because he might be stuck in the past. He's writing a book. I've written books, right? Buy this, not that. How to engineer your layoff. It takes two plus years to write a book. The ideas you have when you first start writing a book and the ideas you have two years later can change.

The world can change. Again, back to being dynamic in thought and in action. The dynamic safe withdrawal rate. Yes, 5% withdrawal rate made sense back in mid-2023 when the 10-year bond yield was about 5% and long-term treasury bonds were yielding 5.5%. We talked about this before. Lock in some of that long-term treasury bond money at five plus percent.

So good because I believed interest rates would eventually roll over. I've been believing that forever. Long-term interest rates are going to head down because of technology, efficiency, and better coordination among global economies. But today is different from yesterday. It's different from a year ago. The world changes and you cannot stick to ideas of the past if you want to keep up with people in the present, let alone wanting to outperform them.

Being a retirement researcher is completely different than being an actual retiree with no active income, no steady paycheck, no retirement benefits, no subsidized health care benefits, nothing. You're on your own. Retiring is one of the most psychologically challenging transitions to face. You will not know how it feels like until you say goodbye to your job.

Trust me on this, folks. I've been gone since 2012 and I struggled immensely during the first one to two years wondering, "Did I make a mistake? Did I blow myself up? Oh my gosh, what am I doing with my life? I'm screwed. What am I going to do?" But then over time, things change and then your expenses change.

Your life changes. You might have children. You might want to buy a house. You might want to relocate. Something bad might happen. Things change all the time. Back to being dynamic and flexible with that change. Once you are retired, you don't have the luxury of pontificating about what retirement is like with numbers because you have real expenses to pay.

You don't have a backup. And when you don't have a backup in the form of a day job or a wealthy spouse or a rich uncle or some kind of side hustle that brings in a lot of money, you have to be more precise in your analysis. Now, I know surveys have showed that 40-50% of retirees just wing it when it comes to their finances.

Just like most people, I think, wing it when it comes to trying to build wealth. And then they wake up 10 years later and wonder, "Where did all my money go?" I suggest you not wing it. I suggest you follow a framework. You don't have to follow my framework if you don't believe in it, if you don't want to.

But at least you should follow some type of framework to keep yourself honest so you consistently review your finances, you consistently save and invest for the future, and you consistently look at your asset allocation and compare it to your true risk tolerance and your goals. I'm excited over the next two years because the Fed is finally providing a tailwind for investors and for folks who want to work hard and make more money.

Now, the Fed is not going to be great for savers, but rates are still relatively high and you still want to be disciplined in your saving and budgeting. But for those who want to work hard, who want to take more risks, who want to start companies, having this tailwind is a good thing.

Just make sure you don't get out of hand by borrowing too much money. Thanks everyone for listening to the Financial Samurai podcast. Every episode takes hours to record, edit, and produce, so I'd appreciate a share and a positive review wherever you listen. Also, if you're looking for a professional second opinion about how you're investing your money, go to financialsamurai.com/advisorsor and speak to an Empower professional.

He or she can go through what you're investing in right now and shed some blind spots that you might not realize. We're in a transition period. I'm hopeful about the future, but you never really know. And if you haven't had someone run through your investments in over a year, things can change, and it's good to have a free consultation.

Check out the show notes for a direct link. And if you want to subscribe to the Financial Samurai newsletter, where 60,000 plus others have, go to financialsamurai.com/news. I'll talk to you all later. (dramatic music)