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🧩 Sequence of Returns Risk Solved! Karsten Jeske on Safe Withdrawal Rates 📈
1.3k Plays4 months ago
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🌟 In this episode, David Baughier welcomes Karsten Jeske, aka Big ERN, to explore the critical topics of Sequence of Returns Risk and Safe Withdrawal Rates, essential for anyone planning their retirement. 💼
💡 Karsten shares his journey from a finance professional to a renowned blogger, emphasizing the importance of customized retirement planning and effective risk management. 📈
📝 Episode Highlights:
🎥 Karsten's journey into retirement planning and blogging
🚨 Strategies to manage Sequence of Returns Risk
💡 Effective safe withdrawal rates and retirement timing
📊 Insights into diversified portfolio and asset allocation
🔍 Options for your retirement income strategies
🔗 Karsten’s Links:
📣 Big ERN's CampFI Talk about the Need for Precision
🔗 David's Links:
🍏 Forget About Money on Apple Podcast
🎧 Forget About Money on Spotify
#️⃣ Hashtags: #SequenceOfReturnsRisk #SafeWithdrawalRates #RetirementPlanning #KarstenJeske #MarketVolatility #RetirementIncome #AssetAllocation #DiversifiedPortfolio #NegativeReturns #FinancialSecurity #TaxEfficientRetirement #FI #FinancialIndependence #EarlyRetirement
🕒 Timestamps/Chapters:
0:00 - 🚀 Introduction to Sequence of Returns Risk and Safe Withdrawal Rates
2:32 - 👨🏫 Karsten Jeske's Background and Expertise
5:03 - 📊 Transitioning from Professional Work to Blogging
11:11 - 💼 Karsten's Experience in Finance and Economics
14:37 - 📉 Defining Sequence of Returns Risk and Safe Withdrawal Rate
23:46 - 🕵️♂️ Factors to Consider Before Officially Retiring
29:11 - ⏳ Planning for Retirement Timing and Market Factors
36:06 - 🔄 Mindset Shifts from Accumulation to Decumulation
39:55 - 🌐 Navigating the Safe Withdrawal Rate Series on the Blog
40:21 - 🔥 Introduction to the Fire Community
47:04 - 📚 Importance of Research Before Retirement
52:16 - 💡 Debunking the Bucket Strategy
1:05:19 - 📉 Managing Sequence Returns Risk
1:14:55 - 📉 Considering the Risk of a Recession
1:17:37 - 💬 Perception of Safe Withdrawal Rates
1:19:34 - 🧠 Acknowledging Expertise in Safe Withdrawal Rates
🎧 Listen & Subscribe:
Don’t forget to subscribe to "Forget About Money" for more insightful episodes featuring experts who guide you on simplifying your finances and achieving financial independence. Hit the bell icon 🔔 to get notified of new episodes!
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Transcript
Introduction and Guest Background
00:00:00
Speaker
Sequence of returns risk and safe withdrawal rates. Big earn covers everything you need to know so that you don't run out of money in your retirement. Here we go.
00:00:12
Speaker
Welcome to Forget About Money, where we encourage you to take action today so that you can focus on what matters most to you. It's one thing to know if your money will last a few years in retirement, but it's another thing to know if it will last your lifetime. Today, I'm here with Karsten Jeske, AKA Big Earn. He is the premier expert of safe withdrawal rates and sequence of returns risk. Welcome, Karsten. Hi, thanks for having me on the show.
Karsten's Journey into Financial Research
00:00:38
Speaker
So Carson, tell me how you got involved and even thinking about that you were interested in sequence of return risk or safe foot withdrawal rates. I can't imagine you were eight years old and that's what you wanted to do your entire life. Right. Right. Uh, so in 2016, uh, right about 2016, when I started my blog, I got interested in early retirement and I was probably five or close to five and, um,
00:01:04
Speaker
Probably in hindsight i was fine in real time i didn't quite trust my numbers yet, ah so i work actually until two thousand eighteen until i retired but as obviously the it's the thought process was already going and i you know you you save and you accumulate assets and in some way, ah Mentally, that's ah that's the hard part, but mathematically, it's actually the easy part to accumulate a lot of assets. I just put money in, ah forget about it, and don't even check your statements. And then you end up with this big nest egg, but then withdrawing money, it was always on my mind, well, how much can you actually withdraw? And then Googling, um is there any research out there that I can use?
00:01:47
Speaker
to model my personal safe withdrawal strategy. And the only thing I found was basically the, the bangin study and the Trinity study, which is so bland and so generic. And it obviously, it has to be generic, right? Because these are studies that are published in academic journals and you have to do something very generic because if it looks like, well, this looks like your aunt's retirement ah plan with lots of bells and whistles. And she has a house here and ah and a vacation home there. If it becomes too idiosyncratic, then nobody takes your academic or practitioner journal, very research, very ah serious. So it had to be bland and generic, but again, I'm not bland and generic, right? I'm, I'm me and I have all sorts of idiosyncratic parameters, right? I'm an early retiree. I may have some extra income ah first few years in my retirement. So something like deferred bonuses ah from my workplace.
00:02:42
Speaker
ah Then eventually I'm going to claim social security. That's the difference between a traditional and an early retiree. ah Traditional does it usually youre around the same time. And for me, this is something like 20 year or 20 plus a year gap between ah early retirement and then claiming social security. And then once you get benefits, you can then draw, you can then reduce your withdrawals from the portfolio. All of these bells and whistles are not modeled in these generic studies. So I thought I have to do this myself. And so in that, process of studying, um, how can I model my personal, uh, safe withdrawal rate? Oh, did a
Professional Expertise and Blog Evolution
00:03:20
Speaker
lot of research. And, and again, I didn't find anything online that could help me. And I said, well, if I can't find it there, I have to do it myself. And this is how one thing led to another, because I never thought that I think in 2016 in December was the first time i published I published series, the safe withdrawal rate series part one. And I maybe.
00:03:41
Speaker
Would have had material for somewhere between five to eight blog posts. And I thought, oh yeah I'm just going to write this series and then it's, and then it's good and it's done. But then of course you, you can't write fast enough to, to cover all the topics that come up by the time you start digging and did you do this rabbit hole thing, right? You go and then you find more stuff to write about. ah You find stuff that readers point out, right? So it's not a one way street where. where I write and then I'm pontificating here and then preaching and people just consume where there's also is a two-way street and and I get a lot of insights and impulses from my readers. And so this is how this has grown now to 60 plus parts in that series.
00:04:25
Speaker
so oh No, I can't imagine somebody not knowing who you are by now, at least someone who might be interested in early retirement or retirement and wondering if their money's gonna last. But for someone who may have never heard of you, you're not someone who just picked this up as a hobby. Like for me, I'm a hobbyist. This is not my career. I'm not a numbers, well, I'm a numbers guy, but I'm not a, I've never got paid for doing financial analysis or anything like that. You on the other hand, this is not, You didn't come out of nowhere and just start doing this research. You do have an economics background. Can you explain ah why someone should be listening to you and reading your blog? Right. So, I mean, it's it's not like I did this for a living, right? I wasn't paid ever in my career to study sequence of returners, but I have something that's correlated with that, right? So I studied economics. I have a PhD in economics. So I know a lot about um quantitative methods.
00:05:23
Speaker
ah both in economics and in finance, because I used to work for the federal reserve for a while. I was teaching in academia for a while um in economics, mostly. So not mostly macroeconomics. And then in finance, I worked for a bank of New York Mellon asset management. It's one of the largest asset managers in the world. And we were not doing stock picking. This is what people usually think that that we would do. um Some people probably there do that, but I was in the global asset allocation research. So we were thinking about um index investing, but well, what are the weights on all the different indices, right? US stocks-US stocks, long-term versus short-term money market style funds.
00:06:11
Speaker
um And then also there some commodity trading. So we would ah do that and try to eke out a little bit of extra return, which by the way is really hard. ah we We might get into some of this later when we talk about some some tactical asset allocation or bucket strategies or something like that. So I've i've been ah doing related research my entire life, but I have to admit that this whole ah retirement withdrawal stuff is actually new because if you're working in finance, right, you are thinking in in terms of, well, I maximize my risk adjusted return.
00:06:50
Speaker
right Risk adjusted return means you you look at something like a sharp ratio and how much excess return do I get for per unit of risk that I'm taking on. And you are, for the most part, thinking like a buy and hold investor. And so the the amazing insight that I got from my research on unsafe withdrawal rates is that If you have this fixed amount of assets and you're withdrawing from that and there's not much more money coming in. is so So, for example, like in a pension fund, there's usually money coming in, money going out, unless you're some very, very mature pension fund that has only 70 year old retirees and you're basically drawing this down. I mean, the modern pension fund
00:07:33
Speaker
Oh, is money coming in, money going out?
Understanding Sequence of Returns Risk
00:07:35
Speaker
ah You don't really face this this issue of sequence of returns. And I have to admit ah that maybe it was my ignorance, but in my entire career in finance, I have never encountered this issue of sequence of return risk. and ah you But you do have ah a similar and a related risk. right I mean, you obviously have this almost a reputational risk, right? So if you are an asset manager, you want to avoid a strong drawdown because, well, the client is going to fire you and then hire somebody else back and then they write the market up again, uh, when the next bull market rolls around. So you also have, you have a similar problem, but, but you call it differently, right? You call it, well, we, you know, we want to avoid this negative skewness in returns. We don't want to have these really, uh, big drawdowns and, um,
00:08:25
Speaker
But it's for a different reason. It's not sequence of return risk. It's more of a reputational risk. And and so amazingly, this this whole issue of sequence of return risk and retirement was something that that I learned afterwards and and read about it and then did my research on that. So it's, ah ah and again, so which Which is good, right? Because i what I did on my blog is not exactly what I did, but it's ah it's a corollary of of what I did in in my and my various jobs before. So you clearly were busy as a professional. Right. And if anybody were to go to your blog, earlyretirementnow.com, they would see that this is not just surface level research.
00:09:12
Speaker
right How did you transition from all that work for pay officially to then starting your blog and having a passion for helping others? Is it your passion for wanting to help others? What started the blog or maybe that's what's keeping it going? Or was it just your desire to solve this problem? Yeah. So it's, it's, it's a little bit of all of the above. So I, um, I, as I said, I am just a naturally curious guy, right? So if you work in academia, you sometimes you don't take anything for granted, right? So if somebody publishes something, you want to get in the weeds and try to understand every single, uh, line in some mathematical proof, every single, every single result in, in somebody's paper and the intuition behind it.
00:10:01
Speaker
So, um, I actually started the blog when I was still working, which was a little bit of juggling, a lot of things, so right? Family with a small, with a wife and a small kid at home, a busy career and a blog. And I tried to publish something at X, actually I published more of when I had a job than than i'm publishing now. Uh, but I mean, yeah, admittedly, um, uh, it's the, the blog posts early on, they were probably not quite as deep as I can go right now. And so sometimes I. write something like 4,000, 5,000 word posts with a lot of custom simulations. I don't usually write something, oh, I read something here. And then I paraphrase what I read and then publish that as a blog post. um What I'm trying to do is I try to publish something that you can probably not read anywhere else. And, or if you read it anywhere else, um, I, I was able to redo all of the work and check it.
00:10:59
Speaker
And, uh, yeah, so, I mean, this is, it is basically yeah out of academic curiosity, right? You want to do everything yourself and go really deep and try to understand what works, what doesn't work. And, um, uh, and this, this was something, uh, for example, in my, in my job as, uh, when, when I worked in finance, right? And you come up with some kind of an idea or here's a signal for, I'm going to, shift into this asset class, if this signal shows a green signal and then you simulate that and then suddenly you realize, well, it doesn't work. And well, what do you do with that? Do you just throw up your hands? I said, well, it doesn't work. Sorry. Um, try something else. No, you try to go in and try to find out why it doesn't. Right. And this is, this is also something with, uh,
00:11:46
Speaker
uh, safe withdrawal rates, right? So sometimes people tell you, oh yeah, I mean, uh, the withdrawal strategy is really easy. Can't we just do X, Y, and Z, right? And, um, sometimes, uh, you, you can write just write right off the bat. You can say, well, this is kind of nonsense, but sometimes yeah ah people have brought forward some sometimes intuitive, uh, solutions to sequence of return risk. And, um, But then they don't work or they don't work even 10% as well as as they are marketed. And the only way you can really confirm that is if you if you look under the hood and see how does this work. I mean, sometimes people tell me, well, can't you just build a portfolio with with a high dividend yield, right? And then you never dig into the principle. You just live off the dividends. And um then because you never dig into the principle, you are avoiding the sequence of return problem.
00:12:42
Speaker
oh sounds really good on the surface, but then if you look at, well, what what happened during past recessions, right? So some of the high dividend stocks, some of the high dividend ah bond indices, they also became really risky, right? So you say you go from treasuries into, ah into ah corporate bonds, and then you go from investment grade corporate bonds into high yield bonds, or from high yield bonds into preferred shares, and you go riskier and riskier. but Well, guess what? They, ah they also got hammered, say in the in the global financial crisis. so A lot of ah interesting solutions, um they
Market Strategies and Risk Management
00:13:18
Speaker
only look interesting on paper and you can't really ah use that. and yeah i mean You have to really get your hands dirty and you can't just wave your hands and think you found a solution to sequence risk.
00:13:30
Speaker
um if uh, if, if you don't do, do the simulations. And I mean, I've tried to, and obviously it's not like I tried to be the Grinch here and I talked to, I tried not trying to talk people out of retirement. Um, but, uh, in, in effect, I want us to find a solution to sequence risk, right? I mean, it would be great. I i would probably get maybe not the economics Nobel prize or anything, but I would, uh, I would probably, uh, became, become very famous if I found the definitive solution to sequence. So I'm.
00:14:01
Speaker
very much in favor of finding a solution. but um ah yeah But sometimes that also means that I'm the one who has to shoot down all of the of the crazy ideas that people bring forward there. I've been in the audience of a presentation where you did just that. And it really was, it wasn't as bad as you're saying it. And it was, it was very enlightening. And you brought up a lot of things for not only early retirees to consider, but just retirees in general or anybody actually just accumulating their wealth. but So let's take a huge step back, Karsten. We already got into the weeds a little bit.
00:14:37
Speaker
ah If someone has never heard of sequence of return risk, let's define that, right and let's define safe withdrawal rate, the relationship between the two, and why a retiree should consider this in their planning. right so um One doesn't go without the other. so let Let's start with the with the most basic one. What is a safe withdrawal? A safe withdrawal. rate is so you Imagine you have a portfolio and you ask yourself how much can you withdraw in the first month, the first year and keep that spending level the same, at least inflation adjusted over the ah retirement horizon, and usually 30 years or so.
00:15:19
Speaker
and um Normally, what you would have is something that is not 100% equity portfolio, something more ah balanced, something like a 60-40, 60% stocks, 40% bonds, maybe go all the way up to 80-20. So somewhere between 60 and 80% stocks and the rest are intermediate bonds, maybe 10-year treasuries. um And so the question is, how much can you withdraw ah without running out of money? and ah So research has shown that even during the very worst market events like the the Great Depression, ah the dot com crisis, the global financial crisis, the seventies were also very nasty. So ah the oil shocks in the seventies and then the Volcker shock with higher interest rates in the early eighties. So that that sank the stock market and the bond market. So we have a lot of ah market events that we can expose still and it turns out
00:16:17
Speaker
that right around 4% seems to be the the floor. This is how much you can withdraw without running out of money. and yeah maybe there were some If you have been so unlucky that you retired right at the peak, right before ah that big market meltdown, I think in September 1929, you would actually dip a little bit below 4% of a safe withdrawal rate. you could have But you could have still withdrawn something like 3.8%. I think 3.8% is roughly ah What you could have withdrawn over 30 years, ah both in 1929 and then also right before the ah the oil shocks, ah mid 60s or 1972, there were some retirement so historical retirement cohorts where ah you also dipped a little bit below 4%, but not much. So it's quite amazing that even in these absolute worst case scenarios, you could have ah withdrawn
00:17:15
Speaker
Uh, 3.8% is not bad. And, um, so the question is, uh, and it's, so the rhetorical question is what causes these low, um, safe withdrawal rates. And somebody might be tempted to say, Oh, the average return over your 30 year retirement was really low during some of these events. And what people will be amazed to hear that. For example, going from 1968 to 1998, that 30-year um return window, um I once calculated, so a balanced portfolio, something like 75 stocks, 25% bonds, would have had an average return of 6.1%. Make it 6%, 6% in real terms. So why is it that your safe withdrawal rate was only 3.8% if the average return point to point
00:18:12
Speaker
buy and hold was 6.1%. Well, ah it's the buy and hold average return is meaningless if you're taking money out. right So if there is a recession that's deep enough that takes your portfolio down and then you withdraw from the portfolio and you withdraw while your portfolio is down. So think of that as the opposite of dollar cost average. right So you ah Instead of buying more shares on the accumulation rate, instead of buying more shares, uh, when prices are down, no, you are now selling more shares when the portfolio is down. So even though, um, the point to to, uh, 1998 was really impressive. The first 15 years, I think it's 14 years, it's a 68 till 82. I think 82 was the absolute low point, uh, in real terms, both nominal and real terms.
00:19:07
Speaker
The performance was so poor over the first 14 years that you would have depleted the portfolio so badly that even with the subsequent amazing returns that I think were double digit, uh, over the second half of your, uh, of your retirement, because you, you depleted your portfolio so much. If you kept withdrawing 4% of that initial amount, that would have amounted to something like a 20% effective withdrawal rate. What do you withdraw as a percent of your. of your portfolio so that even that very impressive ah return recovery would not have saved your portfolio. So it means that um the the average return over your retirement horizon, I wouldn't say that is meaningless for your retirement success, but there's only a relatively
00:19:59
Speaker
useless, small correlation between the overall average return and the the returns that matter most are say the first two five, 10, maybe 15 years of your retirement horizon. And and then the subsequent um T minus 15 years is, and again, it's not meaningless. It's it's good that your portfolio recovers again. But if it's been wiped out so badly over the first 10 years, there's really no saving your portfolio. So that means there's actually the the distribution of returns, whether it's good returns first and then bad returns later versus the other way around matters a lot in your retirement outcomes. so And, um, the, it actually matters more than the average return. So, uh, it's actually all of the, uh, historical failures of the 4% rule happened when
00:20:55
Speaker
The average return was at four to 6%. And it's just because of this crazy volatility, you had very poor returns in the 15 years and then extremely good returns in the subsequent 15 years. That's what wipes out your portfolio. And there were tons of examples where returns were much lower than 4% and you still survive with the 4% rule. And then of course, if you have returns, I don't know. eight or 9% in real terms, then yeah, you don't have to worry about the 4% rule. Then you are so far beyond, I mean, at least in historical simulation, then you are so far beyond, uh, uh, beyond running out of money that you don't have to worry about. But this, this sweet spot in the middle, if you have average market returns and the the distribution of good versus bad is, is going against you, then you can actually run out of money. And that usually happens.
00:21:46
Speaker
at these ah historical market peaks right before the global. ah the the Great Depression um and the 1970s. So let me see if I can sum that up.
Retirement Planning and Withdrawal Strategies
00:21:58
Speaker
Two retirees with identical average rates of returns and exactly the same portfolio balance at the time that they retire, but they experienced different return or sequences, can experience vastly different outcomes. For example, retiree A faces a bear market early in retirement,
00:22:18
Speaker
their portfolio will deplete faster and retiree be faces a bull market and their portfolio grows which provides more cushion for their later years does that sum up yes yes absolutely and the the the span could be could be really wide so i did some simulations where you know you look at all the. retiring retirement cords that had a 5% average real return, not, not nominal, but real return 5% and you withdraw 4% at the beginning. You shouldn't run out of money. Well, guess what? There are some courts that ran out of money with a 5% return. And then there's some cohorts that ended up with, I think it's more than $2.5 million. dollars ah So to more than 2.5 X after withdrawing, they still have 2.5 X what they started. So it's a, it's a $3 million wide.
00:23:09
Speaker
Interval after 30 years and this this only blows up more if you go with ah with a longer retirement horizon and this is a 30 year ah retirement horizon for traditional retirees for us early retirees is is more extreme. So yes so that's exactly what sequence of return means. So let's say we're getting close to our magic number, our five number, our 25X or whatever that is we've decided for our own our own portfolio, our own lifestyle, whatever that is. As we get closer to that, pulling the trigger and getting out of the workforce, officially retiring or moving on to something that we're passionate and that we love and that we enjoy, but that's before that official retirement decision, what should we be looking at
00:23:51
Speaker
like market factors to try to not try, I guess, not trying to time the market necessarily, but are there some indicators that say, Hey, now might be a good time. Now might not be a good time to actually retire. So, but and again, it's, you may still retire. I think you should be able to retire in any market environment. So I don't think there's any market environment where you would say, I can't retire period. but So I think the the dial that you should work with is not whether or not you retire. The dial should be, well, how much are you going to withdraw? Because I'm i'm amazed that um you could have done a 60-year retirement and you would have retired right before the the Great Depression. And I think even a 3.25% withdrawal rate would have survived for 60 years. So it's it's not that you have to
00:24:45
Speaker
set your withdrawal rate to zero, which means not retiring. It just means that you might have to retire with a little bit smaller budget. And um ah so so that's that's one thing to consider. So i I never want to talk people out of retiring. I'll just tell people, well, don't retire with a too generous of a budget. ah The other thing is that um I think that I have been well served with a essentially a hundred percent equity portfolio during accumulation. And um I don't know whether this was just ah dumb luck or um or or skill. It worked out really well for me to take a very aggressive approach to ah to the accumulation phase.
00:25:34
Speaker
but um ah In retirement, you have to be a little bit more cautious. and there might be you know If you are a very high powered fire influencer and you make enough money from your blog and podcasts that you don't even have to withdraw money, yeah then you can keep that 100% equity portfolio. But if you actually take money out of your portfolio to live in retirement, you should not be 100% equities. right so ah so You should have some diversification benefit and you should have
00:26:06
Speaker
somewhere between 20% and 40% diversifying assets and that would be likely bonds. Now, there might be some people that are very heavy into real estate and you know you have a lot of um very good cash flowing real estate assets. We might talk about that, but the the average retiree who wants to be really hands off do this completely ah the financial asset way. ah you cannot get away from diversifying your portfolio a little bit. Because even though 100% equity portfolio obviously has the best average return ah in in terms of return volatility and then also sequence of return risk, that would be a terrible idea. And in the worst possible cases, you would drag your safe withdrawal rate actually below 3%. There would have been some historical cohorts where 100% equity portfolio
00:27:00
Speaker
would have sustained, um, only something like a two, two and three quarter safe withdrawal rates. So don't be too aggressive. Uh, I think it would be good that before retirement you shift into, into a little bit more. uh, diversifying assets. And the nice thing is, and this is the, this is the beauty of what has changed over the last few years is that bond yields are actually no more attractive, right? I wouldn't retire on a hundred percent bond portfolio, but as a diversifying asset, mixing it in a little bit with, uh, with, uh, with an index equity portfolio, I think, uh, it works better now. And, uh, I mean, use that opportunity, uh, because
00:27:43
Speaker
I think the next recession is again going to be something like a demand shock recession where ah inflation is going to go down and and and the Fed will lower interest rates. It's going to be good for bonds. Your stock portfolio is going to fall, but your bond portfolio is going to diversify that and it will actually go up. So ah now is actually a good time to be a little bit in in fixed income. So you talked about some strategies already that not only retirees, but pre-retirees used to mitigate sequence of returns risk. But you also alluded that during your accumulation phase, you were very aggressive and almost 100% stock, if not 100% stock equity, same thing.
00:28:22
Speaker
Do you advocate like a complete mindset shift the minute you retire? Because you just during the accumulate accumulation phase, you're advocating for be very aggressive, 100% stocks or equities. And in your retirement mindset, you said, let's diversify and friday and it's going to be better for you to weather the storms. Right, right. And it doesn't have to be a a ah drop of a hat. ah switch in, in terms of philosophy, it could be some gradual process for maybe the last two to five years during your accumulation phase. You also, you already shift a little bit into bonds. Um, the, the, if, if you are very dead set on retiring at a particular date, right? Because I mean, some people are military and they get to that 20 year deadline.
00:29:18
Speaker
And they say, I want to retire then and not a day later or not a week later. Um, then, um, maybe you, you smooth out that because it's possible that exactly at that date, uh, we're going to, we're going to be another bear mark, right? So it could have been beneficial for you to already shift out a little bit before that. It also matters what tax consequences, right? You don't want to do that shift in a taxable account and sell 30% of your equity assets in a taxable account and move them into bonds and have these huge ah capital gains. So it it takes a little bit of pre-planning, right? How do you shift in into a safer portfolio without um realizing a lot of capital gains all in a taxable account? so
00:30:07
Speaker
It takes a little bit of planning, so don't delay that planning until the very last a minute. Um, but, um, but I, I've, I run some simulations and, and, and looked at, so if, if you have, if you are a little bit flexible and you, you say, well, you know, if I'm going to keep a hundred percent equities until I retire and you know, if it doesn't work out and it takes me a year longer, I'm fine with that. Uh, so you roll out, you roll. I mean, for example, most bear markets are like the bear market we had in 2022, right? So it's, it's down, but it didn't last forever and it recovered relatively quickly. Um, not as quick as the 2021, but, uh, so the, the 2022 was a little bit more like a garden variety, uh, bear market and, um,
00:30:56
Speaker
Now you just retire a year after and you have the flexibility to do that. Maybe then you can keep a hundred percent equities until the day you retire and then you do some ah shifts in the portfolio. But even then maybe I would be, I would be a little bit hesitant to do these big shifts all in one day because you, you just kick yourself afterwards. I said, ah, I could have waited a week longer and ah the equities would have rallied a week longer and the bond market would have been better prices too.
Shifting Investment Strategies in Retirement
00:31:25
Speaker
Um, and so maybe do that also, uh, you do a few percent every month and you do a little bit of a transition to, to, to have this, this regret, uh, risk. And, uh, so you're not overreacting to something, um, and then automate that too. So you take the emotions out, but, uh, yeah, so it definitely, um, that mind shift from accumulation, taking a lot of risks to decumulation. We have to be more cautious that.
00:31:55
Speaker
It's probably something you want to plan for and you you want to do a shift. I mean, there are um people who basically propose target date funds where you shift out of equities over a 20 year horizon. Now I think that is probably not not recommended for early retires because 20 years might be less than your accumulation phase. So you want to have at least. For most of your accumulation phase, you want to be at that. I would say 100% equities. I think target date funds, they they are kept at 90%. There are some ERISA rules that basically keep this fig leaf of, well, we have 10% bonds. We need some diversification. So if somebody complains and sues us, we can show, oh, no, we had a little bit of diversification. um But yeah, so a target date funds, um
00:32:50
Speaker
probably not a good idea for early retirees. You have to, you have to custom fit that more to your, uh, uh, to your personal preferences. And, and then also I think, uh, a lot of target date funds. Um, I, I did some research on, on how target date funds were constructed. Um, they, uh, they are usually calibrated to, uh, through some Monte Carlo simulations and Monte Carlo simulations, there's a little bit of a difference between Monte Carlo and actual market data. It's actually the market often recovers a lot faster than a Monte Carlo simulations. And that's why, uh, target date funds, they have to roll out already 20 years before retirement. Whereas with actual market data, I think you can take a little bit more risks because just because sometimes market overreacts like in 1987, um, the flash crash there.
00:33:42
Speaker
Or 2020, right? That recovered so quickly. that The bear market only lasted for a little over a month and then um within 90 days or so, it was a new all-time highs again. I think it was a little bit more than 60 days, but I think by August of 2020, we had new all-time highs again. so Which is something that you can very well um calibrate and simulate with a Monte Carlo. so i I usually stay away from from target date funds. i think um especially in in the fire community, because our accumulation process is a little bit compressed. um You can probably do better by by managing this yourself, 100% equities. And then towards the end, you roll a little bit out and maybe get to something like a 75, 25, or maybe even 60, 40, because bonds are looking really attractive ah now again. so ah
00:34:37
Speaker
and And then in retirement, um you might actually roll back into equities a little bit again, which is another reason why I don't like target date funds so much because ah target date funds, even in retirement, they keep rolling out of equities, which is the opposite of what you want to do because the one effective way ah to hedge a little bit against sequence of return risk is to shift very slowly back into equities. So that hedges a little bit of the sequence of return risk. And we we can, we can talk about that more in detail later, but that's, uh, that was one, uh, method that I found and I'm not the inventor of that, as other people have written about that too, Michael kids and, and wait file, I think. Um, so it's called the reverse glide path in retirement. Um, and, uh, so, uh, so again, and retirement,
00:35:27
Speaker
That's basically the the very risky time where, well, what if I just got lucky and I rode the wave up and I'm retiring right at the peak of the stock market and then everything falls apart again. So that's that's the time when you want to be a little bit more cautious. And even though I've been aggressive, even I have taken my foot off the gas pedal a little bit um at at my retirement date. And by foot off the gas pedal, you mean you've put more and more, you've allocated a higher percentage of your portfolio to bonds. than next To safe assets bonds. Yeah, that's right.
00:36:05
Speaker
Now, please correct me if I'm wrong. You are a pro and an expert at this and I am not. The Trinity study, I believe at least one of their substudies was the 4% rule was based on a 60-40 portfolio. Was that correct? I think they did ah in 25% steps. So 0, 100, 25, 75, 50, 50, 75, 25, and 100, 0. So this is what the tables look like. And then they said that right around the 50-50 and 75-25 is where you have to basically minimize the risk of failure. The 100-0 gives you better average returns, but also it gives you slightly higher failure risks. And um so so that's that's what I remember from the Trinity study. But there there might be some newer versions of that where they ah they revised some of that. but ah
00:36:59
Speaker
Yeah, so that's that's what I remember is you look at the 4% withdrawal and then you look through the table through the different asset allocations that are at the sweet spot is somewhere between 50-50 and 75-25. And your personal portfolio right now is 75-25? Yes, ah so right around 75-25. And it's not literally in these assets. I have some other assets. I have a portfolio where I have some preferred shares. So preferred shares are hybrid between stocks and bonds. It's not quite as risky. as ah stocks, but it's still a lot riskier than than treasury bonds, but they definitely have some interest ah sensitivity to them. So if interest rates were to go down and crash overnight ah because the Fed takes interest rates out. So then that would be good for the preferred shares. So it I have a portfolio that acts a little bit like a 75, 25 portfolio, even though it's it's and not quite a 75, 25 portfolio.
00:37:57
Speaker
So on your blog early retirement now, I just saw that you posted number 61 in your safe withdrawal rate series. So for somebody who doesn't want to read or write 61 blog articles, Are there rules of thumb that us lay people can use and refer to to help manage our portfolio through these sequence of returns risk? Right, right. So ah very important. So don't read this part one through 61 because it becomes jumpy. And this is the order in which I wrote it.
00:38:39
Speaker
But there is a landing page. So if you go to my blog and at the top menu, there's the SWR series, or you type earlyretirementnow.com forward slash SWR. I think and it has these key sensitive small letters, SWR. You should get to a landing page, right? And the landing page is one blog post where I write about my general philosophy, what I'm doing, what are the different, and it has a little blur on all of the different subtopics, right? It writes something about sequence of return risk. It writes something about, well, could you hedge against sequence of return risk with certain, um,
00:39:23
Speaker
basically asset allocation strategies, where you were you strategically or or tactically change your asset allocation over time. What what are ah ah what are um some some subtopics? How do you mix in real estate or some other alternative assets like gold and commodities? So for each little subtopic, there's a little blurb and a paragraph and with the with a link to that specific blog post. And if you're not
Importance of Tailored Retirement Planning
00:39:54
Speaker
interested in that, you can skip that. But if you read that landing page, you might get some, uh, some additional information. And then also occasionally I write something little bit tongue in cheek. Right. So, uh, the, the, the last one was, is called 10 things the makers of fire don't want you to know.
00:40:14
Speaker
Um, which was, uh, was actually the presentation that I gave at the San Diego campfire. Uh, and, uh, it's of course, it has changed a little bit over the months. Uh, and, uh, but this this is basically the blog post version of that, uh, of that talk. So, so 10 things that people think they know about a fire and, and, and safe withdrawal rates. Um, where, uh, I beg to differ and, um, maybe demystify and and do a little bit of myth buster, uh, work on, on some of these, uh, uh, some of these, uh, generally accepted wisdoms in the fire community. And I did a previous one. I think that is part, uh, 26. Yeah. That is a 10 things the makers of the 4% rule don't want you to know. Uh, there's a similar post with, uh, again, tongue in cheek.
00:41:09
Speaker
ah the The way I got this was ah there was an old um ah money magazine, I think it's called Smart Assets or Smart Money. It was a paper magazine and they had usually a one page ah article on 10 things your real estate broker doesn't want you to know. And then it kind of told you a little bit about the dirty secrets. Uh, of, uh, of one industry is a real estate or insurance business. And so that's what's inspired by that guy. And again, as a tongue cheek, of course, I'm not saying that there's some grand conspiracy theory that the fire bloggers don't want you to know. This is, they probably don't know it themselves either. So, um, and ah so sometimes I have these, uh, these more overarching posts where, uh, you could also start with that, right? So that might be something that you re that you read after the landing page.
00:41:58
Speaker
and and maybe get some more ideas. um but yeah so it was is Because maybe not everybody wants to read everything. and By the way, there's some readers of my blog that have been around since I started my blog and yeah they tell me, yeah I mean, I read everything and I read it in the order it came out. and But of course, if somebody just finds my blog, And shame, shame to you if you if it took you so long to find my blog. No, I'm just kidding. Um, so if you just find my blog, yeah, I mean, it could seem intimidating to see 61 blog posts and, um, would take a long time to dig through that. But so, I mean, yeah, I mean, obviously go to the landing page and then different people with different preferences can, uh, can read different posts. But, uh, I mean, I always say, look,
00:42:46
Speaker
I mean, it took you so long to accumulate assets, right? And now you're retiring 20 years early. So you're giving up 20 years of earnings, right? When is the last time you purchased something 20 times annual earnings, right? For a car, you you buy a new car and it's maybe a quarter to a half annual earnings. And you do a lot of research, right? You buy magazines, you you compare, you go to different dealers and you do some haggling here, hagg maybe some people do this more and impulsively or with the house, right? You buy a house that's maybe three X to five X in some places, maybe eight X annual earnings. And you imagine how much research you do for that. And now you do, you, you're doing 20 X annual earnings. And you said, well, I don't want to read 60 blog was it still going to take me 60 hours or maybe, maybe 30 hours. If you can read maybe one blog post in 30 minutes.
00:43:43
Speaker
You don't want to spend 30 hours to read through my series. I just have to wonder why I can't understand that it's a lot of time commitment to do this research, but it obviously took me a lot of time to write all of that, right? So you can read it in an hour or a half an hour. It took me 20 hours to put that together. Uh, so, uh, yeah, I mean, you're, you're obviously doing something that is quite consequential and quite substantial from a, from a, opportunity cost point of view. It made me want to do some research before you do that. And, uh, so that's, that's some of the feedback I get, right? They say, well, yeah, I was ready to retire. I would have never pulled the plug. If I, if your series has given me the, uh, the, the, uh, confidence to do this. And I also have, so for example, I have a, uh, an Excel sheet that I publish a Google Excel sheet where you can run your own simulations with your own, uh, supplemental.
00:44:42
Speaker
uh, uh, cash flows and your own parameters, uh, the length of the whole rise and, and, um, and then see what, what would have been the the worst case scenarios historically. And yeah, a lot of people tell me, yeah, I mean, because I did this, I could convince my wife, uh, Hey, my portfolio passed the earn test. And so she gave the green light to retire now. And, um, ah or, or vice versa, right. that Sometimes the wife does the, uh, does the financial planning and then the husband was skeptical. And then the the husband came on board after, after he read, um, and, and he looked into the simulation says, yeah, I mean, this is, uh, and by the way, sometimes people also find that their personal withdrawal rate is more than 4%. Right. So not everybody retires, uh, the way some of these.
00:45:33
Speaker
famous influencers, whether somebody retired at age 22 or 28. No, I mean, most actual people retire in their 40s or 50s and they have supplemental flows like company pensions, ah military pensions around the corner. um Once you factor that in, ah you would be crazy to withdraw um um less than 4% today because Well, you withdraw a little bit more than 4%. You might draw down your assets over the first 15 years, but then you get your, uh, uh, your social of security, your military pension. Um, once you factor that in, uh, you might actually raise your safe withdrawal rate to much more than 4%. So some people retired, uh, and, uh, if they had believed the 4% rule, they would still be working. Uh, but they did the the research with, with my tools and.
00:46:27
Speaker
were actually able to retire earlier. So um um my my personal estimate is that it's probably something like an 80-20. 80% of my quote-unquote customers, they retire earlier than than with the 4% rule. But yeah, I mean, there were some some people where I had to say, well, probably you want to be a little bit more cautious because the very young and social security and pensions are very long away, ah probably be a little bit more cautious. But it's it it's it's It pays to do your research, especially considering, you know, you have been you have been ah ah doing this, ah you have been frugal for the last 10 to 15 years and you accumulate assets and don't you want to do the analysis a little bit more carefully and ah not just ah not just retire willy nilly and use some so some off the shelf.
00:47:23
Speaker
4% rule, i I would prefer to do a little bit more custom tailored. So if
Critique of Bucketing Strategies
00:47:28
Speaker
someone has gone through and thoroughly explored their particular sequence of return risk, or at least the idea of sequence return risk in their current portfolio, and use your tools to determine their safe withdrawal rate. And they're still around that 3.8, 4.2 range where they might be that little more cautious scenario, but they still want to retire. And then they do retire. What are some strategies that they can use to help manage sequence returns risk? I know bucketing strategy is one of those that people tend to come across. Can you explain what bucket strategy is, how someone would use it, and whether or not you advocate that strategy? Yeah, I i don't recommend a bucketing strategy.
00:48:08
Speaker
And I've had two blog posts. I think it's number 48 in the series and 55. And, um, the problem with the bucket strategy is that it really sounds like what Rick Ferry described in, in, uh, in his podcast appearance, uh, a few weeks ago on your, on your podcast, it sounds a little bit complex and fancy. And it might actually be almost like a ah um like a behavioral crutch that some people use and then also some financial advisors use because they say, look, you have this cash bucket and you take money just out out of the cash bucket. What you don't realize is that, well, the money that refills the cash bucket comes out of the bonds and what was missing in the bond bucket comes out of the stock bucket.
00:49:01
Speaker
So effectively your assets are coming out of your stock and bond portfolio, which is exactly how I simulate my, uh, my portfolio, uh, withdrawal simulation tool. So, so I'm not saying that a bucket strategy is going to be anything evil and it's not going to blow up your retirement. I'm just saying that a bucket strategy is not going to enhance your retirement. Even though I think some financial planners are using this as a kind of a hook while we're going to manage this for you and um to make it complex enough that you didn't feel like you could do it alone. And um I think there's a little bit of false advertising that a bucket strategy could actually increase your your portfolio success ah in retirement. and and So so i've I've run some simulations and ah I can show you examples where a bucket strategy would have done a little bit better. And I can show you um examples where the bucket strategy actually did a little bit worse. and Nothing catastrophically worse, right? Nothing catastrophically worse where with a 4% rule um with a fixed asset allocation, you would have done just splendid and then with the bucket strategy would have blown it up.
00:50:25
Speaker
ah there's Another thing that people don't quite understand with the bucket strategies, usually what you do is you ah you let the bucket weights go a little bit away from your target weights every once in a while, and then you rebalance it again and ah back to target. And you're not really sweating. you know if you're if you're If you have something like a 70% stock, 25% bond, 5% cash bucket, yeah, if the cash bucket is down to maybe 2%, now you have to replenish it. again Oh, and if the bond bucket goes from 25 to 23, now I have to put money back from the stock bucket into the bond bucket. So the, the, the presenting, the differences are really too small to, to make a huge difference. So what I'm, what I'm trying to ah get to here is that if you consider my approach, right? So imagine somebody plugs into my spreadsheet.
00:51:22
Speaker
75% stocks, twenty or seventy let's do 70% stocks, 25% bonds, 5% cash. And you keep it at that same level for your entire retirement, right? So you rebalance monthly even, it doesn't really matter too much if you do monthly or three months or six months rebalancing, it wouldn't make a huge difference. but So it's it's actually easier to simulate if you if you were to rebalance monthly. It's harder in practice, but it's easier to simulate and it doesn't make too much of a difference. And now somebody runs this bucket strategy where yes, now your equities are down. So instead of selling equities, when they are down, I'm still withdrawing only from, uh, from my, uh, cash bucket and from my bond bucket. Well, but eventually you have to rebalance, right? There's no way around. In fact, at the very least you have to rebalance when you run out of cash and bonds, right? If nothing is left in those buckets, then you have to take it out of stocks.
00:52:17
Speaker
And so the question is, when do you put money back into these into these other buckets? And it's it's not really that obvious that you would do better by now, technically, timing. You're now changing your weights. And this is, for example, you talked to to Rick Ferry about. um What do you think your chances are as a retail investor to technically time stocks versus bonds versus cash? You are not going to be successful at timing the equity risk premium. And um I can tell you this from experience because I was in global tactical asset allocation. That is a very, very complicated process.
00:53:00
Speaker
And as actually with only three assets, stocks, bonds, cash is very complicated. You can maybe get a little bit of traction if um you also have some technical allocation between different stock markets, whether it's US stocks versus Canadian stocks versus German stocks and French stocks. Might get a little bit of traction there, but just timing the stocks versus bonds versus cash is a very complicated process because everybody is trying to do that already. Pension funds, hedge funds, So you as a personal retail investor, you are not going to generate any excess return from timing, stocks versus bonds versus cash. So sometimes it can go in your favor. Sometimes it can go against you. And, um, even if you had a little bit of skill, so imagine you could generate a strategy where you added maybe 1% extra return with this.
00:53:55
Speaker
stock versus bond versus cash. And and that by the way, that would be totally utopian. You're you're not going to get that. But let's let's say very generously, I tell you that you could do that. You're not going to do that with your entire portfolio right i mean you are not going to be you gave today a hundred percent equities and then tomorrow you shifted to a hundred percent bonds and then okay no bonds is no longer good you take a hundred percent bond for you put a hundred percent cash and you jump hundred hundred hundred hundred zero zero zero hundred zero you're not gonna do that right you're gonna do that maybe.
00:54:28
Speaker
With a three to 5% share of your portfolio, right? Where you do, um, well, I'm going to bump into, into these guard rails about ah around my weights. And I might have this maybe 3% or 5% guard rail system where sometimes i I withdraw from cash. Sometimes I withdraw from bonds or or stocks. And you have device, some kind of a system where you can generate a 1% alpha. Doing that, but the 1% alpha is only. Applying to 3% of your portfolio, because that's the one where you where you ah very very actively and tactically time. So that's just going to add 0.03% to your return. So if you can add maybe 0.03% to your safe withdrawal, right? So instead of 3.5%, it's 3.53%. Maybe a little bit more, it depends on how how the safe withdrawal mechanics work there. If you're depleting assets or you're maintaining as
00:55:26
Speaker
But you're not going to take a 3.5% safe withdrawal rate and make it a 4% withdrawal rate, but just doing a little bit of ah timing around your 3% guardrails. And and so so this ah this is really the ah little bit of false advertising that. and i and And by the way, i the the person who is very much in favor of this bucket strategy is Fritz, right? So Fritz from a retirement manifest. Are we good buddies? And so we really like each other and we started blogging around the same time. And you should have him on the show. I think he's a good guy. um but yeah and and And I asked him, okay, so do you generate any alpha with your bucket strategy? And of course he has to. He has to.
00:56:15
Speaker
Admit, he does, he cannot generate alpha with his bucket strategy. And then I said, okay, well, the case closed, right? So if you cannot generate alpha, if you cannot, uh, show me how you outperform a fixed static strategic asset allocation, uh, then, then we're done. I mean, and, but. I think it it might be a good strategy for people trying to tinker a little bit with their portfolio and it might get them from a behavioral, almost psychological a sense to get them over the edge to actually start withdrawing money. Or I'm just taking it out of the cash bucket. Oh, by the way, I'm still selling stocks and put it back into the cash bucket. And ah maybe if that helps you, that's fine. But I have more of the philosophy that I you know i i never
00:57:05
Speaker
Tell my readers, well, you know what, um, you're kind of too dumb to, to know what's going on. And I try to give you a different story and some mental hacks to, to overcome this. I would like to give you the, the unvarnished truth on what, what works and what doesn't work. and And in my view, bucket strategies don't work. Now, what does work, um, for hedging at least a little bit against sequence of return risk would be. Uh, not really a tactical shift from, from stock versus cash versus bonds. It would be what I call a strategic shift over time. Right. So you start with a little bit less aggressive and more conservative, uh, allocation at retirement because that is ground zero. That is the most dangerous time of.
00:57:56
Speaker
Uh, of your, of your entire financial career, by the way. And then you shift back a little bit into stocks. And what that does is, and it's, it's what you call a head, right? And the hedge against sequence risk is sometimes you do better and sometimes you do worse than a static allocation. And, but the times when you do worse would be while you retire while at the market rallies for five more years. right Well, if you now started with too much bonds, yeah, you're missing out a little bit on the upside. Well, but that would have been a retirement where you didn't have to worry about running out of money anyways.
00:58:36
Speaker
Right. So you give up a little bit on the upside, ah but it would work really well if you retired at the peak of the market and it would have been a little bit better at each of the past worst case scenarios. So 1929, 1964, 65, 68, 1972. And it would have helped you there, but again, not, not tremendously, right? I mean, we're talking about maybe you can take up your, a safe withdrawal rate, if the your safe withdrawal rate would have been 3.3% otherwise with a fixed allocation with a glide path, it would have been 3.5%. That's still good, right? It's it's not quite 10%, but I think it's something like 7% increase, 6, 7% increase in your budget, right? 0.2% is actually a 6% increase in your budget. um And so it would have helped you a little bit, but it it can save
00:59:34
Speaker
a a bad retirement date and you so can suddenly take it from a 3.3 to a 4.0% safe withdrawal rate. So right now, and again, I think people have been saying the sky is falling in our economy for years now. I'm probably one of those who think that, but for some reason it's still, we are now at all-time highs or flirting with all-time highs once again. However, there are some economic indicators that hint at some future, some rocky road going coming forward. and and And that's not unreasonable to believe that. Whether you know for sure that's going to happen, we just don't know. But if you're planning for your own retirement, you want to mitigate against that. So let's for academics' sake or entertainment's sake, probably more likely, not actual advice.
01:00:21
Speaker
if someone retires right now and let's say it's at the beginning of a bear market. What are some things that retiree should consider? You've already mentioned that one good starting point is to go 70 30 and then adjust from there as you move forward through your retirement. But there are there other like particular assets that perform better in a down market that can help. And do you advocate for that or do you just want to keep it simple and just go general index 70%, 30% bond fund?
01:00:54
Speaker
Um, yeah. So the, the quote unquote solution that a lot of people proposes, I mean, one would be be flexible, right? So if you have the flexibility to lower your withdrawals, um, yeah, you could probably start with a little bit more initially, and then you take it down. Um, if the market doesn't cooperate, um, the, the problem with that is, and and again, and I've built some tools to study that on my side, people underestimate that.
Exploring Economic Indicators and Market Predictions
01:01:23
Speaker
the length of time that you need to be flexible, right? So sometimes ah people have this wrong impression that you have to be flexible only for as long as the bear market lasts. The problem is once the bear market is over, you're still at very depressed equity e valuations. So sequence of return risk means you're taking money out at depressed valuations. um And the day after the bear market is over,
01:01:53
Speaker
You're still very depressed. In fact, you're more depressed than at the beginning of the bear market. So the the fact that the bear market is over is is not particularly meaningful. for what What is meaningful for is how many how many percent are you below ah what you started with at your at your retirement. And ah portfolio might suffer much longer then than what you believe, right? Because that not only has the market, the market has to recover, but it has to recover ah Also compensate for inflation and also has to compensate for your withdrawals, right? So even though your your portfolio might have might have recovered, the stock market might have recovered, but your portfolio might still be down ah because you took money out. And so that that's it's it's ah flexibility is a solution, but it comes with a bit of a cap, right? um The other strategy obviously is you have to find more returns, right?
01:02:51
Speaker
and That is, that's obviously the Holy Grail. And, um, I don't think that, uh, some people propose something like a small cap value stocks. And I, uh, I know you had, uh, you had, uh, Merryman on the, uh, on the show. So I don't, I personally don't, uh, don't believe that there's actually a pretty good discussion between the two at one of the, uh, Bogleheads conferences where, uh, Rick Ferry. ah does a very good job of taking down that ah that small cap value argument. And I have a blog post too, why I don't believe that small cap values is really a viable ah solution. Even though historically you could point so to some outperformance, small cap stocks had a very good run from the 1920s to about 1982, 84. And after that, there's really no more ah excess return from small cap stocks.
01:03:45
Speaker
And value stocks did well for a little bit longer, but then also the last 15 to 20 years have also spotted and actually underperformed growth stocks. No, no surprise with Nvidia and, uh, and all the tech stocks are doing really well. And, uh, value stocks actually lag behind, especially small cap value stocks. So it's so ah short of a glide path, which is what you can do with just. plain index funds. um they Can you describe GlidePath real quick? so Again, that that reverse GlidePath would be you do, and if you think that you want to have something like a 75, 25 portfolio, maybe overcompensate at retirement date and go to 60-40 in light of
01:04:32
Speaker
you know, recession and bear market might be around the corner. And then ah during retirement, you take that up again, and maybe every month you go up 0.2%, 0.3%, 0.4% and shift back into that. ah do that before You might even go all the way up to 100 zero. That might be ah mathematically, um historically was was very good. Now, I don't know if if most people have ah have an appetite for that. ah So that that's obviously ah That's obviously something to do. um So short of coming up with some kind of ah an alpha strategy and I'm doing some option trading, which is also something that I think not everybody should do ah because that takes some some specialized skills and background.
01:05:20
Speaker
I think for the average retail investor, ah yeah just be a little bit cautious. and I think a lot of lots of people can afford that right because they benefited on the way up from the big run-up in equities. If you now take some chips off the table and you do 60-40, then I think you're you should be pretty well positioned, even if the market takes a downturn and Because definitely, if you look at equity valuations, it's very richly ah valued. So ah the cape ratio is well above 30, I think it's something like 33, 34. I have an adjusted cape ratio.
01:06:04
Speaker
Um, that, uh, that I publish on my blog is actually part of that, uh, of that safe withdrawal rate, uh, um, a spreadsheet to, I update that every day or almost every day. If I, if I get, if I get to my computer every day, I think that's at 29 now. So that's still extremely high. So the adjustments ah take out some of the. the historical inequities and the construction of the Cape um that ah people have pointed out. Yeah, I mean, you can't really compare today's Cape of 34 with a historical Cape of 34 because certain things have changed and i'm I'm not going to get too much into this you know the technical stuff there. It has to do with different corporate taxation and different dividend payout ratios because today's dividend payout ratios are a little bit lower and there's more retained earnings that can grow internally.
01:06:54
Speaker
There are some people who say that we can yeah we can generate a little bit higher CAPE ratios without being too ah too afraid because the the way the CAPE is constructed, we have to make some adjustments to that ah because corporate profits have now more ah growth potential because corporations keep more money internally on their balance sheet and reinvested internally. ah so but But even with these adjustments, we're still extremely high at almost 30%. And it's very expensive. And yeah, I mean, every single last, uh, historical worst case scenario started in exactly the situation that we have right now, right? Like 1929 and, um, it was very high Cape ratio, uh, also of decent interest rates on bonds. So, um, yeah, I think.
01:07:47
Speaker
Take your withdrawal rate down a little bit, target it, tailor it to the historical worst case scenarios, and then maybe do something like, ah maybe don't do 80-20, do something like 70-30 or even 60-40. Because you can probably afford it, right? Because your stock portfolio performed so well over the last few years ah that ah you you just just take some some chips off the table there. I'm going to put you on the spot here. Do you think we're going to have a recession in the next 12 months? I look at a few economic indicators and obviously yield curve inversion historically has been
01:08:30
Speaker
and a very good indicator for a recession and a bear market. And, um, while that yield curve inversion has been going on for so long now that, uh, so it's actually, I think a lot of economists are praying for a recession because that's, that was one of their, their best indicators. It's not the only indicator you would use, but, um, um so, so that is screaming red and a recession. There are a few other indicators. If you look at something like industrial production or the PMI index as a purchasing manager index, and they all kind of sort of hanging on. um Usually what you would see at the onset of a recession is an increase in in unemployment claims that hasn't materialized yet. So I would say that out of the sort of the indicators that I usually look at, ah I wouldn't say that there is an urgent call for a recession anytime soon.
01:09:28
Speaker
Um, the, the yield inversion, um, maybe this is the first time that we have no recession after a yield curve inversion because the, the Fed has a lot of credibility and had did, did a lot of, uh, very fine tuning and, uh, uh, to to basically thread the needle, raise interest rates without causing a recession, which normally in the past, they raised interest rates and then they overdid it and then caused a recession. Maybe this time they did it just right. And because it's true that they stopped raising interest rates when inflation was still quite high and it was high, but coming down. So maybe the Fed ah did did something a little bit
01:10:17
Speaker
more nimble and and intelligent than than what they did in the past. Also, were obviously what helped was ah because of the pandemic and all of these cash help so that that was on the consumer balance sheet, when the recession would have normally happened right in 2022, 2023, when the Fed raised interest rates, The consumer was still extremely healthy. So usually late cycle, the consumer is already a little bit over leveraged and you raise interest rates, you would normally cause a recession. So my personal theory, why the yield curve inversion hasn't caused the reset. Well, for the the real curve inversion doesn't cause a recession, but but the why the yield curve inversion hasn't coincided yet with a subsequent recession is that, yeah, I mean,
01:11:06
Speaker
ah it's ah It's going to slow the economy, but the the economy could afford some slowing because the consumer was still quite solid ah from all of these handouts that that we got in 2020, 2021. And then some other macroeconomic signals, they don't really scream recession either. The only thing that screams recession is is the year cup. But then again, other indicators Uh, in finance, something like, um, uh, a yield spreads, right? So the, the corporate yield spread, uh, that hasn't shot up yet. That's normally what happens ah right around the the recession start. I mean, that's ah obviously something that I would monitor. Uh, if anything changes, I'll probably publish that on my blog, but again, I, I don't quite see the urgent need to call a recession over the next 12 months. It's it's elevated. It's not really screaming.
01:12:03
Speaker
screaming recession yet.
Retirement Strategies During Economic Uncertainty
01:12:05
Speaker
So if you're if I'm about to retire or I think my numbers look pretty darn good, I'm ready. Are you saying I should not be worried right now as long as I take some kind of steps with maybe a 70-30 portfolio to go ahead and retire now, even though there are some indicators out there that indicate that the future economy might be suspect? Right. So, and again, if, if you put me, if you put me in the time machine and you tell me, well, what is the probability that I land in a recession month? I think it's about 13 to 15%, right? Completely unconditionally, right? Or historically, I think 13% of the months we were in a recession, uh, 87% of the time we were not in a recession. We were in an expansion, right?
01:12:49
Speaker
um And then the stock market obviously goes hand in hand. I think every recession in the past has been accompanied by a bear market. And then there were some bear markets that didn't have a recession. 1987 technically was a bear market. 2022 was also a bear market, quite an extended one and deep one, ah we never had a recession. So um so obviously, Completely unconditional, you have already a 13% chance of a recession. So, and then I just told you, ah there is some, it's not screaming a hundred percent recession or 80% recession risk over the next year, but maybe it's a 25 to 30% chance of recession over the next 12 months because it is elevated because of all sorts of factors, ah geopolitical,
01:13:44
Speaker
Right. Um, uncertainty after the election. I don't want to get into that any more than that. I'll just say that, um, it's uncertainty about, uh, federal reserve policy. Might they increase rates some more if inflation doesn't come down on its own? Uh, housing market is a little bit overextended. Could that crash? Um, um, people, maybe some kind of civil unrest because people had it with high rents and, uh, ah high food prices. ah i there some There's some uncertainties. I'm not saying that it's zero. I'm not saying that it's 100%. But i'm I'm saying that completely unconditionally, it's already 13 to 15%. And it is a little bit elevated, so it's more than that. So if you retire today, you potentially retire at the peak of a bit of a bull market, and we have another bear market. I can't tell you how deep the bear market is going to be if we have a recession.
01:14:42
Speaker
In some way, 2022 was was't the bear market that was associated with that yield curve inversion, but there was no economic recession. Maybe this is maybe this is over, and we don't have to worry about the the economic recession anymore. ah But if there's an economic recession, there will be a bear market. It's ah is a 20% or 30% chance that we have one. ah Yeah, question is, do you want to retire and maybe have a 20% to 30% chance of running out of money? right And I always tell this analogy. ah If you go to the airport and to catch a flight, I'm not talking about a connecting flight, but you you go from your home to the airport. Would you be willing to miss your plane with a 20 to 30% chance? Have you, I mean, in the hundred or so times that you took a round trip and fly some more on vacation.
01:15:31
Speaker
Have you missed 20 to 30% of your flights because you you arrived at the airport late? No, you go to the airport and I have never missed a flight. One or two times it was a little bit tight, but I've never missed a flight out of maybe hundreds, hundreds, hundreds, maybe 500 flights or so I've taken in my in my life ah where I was in charge of making it to the end. I'm not not talking about connecting flight. I'm talking about going from my home to the airport or going from my hotel or friend's house or family's house back to the airport and flying back. So out of 500 times, I have missed exactly zero flights because I'm not willing to have a failure rate of 20%. I'm not not even having not even having a 1% failure rate.
01:16:17
Speaker
and So the question is, are you willing to have a 20 to 30% failure rate with your retirement strategy, which is a little bit more substantial, a little bit more money on the line than missing a flight, or maybe they they rebook you and it costs a few hundred dollars. But we're talking about hundreds of thousands of dollars, maybe millions of dollars, if you run out of money after 20 years, what kind of the the damage that I would assign of a failure in my retirement strategy. So yeah, no, I'm i'm not willing to. have a 20% failure in my retirement strategy. And if you, if you hey, if you miss 20% of your flights and you're totally fine, of so ohm I'm just, I'm
01:16:57
Speaker
I don't want to waste any time at the airport. I'm just going to go willy-nilly to the airport. ah maybe Maybe it works for other people, but for me personally, I don't think I want to have a 20% chance of of failure. so yeah i mean you you You might face a a a chance of ah of a bear market coming up. so yeah Yes, you absolutely want to ah tailor your withdrawal strategy to something that looks like maybe the Great Depression or the 1960s. If it works out better than that, you can always raise your ratio withdrawals. i mean as the Most people I know
01:17:36
Speaker
Um, they, it's actually the other way around. They, they have so much money saved and, uh, they have a, they have a two and a half percent withdrawal rate and they ask me, oh, am I safe? Am I safe? I say, of course you're safe. It's actually, most of the time is actually the other way around where people, um, are afraid of a recession and they, now they think they have to take down their safe withdrawal rates from two and a half percent to one and a half percent. And because there's a recession around now, that's, that's kind of crazy. But yeah, I mean, I don't, I don't recommend that somebody say, who has a $600,000 saved. And they say, Oh yeah, I can do a 5% withdrawal rate and, uh, I can live off of 30, $30,000 a year. And, um, uh, I'm just going to make it work. I was just being going to be flexible. Uh, yeah, probably that, that sounds a little bit too scary. That might have something like a 20 or 30% failure rate.
01:18:28
Speaker
And I would not, I would not be comfortable with that. but Most people, you know, you made a lot of money on the way up. Um, and, uh, maybe take down your retirement budget a little bit. You can still retire today with a, with a very, uh, very generous, uh, safe withdrawal rate. And it might be a little bit before below 4%. Uh, that's fine too. Uh, but it's, it's still gonna be awesome in in early retirement. All right, Carson, thank you so much. I would say this, if the first time I think I ever met you, honestly, I don't even remember the very first time I ever met you, but I remember the feeling of like, I think I know this stuff pretty well. And then I either even jump into a conversation that you're having with somebody else or
Final Thoughts and Personal Insights
01:19:12
Speaker
you give a presentation. And I'm thinking this dude is on a whole other level and I'm so glad to know him. Okay. That's good. That's a, that's a good compliment. Yeah. Thank you. Yeah. and Please take it as one. Yeah.
01:19:24
Speaker
People ask me about the secrets of returns are and of course I'm familiar with Trinity study and 4% rule and safe withdrawal rate. However, I don't really get into it that deep with them other than just the very surface level. And I say, if you want to know anything more about safe withdrawal rate and you want to know more because this is your life here, go to Big Earn's website, earlyretirementnow.com. He's got 61 posts on this stuff. And I can't imagine ah the the dinner discussion that you have with your wife on this. I'm sure she's just got to be completely enthralled. But I know she's not a fitting from all of your knowledge and your willingness to put it in place. Yeah. Funny thing is i but with my wife, I i talk about
01:20:08
Speaker
My day, how was the market today? How did your trading go today? We don't really talk about safe withdrawal rates and sequence of return risk. And the nice thing is that, well, we feel safe enough that we don't have to worry about, right? So, I mean, don't worry about money. but Or don't think about money. Don't worry about running out of money. ah That's a great comfort. This is a great luxury that we can talk about a lot of other things. And the kind of financial stuff is usually not that big a topic. But but um but my wife um my wife has a technical background too. She has she has an engineering undergrad degree, so she she appreciates ah anything that has to do with with engineering and math. so i
01:20:56
Speaker
i and And she's a nurse too, so she has both she has two careers, one in nursing and one in engineering. so um and ah But she ah she she appreciates what I do. ah She doesn't ask me every day, hey, how is what's what's your what's your recession risk and what's your sequence of return risk indicator for today? So she she trusts me on that. So it's it's ah it's a great, great luxury that I have. yeah Well, thank you. I'm very, very glad to know you. And I really do appreciate you taking the time on very quick turnaround time. I think I just texted you a couple of days ago. So, hey, do you want to come on? you' like Yeah, let's do it. Yeah. So I'm very grateful and I'm sure our audience will be grateful as well. Thank you very much for chatting with me, Karsten. And thank you all for watching and listening. Thank you.