You read a lot on burnout in Physician land. There was an administrator at my old hospital who had an MBA and went to med school in the Caribbean and got her MD. She didn’t do an internship or a residency and she held no license but she still was used as an in road into the physician community by the hospital. One time there was needed some kind of physician to sign off on some kind of workup in the hospital and I heard her telling her boss the CEO “we’ll just get some physician in the hospital to do it like the Anesthesiologists”, like we were just sitting around on couches waiting to be called to do a H&P on someone. This kind of points out the typical MBA’s perspective as physicians we be grunts. It’s a well known fact most physicians will sell their souls for a free ham sandwich from the drug guy. The MBA’s are jerks but nothing if not masters of manipulation “I’ll give you a quarter to hop on one foot 10x” and so systems develop that are about coercion and doing more with less. Enter the bell curve.
A physicians life is all about this curve. Notice its shape 34% is a big area 13.5% less than half of 34 (40%) of that 2.5% less than 1/10 of 34 and about 1/5 of 13.5. Notice the X axis intervals these are equal. This means for the effort it takes to go from 0 to 1 you get a 34% return. From 1 to 2 a 13.5% return a 200% increase in effort from 0 for 40% more return. 2 to 3 a 300% increase in effort from zero for a mere 10% extra return. It takes a lot of horsepower to get to 300%. This is called diminishing returns. To get into med school you had to walk down the curve and as you descended your effort went up. Then you got into residency and it went up more. Then you became attending and it went up even more. You started getting paid for your effort pretty well but still running at 300% takes it’s toll. The MBA’s would like you to run at 350% so they incentivize you with ham sandwiches and of course you’re a codependent people helping dope and agree to eat the ham. You think the extra effort is linear but in fact it’s Gaussian it is in no way linear. Each of us has his/her natural/mental/physical limit. Each of our families have that as well.
The solution of course is to walk back up the curve, tell the MBA to go pound sand, he’s just a sniveling drunk anyway, and move back toward 200%. How many of our colleagues follow this exact path into perdition and how many retrace back to health, because running at 350% clearly is a distorted way to live.
Another interesting thing happens. If you watch your P’s n Q’s you can save a little along the way and a little turns into enough. At enough your 200% effort might start to look like risk. At some point you’re going to pull the brass ring, so now the question becomes how much risk is too much risk? At some point you realize every day you practice you are adding only a little dab onto your pile (diminishing returns) and that brass ring is looming somewhere out in your future. Pretty soon you decide to hell with it all, enough is enough, time to do something else. You’ve been living a 1 SD lifestyle while making a 2-3 SD wage. You become used to the security a 3 SD wage provides and freak at the idea of living a 1 SD life on 0 wage, substituting your pile for your wage. This again becomes a bell curve problem. One thing to realize you’ve already been living a 1 SD life, so the question really is how much is enough?
Enter the Bell again!
But in this case the numbers start going negative from zero and it becomes a race to understand if portfolio deflation is going to over take all they days of your life. It’s a weird race, the way you win is to die. It too is a Gaussian problem not a linear problem, yet linear solutions are often proposed 4 x25 is essentially a linear solution with a small fudge factor (compounding) built it and a big risk factor (SORR, over deflation and longevity) built in.
Look familiar? For men we are quite likely to die by 99, we’ve been dropping like flies for years. For women however maybe 15% on this chart are still kicking at 99 waiting to die, clearly not a linear problem. Somewhere in this mishmash is parsimony the best result for the least risk. Since planning for yourself necessarily implies planning for your wife, plan accordingly. Marriage, it’s a double bell whammy! At least this fleshes out both problems of burnout and retirement deflation risk in terms more akin to reality. Knowing your enemy is critical to success. Sun Tzu or Napoleon or Julius Caesar or one of them jokers.
Lemme see if I just max out my pre-retirement accounts and invest in low cost index funds……. I CAN QUIT MY JOB AT 30, RIDE MY BIKE, BE JED CLAMPETT AND HANG OUT BY THE CEMENT POND!!! whee doggie It’s shockingly simple, shockingly I tell ya!
The old saw is you can’t beat the market!!! But in fact people do it every day. I bought BTC @ $275 3 years ago and am up 1250%. The old saw is invest in low cost index funds…. Studies have shown low cost index funds beat actively managed funds bla bla bla. True enough but actively managed funds do not constitute the universe. What if you don’t invest in “funds” but invest in stocks? The old saw says: diversity, diversity I tell ya! It’s your savior!
Looks to me like diversity isn’t cutting it. The arrows are pointing into the ground. Notice the YTD return is -0.79%. I was reading an article on the Dobermann’s of the Dow which is a screen of the old Dog’s of the Dow. The dogs theory was a value play on the Dow stock universe. When picking you don’t screen 3800 stocks you screen 30. The 30 are the best run companies in the world. The 30 are adequately diversified and cover all sectors well. The 30 have killer management. The 30 if they flunk get kicked off the team and sent to the hinter land to be replaced by creative destruction. The 30 are analyzed 10 ways to Sunday so there isn’t much in the way of catastrophic surprises. It took GE nearly 20 years to get the boot after Jeff Immelt choked it to death for most of those years. All of this implies much risk management is done for you.
The The Dogs screened share price and yield on the 30 stocks once a year andyou bought the 10 lowest priced highest yielding stocks. I did a calculation once and found over 40% of the Dogs return was based on dividend, only 60% on capital appreciation. It’s a value play because you are buying stocks cheap, buy low sell high. Sometimes cheap stock means out of favor sometimes trouble is brewing and the Dogs screen doesn’t sniff that out.
The Dobermann’s OTOH are screened for Free Cash Flow, as in a river of revenue, and Return on Equity which is a measure of productivity and quality. This gets to some extent to not what is the cheapest stock but what is the best bang for the buck stock of the 30. The choices are winnowed by screening and elimination until 10 remain. You buy those 10 every year, replacing those not still on the list from last years purchase. Not very expensive to own either @ 5 bucks a trade if you turn over all 10 stocks once a year it’s $100 even on a $5M portfolio. So how’s it work out?
510% better than the index over 20 years. It paid off 17 of those 20 years. Not Bad!
I put the issues into the EF calculator at equal percentages
17.56 expected return @ 16.18 risk A lot more return and a little more risk compared to S&P 500! I then decided to look at adding a bond fund. Right now I’m in VBIRX so I added that in a 50 bond/50 stocks AA
It tamed things down considerably. This would be a good portfolio to weather early retirement. It has reasonable return and pretty low risk and is cheap to implement and re-balance. This portfolio is not on the efficient frontier so I let the calculator do it’s work and create a portfolio on the EF
With the same 50/50 bond stock mix, the return is now almost 9% and the risk is virtually the same. The calculator picked only 7 stocks and the bond not 10 and a bond and it adjusted the % of each stock in the portfolio to park me on the EF.
The S&P YTD is down -1.35%
When I did a weighted analysis of the 7 stock 1 bond EF portfolio, it’s YTD return is +4.54%, compared to the venerable S&P 500’s “well diversified” -1.35%. I’m thinking strongly about pulling the trigger on this for a couple hundred K next year and see how it does. It’s 50% in bonds which are safe, and 50% in super well managed stocks which though volatile are also safe. HD MRK and VZ are not going out of business. I have some Roth money just begging for this since I can trade to my delight and incur no penalties. The low risk is what attracts me most given the market turbulence and if Bond yields go up good deal, I’m in short term paper and will see the benefit of that. I can’t see much downside.
Here are asset statistics and correlation statistics
Note the good degree of non correlation between these companies
THIS IS NOT INVESTMENT ADVICE just my latest musings
I notice an underlying theme within the FIRE community about work. What is work, what is retirement? Do you ever stop working? Work is required! Not working is not optional! Is a side gig work? Is a side gig retired? I got real estate! I got a prune farm! At least the guy with the prune farm is regular. It seems the 40 somethings are most flummoxed by this retirement idea. It seems they know they are squandering their productivity and feel guilty about it while steadfastly trying to maintain the delusion. There are all kinds of virtue signaling like “I work (drink coffee) in an animal shelter half day a week” therefore I’m still somehow productive. I quit my highly productive job as an engineer and now I spend my day sending prose into the ether while my wife still slaves away for the man. It’s how we have health care man, plus she likes it! No what she likes is having healthcare while you sit on your ass pumping prose to nowhere. And it’s always some internet straw man that is harassing them about their lack of productivity.
It turns out serotonin is probably not related to depression but related to social status. Serotonin is biochemically what makes you engage in the pecking order and keeps you engaged. It happens when you reinvigorate serotonin by taking a SRI like Prozac the re-engagement in the pecking contest looks like the lifting of depression. Lowered serotonin makes you withdraw from the pecking contest and you just kind of accept your fate somewhere on the social ladder. Some people accept their pecking fates at 20, settle and just attend to living their lives. This is the hard charging 40 somethings dilemma. They want the status of being a pecker but they don’t want the hassle and they don’t like settling and they don’t like the guilt of being the dope in the jammies sending all that really important prose to nowhere regarding the blood sweat and drama of their investment hobby.
I read no less than 3 posts this weekend admonishing sitting on your ass doing nothing complete with YOU SHOULDs! and dumb assed comment like “life doesn’t just end because you’re retired”, all of it directed toward their guilt their life has ended and they are no longer relevant to the world of real productive work, the work that pays the bills, move investment portfolios forward, saves lives, wins valuable prizes. Substitutes like blogging, virtue signaling volunteer nonsense going back to school bla bla bla does not improve the GDP. I think there’s a part also related to the fact FIRE is at some level a con job and the one being conned is the FIRE bug himself.
Here is a typical age 60 retirement the area under the red line is expenditure of human capital to age 70. After 70 you’re pretty well burned out. Age 60 throws away a little of his human capital, the orange part under the red line. He amassed a fortune over his 40 years of work (purple) and will spend 30 years spending his fortune (orange) He saved so well he could afford to retire a little early and throw away some human capital because he had more than enough. The purple area is > than the orange area so his life is not leveraged. He doesn’t care about working anymore. He has the cash and doesn’t need the status or the cost of that status. He has no guilt, and goes fishing 4 days a week, golf on three.
Age 50 is in pretty good shape but he’s playing the odds. His need (green) is bigger than his pile (purple) so he’s going to need growth to survive. He threw away a pretty big chunk of human capital (green area under red line) but bought into the 4 x25 investment club narrative. If he doesn’t crap out he will probably make it. Bad SORR maybe not. At 50 he feels guilty at loosing his status so he writes a blog and keeps repeating the narrative to convince himself everything will be OK. He also buys into a new social order and reinvigorates serotonin since he can now play in a new pecking order. Being in a pecking order feels good so is investing hobby takes on greater import.
Age 40 has a high paying hard charging job so he makes a lot of dough early. He throws away a huge chunk of human capital, so much so he has to twist and turn in the wake of that waste. He is also very leveraged he has a little accumulation triangle (purple) and a big deflation triangle which needs to be filled with money. He is very leveraged but he denies the importance of that. Like prayer beads he repeats 4 x 25 4 x 25 4 x 25 but inside he knows the risk is pretty excessive. He hasn’t figured out all the vagaries of tax consequence and asset allocation and keeps quacking “diversity, I got diversity tell ya!” like that’s going to save him. This guy is so uncomfortable about his plan he is always into gigs to try and reduce the leverage. It’s kind of stupid since if this hard charger had worked another few years he’d be much closer to his age 50 counterpart but he wanted the prestige of being “retired” at 40. It’s hard to eat prestige when you’re 60 and no one cares when you retired.
Age 30 this guys delusional whether he rides his bike or not. No point in analyzing crazy.
So it’s not about work work work. It’s about understanding how you feel about your net worth and social situation and coming to terms with the situation you’ve placed yourself. I’m done with work and don’t need work to realize some serotonin driven pecker drive. I’m old enough society expects me to be retired and I’m wealthy enough to be leverage free. I retired at 58 and again after 65 and have purchased myself maximum freedom to explore or not. Not working and no money concern is a blast. It’s the end game of a plan. Telling me I “need to work” to find fulfillment just points out to me your level of insecurity and lack of insight. Homey already worked, he done with that nonsense. Be honest with yourself and you won’t feel compelled to tell me what I need to do. What you are really saying is what YOU NEED TO DO.
I wasn’t sure how retirement was going to work. It was all based on guesstimate, projection, a wish and a prayer. I pretty well knew what I was spending a month while employed about $13,500/mo and that went to 2 kids in college, funding retirement. the cost of being employed, my wife’s side business and charitable giving. Retirement brought a lot of changes. One kid graduated and launched, the other continues in college, we went through a hurricane and sustained some damage from that, I stopped funding retirement and reduced some charitable giving, and settled into a lower cost life style. After doing some reading I found people do well with 75-80% of their pre-retirement income so I built around $10,000/mo. I could easily “afford” my old number based on all of the calculators so I had some leeway up if necessary.
There were a couple initial expensive months. Months where insurance on 4 cars came due, tuition for my daughters last semester had to be paid, a car for her launching had to be purchased, an escrow for her to get an apartment where she was working needed to be funded, property taxes and home owners insurance, I had to replace 2 air handlers and compressors in my A/C system etc. Much of it I had pre-planned and funded prior to jettisoning the W2. My daughter also spent a semester abroad and my wife and daughter toured 5 cities in Italy last Christmas. Making a plan for the pre-pay was critical. Pre-pay takes some heat off of early SORR risk.
A few months into retirement after all the dust settled, Christmas was over and college was paid for I ran an experiment to see what belt tightening felt like. You always read “we’ll just tighten out belt if the bad times come!” So what the hell does that mean? I was living on less than the $10K I had allotted somewhere around $8K/mo or 20% less than the 25% less I settled on as my “Budgeted amount of $10K. We took it down to about $6400/mo. At this level I needed to start planning payments like car insurance and the travel budget was curtailed. But neither I nor my wife felt particularly constrained we just had to be mindful. This was an important data point for me. At this point my biggest line item was insurances and insurance was a number that could not be contracted, same with taxes. Food had some flexibility as did driving, so I could tell there was a lower limit where “belt tightening” became not only uncomfortable but debilitating.
After a few months of that we loosened up again but never to $10K/mo on the average. Over the past 16 months the average has been a little under $8K/mo even with fairly generous kid related expenses. By operating in the 8K/mo zone If we want to splurge we simply save up the $2K/mo differential between $8K and $10K till we have enough otherwise we just bank that differential. Initially I was very anal about watching the cash flow because I didn’t know what to expect. After a year and a half I do know what to expect and anal-ness has given way to automaticity in that the budget largely runs itself without much need for input. Big expenses now are related to Roth conversion and taxes will dominate the line items for the next several years but all of that is already accounted for. In addition I’m living off cash during conversion so stock market swings are not part of my day to day thinking. After Roth conversion SS commences and I will leave some money in the TIRA as opposed to total conversion to the Roth. This reduces the tax bill while still dramatically streamlining taxes going forward.
It turns out the tax code seems to be written around a RMD on an approximately $600K portfolio. If you have $600K in bonds @ 3% the first RMD is $21K rising to $28K in the 10th year and $31K in the 20th year. If SS generates 42K taxable the first year and grows at 2% inflation it will generate $63k taxable 20 years in the future so the age 90 taxable income is about 94K still in the 12% bracket married filing jointly, and cap gains on money you extract from a taxable account is zero up to $104K and only 15% on dollars over 104K. If you have some tax loss harvested you can write off the TLH against the 15% for zero tax, highly efficient. If you have a $3M TIRA @ 6% it will RMD $109K the first year, $189K the 10th year and 290K the 20th year. Mixed with SS in year #1 your taxable income becomes $151K the first year well into 22%, $241K the 10th year well into 24% and just below where the Medicare surtax kicks in. At this level they charge you triple for medicare parts A & B as well. 20 years in you are paying taxes on $350K into the 32% bracket plus the surtax. Your tax bill is almost $70K/yr. If you die at the same SS level your wife would pay 95K/yr in taxes on $350K of RMD. So you can see taxes are quite progressive and the rich definitely get soaked. Those are some of the moving parts. You can combat much of this bracket creep by Roth converting for a few years prior to RMDto get the TIRA down to about $600K and putting that $600K at least in part as the bond portion of your portfolio.
With this kind of well funded and tax streamlined plan SORR is reduced. By living on cash during Roth conversion the portfolio is pretty closed to SORR and by controlling taxes as well. Roth conversion does constitute some SORR on it’s own but that risk is overcome later in retirement due totax savings. In addition living on cash reduces the AA which is a good thing to combat SORR early in retirement. As cash gets spent down for living and taxes your AA glides back up in aggression automatically also desirable. I figure you already owe those taxes so getting uncle sam out of what little hair you have ASAP is a good thing. I never budgeted formally while saving but I was a diligent saver and investor. Now that I’m retired and deflating my portfolio I find some pretty well defined budget knowledge invaluable. It doesn’t run my show but it gives me a quantitative picture of cash flow.
Bringing it down with the solid soul sound! Gasem does a podcast.
I’m a regular poster on Doc G’s website Doc G has been kind to me and allows me to comment, often extensively, and I comment within what I consider my license. Doc G is a successfully entrepreneurial character something I respect and something I consider uniquely American though not exclusively American. Here regardless of status you can experiment with inputs, time, energy, money, intelligence, drive, risk, and build from that success. Much of FIRE is about formula a kind of cook book set and forget approach to investing. It’s unclear to me if FIRE investing actually works or if it’s mostly hype and projection and hobby. A projection starts out small and by the time it hits the screen it’s big. A projection starts out with crisp fine detail but by the time its big it’s definition is fuzzy. Neither projection nor it’s screen image is real because it’s just a projection. FIRE’s formula purports projection and expects the projection to be considered as in fact reality. So it’s a kind of denial, but still there is information contained in the projection so it is a useful fiction.
Doc G’s approach is to unpack different aspects of his take on the projection compared against his success (which in fact is real and not projection, and he is nothing if not successful). So it gives the reader a contrast from which to judge based in some reality. It’s not so much a cook book as a report on what the recipe produced in his case and tweaks he may have done to the recipe, so his site offers something between experience and dogma, while some sites just preach dogma. Dogma is not truth, the result of following and tweaking dogma is truth.
My bent is to further try and tweak the truth through my experience in achieving a fully functioning retirement which was largely not contrived by bogglehead dogma but by a different path. The dialectic between my experience and his experience therefore hopefully further elucidates the truth and improves the fidelity of the projection so the reader comes away with a bit more clarity from which to make his own judgement and the experience is provided for free, and out of a commitment to forward progress.
Doc G and Paul Thompson started an ambitious endeavor called “What’s up Next” published on the Doc G website in order to explore aspects of FIRE life and FIRE media. The last published cast was on children and retired or semi retired parents and how to approach money with your kids. He invited me and Vagabond MD and Susan from FI ideas. We are prolific “commentators” and his interest was to explore the world and motivation of commenting. It was fast past and quite professionally done. I’m more of a writer than a speaker so it took me somewhere else in this journey. It was good to put face to intellect as I read these commentators quite often but have little else for referents. The podcast functions differently than a blog, it’s more like a discussion at a bar or a dinner table, equals engaged in dialogue. Doc and Paul put a lot into the production and I was quite satisfied with the experience. Keep an eye pealed for What’s up Next!
The usual saw is save 25x spend 4% and Bob’s your Uncle. Nothing of course is said about spending because spending is left to daydreaming. Lounging on the beach, traveling the world hacking credit cards, starting a little bizzy on the side to make pin money, why I can feel the Tahitian breeze and taste the Chipotle Tequila Colada as I write the words.
Then you think about your parents and aunts and uncles and grand parents and great grand parents and realize they are either dead or in some stage of dying, not all at once but eventually they start dropping like flies. Guess what’s going to happen to you kemosabe and it’s going to happen to your wife too. It’s inevitable, just like taxes and it ain’t necessarily cheap. I wrote a post on it here.
Your chance of getting cancer for example is 1/3 and once got, your chance of dying is 1/5. That means 4/5 live, but whats the quality of life and cost of palliative care if any? Your chance of being wiped out financially is 42% and the average expenditure per year is $92K and your odds are the same as your wife’s odds meaning the odds multiply. You could of course draw the royal flush and both become terminal together which would wipe you out twice as quickly. So the Trinity plan was $40K per year with enough leverage to extend your 25x out to 30x or maybe a little more in case the dreaded early SORR come up and bites you on the patootie. You of course are the master of the universe, save half and retire early. You’re leverage balloons since instead of making a mere 5 extra times, you now need to make 25 extra times to cover your extra 25 year extension added onto your original retirement. Why do you think early retirees have all their dough in stocks? Because it’s the only way to make the excessive leverage needed to reach nirvana. They talk a good game about very long averages bla bla bla. No one has the real skinny on a 50 year retirement.
But wait you say I have real estate to which I say good deal. But wait you say I’m a media mogul my blog clears 12K per year to which I say I’m digging that. But the deal is where does the $92K per year cancer money come from? Being sick is expensive and you can’t substitute aspirin for chemo and rads and surgery. Where especially does it come from when what you have is already levered out the wazoo? Who’s paying for your ol’ lady when you used up all the cash? And oh yea the government wants those taxes you deferred NOW. They have a boon dogle to fund or some paper pushers age 50 retirement.
You embarked on the retirement with a plan priced to perfection, and you threw away 25 good earning years in pursuit of leisure. One method to come up with $92K is to save for the eventuality in fact likelihood of this scenario. You do that by completing your retirement portfolio and then embark on creating an insurance portfolio, 2 separate portfolio products. The retirement portfolio product pays for retirement. If you want Tahiti, stash enough in the retirement product to pay for Tahiti. The insurance product is there to pay for the $92K haircut independently from the retirement product. Both products consist of principal and interest. You can fund them serially or in parallel to taste. I won’t go into detail. When the FIRE community got pissed off at ol’ Suze O, this scenario is what she was taking about. Either FIRE or Suze is in denial and I’m not talking about rivers. As for me I have an insurance portfolio carved out of my net worth. It cost me about an extra $1.2M reached by age 70 to satisfy my conception of security. It consists of both principal and interest. It’s wrapped in Roth wrappings and will continue to grow side by side with my retirement portfolio. It will remain unmolested until one of us pulls the brass ring when it will kick into gear. If It grows excessively (praise God) I can drain a little for a retirement rainy day, like the retirement account running out of money. At that point it’s all purpose insurance. I’m not paying an insurance company for my insurance, I’m paying myself. Pound sand Buffet!
I went into Locums practice in 1991 after I got out of the Navy. I’d always been an electronics geek and had built a few computers. In those days it was Z8o chips and then Commodore, and hacks on the motherboard to make the peripherals work. It was a command line interface where you used arcane commands like: COPY D0,”FILE 1″ TO D1,”FILE 2″ to copy a file from disk drive 0 to disk drive 1. Primitive, slow but computing none the less. When we went on the road I realized we needed something better. I needed to log my finances, pay my taxes, create a savings plan. So Gates and CO had purchased a “DOS” product from some guy and set about porting that O/S over to the new IBM PC x86 architecture. I bought a cheap laptop (probably $2000 in those days) out of Computer Shopper likely of Japanese origin . It was a 386 SX16 with 2mb of memory and a 10mb hard drive and a 12″ black and white panel. I put DOS on it and bought a program called MS works which had a word processor and a spreadsheet and a way to navigate the file system without COPY D0,”FILE 1″ TO D1,”FILE 2″. I also bough a disk based tax software called Andrew Tobias TaxCut from MECA software. They also had Managing your Money which was a generic business and aggregating package, a cross between a database and a spreadsheet, all DOS based. TaxCut had a couple dozen IRS forms included and you could log the data into a database which carried forward to next years version. In 1991 TaxCut on a floppy was $90, next year you paid another 90$ to get the latest updates and tax tables, nice subscription kind of business model. The two programs allowed me to easily track expenses, writeoffs, income, net worth which I could use that data which was reliable, and I could to then write my own “what if” spreadsheets using that data in MS Word’s spreadsheet program.
TaxCut eventually was sold to Kiplinger’s and later was acquired and expanded upon by HR Block as their premier software product. Every year I dutifully bought a copy and used it to do my taxes. It dramatically increased my productivity and had error sensing built in with checking against mistakes that could cause IRS to scratch their chins. The program also knows stuff I don’t know and else wise gave me clues where to look for that knowledge. This year I downloaded my 2018 addition to check my Roth conversions. I had to do a little hack on the inputs and do some calculations by hand to make those hack adjustments. When I went to the 8606 form that calculates the % of my IRA money that is taxable and the part that’s already been taxed, I had a nice surprise. I had more already taxed money by about twice than I thought I did. My program remembered and counted some SEP’s I had not counted. The result is I can either pay less taxes or convert a greater amount for the same taxes. Oh woe is me! I’m likely just going to stick with my previous plan and pay less taxes because my goal is to not convert my bonds. By not converting my bonds to Roth and leaving them to RMD my AA will slowly become more aggressive over time as I age which I consider desirable, and it reduces the probability of ever accessing the Roth unless disaster strikes. I can also use RMD to buy hamburgers, and homey likes his burgers.
I do have a clear understanding of what my this year tax picture will be, how much to prepay and how to avoid any penalties even though I’m a 1099-R virgin. The 1099-R has literally 2 dozen+ scenarios and 2 dozen+ modifiers from which to choose and the choice determines how the program acts. Choose wrong and things go GIGO (garbage in garbage out). When all the forms like the 1099-R come through I can erase the hacks and do it live with Bone Fide data. I’m going to pay a little extra since I’m going to do the second tranche of Roth conversion in Jan and I will use the excess therefore have some of my taxes paid early, a good thing to have done if the IRS comes knocking. My estimate over the course of conversion and TIRA RMD is the post tax contribution portion will save me about $50K in taxes until the basis steps up at my death. Thank you TaxCut!! If I would have switched as I was tempted to do many times likely I never would have caught my mistake. Best $90 I ever spent.
I spent quite a bit of time developing a Roth conversion plan. Conversion to effectively modify the bottom line has several moving parts to be optimized. Each aspect in turn has it’s own set of optimizations.
Difference between assets left in a TIRA (bonds v stocks)
Eventual use of Roth in a portfolio + SS (spending model)
Tax treatment diversity
Sequential portfolio diversity (non-Roth v Roth) clean out risk first.
Planning money to live on while Roth converting
Tax loss harvesting
post tax 8606 IRA money
1 When to convert
The problem of when to convert is related to the W2 income. When you are earning any conversion will be added to your ordinary income. If you make for example an AGI of $189K (top of 22%, married filing jointly, under age 65, standard deduction of $24K) it will cost $28,179 in taxes. If you Roth convert 100K the AGI will increase to $289K (well into 24%) and your taxes will be another $24,000 or $52,179. Every additional dollar above $189K gets 24 cents whacked out of it. In the end you spend $24K to get $100K into the Roth. If OTOH you are living off of cash there is no income tax from a W2 source. So you can convert $289K and your tax whack is still $52,179, BUT when it’s done you have $289K sitting in the Roth. You can convert 2.89 times as much money for the same tax dollar. Tax law certainly is “progressive”. Let’s say you want to convert $1M. If you do 4 conversions while W2-ing it you will have made a W-2 of $756K (189×4) over 4 years, 400K net converted and a $208,176 tax bill of which 96K was due to your Roth conversion. Not so efficient. Convert while living on cash and in the same 4 years you will have 1,156,000 net in the Roth and the same $208,176 tax bill. If you converted $250K x 4 years to get your 1M your tax bill would be $386,513 well into 35%. Clearly if you want to minimize taxes, live off cash while doing it.
My analysis of when, is when you are retired and able to live off cash with no other income and you need to be able to live off cash for 4 years plus have the tax money available during conversion, which means pre-plan how to fund the conversion. For the above 4 year example I would go to cash at age 66, 4 years before RMD and commence to converting, to end your conversion at 70. Once you RMD the RMD money is ordinary income and just like a W2 can dramatically raise the cost of conversion but it’s even worse since you won’t have a W2 income to compensate so your portfolio is rapidly deflating. Where you get “living on cash money” will be covered further on down the line.
2 How much to convert
Every dollar you efficiently convert is a dollar that will never be taxed again. If you leave money in a TIRA especially money in equities it will continue to grow and that money once RMD’d will generate a tax bill. If you have 500K in an equity rich TIRA with an 8% return you start at 18K distribution at age 70 and by age 80 you’re distributing 38K. Your SS is 42K + 38K for 80K taxable and a tax bill of 6K well within the 12% bracket limit.
What if you have a 2M TIRA?
Once again you start out slow at about 73K and by age 80 it’s $153K. You left the 12% tax bracket long ago and you are approaching 24% bracket only 10 years into RMD! If SS is say $50K/yr your taxable SS is $42.5K (SS is taxed at .85%) so your net is $195,500, into the 24% bracket. Tax on $195K is $29K. And the tax picture only gets worse from there. So cleaning out the TIRA is a tax saving maneuver. #1 the tax is less so the strain on the portfolio is less and #2 you have to get tax money from some where to pay. The W2 is no longer buffering the assault. If the market is down, you get to sell your shares low to pay the tax man. Bad for SORR. If you had the same situation with a 500K account SS of $42.5K + $38K is an income of 80.5K and a tax bill of $6087 Much easier to come up with!
Let’s say you die at 80 leaving the estate to your spouse. She will loose you’re SS and keep her own, or she will claim survivor benefits. I estimate survivor will pay her maybe 36K/yr or 30K taxable. At 81 the RMD will remain the same or be recalculated depending on the inheritor’s life expectancy, so let’s say it stays on the same schedule. The next payout would be $164K, add 30K SS for 194K The (age 81) tax bill will jump to $39K from 29K from jsut into the 24% bracket to the 32% bracket. Your ol lady is getting hosed! She makes less on SS and pays a lot more in taxes because you died. Cleaning out the TIRA into a Roth does the following: The age 81 RMD is 41K plus the same 30K from SS for 71K for a tax bill of $8.5K just into 22%. So your death in this scenario keeps her 2 tax brackets below the other scenario. Uncle Sam already has his money so he leaves her relatively alone. It only gets worse with a bigger TIRA. By cleaning out the TIRA as much as possible and as efficiently as possible this scenario is avoided.
The other problem with not converting enough is growth in the TIRA post RMD. Let’s say you have 2M and pull out 500K into a Roth leaving 1.5M
At age 80 your RMD is 115K and SS is 42.5K for $157K and a tax bill of about $21K intermediate between a 6K bill from a 500K TIRA RMD and a 29K bill from a 2M TIRA. Cleaning out 500K helps but because the tax is progressive the power of conversion is eroded.
How about the whole shooting match! You convert all 2M at the tip top of the 24% bracket! The tip top is 340K when you include standard deductions, so 2M would be almost 6 years of conversion. The taxes on 340K is 64K for a 6 year conversion cost of 375K. With no RMD your tax bill on 42K SS is about $1700
so to recap
TIRA @ RMD
age 80 RMD
tax in K going forward
total tax paid at conversion
living on cash 4 to 6 yr
conversion to keep
bracket below 24%
Spouse tax hit
The race is between dying and higher tax brackets. The less you convert the higher the future tax bill, BUT the more you convert the higher the conversion tax bill so it’s pay me now or pay me later. You owe the money and it will be taxed at an ever accelerating rate and once you die your spouse is hosed unless you planned for that. Once RMD hits you’re locked in so what you gonna do? Call Gasem! One thing I did not cover are medicare cliffs.
Cliff 1 at 250K (married) a 3.8% surcharge is placed on your income so converting at 340K is even more expensive making a 250K ceiling more attractive
Cliff 2 If you make more they charge you more for medicare
This does not include a supplemental (typically about 150/mo) and it is per person so when you convert 340K and you’re both 65 you pay about 11K per year
What you want is to stay in the 12% bracket for as long as possible and then in the 22% as long as possible. The code is progressive so being middle class is your friend. Soak the rich is alive and well! I was noodling with the RMD calc and if you put only low yielding assets (bonds) in the TIRA the RMD goes down The age 80 RMD @ 3% return on a 2M TIRA is 95K v 153K in a 8% TIRA, and the RMD accelerates more slowly. For 0.5M the RMD at 80 is only 23K Here is a table:
TIRA @ RMD
age 80 RMD 3%
RMD + SS
top of 12% tax bracket
top of 22% tax bracket
I estimate at a 1M IRA you will be well into the 90’s before you leave 22% and at 0.5M in bonds in the TIRA at RMD it will be a couple decades till you leave 12% The outlook improves for your widow as well.
Tax savings if you don’t convert:
tax savings between
100% to 0%
on RMD conversion
If you don’t convert you save those taxes and they can keep compounding BUT the tax code is progressive so more and more will be taxed. The rate of taxation goes up while the rate of return is pretty constant so the tax saving will erode quickly.
3 Account mix
I suggest 4 types Roth, TIRA, and post tax, and a Tax loss harvest account. Your portfolio will develop over decades and there will be occasions to tax loss harvest. Tax loss can be mixed with cap gain for a 0% tax bill. Also as long as you stay in the 12% bracket the cap gain tax is zero and you only pay cap gain on the amount over the 12% limit. If you have tax loss it can be applied to the over amount so a little dab of TLH can save you money if you bother to acquire it. My FA has all of my tax lot info in his software so it makes harvesting effortless, and lucrative.
I used my post tax account mixed with TLH to pay for my Roth conversion. I converted about 600K of post tax stock mixed with TLH for a zero dollar tax bill. I saved about 100K in taxes. The 600K pays for living expense and conversion taxes. It offers another advantage in that it lowers my overall AA during conversion and in my early retirement which offers me some SORR protection. This is recommended. Most people are in accumulation mode but upon retirement you enter deflation mode and need to be ready to spend some money once the W2 disappears. As the cash gets spent the AA will rise again but I’ll be farther into retirement so SORR becomes less important. SS is deferred till age 70 so I have no income. My chosen conversion is 250K per year x 4yrs which avoids most of the cliffs, and will convert net 1M and a gross 1.4M @ 4% when compounded at conversion end. My TIRA will be about 600K all in bonds and at 3% will RMD 22k the first year and 28K at 80. My net tax saving will be about 130K which will stay in the post tax account compounding. I am moving the riskiest assets first, then down the line till only bonds remain. My disbursement model at RMD is SS + RMD plus I will sell some post tax stock as needed. Since I only get taxed on RMD and 85% of SS, my taxes will be low for a long time. Between my TLH and <12% income I will have no cap gains as I disburse post tax money. I won’t touch the Roth and let that grow as insurance in case of medical disaster or as a wealth transfer vehicle. Everybody gonna die from something and some of those causes are very expensive so having money stashed beyond living expense money is a comfort, and not only you but your wife will incur expense. By owning 4 account types I have excellent control over my tax picture going forward. A lot of my “conversion money” is from interest accrued in my post tax account over the decades
4 Account imbalances
You read a lot of boiler plate “fill up the pretax accounts” it may not be the best advice. Those accounts are tax deferred not tax free and their size determines the tax consequences which are progressive and tilted toward soak the rich. I’m sure there is controversy on this but I think equal tax deferred and post tax up to maybe 4M and then over in the post tax above that. A 5M tax deferred is not a trivial liability in the grand scheme IMHO. YMMV but that’s my take.
5 8606 Money
My IRA and my wife’s IRA were funded post tax. I kept all the 8606 sheets. It turns out once taxed that money changes the tax basis for the life of the TIRA. Every year a proportional smaller amount will be taxed than what the RMD requires so if you RMD 25K and you have a 80% basis adjustment you will pay tax on only 20K. My adjusted basis allowed me and my wife to transfer 265K into the Roth with only 245K taxable. I’ll top that up once I have a better picture of for the taxable portion of my ordinary income from my post tax account. All of these little tid bits add up. 265K compounds faster than 250K.
This was all modeled in Excel in modules so could understand the implications of each on the other and get some idea of multivariate optimization. My portfolio and conversion strategy was further modeled in some commercial software designed to advise optimized Roth conversion strategies. My actual modules matched the commercial strategy very well in terms of prediction. My final optimization was different than theirs because they suggested 100% Roth conversion. Over a very long time I agree with their strategy but it takes a while for the conversion to turn cash flow positive, for the tax progressive savings to over come the initial cost of conversion. The initial cost can be initially viewed as a negative SORR. A slightly less aggressive conversion has less SORR character. The cash flow positive point is about the same. My wife is younger than me by 7 years and is genetically predisposed to live a long life, with no real history of cancer, typically age to 90+. My side is dead by 80 from CAD and metabolic syndrome, so some attention to that is built in. My modeling is more extensive than 10 years age 80, but models 5 year aliquots of time with and with out married filing jointly and takes into account progressive tax codes. I also optimized SS but won’t go into that here.
6 Budgetingand cash flow management
I believe in budgeting as a means to judge progress but I’m not a slave to it. I can afford my pre-retirement income, including a risk premium for health care etc aka the bennies I lost with the W2 I’ll call that Max budget. I retired on 80% of my “max budget” as this was described as comfortable to most retirees. After the dust settled I decided to experiment with belt tightening since you read about that as a solution to bad times and I wanted to understand what that actually felt like, not as just some bromide. I could go down 80% of the 80% or 64% of what I can afford. So I oscillate between 64% and 80%. Some months are cheap months, some expensive. If we want something like a trip to EU (been twice since pulling the trigger) I save up the differential between cheap and Max months and when I have the differential we fly. My wife is good with that technique. All in all I came in 11% under my 80% max budget last year. This year looks about the same, a little more expensive but likely inflation related. Inflation is something to consider as it will eat up the slop in the calculation, but I ain’t skaired.
This is pretty much what I did and am doing. I’ve invested for several decades and investment vehicles exist now that did not then so you do what you do in the environment in which you find yourself, and the environment into which you are retiring. If you got a ten year nest egg and a 50 year horizon, that life has a very different risk profile from mine. That life is quite leveraged, my life is not. I can survive quite comfortably at 0% interest for decades, but it gives some insight into my thought process. It is not advice just my experience. It’s complicated and based on probabilities and probabilities are not certain.
I’ve completed my first conversion this year and will convert my second early next year probably Jan and then be done till 2020. I owe the IRS 42K by my estimate and 44K by the HR block Free filer which doesn’t take into account some writeoffs I will claim. The official HR block software won’t be live till Dec so I will get a more precise estimate then, and will owe essentially the same tax again next year, so it’s working predictably and according to plan. I came across a tax penalty rule that says for high earners (>150K) you need to prepay 110% of last years tax to avoid the penalty so I take that to mean if my tax is 42K this year I must pay 46.2K next year to avoid the penalty. Of course I would then apply the extra 4.2K to next years taxes, talk about soak the rich! They’re screwing you 2 years out on money you haven’t made yet! All the more reason to get them out of your hair. I also checked the credit card option to see if I could claim cash back points and with the “convenience fee” it worked out to be a wash between CC and a check.
I’m now officially sick of researching Roth conversion, but quite satisfied in the result.
FIREcalc is not my favorite. It tells you what happened not what will happen, but it does give you some information. There is a portfolio disbursement method called the Bernicke’s Reality Retirement Plan based on a scheme by Ty Bernicke built into FIREcalc. The scheme is to start with a high payout and gradually reduce the payout by 2% or 3% per year to a constant payout in the future.
This is a payout scenario. The retiree is 50. The retirement amount is 3M and SS kicks in at 65. He takes 160K for 5 years (55) then decreases the take so at 76 he is making about 75K per year till he dies. Here is the scatter chart
It get’s pretty close to zero but never flames out for a 100% success looking in the rear view mirror. BUT who wants a >50% paycut when they are 76? You party like it’s 1999 and then ??? eat beans? You get cancer at 77??? Your old lady starts alzin???
Here is 1M @ 6% over 20 years
It grows to 3.2M in a relatively safe 50/50 2 stock account if you don’t tap it. Let’s tap it! At 65 Bernicke is paying maybe 115K and living is getting kind of tight. You;ve seen an income drop of 30%. So 15 years into retirement we’ll tap the million for an extra 40K per year for another 15 years taking you out to age 80.
The million pays you 600K and you still have 1.4M in the bank at age 80. Your take has tailed off from 160K/yr to 75K + 40K or 115K/yr and you’re now 30 years into retirement. You had a blast when you were ER and later after cruising the world for a decade travel has lost it’s luster and you don’t drive much so your car replacement need is diminished etc etc. If you get cancer the $1.4m can pay you the average 92K per year excess medical needs for 30 years and still not run out of money or you and mama can split 30 years of care. This is 1.4M @6% for 30 years at 92K/yr disbursement.
While you’re living large off the Bernicke acct 1M is accumulating and basically gives you a second retirement income when Bernicke starts to pinch.
FIREcalc does not give absolutes on the future and this article does not look at tax consequence or SORR. Instead it looks at a time shifted kind of diversity with different distribution schedules and different compounding and different SORR for each portfolio Bernicke and 1M. For my example you need 4M total at age 50, fat fire for sure, but maybe only 20 years into a typical medical practice it might be doable without need for side gigs post retirement. You can FIREcalc the 1M portfolio separately and get a different worse probably more likely result. but still surviving 85% of the time over 15 years. Like said this is play but intriguing. It was too confusing to try and present those scenario’s
Here is a spread sheet of retirement spending. At 57 spending starts to ramp down until age 66 where the Bernicke retirement has lost 20% (headed to 39% loss) at a $127K payout. At 67 portfolio 2 has grown to an estimated 1.5M (range .9M to 6M) and starts to throw off $40K/yr constant. The tail off starts again but this time winds it’s way down to $138K where it normalizes. Over the 50 year course Port 1 pays out 5.9M and Port 2 pays out 1.3M on a $4M investment. This isn’t a detailed analysis accounting for taxes and SORR etc but a quick FV calculation says Port 2 will have several M at age 99 and FIREcalc says a 1M to 9M range in port 2 at age 99. My numbers differ from FIREcalc’s numbers because FIREcalc does look at historical SORR. These are my calculated numbers not from FIREcalc.
I woke up this morning thinking about diversity, as in non-correlated diversity. There is correlated diversity and a vehicle like the S&P 500 is all about correlated diversity. The stock mix reduces single stock risk down to market risk, but once market risk is achieved there is not much to be gained in Piling more and more issues higher and Deeper (PhD). 20 stocks across 10 sectors is 95% diverse. Adding 980 more stocks only makes you 99% diverse. A nod is as good as a wink to a dead horse. I study the S&P 500 and all year long it’s been troubled. 20% of the stocks were in a bear market, 20% more were under water, meaning 200 of 500 stocks were doing bad the entire year despite the “RAH RAH best economy in history”. Only 40 stocks were responsible for the majority of the gains and especially the FANG plus a couple, at any time. The index has broken down and those 40 are no longer performing and some of the high FANG flyers are now in a bear. How is this diversity when you are relying on 40 stocks to give you gain? The problem is these stocks are highly but not perfectly correlated and so stocks have a general direction when going up and a very tight path when headed into the dirt, like a hand. On the way up stocks look like an open hand each finger pointing in a different direction slightly diversified and slightly reducing risk. On the way down the hand becomes a fist plowing into the ground. The algorithms sell first and ask questions later. Because of the high correlation the in the bad times algorithms erase the “illusion of diversity”.
Here is a picture of GLD (gold line) v S&P500 (blue line) since 2013. The correlation between GLD and S&P 500 is 0.04, and the picture shows that gold is flat while S&P is exploding. This is non-correlated diversity, the kind of diversity that saves you.
This is a longer term picture of S&P v GLD including the 2008 debacle. Looking at GLD from 2005 when the S&P went in the toilet and dropped 50% GLD exploded in value, the typical flight to quality. Again you see the benefit of non-correlation. Stocks went down and then stayed flat for a long time while GLD went way up.
Stocks are property, GLD is property, just as Real Estate is property and Bonds are property. These assets are not money, they however can be converted into money using a market mechanism. The property is worth whatever someone is willing to give you for it at the instant you want or need to sell it. The way you make money is buy the property low sell the property high. The way you loose money is buy property high sell the stuff low. Suppose you retired in 2005 and are living off your assets. What asset would you sell in 2008? You bought GLD low sometime previous 2005 and you bought S&P high sometime previous to 2008. Buy low Sell high, you would sell some GLD (sell high) and keep the stocks or even add to the stocks (buy low). You sell some GLD and have money for hamburgers!! Selling the stocks low would blow up your compounding plan in the long run. If all you own is stocks you’re hosed.
Let’s add some Bonds (BND the teal line) In a 3 asset portfolio BND and S&P has a .05 correlation. GLD and BND has a .44 correlation so BND pretty much does its own thing as the chart shows. BND remains flat while S&P is crashing and GLD is soaring. In the case of a stock crash, BND might be a good source of hamburgers, or maybe a lil’ GLD AND a lil’ BND. You see you now have 2 choices that won’t cream your retirement plan by being forced to sell stocks low. Your GLD doesn’t have to last you forever only long enough to get through the bad time. You can always buy some more from William Devane when the price comes down later. It gives a ready source of value and gets you a year closer to death with your growth motor (stocks) intact.
You say yea but I’m a Real Estate guy!!! So let’s add some REIT
Purple (VNQ) doesn’t impress. It doesn’t grow well but dives into the ground just fine, even more so than stocks and in the same time frame! The correlation between stocks and VNQ is .72 You say I’m a Globalist! I have Global to save my butt! It’s diversity I tell ya! Let’s add VHGEX which is .96 correlated with S&P.
Salmon (VHGEX) looks pretty much like dark blue to me from a diversity perspective. If you gotta sell something you’ll be selling salmon low same as dark blue in a crash. This is the story of non-correlated diversity.
I was thinking about dividends. In a crash dividends at least for a while tend not to change even though the asset value plummets, so dividends may be a source of diversity but I’m not sure how to model that. Many people brag about living on dividends as if that’s safe. Not so sure it’s safe but the diversity may pay you.
Here is a calculator that looks at S&P 500 since Dec 1999. I chose Dec 1999 since it would represent 18 years into a retirement spanning 2 downturns and is familiar since most of us lived it. The average return on the S&P in this 18 yr period is 3.8% (NOT 10%). The reinvested growth is 5.8% The dividend is 2%. When you spend the dividend it is not really different than selling stocks, you just “sell” before you even “buy” (re-invest) The fact the dividend might be considered diversified hurts and helps you. You have a relatively stable stream at least for a while in a crash, but not re-investing means you don’t use that money to “buy low” in a crash.
Here is the inflation adjusted dope:
Inflation adjusted the S&P 500 sans dividends over the past 18 years has only grown 1.6% per year and only 3.5% with dividends reinvested. Dividends therefore were 1.9% inflation adjusted. To me this says dividends pay because of their non-correlation not because they are “safe”. Next time some bogglehead putz tells you it’s stupid to own GLD tell em to go pound sand!