Why Paying Off Your Student Loan Early is Like Buying a BMW.

All you read is how people have paid off their student loans early. They beam with pride at their financial prowess. They write books about it! Dave Ramsey is their god!!! Let’s think about this. You take a student loan for a reason. The reason is to multiply your prospective lifetime income potential. You go to college and you decide to major in biology. You’re not that great at math but OK, and chemistry is hard, and physics fergitaboutit. You come out of college basically qualified to be a bio high school teacher @ 50K/yr or something. Not a bad job, union, benefits, pension after 30 years, you’re 22 that means retirement at 52, summers off. You meet Miss Cathcart who teaches computer coding at the same high school same 50K and terms. You get married and live a great life. Out of that 100K you saved 20K/yr and over 30 years your 60/40 returned 6% on the average and you have 1.6M in the bank and a pension. You retire at 100K/yr the pension pays half and the portfolio pays the other half. You die at 92 40 years in the future having spent 4.2M from your pension/portfolio combination. Your total earnings need for your life therefore (not counting taxes) is 100K x 30 yrs (3M) plus 4.2M or 7.2M. How did you manage such a feat on 100K/yr x 30 yrs? The answer is leverage. Instead of spending money you bought property also known as stocks. The market went up over 30 years and you levered that property a from 20K x 30 yr principal donation (600K) into a 4.2M lifetime bonanza. Such is the power of capitalism and risk (another name for leverage). This future is just how it worked out, it could have gone the other way where a long bad SOR early in the 40 years of retirement and the risk could have eaten part of your 40 year nest egg or killed it altogether.

You have bigger plans. You manage to get into med school with your bio degree signing up for an additional 10 years of schooling, going into debt for 200K . So now you’re 32, 200K in debt but you have a job that pays 300K/yr. 300K however has a lot of extra taxes etc associated (soak the rich) so you really make 225K. During the course of 10 years guy 1 bought a house, has a kid, has been contributing to a college fund. His portfolio is worth 300K and his 15 year house loan is 2/3 paid off.

You have 200K in debt a 225K job no house, no pension, no portfolio, you married a nurse and have a kid but have yet to address college. Dave friggin Ramsey says pay off your loan!! is that wise? Your loan is a known known. It has a term say 10 years, and a payment schedule in 10 years depending on the interest you will pay back 200K plus some interest say 50K for a total of 250K and the payback over each year may be 25K/yr. What is that 25K? It’s the cost of doing business. It’s the cost you pay for multiplying your ability to make 200K/yr instead of 50K per year, but you also lost 10 years of portfolio growth and pension and college funding. What does paying off your debt 5 years early buy you? You will pay a little less interest, you will be 5 years older. You still will not have really started saving enough to catch up with guy 1 or pay for college. You bought too much house, too much car, ’cause you’re a doctor. At 37 can you catch up? At 15 years in guy 1 is just shy of 500K in the portfolio. You now start saving aggressively but you have to aggressively fund college and fund that big damn house as well. If you invest 65K/ yr for 15 years you will almost catch up to guy 1’s portfolio so you are now 52. Wait a minute guy 1 has a pension! That means you need not 1.6M but 3.2M at age 52 to have enough to generate 4.2M you need till you die. Pony up 130K/yr to get even

Instead of putting all your money in the known known of a student loan you would have been far wiser to expose that money you spent paying down the loan early to the long term risk necessary to support you to age 92. The loan is a strictly defined nuisance in terms of your life long risk and any extra money you put into paying that off early is money you do NOT put toward a potential 60 years of growth you could have had. But it’s not even a nuisance since it is the tool you used to buy your way into your career. You would be the first one to criticize someone for buying a depreciating asset like a BMW but a loan is just a depreciating fixed term liability wasting too much assets on that is just as dumb as buying a BMW. OH but I saved 20K in interest!! At 32 you have 60 years left and at 37 you have 55 years left that 20K you “saved” could have become 659K in 60 years instead it became 493K without those extra 5 years of growth. That 20K and the “good feeling” of not being in debt you bought with it at age 32 cost you 150K over the course. Notice what occurred, what drove you. It was a feeling and a narrative somebody sold you. You hate debt!!! you say self righteously! Debt doesn’t hate you, neither dose it love you. It’s a tool. A known known. Something you can completely plan for and optimize relative to the other features of your financial life. It’s leverage, a force multiplier.

When I retired Obama was president and Clinton was running. The government had a program to take out some money from house equity, and as a Navy vet I could extract some big dough from my equity and put it in the market. You had to do it while you had a W2 happening. I considered it and decided against because the economy was doing less than 2%. Too much risk. The economy was a wreck, like a one lung COPDer with cor pulmonale and a peg leg. That guy ain’t climbing any stairs despite what CNN says. The pathology is too obvious to ignore. The program expired and so did my W2. Trump won, I shoulda!


I recently read a post by a so called FIRE investing hot shot. I’m growing increasingly disillusioned with FIRE narratives. In the post a reader asked a question about how to invest something like $100K sitting in the bank in cash. The blogger went into this long explanation about dollar cost averaging over 3 to 6 months, bla, bla, bla! Lets think about that advice in the face of what we actually own when we own a retirement portfolio. The misunderstanding comes from the mistaken belief stock portfolios compound interest. THEY DO NOT! Bond portfolios can be setup to compound interest and there is a class of bonds called zero coupon bonds that automatically do this. You buy a zero coup at a discount and some number of years later the bond pays you what you would have had, had you reinvested the coupon yearly for that number of years. Interest compounding means you take a principle and multiply it by the interest (the coupon) and add that back to the principle so the next year both the principal AND interest get a new dab of interest. This is the actual “magic of compounding”. In fact the magic of compounding is what lead Leonhard Euler to discover the number e. e is an irrational number and is the base of the natural logarithmic system like 10 is the base of the base 10 logarithmic system. If you’ve seen a log equation using the notation ln() instead of log(), ln refers to the log base e. It turns out if you have compounding going on you can divide the interest payment into periods, once a year, twice a year, quarterly etc, and it turns out because of the interest being added back to the principal the more often you add interest the better the investment. Euler studied what happens to the magic if the interest is taken to the limit of continuous compounding. That limit turns out to be a number called e and is about 2.718. You might call e MAX MAGIC! Note in tax law interest is taxed as ordinary income which tends to define it’s asset class. Interest is not converted to cash IT IS CASH. Compounding therefore is not a variable, it is a constant and best compounding is defined by the number e. The money you make compounding is strictly defined by the length of time, the interest rate and the period of payment back into the principal. Interest is covered by 4th grade math. There is a bond market where you can buy and sell bonds but it’s the 4th grade math that sets the value of one bond compared to another, so the bond market is secondary. If you hold a bond to maturity it will pay you exactly what the contract specifies (assuming the bonding agency is still solvent) This is why bonds tend to be lower risk because you own a contract to pay you cash, and your risk is related to failure not variability. Good bonds low risk of failure, bad bonds high risk. Good bonds tend to pay low interest because the risk is small, junk must pay high interest because the risk is high. In addition you get paid a premium for how long your willing to tie up the money. There is more but these features are what is salient.

Stocks on the other hand are not cash, not cash at all. Stocks are property, and a stock’s return is entirely variable and set by a market action. Let’s buy some IBM! We see IBM is $100/share and we decide to buy 1000 shares and pony up $100K. We now own some property! The very next day IBM pays a dividend, enough to purchase another 100 shares because we checked the box “reinvest dividends” so we now own 1100 shares of IBM and on this day after the dust settles IBM goes up to $105 and our 100K investment is worth 115,500 wow! Notice we had something like compounding occur in that the company paid out some money and reinvested that for us by buying more property but the company determined what was paid out, if and when. There was no contractual payout like with a bond. The payout is a variable. In addition the value of our property was set by the market response to the divided. People decided IBM property this week was worth 5 bux more compared to last week, so that entire improvement in value was due to variables and not constant as defined by a contract. This makes owning IBM risky, volatile and variable. The next month IBM gets a 10B lawsuit and the stock drops to $90 You still own 1100 shares but the value is now 99K and you’re under water! HOW CAN THIS SEQUENCE REPRESENT COMPOUNDING? In fact it does not represent compounding. Instead of a linear predictable return, the “return” is all over the map or shall we say all over the risk reward plane. IBM is 2 dimensional, it has a risk and a reward and the risk and reward are set by market speculation and business activity.

This is the key understanding that is missing in the FIRE narrative. What you do when you buy a stock is place some money at risk and hope to God for some return. Underlying that return is the economy, the company and things like rule of law, and a stable currency, and a stable capitalistic society and you make a judgement the reward will be worth the risk. This is why people freeze when investing and why someone ends up with 100K in cash in a bank account. Notice in the above example you were 15K ahead an 1K down in a week, The next month the lawsuit is dismissed and IBM over the next 4 months rises to a steady 136, same 1100 shares of property your 100K is now 150K. Wait a minute your hamburger account is empty and you need some beef! So you sell 10 shares for $1360 and you buy half a steer and freeze it! You now own 1090 shares of IBM up 90 shares from the original 1000 shares, you got a meat locker full of hamburgers, break out the charcoal! 1090 shares are worth 148,240

Note what paid you here. It was not compounding or cash, it was risk. In an equity portfolio you d on’t make the return until you take the risk. In 6 months in this example you were up 50K! Suppose you dollar cost averaged at 20K per month You’d buy 20K of IBM month 1 for 200 shares and get an additional 20 shares from the dividend you own 220 shares and have 22K in stock value and 80K in cash. The next month the stock is 90 and your 20K buys 222 shares so you have 442 shares and the value is 39,780 plus you have 60K in the bank IBM is stable at 136 for the next 3 months of purchase and you buy an additional 441 shares over those 3 months for a total of 883 shares. Month 6 the meat locker is empty and you need to buy some burgers for $1360 bux that’s 10 shares. So at the end of 6 months you have a full meat locker and 873 shares worth 118,728

Wait a minute isn’t dollar cost averaging supposed to pay you??? The FIRE hotshot told me so!!! You only get paid for taking risk. Taking risk is known as buying IBM. If your dough is sitting around in the bank it’s not at risk so you ain’t getting paid! You spent 6 months playing with yourself, pretending to be “smart” because some swinging weenie told you so! When is dollar cost averaging smart? When you invest every month! The whole point is to get the dough at risk ASAP and not sit around accumulating money in the bank. Once you decide on your risk like a 60/40 market risk of 62% just put the damn money in the market at 60/40 ASAP. If you don’t understand these relationships COLD you don’t understand jack. If you’re wasting your time worrying about saving 2bp on your portfolio cost YOU DON’T UNDERSTAND JACK. Sure the sequence could have been written to give the dollar cost average a better outcome but that misses the point that it’s the risk that pays you. Over decades in a rising economy the little piddling around with dollar cost averaging a wad is a waste of time. In a falling economy like Japan post 1990 you’re hosed whether you dollar cost average or not because one of those variables is “the economy” and if the economy is busted DCA doesn’t matter a whit.

If you understand this post you understand 90% of sequence of return risk. Bonds are not correlated with stocks which means even if they don’t make much money, they don’t loose money so they are a ready way to shuttle money into and out of stocks. That’s what the AA sets, the risk and the 2 funds allows for cycling between buy low and sell high. Stocks high? sell a little and stash in bonds do that for a few years since in our economy stocks are down <20% of the time. When stocks crash you re-balance some of that sold high stock money you stored in bonds back into stocks when they are cheap. If you have extra money you add according to the AA and you would buy relatively more bonds when stocks are high with the extra money to also be used to buy stocks when they go low. That’s the juice dollar cost averaging buys you. Recall interest was taxed as ordinary income stocks are taxed as property using capital gains two very different tax treatments for two very different investment classes. If you’re analyzing your stock portfolio by using what is effectively a bond interest calculator you ain’t playing with a full deck. The other thing this post shows is the danger of thinking living off dividends is “safe” Dividends I think provide some diversity but only if reinvested, which then puts that money back at risk by buying more property. Siphoning off the dividend is like siphoning off the risk in an unpredictable way. You want some hamburgers sell some of the portfolio according to the AA if the market is down you will sell more bonds than stocks if up more stocks than bonds. You are always buying low and selling high anyway. This is where my last post really comes into play. If you have a separate small low risk portfolio when stocks go low you can sell from the other portfolio.

It Works

This is the average return for the S&P 500 over the past 20 years and its SOR. It includes 5 down years including the dot com bust, the 2008 recession and 2018. I adjusted the returns by using the % risk of a less risky portfolio namely a 60/40 portfolio. A 60/40 portfolio would expect to be 59% as risky as a 100% S&P portfolio, so I adjusted the returns such that the 1998 28.58% return became an expected 17% in the 60/40 and then generated a SOR for the 20 years risk adjusted. I also took the tangent portfolio which is a 16/84 portfolio and risk adjusted that list of returns. I then generated what each portfolio would return if you started with 1M total and subtracted 4.5%/ yr in both the static 60/40 and low risk/high risk portfolios. This portfolio has a bad early SOR of 3 years in years 3,4,and 5, the dot com bust years. Over 20 years the 1M portfolio delivered 945K total return into my bank account.

I then generated 2 portfolios one with $135K (3 years WR) and generated returns for 20 years in a 16/84 portfolio (low risk). In down years I subtracted the 4.5% WR from the low risk account, and subtracted nothing from the high risk account. In up years I subtracted the 4.5% from the high risk account. The high risk 60/40 account started with 865,000 and the low risk 135,000 for the same 1M start. I extracted the same $945,000 from each account over 20 years. At the end starting with 1M the 60/40 account had generated a total 1,772,226. The dynamic low/high account generated 1,793,801 or an additional 21,500. The low risk account flamed out in 2008. It provided funding for the entire dot com bust plus some for the 2008 recession before all the money was exhausted. The improved rate of return is small but positive and it’s effectively free money generated by the improved non correlated diversity and the efficiency of the tangent portfolio. Note these low/high risk portfolios both reside on the efficient frontier. If you were to compare to a BH3 for example you would generate more free money in the low/high portfolio. It’s not harder than re-balancing a 60/40 to apply the trading rules. It does exactly the opposite of what the “bucket method” does to a portfolio. I might fool with this a little more to see how a higher risk portfolio say 80/20 or 90/10 performs against a low/high with a similar high risk portion.

Vent your Spleen

The question arose what about disinterested spouses and the DIY portfolio. Here is a quick 15 years of projected retirement starting at age 70, married and single

The assumptions are a WR inflation adjusted to 120K/yr. A TIRA of 600K with a return of 4%. A married net SS income of 44K/yr or a single SS income of 35K/yr. Residence in FL. The taxes are for married filing jointly or single. I did not include cap gains on the portfolio since that is not easily predictable but absolutely needs to be considered. This portfolio is for WR only. It is the portion of a greater net worth that provides yearly income. It consists of SS income as described both non taxed gross inflation adjusted and inflation adjusted taxable, it includes the projected TIRA annuity payout, It includes the amount needed to be taken from a portfolio like a post tax portfolio which makes up the difference between need and the annuities of TIRA and SS. I only did the taxes for the first 5 years so a trend can be established, You can use the chart to compare circumstances. For example, you can easily see how a single gets hosed in taxes. You can easily see how a single needs to stress the portfolio more since the SS is less and the taxes are more. For example at age 75 for the same total 132490 WR, a married has 48580 of SS money available and need only tap the portfolio for 57600. A married pays only 4539 in taxes. A 75 yo single would make only 38643 in SS and need to tap the portfolio for 67537 and the single’s tax bill would be 5962. So you have to pull another 12K out of savings to live the same 132K lifestyle as a single as your married counterpart. If your non TIRA nest egg is 1,500,000, the single is pulling out 4.9% from the nest egg when you count taxes, while the married is pulling out only 4.1%.

This is the kind of granularity you need to survive in retirement and it’s only a part of the story. You also have to worry about health care inflation. It works a bit opposite for health care. If there are 2 of you twice as much medicare payment will be extracted monthly from your SS and twice as much supplemental insurance cost. With this kind of personalized chart you can ask and answer questions like what happens to the old lady’s income when the old man dies at 75? What happens when RMD forces us into a new tax bracket? How does going from married to single affect the tax bracket? What happens if we get a cap gains bill after the tax loss harvest runs out? If there are 2 of you different income cliffs exist where if you make too much money they charge you double or triple for Medicare. There are all kinds of progressive soak the rich fees built into retirement by the government which are hidden from simple minded formulaic predictions. It gets even more complicated tax wise if you happen to have made a post tax contribution to a IRA or SEP and you better have the supporting docs so you can make the calculation. I get about a 6% tax break each year because I saved the paper work. 6% compounded over a couple decades ain’t chicken feed. I’m doing a dance with how we take SS. My wife is younger and as of this year I am filing her as retired. She will take SS at her age 62 for 80% of her FRA income. I will take spousal. So for example if her FRA is 1000/mo her SS will be 800 at 62 and I get 50% of that or 400 for a net 1200/mo payment. My SS will continue to grow till 70 @ 8%/yr. At age 70 she will continue and I will take about 43K/yr for a net 52,600 in SS between us of which only 44710 is taxable. If I RMD 25K/yr at age 70 my portfolio need is only 42,400. I will get a 6% tax break on my 25K RMD and a 15% tax break on our SS plus I will pocket several years of 1200/mo from my wife taking early plus my spousal. At my death she will claim survivor which will pay her about 3500/mo or more depending on inflation. In the end this scheme will generate 150K extra money if I live a normal life span because of the SS growth and it’s subsequent easing on my portfolio need. 150K free money pays for an extra year of retirement by the time you work through the doe see doe. More SS = less from the portfolio = safer WR and better immunity from SOR. This should result in a larger portfolio at the time of my death which translates into safer WR and better SOR immunity for my wife as well.

If you listen to the shuckers who claim “easy math” or reading those same damn 10 bullet points month after month you get what you pay for. I don’t seem how you do this kind of analysis using 4th grade fractions. Also you can now see the utility of doing a low risk high risk portfolio in the WR aspect of your money. In my portfolio I have WR money and disaster money and I consider them separately in my NW. WR money comes from an open portfolio made from SS, TIRA and post tax brokerage and disaster money is closed in a Roth. The open portfolio is liable to SOR the closed is not since nothing is being extracted from it. It is in this kind of SOR sensitive open portfolio that 2 tiers of risk should shine. More to follow.

Splenic Portfolio Theory

The spleen is an organ that sits below left diaphragm in the abdomen. It’s generally thought of as an organ that filters bacteria and old blood cells. You can live without a spleen but you live better with one. Not only does it filter but it stores considerable blood, and it’s contractile. In the case of shock, a spleen through contraction can auto-transfuse it’s stored blood into the general circulation improving blood pressure and oxygen carrying capacity, just in the nick of time. Of course massive hemorrhage can overwhelm the spleens storage ability, but in terms of the so called golden hour where shock turns from a reversible phenomena to terminal that extra auto transfusion can make the difference.

I’ve written a good deal about my theory of a large portfolio risked at around 60/40 or 70/30 and a smaller portfolio risked as the tangent portfolio on the efficient frontier. I’ve written extensively about the risk and inefficiency involved in portfolios off the efficient frontier. The inefficiency is described using Monte Carlo analysis as an increasing portfolio failure rate and a failure rate that starts sooner into retirement. In my reading it appears poor SOR in the first 1/3 to 1/2 of retirement dominates the sequence and available funds in late retirement. The classic graph from the homepage of FIREcalc is:

This graph is of 3 identical 750K retirements, red starting in 1973, blue starting in 1974, and green starting in 1975.

This is GDP growth during 73-75 and the red line is average GDP from 1947-2009. GPD growth therefore were contracting by as much as -7.5% since normal is around +3.5%. This is the bad Juju of SOR. This chart describes 9 quarters of bad SOR Q2-73 to Q2-75, which is consistent with the red 1973 portfolio above, 6 quarters of bad SOR consistent with the 1974 portfolio’s outcome, and 2 quarters of bad SOR consistent with the 1975 portfolios outcome. A 30 year portfolio consists of 120 quarters so only a tiny fraction i.e. 9/120 quarters or 7.5% of a 30 year retirement was sufficient to run the ’73 portfolio out of money in just 20 years. ’74 survived 30 years but ended at half of it’s initial value, and ’75 thrived despite some bad SOR to start to close at more than double it’s starting value. To be fair the withdrawal load on these portfolios was 35K/yr or 4.6% so a smaller withdrawal could have lead to ’73’s survival as well. But what if you had a financial spleen? Could a reservoir of efficiently stored dough auto-transfused at the right time make a difference?

An alternative to a smaller WR would be to hold 3 years of WR in a differently risked portfolio, namely a efficient frontier tangent portfolio. So in this case for the 750K portfolio, 105K would be stashed in a 20/80 tangent portfolio and the remaining 645K left in a riskier say 60/40 or 70/30 portfolio that also rides on the efficient frontier. The idea would be in times that are good to remove money from the $645K portfolio and when times were bad to remove money from the $105K portfolio. To do this effectively you need to know when to pull the money from which account. A 35K withdrawal on a 645K portfolio constitutes a 5.4% WR so in years where you make greater than 5.4% take your money from the higher risk portfolio. In years when you make less take your money from the splenic portfolio.

In a 50% market downturn you would loose half your money if 100% in stocks. You would loose 33% if in a 60/40. You would loose 14% in a 20/80 since it’s mostly bonds.

The rule is to sell high, and in a crash the portfolio with the 14% drop is the high portfolio so sell from that portfolio. In normal times the 60/40 would be high and you would sell from that portfolio. The result of this is each portfolio has a chance to automatically donate at the proper time and recover in the proper time, according to it’s relative value. In the case of a crash the high risk portfolio is closed and re-balanced and no money extracted. Money is extracted from the low risk. In the case of good times money is extracted from high risk and low risk is allowed to grow unmolested. The expected rate of return on a 20/80 is 6.8% which isn’t chicken feed. The expected return on the 60/40 is 9.17% So a small percent of your money (14%) is growing at 6.8% and a large percent (86%) is growing at 9.17%, but in the down turn the portfolio with the larger risk suffers the worse insult and can least afford liquidation and is protected from the ravages of bad SOR. The protection isn’t perfect and given a long enough drain in bad times the low risk fund will run out of money, but it’s in bad times early in retirement that you you want the protection. It’s less necessary as time goes on. If you don’t use the smaller portfolio once it begins to accumulate interest over inflation, you can start to dollar cost averaging the excess from the low risk to the higher risk. If low risk runs out of money early do not refill it, as it served it’s purpose to protect the high risk portfolio. As retirement proceeds you begin to move out of the period of portfolio failure due to bad SOR, say year 10 – 15 in a 30 year retirement. As long as the low risk portfolio insurance exists you can start to glide up your total asset allocation by say 1%/yr as you re-balance every year with the added excess and dollar cost average from the low risk fund.

This technique solves the issue with the usual bucket theory problems where the cash bucket is constantly draining money from the riskier buckets. Instead you are using a buy low sell high strategy. It also solves the problem of a bucket of cash which returns virtually nothing. The low risk portfolio is in fact risked most efficiently and though returns aren’t stellar they are quite consistent because their risk is low, adding their own value to the portfolio in terms of stability. The other thing I like about this is it mechanically forces you to buy low and sell high. In the case of a crash by not selling low in the riskier portfolio you are effectively buying low relatively speaking. You sell high and buy low when you re-balance from the bond money you have been stashing from selling high on the way up. That excess money sold high is then reconverted to cheap stocks when they are at the best value. If the low risk portfolio is transfusing it’s excess gains into the higher risk portfolio it is another form of buying low. This portfolio is cutting it to the bone with a 4.6 WR. The S&P 500 has only returned 5.5% on the average over the past 19 years. I would feel much better about a 4% WR or a little less but none the less this takes advantage of a kind of risk shifting over time to protect at least to some extent against SORR. Add a little SS to the mix and you’re golden. I don’t think I would get hyper anal about precisely a 5.4% return as the trigger but in a year like last year where the market was down 5% that a net of 10% below where you need to be and I’d think about pulling the trigger. I haven’t done an in depth analysis especially on when to pull the trigger so I won’t recommend this but I wanted to get it in the archive while I had it in mind.

Is it Diversity or Mirage?

I’m always getting into pissing contests over foreign investment. It just points out how much of bogglehead land is steeped in mythology and dogma. Foreign investment is best characterized by the BH3 the three fund that holds 20% bonds 30% foreign and 50% US. The argument goes somehow owning foreign pays you compared to not owning foreign. Somehow owning foreign improves your “diversity”. If that’s the case there should be metrics to support that. Let’s consider Japan. Japan is a well run economy the 3rd largest in the world.

Here is the Niekki 225 dting back to 1970

And here is a S&P 500 chart dating back to 1950 but including a similar period as above

In the 80’s foreign was the hot topic, especially Japan. You threw some money at Japan and it threw more money back at you, multiples of more money. It was almost as good as buying AMZN in 1997. Then came 1990 and the party was over. Japan deflated. It’s now 30 years later and Japan is still deflated. In my opinion the loss is permanent, at least for anybody relying on Japan to pay them in retirement. If you retired in 1990 with 50% of your dough in Japan and a 4% so called “SAFE” WR you ran out of money decades ago. The contrast is the USA. It’s trajectory is up at a greater rate than 4%. Over 30 years the S&P has grown at 10+% per year and 4% even with a bad SOR is overcome by the monster 10% return. This is the reason 4% is “Safe”. This and no other reason. The reason the S&P grows like that is because US productivity rages at about 4% long term and productivity is the furnace that keeps the balloon inflated. There is nothing inherent in our economy that guarantees 4% productivity. In may respects it’s because we lucked out historically and benefited immensely from creative destruction.

I once owned stock in a Russian mining company. Big company with big profits and superb growth. I was so pleased with that ownership, I dutifully checked it every day. Mining is a big deal in Russia. Russia for example is the second producer of gold in the world along with things like cobalt nickel copper iron etc. One day Putin indited the oligarch prez/major shareholder of this mining company. In addition Putin suggested taxes be placed on this company I owned! The stock plummeted. Without it’s head and with the threat of monster taxes the stock deflated like the Nikkei. Putin was short the stock. I had a Russian partner in my practice and he filled me in on the reality. Being short means you sell high and then buy low at a later date and pocket the difference same as with profit on a long trade. By arresting the head of the company and threatening taxes Putin pocketed billions. As well, he then owned the stock, bought low, and owning the stock was equivalent to owning the gold mines that constituted the property of that company. Just because the stock price fell didn’t change the worth of the underlying property. Putin has a plan to put the world back on the gold standard, and remove the US as the reserve currency. If you make gold the reserve and you own all the gold, you do the math.

This is why foreign is problematic. We live in a bath where the water temp is always fine and sustaining, and we stupidly presume the water elsewhere is equally as pristine so we “diversify” in our doe eyed stupidity.

Here is a graph of the BH3 Efficient Frontier plane with the BH3 described by the point Provided Porfolio.

The global fund is WAY low and right with a piddly 7% return and near 18% risk

Here is US Stocks 11.3% return at 15% risk. 4+% better return with 3% less risk.

Here is the BH3 R/R

8.9% at 12% risk

Here is a Efficient Frontier 2 fund with a 12% risk AND 10.11% return. 1.2% better return for the same risk. If you do the math that 1.2% advantage of the 2 fund over 30 years is a 38% improvement in end portfolio value compared to the BH3. 38% is a lot of money to pay just to wear the badge “diversity”.

Don’t even get me started on the BH4 fund! The BH4 adds TIPS to the BH3 mix. It’s long term return is 6.57% at 12.3% risk MORE RISK LESS RETURN!. Just goes to show you can make a bad thing even worse no problemo.

Take away:

  • Deflation is a real thing
  • Foreign is quite open to manipulation and permanent losses
  • Rule of law matters
  • Productivity and protection of productivity is paramount
  • Diversity does not mean “just own everything” and you’ll be safe. It means own the right things and do the right things and you’ll be safer. The right things are easily discernible.


If you retired in 1988 and died in 2018 This would have been your S&P 500 SOR. Bold is negative returns. Only 6 years in the last 30 were down years! In a 1988 retirement you didn’t experience a bad SOR till 12 years into retirement, just one small loss near the beginning. The average 30 yr reinvested return was 10.012% Not bad!

Here is a retirement in 1998 now 20 years old. It’s average return is 5.86% and 5 down years. Notice the negative SOR is bunched up early.

Here is a 19 year retirement beginning Dec 1999. it’s average return is 5.09% and 5 down years.

And here is a 18 year old retirement with a 5.735 return and 5 down years.

Notice how the worst return starts the year BEFORE for bad SORR. 1999 the year before the dot com bust was the worst year in the past 30 years to retire. The next year (2000) the year of the actual bust was better.

Get ready FIRE crowd!

This is a 2008 retirement!

This 10 years yielded a whopping 13.654% annual return and 2 down years.

One year later only 11.967% return, and only 1 down year.

The thing to note NONE of these includes withdrawal of any money, It’s just what would have happened to the portfolio had you filled up the portfolio on the so called year of retirement and let it ride adding no more money, nor subtracting money. Look at the variability WRT to when retirement started and when the bad SOR started in the sequence. It makes a huge difference in income and portfolio viability. Also it points out the red herring of the FIRE movement which came of age during good SOR. It’s hard not to become a Johnny come lately millionaire if you’re making 13%.

I read a recent article on Bucket portfolios by Swedroe, extremely interesting. The paper contains a discussion of techniques to prolong portfolio longevity based on AA optimization in the face of SOR. You have to drill down to the PDF files cited to get the full discussion. The upshot is the bucket portfolio destroys end of life portfolio value based on it’s constant withdrawal of higher risk assets into a risk free asset which earns virtually nothing. A risk free asset is also a return free asset or may even loose some money due to inflation. What the study found on the average the optimum portfolio is a 60/40 portfolio. It beats the bucket because it is properly risked. It also shows people running 80/20 portfolio are suboptimal. It discusses the creation of a metric that looks at half the SD, the downward pushing half, which is the half that drives you into failure. It’s more complicated than I want to write about but I agree with the concept. I’ve been brewing a scheme for a couple years that combats SOR early in retirement. It allows re-sequencing the higher risk portfolio (say the 60/40 portfolio which seems to be optimal) to a more favorable sequence by providing a respite to 60/40 withdrawal from a fund different fund that is the efficient frontier tangent fund. The EF tangent is the balance point of risk and reward, the point where your reward costs the least risk. It has a bit more risk that risk free but also has the propensity to grow. The tangent portfolio of a S&P 500/Short term treasury fund is 20/80 with an expected 6% return. So if you put $500K in a tangent $400K is risk free and 100K is risked optimally. If the market drops 50% the next year (which we saw was worst case). Your tangent would drop $50K in the stocks leaving $450K available, only a 10% dent. You would start living off tangent money and leave the 60/40 closed to withdrawal except for re-balancing. If you go 2 years with no bad SOR the tangent will grow to 561K. Extract 61K and use it to add to the 60/40 by withdrawing less and re-balance the tangent. In other words for the third year of retirement at 100K/yr withdrawal pull 61K out of the tangent and 39K from the 60/40. This effectively donates 61K to the portfolio and you are 3 years into retirement. Do the same at 5 years except donate 100K to the portfolio by removing no money from the 60/40 that year and 100K from the tangent. Re-balance everything. You are now 6 years into retirement. If bad times come close the 60/40 and live off the tangent. If not continue to dollar cost average into the 60/40 by modulating the wealth transfer from the tangent into the 60/40. Since the hit from a SOR is most deadly early you need SOR re-sequence insurance early. As time goes on the portfolio becomes less susceptible to SOR. Eventually the tangent WILL run out of money which means it did its job. There is no need to refill the tangent since the tangent’s job is to refuel your portfolio not act as a drag as in the bucket method. In this case the tangent acts as a supercharger by limiting SORR.

I haven’t worked out the details so the money injections into the 60/40 are my guesstimates and not quantitative. I did do some preliminary work on AA and portfolio SOR risk and it turns out There is a definite danger in excess risk if you draw a bad SOR. On about the 20% SOR line a 80/20 portfolio does much worse and fails much more often than a 50/50 or a 20/80 for the same WR using a total stock/total bond portfolio.

Lotta stuff to think about in this post. In the end low WR big, nest egg and a couple pool’s of variable risk and a plan is a good thing. Early retirement in the context of unusually high rate of return (good SOR) regression to the mean plenty of threads to pull on

Emergency Money

There are all kinds of schemes to have some money on hand just in case in retirement. They range from 5 years of cash on hand to “just use credit cards and leave the emergency money invested. I think in retirement the “just use credit cards” ploy is stupid. When you have a W2 it’s might be an OK plan. Enjoining leverage at 19% is the last thing I would want to do in an emergency, penny wise pound foolish. You incur the full market risk of your portfolio and add a 19% loan on top. But then a big wad of cash is a slow drag on your net worth because of inflation. $1000 @ -2% is worth $800 in 10 years. So whats a mother to do? How about employ the efficient frontier? The tangent portfolio on efficient frontier is the portfolio that provided the most return for the least risk.

This is the efficient frontier of total US stocks v short term treasury. It has an expected return of 7.11% over a 40 year period with only a 3.97% risk. Why would you choose this for your safe emergency money? Most FIRE types are way over risked. They’re all running 80/20 portfolios. In an 80/20 portfolio if stocks drop in half that 80% goes to 40% and you go from rich to poor as you are down to 60% of what you were. In a 20/80 portfolio if the stock market drops 50% you go down 10% and therefore are at 90% of your previous glory. Numerically say you have $500K in a rainy day fund $400K in short term treasury and $100K in total stocks. If the market drops in half like in 2008, you have $400K in treasuries and $50K in stocks, barely a dent. The value of your emergency is effectively maintained.

Let’s say you don’t use your emergency money for 10 years.

Your emergency money grows to close to 1M on the average. Yea but what about inflation you say.

Even with lousy 10% SOR you’re still money ahead inflation adjusted. Just from inflation you would expect your $500K to be worth $400K if you were in cash. This analysis assumes re-balancing to keep the fund at 20/80. If you recall the 1973 recession it looked something like this:

You’ve all seen this picture, it’s from FIREcalc. This is the SOR if you retired in 1973 (red), 1974 (blue) or 1975 (green). In a 73 retirement you were out of money in 20 years. In a 75 retirement you were worth double. 2 years mattered. If you had the emergency fund you could easily live off the emergency fund for 2 (or 5) years while the market recovered effectively indexing your retirement from a 1973 loser to a 1975 winner. Can’t do that with a credit card. It turns out in my analysis you would only need to use this money once to save your portfolio. The graph also informs you a bad SOR still lasted 20 years, one year of indexing to a 74 retirement lasted all 30 but lost some and a 2 year indexing lasted all 30 and doubled, so the risk is early and takes a while to manifest but the manifestation is relentless. 10 years into your retirement you can probably begin small withdrawals from your “emergency money” to supplement your income if you don’t need it to save your bacon, and still keep a nice pot around “just in case”.

I was alive and kicking in 73 and my first year of investing was 75. I remember it. Retired people were freaked out. People talk a big game about their risk tolerance. I’ve lived through and remember 1960, 65, 73, 80, 87, 93, 2000 and so on and so on. One thing is for sure if you whip it out someone is going to cut it off. A little cash in an emergency fund tangent portfolio is just the ticket against the castration of too much bravado.

It’s All Speculation Don’t Kid Yourself

Everybody has a strategy. Some people call themselves investors and look down their noses at at people they call “speculators”. Speculators look down their noses at commodities traders like those ex-football jokers on CNBC with the pony tails. Those guys look down their noses at the Vegas card counters they call gamblers. My favorite lottery game is going out of business. It’s a game that has 3M:1 odds so for 3 bux you have a million to one shot. I usually spend 2 bux because the real odds are nearly zero and as the game progresses without a winner the excess the prize money of the lower payout more likely wins grows. This week I’m playing 4 chances for free on winnings from previously won payouts so my odds are 750K to 1, still effectively zero. The next higher up odds are lotto at 22M:1 but I haven’t bought into that so my risk tolerance is somewhere between 1M:1 and 22M:1.

My wife looked into scratch-off games and found web sites devoted to scratch-off strategies devoted to changing the odds. These strategies are quite similar to card counting and betting strategies used in Vegas. I didn’t know anything about them till she mentioned them to me. She was considering to get my kids some scratch-offs for stocking stuffers at Christmas and decided to teach herself about scratch-offs. In the end she didn’t buy any because if one kid won $100 and the other kid didn’t win the non winner would feel gypped and who needs that headache. My wife is smart. I would have just bought the tix and stuffed ’em in the sox next to the Christmas tree snickers. The correct trick would be to buy each kid a an entire roll of scratch-offs since each roll is pretty much guaranteed to have winners, and the fun is in being a winner but then the kids might have to go to gamblers anon if they had too much fun.

Doesn’t this narrative sound like a FIRE narrative? The investor considers himself quite wise investing only in blue chip stocks like wait for it: GE and SHLD better known as General Electric and Sears. Remember Blockbuster? Replaced by something that looks like a red industrial refrigerator and Netflix. Bet you’re glad you don’t own any Blockbuster! What about AAPL? People have made a fetish about owning iPhones and AAPL reaped the profits hitting $227 last Aug but $150 today in a roaring raging bull economy where a $1000 for a phone shouldn’t phase anybody, should it? Don’t look at me I’m running a five year old $200 Google 5x. When they quit updating the software I’ll move on up the line to something new/er that continues updating.

The point being what exactly do you own as you look down your nose? Do you own hype? AAPL is hype, GE making a come back is hype, winning the lotto is hype. They are stories we tell ourselves in which to encase our denial and shield ourselves from our stupidity. 4% x25 hmmmm low cost index funds is the BEST PORTFOLIO hmmmm You can’t beat the market hmmmm Can you clap with one hand? It’s all speculation. How much of your future have you based on hype? What’s the likelihood your portfolio will become a blockbuster, a Blockbuster or a GE? Bitcoin? Only a dope would invest in BTC but then I’m up 1300% in BTC with a free trade. I have no equity remaining in my BTC only profit. I took out the equity when I was up 5000% and put that into BRK.B which has gone up 30% since I bought it in 2016.

The first thing they tell you is thew “low cost mutual fund rap”, that’s the hook. The next they tell you is to pick your risk tolerance like you have a friggin clue what your “risk tolerance” is. (I’ve established my risk tolerance it’s between 1M:1 and 22M:1). You don’t want to look like a chump so you pick 80/20 OUT OF THIN AIR. They ask you how much do you need in retirement? You wan’t to look upper middle class so you pick $100K OUT OF THIN AIR and they go: OK daddyo here’s the deal save up 2.5M take out 4% and you can live forever on that dough! Have a nice day! They point you to a calculator that looks at periods of history of adjustable lengths and it query’s the history about failure. The first period starts in 1871, 6 years after the Civil war ended and only 2 years after they drove the golden spike. Only 10 years after the demise of the Pony freakin Express! You mean I’m supposed to base my projected income need for my 2036 projected death on 1871 economic conditions??? That’s supposed to make me feel warm and fuzzy and confident? I just looked in the mirror and do not have MORON tatted on my forehead. What’s tatted on your forehead? A screed by MMM or 10 bullet points by WCI? Famous WCI quote “it’s 20% content and 80% marketing”, iPhone “it’s 20% phone and 80% marketing”. Like the title says it’s all speculation don’t kid yourself. If you look in investopedia they define speculation and investing in terms of longevity and risk. A good assessment. If you base your 50 year retirement need on a highly speculative stock portfolio are you pretending you short term bet is a long term winner? The variables are amount, longevity, reward, risk, sequence of return, budget, taxes. All of these are quantifiable and none of them get picked out of thin air. None of them should rely on economic data analysis leading back to the era of the pony express. It’s always good to consider and re-consider the assumptions and then track the plan as it plays out.

Addendum: I didn’t win but found another game to play with the same kind of trickle down payout strategy. The odds of the grand prize is 1:300K, over all odds of wining something 1:7, In this game I’m looking at using a number choice strategy of most likely distributions as opposed to quick picks. I’ll limit myself to $100/yr and see what happens.

Sir Francis Galton, Blaise Pascal and Where You End Up in Life

There was a mathematical genius that lived in 19th century Victorian England named Galton. There was a triangle invented by Paschal a 17th century French mathematical genius. The work of these two don’t define reality but it completely informs reality. Paschal invented his famous triangle:

You can read about the magic of Paschal’s Triangle here

It turns out the first reference was by the Chinese in the early 14th century and was used as a calculating machine. Francis Galton invented a means to animate Paschal’s triangle  It’s worth watching the progress of the balls as they settle from the collection bin into the distribution. The distribution of course is the famous Gaussian distribution described by mathematicians and gamblers Gauss and Adrain in the 19th century but hinted to by Galileo in the 16th century. Galileo noticed errors were distributed. Small errors more likely than large errors which then leads one to ask what is error accumulation and how does error accumulation effect things? The answer of course is the effect can be massive or indiscernible since errors can be of either sign and can add or cancel. This is the concept of sequence of return risk from the 16th century.

David Byrne et. al. put it this way:

And you may find yourself 
Living in a shotgun shack
And you may find yourself 
In another part of the world
And you may find yourself 
Behind the wheel of a large automobile
And you may find yourself in a beautiful house
With a beautiful wife
And you may ask yourself, well
How did I get here?

Where you end up is a function of a normal distribution of millions of decisions.

Notice that one lone ball way out in the right tail. How the hell did he get there and what is the probability? (the answer is 2^14) This assumes the board is level and gravity is acting equally on each ball and there is a 50/50 probability of a ball bouncing left or right at any given peg. Tilt the board the odds change. Here is the story of how you got there. This is how life works in a probabilistic universe, and you can use that to qualify your risk and effect where you end up. If you constantly make rightward choices you end up in right bins. Left choices, left bins. This example belies the silliness of the expression “you can’t beat the market so invest in low cost mutual index funds” . What that statement defines is the 50% bin. Clearly A LOT of balls beat the 50% bin. So the next time you hear someone quacking that party line tell ’em “you’re a clueless dumb ass” because they are. The way you end up on the left of the 50% bin is to make leftward choices. The next time you hear someone quacking about 4% x25 understand it depends. In a 50/50 portfolio counting from the left that puts you in bin 6 or so (98% chance of success). 80/20 moves you to bin 7 from the left. 99/1 gets you to maybe bin 8. Yes you can beat the market but the market can also beat the hell out of you by rightward decisions instead of leftward decisions. People do this all the time, claim you can’t beat the market and then proceed to try and beat the market by using real estate or by taking monstrous equity risk in their portfolio. People sit around with cash in the bank which they intend to invest but just can’t bring themselves to invest “waiting for a pull back”. This is called market timing and market timing can be a leftward decision, except you have to know when an event leans left which implies you need rules for trading that force leftward decisions. An example of leftward market timing is re-balancing to a predetermined portfolio risk level every so often. The mechanical nature of re-balancing forces leftward decisions. Sitting around waiting for a pull back merely means your portfolio is not risked correctly and money you intend to put at risk to procure some profit is not doing the job, a decidedly rightward decision cloaked in a leftward delusion. Lets say you choose to “MAX OUT YOUR PRETAX accounts” ever hear that one? Is that a leftward or rightward decision? How did you get here? You let the days go by. What that means is you wind up with a huge pretax pile some of which is owned by the government and at age 70 is wholly controlled by the government. RMD is progressive and taxes are progressive so the government by law is going to take a (progressive)^2 tax bite. Here is what happen in a (progressive)^2 scenario:

The red line is the ever evolving tax bite eaten by the government in retirement. The black line is money already taxed. Over time black beats red. Betting red was a rightward decision, black a leftward decision. It just took some time to manifest itself, yet people quack that nonsense all day long. A better tactic (and the leftward decision) is some of each and to optimize that ratio along the way. To understand that you need to understand what each account will be used for in funding retirement and the rules of taxation for each account going in and coming out, so you can make leftward decisions. Do not just let the days go by or it will be the same as it ever was.

I took a little break from the blog to live my life. I bought some Udemy courses on various topics on black Friday for $10 each, topics heavy into computer programming, micro controller programming, excel programming and a few others. Udemy is a little better choice than Youtube since you can correspond with the lecturer. I also completed my CME to keep my medical license active and I’ve been doing stuff in the yard since it’s FL and 70 degrees outside. It’s a great time to make some vitamin D in FL. I’ve really started to whittle down my blog involvement especially other blogs since the information contained is often useless if not actually wrong. Some sites are so agenda and marketing driven as to be unreadable. Some sites conflate ideas into a miss mash of gobbledygook and then dole it out in “10 Bullet Points of Nonsense”. If if the adage is “it’s 20% content and 80% marketing”, that’s another way of saying “you can rely on 80% of what I say to be BS!” Who needs it? I started working on an outline for a non Bogglehead approach along the above lines of processing probabilities in making financial plans. We’ll see where that goes. May be worth while may be a piece of junk.