How to Survive Demographics

In the last post Existential Doc posed the question what to do? I went through how I would analyze it but a more formal presentation might be useful.

What would happen to survivability if the stock market dropped in half permanently? How does AA affect this? Lets start with the good old bogglehead triple fund. The triple is a 80% stocks 20% bonds fund of US stocks Global stocks and total bonds and if you used it as your retirement portfolio for 30 years and a 4% WR the probabilities would look like this:

82% survival for 30 years. I’m going to treat this as an 80/20 portfolio socks to bonds. Let’s say stocks fall in half. A 1M portfolio now becomes 200K in bonds and 400K in stocks so the portfolio is worth 600K and the AA is 67/34. Lets monte carlo that 67/34 portfolio using the same ratios and WR on the 600K principal

43% survive at 40K/yr WR. If you knock the WR down to 28K we are at 82% survival once again. So to survive a 50% equity hair cut using an 80/20 bogglehead at equal levels of survival and a 1M start you’re 40K/yr WR must drop to 28K/yr or a 30% cut. That’s almost 2500/mo. What about a 60/40 Stocks v bonds at 4% WR and 30 year horizon?

Just by changing the AA to 60 /40 and getting rid of foreign survivability goes to 96%. What happens if we loose 50% of the equities? on a 1M portfolio the bonds are 400K and the stocks are 300K, so you immediately start with an extra 100K in the bank compared to the BH3 example. The AA of that 700K is 43/57 stocks v bonds so lets MC that sucker 700K, 40K WR and a 43/57 AA

so a 40K WR on 700K drops survival to 70% What if we re-balance back to 60/40?

74% It helps a little, so let’s keep 60/40 and try reducing WR to 30K/yr

We see a 94% success at 30K/yr nearly the same as the original 96%.

So what does all this mean? It’s how you plan. What do you do if you loose 1/3 of your money? What do you do before you loose your money? We saw what happened to a typical 80/20 portfolio not on the efficient frontier. WE saw what happened to a safer 60/40 portfolio on the efficient frontier, and we saw the survival rates. To get the bogglehead 3 to 92% survival required dropping the WR from 40K/yr to 19K/yr after the disastrous loss.

The other thing that matters is when SS kicks in. If you are close to SS when the disaster hits you are largely immunized. If you are far away from SS because you retired early…

Demographics

I’ve been watching youtube video and have discovered Raul Pal and Real Vision Finance (Also). He is talking about in a clearer way my concerns. In my opinion he is right on. We are heading into deflation, not growth, not recession. Recession is about the business cycle. It’s a temporary downturn that later reverts to an upturn. In America we expect the down turn 30% of the time and the upturn 70% of the time. As long as that happens we grow. Growth has been spurred by consumption. The FIRE movement turns its nose up at consumption, as if “those people” are lepers the Jones keeper uppers. It’s the Jones keeper uppers that support the business cycle so when you are turning up your nose at these folks you are turning up your nose at economic growth and economic growth is how you expect to pay for your hamburgers in retirement. The Jones are the golden goose.

The boomers are retiring and one thing happens when boomers retire consumption plummets. The reason unemployment is low is boomers are quitting more than the economy is booming. It is the reason we ave low unemployment AND low inflation. People leaving the workforce explains that. People own a ton of equities. Equities are directly tied to consumption, and equities have been leveraged by corporations buying back shares using debt. There is a corporate debt bomb out there of greater impact than the 2008 consumer debt bomb. so expect a huge crash aka a huge reversion to the mean as the leverage gets un-levered. What this means if the market is riding 90% above the mean, when it reverts literally 45% of the dough especially equity dough is going away permanently. You can expect a 45% permanent (or possibly decades long) hair cut on your portfolio. With permanently curtailed consumption the motor that drives growth will no longer pull the train. It’s happened in both Europe and Japan. If it happens here China is also hosed.

I retired normally at 65, so I have less time to live, and I have a pretty large portfolio and a small WR of under 2%. If my assets permanently fall in half my WR only goes to 4% and I have only about 20 years for my portfolio’s survival. I have further reduced my equity risk into other non correlated assets like gold bonds and cash and some BTC so my exposure to the leverage in equities is muted. Imagine if you are 45, heavily invested in equities and retired and have a 45 year horizon and only half the money and still have kids to send through school, or not because no one will be able to afford it. Imagine you’re sitting on a 1M property or a 1M apartment building and can only rent for 1/3 of the break even or sell for 250K. That’s what could happen with permanent deflation. People will dump their homes and move into cars and trailers. This happened in 2008. Excess leverage will eat your lunch. The problem with deflation is it’s near impossible to re-ignite inflation aka growth. This is a graph of the Nikkei, Once 45,000 now hovers around 10,000

Watch this video and consider deeply the consequences. If you are FI, are you still FI with a 50% hair cut? If you are FIRE can you survive twice the time on half the money? I find this guys argument entirely credible.

Toward a Unified Perspective on Retirement

I’ve been spending some time looking at retirement sites written by people who dream about retiring. There are many ways to get there some more effective than others. Investment vehicles and techniques have changed over time. The Motley Fools are a media organization started by a couple brothers and not that much different from financial blogs today

Back in the 90’s the funds they touted were not index funds. Portfolios were sets of managed funds often that addressed specific sectors like tech based or hot fund managers who were thought to be the golden children of investing. By the time you paid the fees and the loads and transaction costs it was damn hard to make any money. But you could make money publishing “articles” touting fund runners magic powers. It was a common theme in those days and was often driven by advertising. The Fools are all about the media and media sales. They are also into systems like versions of Dogs of the Dow all of this is about “beating the market”.

As a professional stock picker you can beat the market but you have to be a lot closer to the information than some source like the Fools can provide. If you’re not a professional speculator, it’s very unlikely you can beat the market because your competition is deadly. smart and exquisitely informed. The point being buying Fools books and systems is unlikely to make you rich, it just makes them rich.

The boggleehad approach has some advantages. It forces you to right size your life in a way that discourages debt and living in or close to the edge of debt. As a high wage earner living toward the mean gives you the ability to reliably invest excess money every month. The investment vehicle of the bogglehead approach are index funds. The system is designed to pay off over a long time as long as the market over decades continues to go up. Companies in America are well managed and we have good rule of law, a stable currency and some control over inflation so the likelihood of going up more than going down is good, so the likelihood of index funds paying off is good. Your investing return is not dependent on you, it is dependent on the people in the C suites of the corporations making the correct decisions. You are basically along for the ride.

Your return will be AT BEST the market return and If you don’t do it right AT WORST you won’t do very well or may loose money. So what do you need to do? First create a plan based on index funds, the simplest being a US total bond fund and a US total stock fund. The 2 fund approach puts your portfolio on the line of the most efficient portfolios, returning the most return for the least risk. Adding more funds unless done correctly tends to have lower returns for greater risk both undesirable.

The next thing to do is put all the money you want to invest in those funds and add to those every month or even week as you acquire more cash to invest. Do not mess around trying to market time. You don’t make a thing until the money is invested so sneaking up on it merely means you’re making less because you’re not invested. You need to choose an asset allocation, how much of every dollar to put in the bond fund and how much to put in stocks. The more stocks you own the more risk you own, and the more risk you own the worse you do in a downturn. I’ve read papers that say 70/30 or 75/25 over time are most efficient. Higher than that you own too much risk, lower you give up some return. During accumulation I ran my portfolio at 75/25. In retirement I own less risk so I’m about 57/43 including cash.

The next thing is re-balancing. Stocks tend to outperform bonds so the ratio will become unbalanced so once in a while if stocks get heavy sell some and buy some bonds with the proceeds on the way up. It’s a means of selling high and stashing some of that value in bonds. This manages your risk because 75/25 has lower risk than say 80/20 or 85/15. When the crash comes you re-balance the other way you pull some money out of bonds and buy stocks cheap so you are constantly cycling sell high and buy low, mechanically controlled by the asset allocation, which takes human guess work out of the equation. The human brain is not wired to make smart decisions in a crisis unless trained.

The last thing is NEVER SELL. When the crash comes NEVER SELL, just re-balance. When you buy stocks and bonds you are buying property. The more property you own the richer you are, so the whole point is to keep buying property. The value of your property is variable and set by a market. If the market crashes you own the same amount of property it’s just temporarily worth less. Relative to other property owners if you have a lot of property whether the market is low or high the one who owns the most property is always the wealthiest. If you sell low you are giving your property away, stupid move. If the market is down your purchasing power will go farther so buy more property for the same dollars and get even richer. Buy low Sell High is the mantra.

Over decades the price of your property will appreciate and the property you bought first will appreciate the most so buy soon and often. If you are 30 and you die at 90 your property has 60 years to grow, and with a bogglehead approach it’s those 60 years that pay the rent since the best you can expect is market return. With this approach YOU CAN”T BEAT THE MARKET so don’t even try. You’ll only goof it up, with hair brained schemes so sit back tend to the knitting of property purchase and enjoy the ride. I’m a fan of investing in 3 types of accounts Brokerage. Roth and IRA like accounts all the numbered accounts) and maybe HSA if its available but don’t overdo the HSA. (I think a big HSA is a likely target for means testing)

The reason to own 3 accounts is when you go to spend down in retirement the government has some tax surprises in store for you and owning 3 account types improves your ability to tax plan in retirement because the 3 types are treated differently when it comes to taxes. I’m not a fan of retirement formulas like 4×25 or 3 x 33. There is no reason not to sit down and plan a yearly retirement budget with some granularity. You are surrounded by old people, patients and relatives so use their experiences to inform you about likelihoods. You need to plan for expenses but also disaster and end of life and if you’re married 2 disasters and 2 ends of life. Disaster would include things like a CA diagnosis Alzheimer 24/7 memory care for 15 years, stroke, high inflation, bad sequence of return on investments and the increased tax burden of the surviving spouse when one spouse dies. None of that is considered by the typical bogglehead, but rest assure that train is coming down your track and when you’re 80 it’s too late to do anything about it. It’s only 50 lines on a spreadsheet to plan 50 years. I have my retirement planned and 25 years will cost 2.7M inflation adjusted in basic living expense. I have quite a bit more than that available for living expense and a spare million tucked away in a Roth which doesn’t get touched as a disaster fund that grows unmolested. Million bucks growing at 7% buys a lot of inflation protection, bad SOR or end of life care (given the inflation rate of healthcare and the likelihood of the government turning medicine into the one size fits all of the VA). I don’t need any side gigs or excessive leverage because my plan covers all the bases. Since I have a plan beyond something like 4 x 25 I have something specific to track and can readily make adjustments based on the economy.

My point is the part that is often missed is the follow through, the spend down part. It just gets assigned a number pretty much out of thin air. You can fart around trying to beat the market, I bought BTC at $275, it paid off pretty good, it’s property so I never sold it, but that’s pure speculation not investing. It’s not the kind of thing you need to retire on. The Motley Fools are in fact jokers when it comes to building a sustainable money machine.

Alternate Portfolio Advice

There were a couple videos posted in the PoF Facebook group which I found very illuminating, They were the tail of 3 brothers each of who retired 3 years apart 1997, 2000, 2003. The videos look at the SOR results, The discussion is by professional money managers and discusses management techniques to avoid failure.

Here is the first video with Mark Cortazzo and Mary Beth Franklin. Cortazzo is one of those dreaded AUM managers, see if his advice sounds dreaded to you! Franklin made her mark as a Social Security expert, who knows how to make SS give up every last dime using various claiming strategies.

In the second video Cortazzo reviews the fate of the brothers in 2018. If you watch video 1 do not miss video 2. It validates all of my mumbo jumbo about risk management.

If you were Mr Retire in 2000 would your plan have had the chops to survive?

Expectancy Theory

Expectancy theory

Description

Expectancy theory proposes that an individual will behave or act in a certain way because they are motivated to select a specific behavior over others due to what they expect the result of that selected behavior will be. Wikipedia

Expectancy is odds making. The human is very keen on odds making. The human brain is sub-cortically wired toward risk avoidance. It is a survival mechanism and it happens without thought, but can be affected by memory and other cortical and subcortical structures. The site of risk analysis seems the Cingulate cortex. It sits next to the center of memory, the Hippocmpus. Other sites are involved like prefrontal cortex but the point is risk aversion happens automatically below the level of thought.

Risk aversion is wired in the human at a level of 4:1 biased in favor of aversion. Given a situation you are 4 time as likely to chose the risk averse outcome. Risk aversion can be modified towards more risk by other sub cortical structures, and is part of the reason an otherwise responsible adult becomes addicted to cocaine, or someone pays 10 grand to go on a Sandel’s vacation to have the time of your life.

So what’s this got to do with expectancy? Humans given rational choices can modify the risk adverse behavior bias towards something more likely to succeed if presented with the right data. The reason people sell in a panic is because of 4:1. If you’re presented with “the data” you close your eyes and hang on. There is a whole huge Social Psychological literature devoted to this kind of game analysis.

David Graham MD wrote recent articles HERE and HERE that looks at the expectancy of keeping or quitting disability insurance at various points in portfolio accumulation. The bet is what is the likelihood of becoming disabled vs what is the cost of insurance with the presumption of “financial independence” (whatever that means) . He uses statistics to game out the statistics of cost vs benefit for keeping vs quitting. The analysis is specific but also global in how to think about risk analysis. I highly recommend the articles. A major conclusion is do not base your decision on sunk cost, the money history of what you have paid. Base your conclusion on the future cost vs the probability of need and the amount of payback.

Part of David’s discussion presumes “financial independence” but as we all know FI is a slippery number. It can be whatever you want to call it up to the very day you retire. When you retire is when the rubber meets the road. The dice will be cast and your future will unfold from there. It’s no more a “slippery” number, it is nailed down and there is no W2 to cover your risk.

My tact will be to look at the outcome on portfolio longevity if you are forced to “retire early” perhaps earlier than you intended with a presumption of “financial independence” People tend to believe they are FI and therefore bullet proof (FU Money) without actually doing the analysis. So I’m going to game out an analysis and see what disability insurance really is, it is not disability insurance at all, it is portfolio protection insurance. Sometimes when you FU you are the one who gets F’d. Earlier retirement (greater portfolio longevity) and early SORR are killers to future wealth and success in retirement. So let’s add a little earlier retirement and SORR to the analysis.

I’m going to use a BH3 portfolio, a common portfolio used by accumulators. I’m going to use 4% WR a common WR used by the presumed FI crowd and I’m going to vary the nest egg size based on a retirement earlier than expected, and I’m going to include medical expenses since permanent disability often includes considerable medical expense and the expense occurs up front. That is the actual scenario of someone forced to go out on disability say 5 years early or 10 years early and tap their FU money before expected. I’ll use Monte Carlo to do the statistical analysis. Follow along with the narrative!

Scenario 1 Drop the disability and save 6K/yr

We have a 60 yo WM Physician in good health who expects to retire at age 65. At 65 he expects to have 2.5M in the bank in a BH3 portfolio and he intends to spend 100K/yr in retirement, the typical 4 x 25 and claim SS at FRA. That’s his plan. He goes skiing the back country of Telluride and destroys is right leg and hip to the extent he will require extensive and multiple surgeries and rehab. He is forced to retire but he let his disability insurance lapse because he believes he has “FU money”. He read it on a blog.

Since he expects 2.5M at 65 he has 1.6M in his portfolio now, and adds 65K/YR which will equal 2.5M at 65, so he’s not really Fat FI but thinks of himself as FI. He is expecting Medicare to pick up his health care risk, and he could claim SS at 65 as a backup plan. He is forced to retire early which means his portfolio must cover a longer period. His portion of the out of pocket medical expense in the first year is 100K and 50K the second year and he has an ongoing 25K/yr ACA plan plus a 10K deductible each year.

I’m going to model the upfront cost as a bad initial SORR for 2 years on the portfolio since that is what the medical cost represents bad SORR and I’m going to keep his 100K living expense outlay constant to start (6.25% WR).

YIKES no scenario survives unscathed. Even at 90% best return, 80% of the money is gone at 35 years.

Lets readjust to 4% of 1.6m. He now lives on 64k/yr (a 36%reduction in life style) and can just qualify for ACA subsidy.

Only 57% of the portfolios last 35 years and remember the ACA, he barely meets the subsidy.

He decides to take SS at 62. His SS at FRA is 35K. His age 62 SS is 80% of FRA SS, or 28K /yr. We add 28K + 64K he now makes 92K/yr but he is still running out of money before he reaches 33 more years, 43% of the time! So he further reduces his WR to 55K/yr

He barely makes 30 years on 55K/yr WR in the worst case. If you include SS plus his 55K retirement income at age 62 he lives on 55K +28K or 83K/yr. His portfolio has a 90% chance of survival. Not a terrible life but he’s not swimming in the dough either. It’s definitely a downgraded future but he does have a future. He still has the ACA insurance costs to pay from his 83K, until medicare kicks in. So much for FU money.

Scenario 2 Disability intact

Our skier has a 10K/mo policy which kicks in till 65. So he will receive 600K tax free over the next 5 years. He still starts with 1.6M in the bank and the 100K and 50K year 1 and 2 medical expense and the ACA cost of 25K and 10K deductible. He scales his living expense back to 80K/yr (a 20% reduction in life style). His first year cost is 100K + 25K + 80K = 205K. His income is 120K from insurance so he has to tap his nest egg for 85K. His nest egg remains constant at 1,600,000 that year despite the 85K tap. Not advancing, but holding even despite the bad SOR (medical expense)

The next year he has a 50K medical expense so his cost is 50K + 25K + 80K= 155K and his income is 120K so he needs to tap his retirement for 35K and his nest egg grows to 1,672,000 in the second year. The next 3 years his medical expense plummets but he is left disabled and continues to receive 120K tax free. He stays at 80K/yr living expense plus 25K ACA but his medical expense is way down so his cost of living is 105K and he puts the extra 15K in his portfolio to grow, because he knows the gravy train is going to end and he is now acutely aware of whatit means to own your own risk and not offload it on an employer or insurance company.

At 65 his portfolio is worth 2M. He retires at 65 on 2M and takes medicare which drops his medical expense to 260/mo or 3120/yr. He continues to live on 4% of 2M or 80K/yr for 2 more years until FRA. At FRA (67) he takes his 35K/yr SS, so his income becomes 115K/yr. He adjusts his living to 100,000/yr of which 35000 is SS so his portfolio WR drops to 65K/yr or 3.25%. His portfolio Monte Carlo’s to:

His portfolio success is now 96%. He lives on his anticipated 100K/yr. He no longer skis. He walks with a cane, but his brain is intact. He writes a financial blog about what it means to be FI. He can reach in his accounts and snatch out 25K for his daughters wedding and he will hobble her down the aisle. His disability costs was $6000/yr. As you can see his disability insurance was really portfolio insurance because it protected his portfolio. It is true he may never have injured himself and wasted an extra 30K on unused insurance. That means he would have wasted an extra 30K to protect the portfolio’s growth to 65. That unused 30K would have guaranteed the extra 500K at full retirement. (2M vs 2.5M)

You can draw your own conclusions regarding FU money and the value of disability to protect your portfolio. Your subcortical structures have already analyzed the reality and the 4:1 risk management bias is kicking in. Do not under estimate your vulnerability with your heady belief in your invincibility. The numbers will humble you in a heart beat.

Disability Insurance in this case is like owning a 5 year alternative 600K portfolio at the cost of 6K/yr. It protects the main portfolio when the main portfolio is at it’s most vulnerable. Portfolios take a long time to disintegrate, typically decades and a wrong move early, like thinking you are more financially independent than you really are, can be devastating despite all the blogoland noise about the joy and power of being FI. The Disability Insurance protected against SORR, for this is also a study of SORR and it’s dangers. The DI also re-indexes the main portfolio to a more sustainable state before withdrawal begins in earnest. The portfolio begins to be emptied at 65 instead of 60 except for a little dab up front for medical expense. In effect the DI is the equivalent to my “fuse portfolio”I’ve written about before. an extra $17,000/yr (1500/mo) makes a lot of difference in the relative luxury of a given retirement.

This post still looks at expectancy. It compares 2 scenarios and the cost of each scenario and the payout of each scenario statically using a Monte Carlo engine. The thing about retirement is it lasts a long time and the effects needs to be analyzed to the end not just to the middle.

2nd Year Anniversary

The end of July effectively marks my the completion of my second year of retirement. I retired having some idea of where I was going but no finely thought out plan. I knew the size of my portfolio, the risk of my portfolio, the expected reward. I really didn’t know my cost of living, so I started with an assumption of 10K/mo, about half of what my portfolio supposedly would support. It was a pretty good estimate but actually a little generous. My actual spending came in at about 9K/mo on the average.

I devised a method using Mint to accurately track my expenses. I also stress tested my budget to find out what tightening my belt actually felt like. Armed with real budget data and real variability data, I could then project what my need would be in full retirement. I look at my retirement in terms of epochs. Each epoch has it’s job to fulfill in my financial life. Prior to retirement was accumulation split into 2 sub epochs pretax savings and brokerage account savings. I maxed out my pretax to about age 50 and then realized what I was doing was maxing out my tax bill in old age. I had a brokerage and began aggressively funding the brokerage. I knew I had to move some money from TIRA to Roth to save myself from progressive taxation and living off brokerage money turned into cash was just he ticket. I also was fortunate to Tax Loss Harvest which helped my tax bill come Roth conversion time.

Epoch 2 was to retire. I completed my last SS payments, rustled up some health insurance, I was on Medicare the family on Liberty Healthshare, and said goodbye to my medical career. Epoch 3 was to map out a plan for Roth conversion, with the goal of converting the most TIRA at the least taxes. Epoch 4 was coming to understand how to optimize my portfolio. As I worked through the Roth conversions. I came to see partial Roth conversion was a more efficient model. In this epoch I subdivided my portfolio according to what I expected from each account type in retirement. I owned Brokerage, TIRA, Roth, Cash, Tax Loss Harvest and at age 70 I will claim SS. Each of these had their own tax treatment so I optimized along tax guidelines to minimize taxes as time passes in epoch 4 and this will further extend to epochs 5 and 6.

The brokerage mixed with tax loss harvest is the source of cash to live on while Roth converting and the money to pay the taxes of conversion. The TIRA provides funds to convert into the Roth. I discovered that leaving myself a small TIRA (500K) was most efficient. The small TIRA will contain money in stocks and bonds in a 20/80 ratio, which will have slow steady and controlled growth. I will let it go to RMD and the TIRA will act like an inflation adjusted annuity, throwing off a couple K/mo basically forever (at least till I’m dead and my wife is dead). My second source of income will be SS, first my wife will claim, then I will claim we will use it together and then upon my death she will claim survivor benefits. Topping of my income will be a little from the brokerage about a 2% WR or less. This setup will keep me in the 12% bracket for 15-20 years. The Roth provides insurance. It will remain closed to grow unmolested until there is an emergency. In an emergency it will fund the emergency without decimating the rest of the portfolio. Each account has it’s job protecting my future.

I analyzed how much I was going to need to live for the 20 years post full retirement using an inflation adjusted amount from my budget, which should be a fairly true estimate and it’s 2.7M inflation adjusted over 20 years. This is an important step because it ties need to reality in epoch 5. I have more than 2.7M so I have no need to over risk my portfolio. Less risk means a better chance of success. Living out those 20 years is epoch 5.

Epoch 6 happens when I die leaving my wife to fend for herself. When a spouse dies taxes can go up 2 brackets in addition to a loss of 1 deduction and part of SS income. Here is an instance where one might open the Roth. Also in the case of chronic debilitating disease the Roth serves it’s purpose as a money source. It took the better part of 2 years to make and implement this plan. This plan has a 99% chance of success despite its moving parts

Otherwise my life is full. My children fare well, my wife and I are closer than ever. I was dealt a little medical set back but am getting along in my recovery. My time is my own and there are a billion interesting things to do, including getting 8 hours sleep per day. The plan is unfolding precisely as planned. I picked a good time to retire. The economy is up as is my portfolio. The county is stable despite the news media’s insistence we are blowing up. I’m enjoying opining on his blog and others… I wouldn’t go back to work on a bet! Once optimized there’s nothing left to do but live a good life. Despite all my missives, hi jinx, conversions, tax payments and 2 years of spend down, I have more today than when I retired.

Life’s been good to me so far! We’ll see what the next year holds.

Bogglehead Time

I give the Bogelheads a hard time. I was on CD’s site and realized in all fairness l should give the Bogel aficionados their due. What they do right is get people to right size their lives. For example for the average guy there is no reason if your employed to live in long term debt except for a mortgage and there is no reason to own a mortgage that is not right sized to your income. There is no reason to own too much car, and there is no reason to not save and invest. There is no reason to not try for a better job since a better job is an income multiplier.

The Bogelheads also get the portfolio basically right. Cheap index funds properly risked in a rising market are a sure winner. Return relies on the economy not stock picking or magic. It’s the jokers in the C suites of the companies that make you wealthy, such a deal. All you have to do is come along for the ride. I poke a lot of fun at the BH3 because I want to teach folks about modern portfolio theory and doing comparative analysis is a good way to do that.

With the advent of Personal Capital graduating to a modern portfolio theory portfolio is plug and play simple. You can upgrade your portfolio to one consistent with MPT and Personal Capital will tell you exactly how to pick your assets and AA to be on the Efficient frontier. It will then add up your cost of owning those funds and Monte Carlo the result to give you some insight into the future and if you are saving enough.

Funds now are dirt cheap to own and transaction costs are dirt cheap as well, the tools of optimization are free, life is good. So what’s the downside of Bogel’s crew? It’s unclear what FI really is. I listened to a “what’s up now” podcast and the panel was interviewing the audience asking if they were FI. Everybody in the room thought they were FI including people with just a few K in the bank. Because they had read a book or read some blogs they assumed they were on their way and could claim the title. Then there is the RE at 30 crowd. They are just gambling or they have a job (like a blog) or a wife who has a good job aka they are freeloading to a greater or lessor extent. Certainly a 1 income household is legit but it takes a long time to reach true FI on one income. In the recent Playing with Fire movie this became evident. The couple were living on their parents couch for a year while grandma baby sat. The wife “tele worked” all day to bring in some dough and the dude hung out tying to figure out a gig. I don’t see free loading as FI or as a means to a 3M nest egg, nor is it a real narrative of success. Free loading by definition is financial dependence.

I find it interesting the narrative seems to have moved from FIRE to FI and people still have a W2 or have manged to start some kind of business. I hear more and more about being FI and less and less about FIRE which means normal wisdom and risk aversion are modulating the narrative. Virtually nobody is retired in earnest they are just FI. I’m not the retirement police so people can do what ever they want, but it causes the narrative to skew wildly away from reality, and I think that does a disservice to those who are being sold the narrative. My hope is the narrative will continue to evolve into something essential and sustainable since we now have amazingly powerful tools, to use to accomplish the true goal of true FI.

So we have now the analytical tools of accumulation, and some ability to attempt to peer into the future using either a historical analysis technique or a Monte Carlo technique. We also have some models of spend down very different from the BH boilerplate of 4% x 25. Kitces for example just wrote a piece of flexibility in spend down. Big ERN includes Sharpes ratio in his spend down viability calculations attempting to better quantify risk and improve his aim at the retirement target. Others are developing odds based models (expectancy theory) to try and determine what is the smartest choice based on probability of success vs probability of some failure or less likely outcome, a very Bayesian approach to spend down. If you look at a normal distribution in spend down, expectancy theory attempts to choose the choices most likely to place you in the better half of the distribution. If you wind up in the better half your chances of being in the worst half tend to zero eventually. My own work at looking at actual year by year spending to arrive at a total cost of retirement and a means to accurately estimate through budget a rational “number” based on your actual life style and not some wanna be lifestyle.

That is the future. Those books have yet to be written, and when they are both FI and FIRE will come into clearer focus. The financial tools and programs for understanding this also exist. Being rich and then not becoming poor is a different thing than day dreaming about being rich. Eventually the hucksters and snake oil sellers who make their fortunes off the masses will die away. People are smart. It’s the reason nobody accepts the 4 x 25 rule as legit. There is simply too much at stake.

How to BEAT The Market!!

I read a recent article on the PoF Facebook site about some stock picker who crushes it at least according to him. I beat the market by living on the “efficient frontier”. Here is an example:

This is 1M invested in a BH3 Vanguard fund portfolio with a WR of 4% over 30 years and normal SORR and historic inflation. The graph uses a log scale on the y axis since it makes running out of money look more dramatic and the graph is inflation adjusted. On the 10% line you are doomed at 23 years and have only 1/4 of your starting portfolio at the 25% line. You are essentially even at 50%. This is a 50/50 scenario half the people do well half do poorly some so poorly they run out of money.

This is a 80/20 US stocks US Bonds Vanguard portfolio made up of the same US funds used in the BH3. The foreign fund is eliminated and that amount is added to US stocks. The 80/20 lives on the efficient frontier. All other parameters the same as above only the asset mix has changed to move the portfolio to a less risky risk return position on the EF plane.

Notice the success rate of the portfolio is 93% in the 80/20 as opposed to 82% in the BH3. Notice ALL lines still have money at 30 years. The 25% in the BH3 had 1/4 of the start amount. In the 80/20 nearly 1/4 is still in the 10% line’s portfolio. And the 50/50 split where “half do worse half do better” is now the 25% line, so in the 80/20 scenario 3 out of 4 do better. Notice the 90% end value of 5.1M in he BH3 and 8.3M in the 80/20. If the BH3 is supposed to represent “the well diversified market”, the 80/20 clearly beats the market and not by a little. On the 50% line you have doubled your money and considerably improved your longevity simply by choosing the the more efficient portfolio. Specifically at the 50% rate of return line the 80/20 effectively has an additional 2.2% of return compounded over 30 years

That’s called beating the market! In my last post I talked about choosing what is essential. Clearly choosing an efficient portfolio is essential. Just as clear by eliminating the Foreign fund, the FOMO turns to the JOMO. The fear of missing out becomes the joy of missing out. This is essentialism and parsimony in practice.

Less But Better

I’ve always been fascinated with the concept of parsimony. Parsimony is often confused with cheapness, but its not about cheapness. Minimalism is often conflated with doing without aka don’t buy anything for a year. Not my gig. I’m more interested in buying the right thing, the thing that is a long term solution to a need. The right solution is the parsimonious solution.

In high school I drove a 66 Ford Mustang. I didn’t have the V8, I had the V6. I didn’t have the 4 speed shifter, I had a 3 speed. My straight 6 engine was indestructible. My straight 6 didn’t fill the engine compartment like its V8 sibling. I could almost climb in next to my engine to work on it, making it easy to work on, a key consideration for a kid who had to do his own repair work. I could tune it up for just a few bucks. The torque of the 3 speed would not allow 30 ft of rubber to be laid so the tires lasted longer. The car was lighter, so easier on brakes and got better mileage. Parts (like mufflers) were cheaper. It was still a ton of fun to bomb around in and I had it up to about 115 more than once so it went plenty fast. It cost less to purchase used. It was just the right thing for a 16 yo punk kid with a part time job working at a gas station. Not too much, not brown Betty the station wagon–Parsimony.

When we moved to my present town after I exited the Navy, my wife wanted a treadmill. I bought one for maybe $700. It was consumer grade. It had a component in the motor speed control which would overheat and eventually lead to malfunction. I gave it away. I bought a commercial grade gym quality machine for just under $5000 in 1992. That machine never broke down and we used it every day even 27 years later. It’s been about 2/3 the way across the planet in terms of miles covered my cost is about $185/yr. Later I added a $120 factory second weight vest which allows for excellent control over the metabolic load. I bought one for my wife as well as weight vests are good for protecting against osteoporosis.

The next year My wife wanted a weight machine. Having learned my lesson regarding buying cheap crap, I bought a small machine that had multiple stations (about 22 exercises) and could be set up to move from station to station with only a weight stack adjustment consisting of 1 pin. It was easy to maintain a metabolic load while lifting across every muscle group. We both use it all the time. It’s not quite as good as free weights but it does quite well and nobody need spot you. It was the kind of machine you would find in a motel gym, low end commercial and it fit the space I had perfectly. It cost me about $4500 or $173/yr. Those machines plus some other minor ex equipment live in my home gym. It was easy to stumble out there any time day or night before work or after on my schedule. I never had to go anywhere and was not tethered to some other gym’s schedule. It removed the energy hump excuse. Even more so now that I’m retired. 10 grand for exercise equipment = parsimony? 27 years of availability with no gym fees or hassle = parsimony. I have another half dozen examples where buying the right thing, not the cheapest or most expensive has paid off over the long haul.

There is a concept called essentialism. It comes from an educational philosophy where what is taught is a function of the teacher not the student and the curriculum is the classics of History English Language Math Sciences Humanities Logic and Philosophy as a core and a few electives. The core was considered essential to creating a well informed and capable adult. I trained my children using this concept. The concept moved out to business. Southwest airlines for example made specific choices to eliminate the noise in service compared to other airlines. No food, no first class, point to point, not all cities covered, first come first served, just the essentials. Southwest made a killing providing just the essentials. Less but Better.

I went to med school in Chicago. There are like 8 med schools in Chicago most with teaching hospitals attached and plenty of duplicated services. My hospital was run by Jesuits, steeped in the essentials. It was part of the reason I chose to go there. It was a classical style education none of organ systems group think approach. Each student needed to experience neuro-anatomy both gross and microscopic, it was not a group experience.

The Jesuits understood in the 80’s the money was in cardio and cancer so they specialized in those. We had every other service like NICU, Peds ICU a big burn unit, Neuro Medical OB Trauma unit etc but in Chicago there were specialty hospitals like Children’s Memorial and Prentice for OB/Gyn and we were set up to rotate through those institutions and see the zebras. Those folks rotated to my place for hearts and cancer. Our hospital had its own affiliated nuclear accelerator at the VA across the street. This is an example of essentialism, doing more with less, and doing that less better. I rotated through all the specialty centers several times and got my chops and pimps from the experts and a much more varied education.

I think this concept could and should be attached to FI. So much of FI is a hodgepodge of conflicting concepts, incomplete and chaotic knowledge. Often it over promises and under delivers. There is an article describing the concept on the Forbes site. The author speaks of Greg McKeown who as written on the topic and is a guru in the field. I have his book and can recommend. Instead of going in 48 different directions each fairly ineffective go in one direction balls to the wall ignoring the noise. Learn the JOMO joy of missing out and the benefits it promises.

Delta tried to beat Southwest at it’s own game by creating a competing “lite” version. It flunked. It flunked because of economy of scale. Delta wanted to be all things to all travelers and so couldn’t be the best to any. Does this apply to your portfolio? Are you so busy attending to crowd funding or silly side gigs which require a ton of risk and work for not commensurate return (FOMO) that you miss the supercharged thrust of sticking to the essentials?

Gym Time! CYA

Financial Planning

I remember in first year med school I was studying the extrinsic and intrinsic pathways of clotting. The pathways first year are taught as part of cascade reactions in the biochemistry course. I decided to learn a little more so I checked out a 2500 page 20 pound text book on Hematology from the reference desk at the library. The book was so dense it took me half an hour just to find the cascades. Once I did I found there was a lot more to know. It was that experience that taught me the level of knowledge I was up against.

Medical school was about learning 10 things, and you were tested on those 10 things. The “neurosurgeons to be” learned their 10 things perfectly. Some others learned less completely, we all learned enough, but here in my hands was a book that contained nearly all there was to know about Hematology at the time of its publication. My 10 things weren’t even in the index. You learn more than 10 things as you progress and more than thousands of thing as you pass through residency to become attending, It starts with 10 but hardly ends there.

I’ve been thinking about CD’s retort that I’m the Socratic Gadfly of FIRE. It is true, but why is it true? Why don’t I just accept the MMM boiler plate? Why do I think that FIRE movie is propaganda? Why when I read misuse of the Pareto principal does it raise my ire? Why do I care? The essential reason I care is people are basing their futures on what is written. They are basing their futures on learning 10 things. In medicine you learn 10 things, then move onto the clinics and those 10 things are fleshed out into the blood sweat and tears of sick people. If you pay attention the 10 things become more than the cliff notes.

I had a pt once the first day of 4th year on the cancer service at the VA, who came in with extremis. It was the day I learned some people come to the hospital to die. It was also the day I met my wife in a bar as I considered what had happened. The patient came incoherent. I spent a couple hours trying to get an IV in him. I would get into a vein, but no flash. I could advance the catheter but no return and eventually the catheter would “blow”. I would pull out the cath and then it would bleed profusely. I thought WTF? and deduced the PT was in DIC. This was the expression of the cascades in reality. During the course he threw a clot or a wad of cancer from a leg vein to saddle in the pulmonary artery and died. The guy was riddled with metastatic CA and the 4th year resident showed up and cancelled the code. In reality there was nothing to do but that didn’t quench my feeling of inadequacy that I somehow let this guy down. The 4th year knew more than 10 things, way more.

It’s this kind of thing I see in the FIRE movement. I see a lot of people who know their 10 things, but knowing 10 things is woeful. There is a whole 2500 pages to know. I see people spouting those 10 things as if that’s all there is. It’s like a blind man exploring an alligator, not big deal till you find the mouth.

There is a kind of scholastic philosophy called essentialism. It is basically classical education, where you learn rhetoric, English, languages, math history, sciences, philosophy, religion. In studying that body of thought a societal cohesion is formed, and a kind of brotherhood of belonging in a way tat fixes you in space. It’s the education I gave to my children. It’s not just 10 things but it’s the 10 essential things that underpin the truth of shared human experience.

FIRE doesn’t have that. It has no truth. It has millions of opinions expressed for millions of reasons, promoting millions of narratives and agendas. It promotes a mechanism of using index funds to risk money in some simplistic formula, but in the end nobody believes that. It could have truth if it was broken down to the essentials, but as long as it’s every man for himself it does not constitute a body of knowledge. It’s a collection of half truths showcased as the truth, and then marketed as the truth. People are hanging their futures on marketed half truths, while the marketeers clean up. I find that disturbing.

There is a fallacy called the planning fallacy which basically states any plan takes longer to complete than planned. Plans are projection and projections don’t lead necessarily to reality. I break FIR down to 2 parts accumulation and retirement, very different beasts requiring very different plans. Refer to the planning fallacy when considering each

Attaining FI is certainly possible but RE doesn’t necessarily follow. Knowledge of 10 things is not enough knowledge to retire. FI may not actually be FI once you take risk into account. MMM became super frugal, made 1M and retired at 30 on 27K/yr aka WR = 2.7% a far cry from 4%. That plan at 60/40 AA has a good 98.68 chance of lasting 60 years, but what about health care inflation? You move to the alpo diet and hope you don’t wreck and fracture a hip on that bike in the Colorado snow. I guess we missed essential “thing” 11 and 12, yet they are glaringly obvious. It’s 98.68 with the caveat: if nothing goes wrong. What could possibly go wrong?

I guess part of my skepticism comes from not knowing about FIRE narratives in accumulation and reaching retirement financially independent by separate means. First time I heard about FIRE was a year after I quit, so FIRE didn’t bring me to the dance. I didn’t know the 10 things, so I had to manufacture essential things to get here. The MMM narrative is not my narrative and I find it remarkably shallow and self serving, so I don’t buy the soap, sometimes I wish I could.

My goal is not to rain on the FIRE parade but to think about that cliff outside in the cold distance.

No reason to get excited
The thief he kindly spoke
There are many here among us
Who feel that life is but a joke
But you and I, we’ve been through that
And this is not our fate
So let us not talk falsely now
The hour is getting late

Outside in the distance
A wildcat did growl
Two riders were approaching
The wind began to howl