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.

6 Replies to “Demographics”

  1. Wow. Excellent food for thought yet again Gasem.

    My radiology colleague and I were just discussing corporate debt this morning and how it is going to impact the future economy.

    1. There are a lot of scary things about these videos on the real visions website. Definite food for thought. I’m strongly considering selling some stock, buying gold miners and buying more bonds. Stocks are running twice what the trend line predicts in price. Everything always regresses to the mean eventually, so why are stocks so high and do they deserve to be that high? Corporate leverage. The corporations used debt to buy back stock and jack up the price. So it’s like thinking you are some real estate tycoon who owns 50 properties but 75 properties worth of debt Suppose consumption falls off because of retirement as spending becomes less in retirement. What will happen to the debt service? What will happen to the stock price?

      We’ve always “gone up” but part of that is because of baby boomer economic efficiency and consumption and personal debt. No job no economic efficiency from them anymore, no job, no more acquisition of debt, no job, no debt, no desire to consume = reversion to the mean as the gas gets let out of the balloon. It will be made much worse by some dimwit like Warren getting in power.

  2. Thanks for the thought-provoking (even if terrifying) post and video.
    Making predictions is difficult – especially ones about the future.
    I share your concerns about the debt loads of companies and individuals.
    Too many young FIRE folks seem to think stocks are guaranteed to keep rising.
    Japan and history teach us otherwise.

    1. A recession is guaranteed, when and how deep are not, but there are systemic and demographic issues for sure that are beyond the business cycle. I’m in the 3rd year and it becomes a race between when SORR would be most devastating and when that risk tails off and the portfolio starts to behave more like a savings account and less like a levered account.

      I did some analysis on SORR. It’s typically reported to matter for like 10 years but my analysis looked at various retirement lengths and it matters a % of the retirement length, not an absolute number so 10 – 15 years is relevant on a 30 year retirement but it looks like 20 – 25 years is relevant on a 50 or 60 year retirement. From papers I’ve read they discuss 5 years before and 10 years after retirement as the period where reduction in risk it most relevant on a 30 year retirement.

      In my case for example I’ve had a good 5 years prior (2012-2017) and a very good 2+ or so years peri and after (2017 to now), where I have acquired about 5 or 6 extra WR above my living expense. That accumulation of excess WR is the equivalent of portfolio insurance. In my case I basically pulled that excess WR out as cash a few months ago since the market is up (sell high), which reduces my over all risk profile and closes my portfolio to withdrawal for 6 years. As the 6 years pass I’m just about 15 years into SORR’s window of effect (5 years before and 10 years after).

      I also cut back some on the AA of the portfolio from 75/25 to 66/34, which means if equities drop in half my portfolio only drops 30% not counting the cash I’m living on. In 3 years SS kicks in, further reducing the drain on my WR and allowing my portfolio to remain closed even longer before I start withdrawing. So I’m pretty well positioned even if equities drop in half (the Japan scenario) and SS gets cut 25% to not run out of money. If the market does crap and I’m still Roth converting, I’m likely to Roth convert as much as I can even to all of it. Since the stocks would become cheap, you can convert more of the TIRA for the same tax bill and I already have the cash on hand to pay that tax bill. That would further reduce year to year taxes essentially to whatever SS generates and would save my wife’s tax bill once I die. If the market drops in half I’ll also tax loss harvest the brokerage, reducing any taxes on that front. So there are economies yet to apply, so turning down the risk too much may be over kill.

      None the less it’s videos like this that gets one off the couch and planning.

  3. I’m also concerned with demographic trends. The millennials don’t seem positioned to take up the slack as boomer 401k and pension funds sell assets to fund their income needs. Add to that low/negative rates, the Fed needing to unwind its book, and corporate equity buybacks propping up the markets. Eventually the music stops and some of us will be left standing. Income inequality will will lead politicians to promise more entitlements when we can’t pay for the ones we currently give out. SS gets cut, Roth distributions may get taxed, and income tax rates go up. Maybe inflation is allowed to run its course while the economy slows. I remember a bit of the gas lines of the 70’s from when I was a kid. The Japan example is scary and I’m hoping American exceptionalism and reserve currency status will keep our economy a target for capital inflows preventing Japanification.

    I’m also diversified into gold, bitcoin, and cash. I’m not sure how defensive to get with the AA when I have 10 years or more until retirement. I’m about 70/30 now and thinking I should head towards 60/40. How do you think about this? Leaving potential gains on the table will mean lower quality of life later on.

    1. At what age do you plan on retiring? A closed portfolio works like thermodynamic state functions from Chemistry days. It’s path is not relevant. It’s feature is: it starts somewhere and it ends somewhere and the difference between start and end are the delta. The problem with early retirement is it ignores human capital. A human has human capital that is available to spend over 60 or 65 years of life. Education is a multiplier of human capital and what you acquire in the first 1/3 or 1/2 of life. It changes the slope or rate of accumulation. Portfolio deflation is what occurs when the rate of accumulation changes and money starts being extracted. A portfolio largely does not consist of money, it consists of property that is convertible to money. Human capital does not consist of money. It consists of activity performed and time spent being converted to money. That value once earned is converted to property. You either buy crap, pay debt, or put something in the portfolio.

      Since the goal is the delta between portfolio start and portfolio end, when you quit is entirely dependent on reaching that delta, but your human capital is limited so at some point that goes away PERIOD. If you made a big enough pile before your human capital peters out you can begin withdrawal converting your property into money. One thing to note is withdrawal is not bang bang. You are not one second accumulating and the next spending. What you are doing is changing the slope of accumulation. Properly planned accumulation lasts till the day you die, just the rate changes. THIS IS AN IMPORTANT POINT. A well planned portfolio accumulates throughout it life. This is why it’s important to plan out every year of life until death. By mapping accumulation and the slope changes caused by spending and loss of human capital, you have a numeric understanding of the state function.

      You should for example be able to say what your retirement is going to cost from the day you quit and change the slope. Upon my “official retirement” in 3 years when I start collecting SS my retirement will last a possible 20-22 years and the cost of that is 2.7M. My wife is younger so including her cost 3.4M covering 29 years. If you had 3.4M and made enough interest on it to pay for inflation in very low volatility assets like tips and bonds and the rate of withdrawal is constant you have “enough” That is the definition of enough. If you instead intend to live 50 years in retirement 5.8M is “enough”. So if you retire 20 years early and shit can your human capital you better have made a huge pile. “Enough” is not a guess, it’s entirely calculate-able and this is the exact calculation that would be done if you saw a professional, and didn’t just plan your retirement based on the opinion of some plumber or book selling guru with a mustache.

      The problem with owning property is it’s value is market dependent. On any given day your property is worth more or worth less, so if “enough” is at risk, “enough” becomes a variable that is market dependent. The need is still constant say 3.4M, but whether the need can be met becomes variable. So now the game becomes multi dimensional along a X and a Y axis and the game becomes non linear X and Y are related by a quadratic function, a curve, not a simple line. Every point on the curve has 2 ordinates return and risk, complexly related. Risk itself is a variable. What if taxes go up? What if you or your wife get cancer or Alzheimer, or a double whammy one of each. Suddenly 3.4M could become 5M in end of life and medical care. One thing is for sure every one is going to die

      So how do you judge? I use Monte Carlo analysis. The Monte Carlo is a statistical engine that list probabilities of success for a given set of parameters. Let’s look at 70/30 vs 60/40 US stocks US bonds. A 70/30 under normal circumstances has a 96% chance of survival pulling out 4%/yr. A 60/40 has a 97% chance of survival. What if the stock market dropped in half permanently? The you would have in the 70/30 case? In a 3M portfolio the bonds would be 900K and the stocks would be 1.05M so your permanent portfolio would now be 1.95M not 2M and your AA 54/46 does this survive 30 years? At the same withdrawal the survival goes down to 67%. Doing the same calc on 60/40 loss of half the equities gives a 43/57 AA and the chance of survival for 30 years goes up to 75%. What if you were close to SS age and could immediately add say 20K of SS? Survival goes up to 93% in the 60/40 case and 92% in the 70/30 case.

      The point is the calculation is complex. A 50% permanent loss in equities is a huge bad SORR but if every thing else works like SS it’s survivable, but in this example you weren’t RE and you didn’t have a 50 year time horizon. The probability of the 54/46 (70/30) surviving 50 years I estimate at 66%%. Since in this 50 year RE scenario SS doesn’t kick in for 20 years. The likelihood of a 50% permanent equity default is small but real. The likelihood of normal market action is probably more likely, who knows? So what you need is a trigger. Maybe if the FED drops rates under water it might be time to take some off the table. The rest of the world is basically under water on interest. US banks have a PE of about 12 European banks are 9 and Jap banks are 7 or 8. There is no reason for EU or jap bank PE’s to rise since you can’t make any money under water, so guess who’s going to fall, and guess what they are taking with them. That’s what happened in 2008. I don’t know the fed has enough snot to be able to pull it off again.

      I was listening to this guy Raul Pal and he’s all gloom and doom and I was listening to Janet Yellen and she’s all peaches and cream so I think the fed action is the switch. They clearly screwed up in Dec but that action won’t play out for another year. Moving some to bonds and shortening the window of retirement, thereby reducing risk and decreasing WR (since your pile at retirement is bigger)is the way to go but maybe not yet quite today. I’ve made a plan on what to sell, and what to buy to reduce my risk and the associated tax consequence, so I can pull the trigger since I know exactly what to do. I haven’t pulled it yet. Still more thinking to do.

      My perspective is not to focus on gains it’s to focus on survivability. I could care less if I die with 10M in the bank. The only thing I care about is that my wife dies after I die and she dies with adequate money in the bank aka not broke and not forced to live in some broken down state run medicaid nursing home with looney toons howling at the moon all night long.

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