RMD Calc and Uses

I use the Schwab calculator for RMD calculations along with Tax Plan Calculator 

Between the two you can quickly make plan decisions. RMD is progressive. Starting at age 70 they take a little more every year up to age 93

If you start with 1M in the IRA at age 70 and are receiving 6% growth you are forced to remove the value of your TIRA x the RMD% from the IRA and that amount is taxed as ordinary income based on your filing status. So a $1M and 3.65% yields a $36,500 RMD on year 1. If your SS is 50K you are taxed at .85% of that or 42.5K. If you have no other income your income is 79K. If you are married filing jointly and both spouses are over 65 your tax bill will be $5,907 (in the 12% bracket) using standard deduction. If single you would owe $10,328 (in the 22% bracket) on that $79K income. Your gross income would be $86,500 excluding the SS tax break and the 7K difference just about pays your taxes. At 6% growth at age 75 and 2% inflation your 1M will be worth 1.126M even with the yearly 5 years of RMD withdrawal and the RMD at in this case is 49206 and SS has grown to 55,240 of which 46954 is taxable so your taxable income is 96160 and married tax is 7966 and single tax is 14104. Gross income is 104,446

In a table the first 15 years of 1M RMD 6% growth

So you can see taxes go up by the RMD% and the progressive tax bracket and by year 10 the single player is already at the 24% bracket. Who might the “single” be? Could be your widow if you kick at 79.

Here is gross income at 70 80 and 85 and the net after tax

Here is the 1M portfolio in Schwab and the distribution schedule

and you can download a printable chart and table to fill in a spread sheet

I set about once to write a tax calculator in EXCEL but it was more time than I wanted to spend to write it and test it. There are plenty of tax sheets out there but nothing that fit my specific need so I spent an afternoon and did it by hand

Here is a shot of Tax Plan Calc’s output


I generally test about 20 years in 5 year increments to test tax scenarios so the calculations aren’t ridiculous and you get a good idea of the trend

Here is a 600K TIRA RMD for 20 years at 6% and a 50K SS inflated at 2%/yr in 5 year snapshots. The top level of the married filing jointly 12% bracket is 104K taxable income. So a married filing jointly with a 600K TIRA @ 6% stays in the 12% bracket for 20 years if you live on just SS and RMD This is good to know. It means if you have 1.5M in the TIRA, Roth convert 900K before age 70 and you will minimize 20 years of taxes. If you have taxable money as well you can sell stocks at 0% cap gains tax up to a taxable income of 104K You be optimized baby! This is your late in retirement WR money, post age 70. I would call it the post age 70 WR epoch. What you live on pre age 70 needs to be developed separately.

Goal: convert 900K of 1.5M TIRA to a Roth leaving 600K in the TIRA cost 124K in taxes

A Money Planorama

I’ve been discussing using a Roth as an insurance vehicle over on XRAY’s site It’s a useful way to demonstrate planning using modern portfolio theory and taking risk as well as reward into account. I’m nothing if not a quant A quant is someone who uses computers to analyze investments. It is also a pole used to guide a large barge, from the Greek kontos “boat pole”. If I’m going to guide my barge I want a good chance at being successful and staying off the rocks.

The discussion devolved to how to fund extrinsic risk like medical disaster in retirement. In preparing for retirement you purchase a product called a portfolio which at some point takes over the job of providing you money. It is bounded. If you have 1M you can leverage it but leverage increases the likelihood of failure. What does leverage mean? You can take your 1M, put it in cash, take out $30K/yr at 2% inflation and you’re money will last 25 years. Whoa whoa 25x should be $40K!, but $40K 25 years in the future is only worth $30K @ 2% inflation

How do you combat the loss in value? Leverage my boy/girl leverage. If you make 2% on interest and take out $40K your money lasts 35 years

That % the inflation ate, is returned and then some. GREAT! I want to make 10% OVER INFLATION then (12% not a bit greedy)!!!

Yep 35M that’s the ticket! So what is it? 40K/yr for 35 years and 0 dollars in the bank or 40K for 35 years and 35M in the bank? That’s the power of leverage all things being equal. This never happens. If you have 35M in the bank at least 50K is coming out or 900K or what ever. If you start yanking more less in the bank. How much less? Lets yank 900K

Lawdy Mama I’m 335M in debt! With that kind of debt I think I’ll grow a beard and change my name to Uncle Sam! This is still the power of leverage when leverage goes against you.

To get back your million and live on 900K/year you only need make 90% on your money every year, EVERY YEAR. So a FV calculator is a blunt tool. It gives some quick information but not very deep information. Are you planning your life with such a tool?

Enter Monte Carlo. Monte Carlo calculators take into account the multitude of variables. Still incomplete but more complete. Lets use Monte Carlo to consider the problem of saving for extraordinary risk such as medical disaster in old age. One thing you could do is buy SPIA insurance. Let’s say you get Alzheimer’s at age 70 and you need 30K/yr for nursing home care. The average length of the disease till death is 12 years but can last even 20 years. So you buy SPIA at $500K and it pays you 30K/yr for life. SPIA doesn’t inflate and you don’t have much variability and you pay taxes on the income. You live 12 years, the insurance company wins. You live 20 years the insurance company looses, but does it really loose? Upshot the insurance company didn’t loose even at 20 years. You’re the looser remember those taxes?

Lets Monte Carlo this suckah

Here is $500K in a 50/50 fund at 30K/yr withdrawal inflation adjusted for 20 years. It succeeds 93.7% of the time for 20 years BUT it succeeds 99.96% of the time for 12 years at a very worst case scenario, the 10% SORR line. This means 90% of the time you do better than 93.7% with inflation adjusted tax free worst case scenario money. If the $500K is in a Roth the money comes out tax free. SPIA costs $500K this plan costs $500K. The SPIA plan pays out for a lifetime (say 20 years) 100%. The Roth pays out nearly 94% for 20 years (essentially a lifetime) but an increasing % portfolio survival if you die sooner in a nursing home aka virtually bullet proof.

Stop being the Tool by Using the Tools

Let’s say you are 24 and you put 5500 in a Roth for 10 years to age 34 ($55000 principal) at the end of 10 years you will have about 85K if you get 6.67% on your money in a 2 fund using the tangent portfolio at the best risk/reward ratio which is 18/82. This is epoch 1 of the accumulation. This best portfolio is determined by using the Efficient Frontier

You then just leave the 85K in the Roth and switch to a 50/50 ratio with no added or subtracted money till age 70 (35 years additional or 45 years total growth). This is epoch 2 of accumulation. It has a different risk that epoch 1. The risk in epoch 1 was 4.2% the risk in epoch 2 is 7.8% or half the market risk (15%). Epoch 1 is only 10 years but epoch 2 is 35 years so you have considerable time for the risks/returns to normalize to the mean during epoch 2. This is about as set and forget as you can get and quite safe. It is extremely safe because we plan around the worst case scenario.

At age 70 worst case (10% line) you will have $685K available for your catastrophe, to withdraw tax free. A 500K SPIA pays 30K/yr foreve with taxes, your Roth in the 10% scenario, can pay $35K/yr at age 70 with 98% success to age 90 (essentially forever). This is a 3 epoch calculation, in accumulation epoch 1 was super safe 4.2% risk. Epoch 2 grew under bad circumstances, 35 years along the 10% line, and the deflation epoch, epoch 3 was along the 10% line. DO NOT WALK UNDER LADDERS, you’re one unlucky dude. But you still have 35K/yr to spend in retirement.

These are worst case projections. There is a 90% chance you will do better. You don’t have to wait till your sick to get the tax free 35K but if/when the time comes that 35K is spoken for and it pays better than a SPIA. If you have a wife then save 11K/yr x 10 years do the same routine. At 70 you will get $70K/yr as a couple and if one gets sick it breaks back to 35K/35K. If you both get sick it’s 35K each and it cost you a 110K cash money outlay plus the taxes you paid each year to get money into the Roth for end of life protection.

This plan is for what it’s for, extraordinary circumstance and some extra money late in life. It’s NOT for RE money, it is not WR money. If you want WR money or RE money make a separate plan for that. Don’t mess with the Zohan! To make it work you need 45 years of growth in a super to moderately safe 50/50 investment, but it’s virtually bullet proof. The only thing you need to do is re-balance once a year after the principal is contributed and since it’s Roth money, re-balance and withdrawal are tax free. Personally I would fund this before I paid loan debt or maxed out anything else. Time is of the essence. That “good feeling” of paying off your mortgage or student loan is going to cost you a mint in lost growth opportunity. Screw your “feelings” and do what’s smart. Dave Ramsey is good for helping credit abusers. If you’re not a credit abuser he ain’t for you. His nonsense is eating your lunch.

So what happens if instead of pulling the 10% card for your whole life you pull the 50% card for epoch 2? Again at age 24 you save $5500 in the 20/80 account till 34 resulting $85K. Notice this is epoch 1 of the accumulation. Your risk is so low 85K is virtually assured in epoch 1. It’s mostly in bonds. Then you change the risk to 50/50 and ride 50% line for an additional 35 years. Instead of the 10% level $685K you have a $1.34M insurance policy in the Roth at age 70. In epoch 3 you can pull out $45K/yr for 20 years on the 10% line and still have 1.88M in the Roth available for disaster. The risk is moderate at 50% of the market risk.

Notice how I did an epoch switch between accumulation and pay out. I did a 50/50 accumulation epoch on the 50% line for 1.34M accumulation, and a portfolio deflation on the 10% line for additional safety in retirement. If you continue to ride the 50% line you can re-retire every 5 years safely boosting up your withdrawal a bit. Such delicious control on your future!

The point of the exercise is to look at how to use modern portfolio tools to create a plan, how to use that plan to target a specific need and how to safely fund that plan. It is not a plan driven by greed which begets excessive risk. It is not a Casino plan despite it’s name. It is a plan that optimizes probability of success at minimal cost by analyzing multiple variables. You can easily tweak the plan and you get both risk and reward displayed and then projected.

The charts displays both risk and reward. The projected amount is the reward and the range of percentiles takes into account projected risk. Far superior to a FV calculator.

You now know more than 95% of the Boggelhead Guru’s, and you understand the power of epochs, Monte Carlo and Efficient Frontier. This is part 2 of the “planning tools” series Part 1 was Goalscape.  A look at Personal Capital and Mint and Schwab RMD calc and SS will follow.

Using Goalscape to chronicle the plan on say a personal blog page.

The goal with a drill down from Goalscape You can chronicle a dozen scenarios on a private blog and rapidly switch back and forth.

Goalscape

Save half, invest in low cost index funds. You need 25x your income and can withdraw 4%/yr safely. It’s a plan. But life is more than a simple equation. If you’re married w children there is educational expense. If you stash money in IRA like accounts the government owns part, is taxed as ordinary income and the government forces you to spend the money in your old age. If you stash money in a Roth account you paid off your government debt early, but the account has its limits on investment amount so you have to save a long time to get any substantial amount. Taxable accounts are taxed with the purchase money and taxed yearly on the investment income and taxed again on its appreciation. Medical expense is a constant and there is an account for that. There are plenty of tricks and hacks and optimizations and “how you do it matters”. So what’s a mother to do?

I would define life in epochs. Each epoch has its purpose. Fore example you get married, that starts the “married epoch” and the need to fund a marriage. You have children, that starts an epoch of needing to fund children at least until they can fund themselves. You want to retire some day with more than a pittance of government subsidy that starts the retirement epoch. You start a business, that’s the business epoch. Epoch can and must run in parallel. Epochs have different sometimes well bounded time frames. For example college occurs over 4-6 years depending for each kid. It should be neither over funded nor underfunded. It should be neither over risked or under risked but properly risked, so the money is there when the time comes. Retirement has a different time frame since retirement lasts a lifetime, but the same kind of constraints apply. You need to properly fund it, properly risk it, and properly spend it. A business has it’s own epoch. You have to build it maintain it and eventually dispose of it. It has its costs and it may or may not fail. Healthcare and insurance cost has it’s own epochal consideration.

These epochs intertwine in a complex way. If you have a business or a wage you use that to fund your future. Once you’re finished working you use what you funded, the accounts associated with each epoch as the means to subsidize your future and your security. Save half, x25, 4% doesn’t do the complexity of the problem justice. It’s basically saying “something is better than nothing”. True enough but woefully incomplete in it’s analysis. You want a plan with a high probability of success. Enter the tools.

I found a website that allows goal planning called Goalscape It’s a tool to plan complex problems like financing life. It has a free version that allows up to 30 goals to be planned in hierarchies with variable percentages in the hierarchies and the screen has a drill down feature. So I whipped together a financial life life

This is kind of the 4% x 25 view of things. You spend most of your life working (31%), saving for college (6%) and saving for retirement (31%) , and a similar time (31% spending your portfolio. In this example the retirement portfolio accumulation and deflation are identical at 31%. Work and interest on investment fills both College which is 6% and. So 68% of your human capital is represented in work and saving, some for college and some for retirement. This is what “save half” means. You use 68% of your Human capital and expend 31% on living, 31% on purchasing a retirement portfolio and 6% on Juniors future. Jr goes to school and spends his 6%, you quit work and are left with 31% to survive in your dotage.

Now we are getting granular. We see “work” can mean W2, small business on the side and something you do to multiply your value called education. We see The Retirement Portfolio has multiple accounts and each account has it’s own feature/s disposition, tax treatment and percentage of funding. which must be elucidated for the plan to be effective. 4 x25 and stuff it all in a TIRA is nonsense when you actually think about this. We see the granularity of portfolio deflation start to emerge. It’s not that you spend 1/25th but actual needs are displayed and some idea of how much each need exists in a hierarchy of expend ability. You can skip splurges and jigger legacy so those categories become a sort of internal portfolio insurance if tings tend toward the sour. You can adjust the percentages because it helps you understand what and how long it takes to fund those percentages. This is the concept of UBER driver FIRE to regular FIRE to FAT FIRE displayed right before your eyes. College may also have components like scholarships and loans depending on income level at the time Jr goes to school. A buck saved from “college” is a buck toward retirement.

Even more granularity on what retirement means. You subdivide your needs and get a clear idea of what is bottom line and what is squishy. You’ve heard retirement is squishy? It mostly is not. It’s mostly concrete with a dab of squishy. It took 20 minutes to whip this up. It’s generic but a hell of a lot more informative regarding reality than 4 x25. It informs you what happens when you use a FV calculator to determine your future and the likelihood of success. It’s harder to delude yourself when you see 30 things need to be funded in retirement and each has it’s own inflation and risk etc.

Note: This is the free version and I used 27 categories. You can just plan, take screen shots (I use gadwin print screen capture tool, not the pro but the free one. Once you do the highest category you can make sub category hierarchies for example I would do a sub category on portfolio accounts to look at and optimize tax consequence vs funding and something about what I expect to do with the account in retirement. For example Roth in my portfolio is for insurance and legacy. As such it doesn’t need to be over funded or underfunded but correctly funded by Roth conversion. If it’s going to serve those purposes it need not be huge and it will grow unmolested to either be used in a disaster or to leave to the kids. If you fund it early it’s time to grow unmolested will magnify it’s value at the end. So if you fund a Roth for 6 years of residency and fellowship @ 6% return that’s $92K. You can get 6% in a 50/50 2 fund easy. In 40 years (say age 70) That $92K is now $1M and you are self insured going forward for long term care and medical disaster your cost for this self insurance? $66K.

Enough for now. I was playing with the Personal Capital program and between this tool and PC’s portfolio planner and some fooling around with the portfolio visualizer suite. I think you can give Buffet a run for his money when it comes to financial planning. You can certainly kick any Bogelheads ass every day of the week and twice on Sunday. I’ll write something on that soon.

The Fallacy of Retiring From a Book

I’m gonna tell a story ’bout a man named Jed poor mountaineer… wait wait wrong channel. What I’m going to tell is a little family history. My grandparents aunts and uncles are all dead so spilling a little family history won’t matter much. My grandfather was born about 1905 and he had a wife a few years younger. Gramps had a sister a few years older than him so she was born 1900. She married a guy probably 5-10 years older than her so he was born 1895 or 1890 or so and he was my uncle. My dad, also deceased was born in 1928. That locks you into a reality of pre depression life. In 1900 there were only 45 states as UT was added that year. WW1 was still 18 years away. Both my Gramps and Uncle were entrepreneurial types but expressed that in different ways. My uncle was technical, he built radio stations and wired telephones and “saved half” even in the great depression stuff needed doing and somehow he managed to get paid to do it. My aunt always worked. She was a telephone operator and they had no kids so the second income helped to create a nest egg. After the depression my uncle bought a failed “summer resort” on Mackinac Island in Michigan. It was a few cottages on the beach. The was no bridge joining the 2 parts of Michigan across Mackinac straits and things were all by Ferry. Now I-75 crosses the straits.

The cottage business was seasonal, rich people from Chicago and Detroit trying to beat the heat down by the beach in the summer, ice and snow in the winter so my Uncle bought a trailer down in Florida and they worked the resort in the summer and enjoyed the sun in the winter. Does this sound familiar? Eventually they qualified for SS and Medicare and sold the cottage business to retire to Fl. My uncle always drove the best Cadillac, it was his feature. My uncle lived into his 90’s and then my aunt into her 90’s. Despite my uncles facility with finance over the ensuing 30 years things got tight. In my aunt’s old age she would go order an early bird special and then complain about it and try to get it comp’d. It was embarrassing, then she died. The disposition of her things fell to my Dad. After all was said and done she had about $15K left to her name. Better than nothing but a real bounce the check for the under taker kind of story, and I understood why she always tried to get her early bird comp’d. They lived a FIRE kind of life. It worked! Barely. She still drove that Cadillac but parts were falling off at the end.

My Grandpa was a hard charger. He started with A&P around age 11 pushing carts from the lot into the store. He didn’t have the job he just pushed the carts and got noticed, and pretty soon he had the job. He wound up as the meat buyer for A&P down in the Chicago stock yards. The cattle and hogs would flow in from far and wide on the trains, and he would buy the herd that would feed the people. The guy could pick a $100 steak while it was still on the hoof. He would bring home a hunk of beef liver that would put sirloin to shame. Roast beef? Don’t get me started. He grew in that grocery business to become Vice Prez and in the end was building shopping centers and all kinds of stuff, but he wasn’t an owner he was an executive and he retired on a good pension and SS + Medicare to a 55+ community in FL about 25 miles from my Uncle. It was a nice new community and he immediately became president of the HOA or something for the community and he got on the building committee of the proposed new church down the road. In the beginning when there was nothing they would have Mass in his living room. Eventually a church and school were funded and built and he continued to live off his pension. I liked the location as my grandmother could go down the street turn right go to church, then go a little farther down the road to a shopping center get her hair done, maybe have lunch, go grocery shopping pull out on the cross street and turn right, go down a ways and turn right and wind up at home. If you ever drove in Ft Lauderdale traffic you’d understand the value of an old lady only needing to turn right to survive. My grandfather died from AIDS in the 80’s. He had a triple A done and as is often the case was transfused with tainted blood which hustlers sold for McDonald’s money. It was a time when AIDS was just being understood. That right turn routine became even more important as my grandma soldiered on. Eventually she broke a hip, went into the hospital, got her hip fixed, infarcted 2 days later and actually blew out the wall in her LV. I trained as a cardiac anesthesiologist and had seen a lot of badly scarred heart but never a blown hole in the muscle! It fell again to my Dad to take care of the disposition. Grandma who was just under 90 when she passed had about $50K left. Her finances initially were solid but as the originals in the retirement community died off the places were sold to families and being an older community, lower middle class families. Those families wanted services like swimming pools so the home owners fees sky rocketed and taxes skyrocketed and Gramps wasn’t president any more to ride herd. So a pensioner was in a bit of a pickle with a fixed income and rising expense.

That’s enough history but it does lay out the reality. Someone born around 1900 had a whole different reality than someone born in 1928 and someone born in 1952 (me) and someone born in 1997 (my daughter). My aunt and grandma made it, barely. A nursing home stay would have wiped them out. What’s the likelihood of a nursing home stay at age 89? You can get out your future value calculator all you like but it doesn’t reflect reality. That 20th century was a century where America had a great expansion and we all remember that. In the 21st century up to 2017 GDP is up on the average only 2.1% over 17 years. 17 years is more than half a projected retirement. It may not give you pause but it gives me pause. Pensions work until they don’t. Real Estate works until it doesn’t. Stocks work till they over inflate and then regress to the mean and the regression steals half your net worth.

You can learn a lot about retirement just by taking a few hours and journaling your family’s history and the economic circumstances in which that history occurred and then thinking through salvation strategies. Beats hell out of wasting your time watching the talking heads on CNN try to beat themselves to death with their lips and trying to out snark each other.

Who Owns Your Money You or the Government or Harvard?

I wrote a response to a forum I infrequently visit about Roth conversion. The math types all were going through their analysis on why it doesn’t really make a difference bla bla bla, but they entirely missed the point of what money is about. You work hard, turn your human capital into value and stash some of that value into an account or two or three. That value doesn’t belong to you. It belongs to you AND the government. How that value is treated is a function of the account type in which you stash that value. If you put it in a post tax account it’s probable ongoing source of income for the government. You pay taxes on the ordinary income to start, stash what’s left and if it generates more value you are taxed again on the new value either as dividend or capital gain. If you loose the government doesn’t charge you for your pain and they give you a credit to charge against future profit. You can stash your value in a TIRA, an account that postpones your payment to the government, but make no mistake part of that value belongs to the government and it’s coming out at the most expensive tax rate, “ordinary income” Pound of flesh time. Ordinary income is progressive. The more you make the higher the “tax rate” not just the higher “the tax”. The effect is a “multiplier” not just a linear “adder” Double the income does not mean double the taxes it means 2.5x or 3x the taxes or more if you start adding surcharges and taxing cliffs. The third place you can stash your value is a Roth. With a Roth you square with the government once and then they leave you alone. You can withdraw without a progressive tax burden of either TIRA or post tax accounts. You can stash value in things like real estate or art or gold but similar tax burdens apply as post tax accounts.

The government has another trick. At age 70 BY LAW they start collecting their money from your TIRA on their schedule and you don’t have any say in it. The calendar rolls over and a predetermined increasing % of your TIRA must be extracted. The % extraction is progressive i.e. a multiplier. In addition as the distribution increases the tax increases as a multiplier because the tax code is progressive, so it’s multiplier times multiplier and you don’t have a thing to say about it. The government is nice and they don’t start this extraction till 70 so you’ll probably expire before your money expires but none the less the government is coming for their money at their leisure not yours. IRA like accounts are marketed such that you can stash value and avoid a high tax rate you may pay on the value immediately in order to subject yourself to the double multiplier effect later and the bet is your tax rate will be lower in your old age so the net result is you MAY pay less but then again you MAY not. It’s a bet! The control variable is the size of the amount of value in the TIRA.

The tax deferment is a middle class perk used to incentive retirement saving. As you make more the incentive disappears, in other words if you’re rich you get soaked today instead of in your old age. At some point the government realized this was a pretty good way to fleece the middle class so they set up a million “tax deferred” vehicles each with it’s peculiar tax treatment and extraction methodology and spending rules. Save for college? No problem 529b, can only be used to transfer wealth from you to something “accredited” Oh happy day if you’re a university. Jr gets drunk for 4 years on your nickel and Harvard’s tuition goes up at slightly above the rate of market return because that’s how much is in your 529b and they want the whole shooting match and you think what a fine deal. Your money grew for 20 years tax deferred just so Harvard could gobble it up, but you didn’t save enough and wound up with a student loan anyway and Jr graduates with a piece of paper and a hangover and a payment schedule, and you feel bad like somehow you failed. NEWS FLASH it was rigged against you. 529b’s are Harvard’s friend not your friend. The point being these tax deferred accounts are not necessarily your friends, yet how many times have your read “max out your tax deferred accounts it’s a no brainer”? You have to think through the liabilities and who benefits in the end.

Value is good for one thing: keeping you comfortable and alive, from your point of view. From the governments point of view your value is good for funding itself under penalty of law, and given the debt the sooner the better! So lets say you followed conventional wisdom and maxed out your retirement accounts. You did well and have a big wad in tax deferred money. You can max out something just shy of 80K/yr in tax deferred accounts. In 25 years you will own 3M+ of tax deferred money! At a 4% WR that’s $10K/mo baby plus SS to boot! Hubba Hubba! So you retire at 62 and take 80% of SS (say 25K) plus your $10K. Your accounts make 6%. 10K/mo is slightly above RMD on $3M. Your tax bill is $17,600 on your netted out TIRA + SS income of $141K/yr or 12.5 cents on the dollar You hit age 70 and the RMD for 8 years into retirement is 164K plus your SS net so your income is 185K and your tax $27,299 or 14.8 cents on the dollar.   At age 75 your haul is 240K and your tax $40,419 or 17 cents on the dollar.

At 76 you get cancer and you beat it! But it takes 4 years at and extra $100K/yr expense. Your RMD at age 80 is 284K plus you had to take out an extra 100K so your tax that year on $384K is $78,500 or 20 cents on the dollar. Now your wife gets cancer and in 5 years she beats it at 100K/yr so at age 85 your pulling 482K out of the TIRA with a tax of $111,800 for 24 cents on the dollar. 

Back when you were 65 you could have pealed off a million or two at a lower tax rate doing a Roth conversion. 250K/yr conversion (1M) would have cost you 17 cents on the dollar and then your done. Your TIRA would RMD at a far lower rate. 120K at age 70 with a 10 cents on the dollar tax  at 75 $165K with 14 cents on the dollar at 80 $210K income with 15.7 cents on the dollar tax and at 85 $261K income at 17.4 cents tax You and your wife still get cancer and you still beat it but you pay the extra from the Roth tax free and enjoy lower taxes on your TIRA distribution as well.

That’s the real advantage of Roth conversion is you are prepaying for disaster coverage and tax free growth as opposed to tax deferred growth at a relatively low rate. In addition if you die your wife is left with paying single rates on her taxes so in her 86th year the 2M + 1M Roth payout would cost her on a 261 K RMD income 23 cents on the dollar On a 3M TIRA the RMD would be 397K and 28 cents on the dollar  

So the calculation is colored by how the money is used and how rapidly it is needed. TIRA retirement is about doling out small aliquots of money and letting the “interest” pick up the slack. If bad things happen and you’re TIRA you are locked in with no flexibility. The government is coming for their money.

Welcome 2019

My wife’s in the other room watching the parade. Girls in grass skirts waving plumes. $300K worth of hydraulics on trailers with billions of festive pumpkin and poppy seeds glued to their surface trying to navigate razor sharp right turns. It’s hard to turn a battleship on a dime. Think of all that wasted DNA. Some game show host narrating. It’s a tradition. We used to watch the Christmas parade till it became unwatchable. We some times watched the ball drop till this year one of the NBC co-hosts decided to tell us all about her menstrual habits and they forgot to show the ball drop. The Pasadena spectacle was OK. Harmony of Union caught FIRE, no, no literally caught FIRE and Chaka Kahn belted out a medley of her hit, so it looks like Pasadena is going in the dumper as well. Disney is too close to Pasadena to not assume control of 3 hours of TV time to promote itself. Welcome to 2019!!

I spent New Years Eve thinking about the past year and my life since I retired. I finished off the 2018 spreadsheet chronicling my spending and spent a little time projecting our longevity. I’m in the danger zone, that zone of early retirement where SORR can rear it’s head and take you out in your dotage. I dutifully calculated WR in 2017, WR in 2018 and what I expect WR to be in 5 years. Retirement is a financial kaleidoscope as different patterns of risk and reward emerge out of the mist according to the “economy” and “tax law”. It’s not what they promised when they told you “4% x25, ya that’s the ticket!” It’s a little more complicated, but all in all a very enjoyable trip. I’m going to talk about ACTUAL RETIREMENT, not some Bogglehead BS full of smoke and mirrors and silly side gigs.

Budget: Have one

The first thing to come to grips with is the meaning of freedom. Freedom is limiting. You might think it’s liberating, it’s that too. Freedom is constrained by something called a budget, PERIOD. When you assume your own risk of living and the possibility of failure silly equations loose their luster. My biggest line items were TAXES, Insurance of all types, food, utilities. Not much of that is negotiable. In W2 times you may forgo a budget since you make so much money it feels decadent to ignore your expenses. Works for me, but when the W2 is history you got what you got. If you have no clue you will die clueless so get a clue, a budget gives you a clue.

I’m not obsessive about my budget. I made enough during W2 days so my budget could be generous, and so it is. Just because it’s generous however does not mean it needs spending, it just means it’s available for spending. Your best sword against SORR is a low WR from the portfolio. The lower the WR the higher the probability of success. Low WR to start gives you a lot of flexibility. I didn’t know what to expect so I picked a number $10K/mo. This number was below what I had been making during W2 but that W2 number was funding many other things beside the day to day. Big salaries mean big taxes and Kids means big expenses. Back of the napkin isn’t really good enough when you have available the ease of something like Mint.com. I track 1 credit card in Mint and 1 bank account and use that to pay ALL of my bills. The categories take care of themselves. The other credit cards are payed from the bank account like a bill and things like electric and health insurance are automatically deducted. The main credit card pays me $1K/yr for the privileged of tracking my expenses with their cash back deal. Given the ease of tracking, not budgeting is pure hubris IMHO.

I was obsessive about tracking in 2017 since I didn’t know what to expect. By 2018 I had a much clearer picture so my obsession went away. The method also revealed expensive months and cheap months so you can decide any given month where to place your spending. Dec was particularly expensive as I sent $50K to the my buddy the IRS, for the Roth conversion I did in Nov. I also did an experiment to see how low I could go. This means we purposely cut back to subsistence to see what that felt like. It felt OK and was worth the experience to understand the affective nature of the income range of our lives. One thing I DON’T want is for my wife to feel pinched in our lifestyle. We have more than enough and a visceral understanding of that makes a difference. It keeps you from making risky mistakes. This is why the freedom of retirement is limiting. You have to redefine the boundaries. That becomes a different question if you don’t retire with enough. Enough is measured in cash nor narrative or presumption. Budget sets the bottom line.

Accounts for the journey from an already retired perspective

I’m Roth converting a big wad of TIRA using a cash stash to fund the process. I’ve obsessively written about this. It turns out to be rather complicated to optimize. What you need is enough cash to cover a period of time to do the conversion which maximizes conversion at least taxes. Once you pay the government what you owe them they leave you alone. Desirable! The time to start Roth conversion is the first year you invest. Stick what you can in a Roth and stick even more in a taxable brokerage account. Tax loss harvest the brokerage account so you can sell appreciated stocks tax free when the “time” comes. The “time” is about 5 years before the government forces you to RMD.

1, The taxable account plus appreciation, plus tax loss harvest is the FIRST of several retirement accounts you need to develop.

You don’t need to put all of your money here by any means but it needs a yearly sizable contribution. It is the money you will live on when you first retire. The longer it’s invested the more of your early retirement will be due to appreciation and not principal. Setting it up first is intentional. It means you are committed to your future and once it’s set up and funded, it’s set up and funded. Over time if you effectively TLH it will be tax free money not unlike a Roth because the tax loss can be written off against the capital gain. This makes it cheap to own in the scheme of things. Cap gain taxes are not particularly progressive in nature especially for the people in the first 2 tax brackets where they are zero. But even for higher brackets they are lower than income taxes.

2. Fund the Roth accounts.  

Once the taxes are paid the government leaves you alone. Even in TIRA accounts if you already paid taxes on some of that money, future taxes are absolved on the already paid part. There s a formula to calculate the tax break, and this money is not subject to future SS and medicare tax since you already paid your Medicare and SS when you deposited. You pay that once and then you are done. This money once accounted for by the tax man grows TAX FREE. This is the LAST money you will spend since the longer it goes the more it grows. Funding this early means it grows a really long time. I’m using my Roth to self insure for future disaster like a cancer diagnosis or assisted living. There are normal periods of risk in retirement like day to day expenses and there are abnormal periods of risk which have a high cost. If you fund a Roth and stick in the back of the cabinet it will be there in your old age. If you don’t use it your kids will thank you.

Finally fund your TIRA accounts

Ya I know “bogglehead heresy”. Every dope know you fund your pretax first! After retirement TAXES they come with a vengeance. The government gave you a TAX deferred possibility, not a tax free possibility with a TIRA, and they are coming for their dough. Part of that money in your TIRA accounts doesn’t belong to you so you are not nearly as wealthy as the bottom line implies. Pay me now or I will force you to pay me later is the governments motto and they force you with RMD. Most people don’t RMD 3 million bucks. The average joker RMD’s $600K and the tax code is set up for that guy. Between SS and a $600K TIRA you live a nice middle class life in retirement. $600K RMD’s $22K the first year, about $2K per month and between that and say $30K of SS you live on $55K of income with a tax bill of $2127, an effective tax rate of 3.86%. If you RMD a $3M TIRA your first year is $109K and with SS puts you into the 22% bracket at a tax bill of $15,397 an effective rate of 11.5% So the trick is to grow your assets tax deferred and then have a plan to get yourself into a low bracket when “the time comes”. From a post retired point of view it is critical to understand these moving parts and their sequencing. I did my first Roth conversion in 2018 and will convert 1M from the TIRA to the Roth over the next 4 years at a cost of about 11 cents on the dollar. I will leave some money in the TIRA to RMD but the amount left in the TIRA will put me in line with the normal retiree’s income and tax bill, and will keep me in the 12% bracket for a long time, meaning my cap gains for taking money out of my taxable portfolio will be zero. My taxable will continue to act like a Roth and throw off tax free money for a long time. In addition I have excess TLH so once I move to the 22% bracket the taxable money will still be tax free. Meanwhile the Roth stands poised to take up the slack just in case. Once I die my wife is well covered.

WHY ISN’T MMM telling you this shockingly simple truth? What about BOGGLEHEADS?

Taking all of this into account requires a shockingly longer work life than those jokers advertise because you have to manage your own risk, and you can’t really sell books and speeches selling “normal retirement”. Hell anybody can do “normal” no magic bullet in that! Just stick some money in low cost mutual funds…

So how did I do?

Budget:  Last year (2017) I came in under budget by a few thousand. Early retirement turned out to be a bit expensive as I had some AC’s and house repair to be done. We also had a hurricane which ate up some dough the month after I retired. This year (2018) I came in $20K under budget despite the expense of launching my daughter in her post college life and the tax expense of Roth conversion. My WR was 2.7% for the year including the one offs. I’m not yet taking SS nor is my wife so this early part of my retirement is entirely portfolio dependent but that was in the plan, and it is being executed perfectly despite market conditions. The “money” I’m living on was obtained when the market was at its peak and at a zero dollar tax bill so the taxable + TLH really worked out for me. I have 4 to 5 years of “money” left in the pile to use without SORR consequence while Roth converting. My future for the next 5 years is market independent and therefore I have no market risk on my life for the next 5 years. After that my WR will drop to 1.4% as SS kicks in and my remaining TIRA annuitizes and begins to RMD.

The view from the portfolio

I’m not one who cottons onto the idea I have to take it like a man. I worked a long time and the advantage of retiring truly plush with resources at a more normal age is you don’t need to make 7% survive your 30 years or 10% to survive 60. A percent above inflation will do. 2% and I’m good for 100 years so there’s no reason to take the risk, since I don’t NEED to. I don’t have the hassle of side gigs and the waiting to fail if it ever gets off the ground in the first place. Who needs em!? I don’t. I’m not living on narrative and a projection, I’m living on cash. When you RE you forgo this luxury because your future is leveraged. Retirement is NOT squishy. The only squishy part is how leveraged you are. More leverage, more chance of failure. More leverage, a worse response to SORR. Leverage is why people fear a downturn. I de-risked my portfolio some this year as my risk is now about 48% of the 100% stock risk. My return is down as well but only by 25% compared to the 100% stock portfolio so seems like a pretty good trade off. You loose a little on the return, but you are still 100% invested, but you gain in that your portfolio goes down only half as much.

The view from retirement is risk management trumps return IMHO.

  1. Multiple accounts with different tax treatments so you have a means to adjust your tax bill

2. Retirement epochs, periods where you can granularly describe what is supposed to happen, and what is happening and how that effects future epochs with an eye toward optimization.

3. Enough time to prosper.

4. Study. The knowledge and insight I’ve gained is amazing, both pre and post retirement.

2019 may be a good year or may be a bad year. Personally I think we are doing OK but the politics are out of control and the politics can do you in. In 1978 Carter signed a bill divorcing S&L interest from prime and the S&L crisis ensued. A few got rich and we all suffered. In the 2000’s Barney Frank pushed sub prime lending to the max and we had 2008. A few got rich and we all suffered. I guess time will tell.

Bottom line retirement is a total gas! Completely different smoke than the work a day world, I recommend!

The View

I’m a fan of the Stoic Philosophers. Stoicism dates back to 300 BC and had 3 ages. Stoic Doctrine covered these notions:

Stoic Principles

  • Nature – Nature is rational.
  • Law of Reason – The universe is governed by the law of reason. …
  • Virtue – A life led according to rational nature is virtuous.
  • Wisdom – Wisdom is the the root virtue. …
  • Apathea – Since passion is irrational, life should be waged as a battle against it.

Stoics varied in station from the slave Epictetus to the Emperor Marcus Aurelius and the American experiment owes much to this philosophy. Heraclitus of Ephesus was pre-Socratic and his view was to explore the riddles and paradoxes of humanity the huge unconsciousness of life in it’s relation to the universe. His writings come to us only as fragments so you don’t have majestic volumes to contemplate but you have to make do turning snippets into whole cloth. Heraclitus can perhaps be summed up in one phrase, “the only constant is change”. In some respect he felt change was the cord that connected the future to the past. His famous saying is:
“No man ever steps in the same river twice” which is the basis of the philosophy of “becoming” where as Parmenides stood in contrast with “what is – is”, the basis of the philosophy of being. In these philosophies lives the tension of FI and the FIRE movement. Heraclitus is where I get the notion of “all time travel is forward moving”. If you step in a river, step out and then step back in, in the second step you’re in a different reality than with the first.

Retirement is nothing if not stepping into a different river. It’s a completely different reality than work life. There is all kind of discussion regarding RE and FI, much of it rationalization and marketing, about retirement. One comment is “retirement is squishy” implying retirement doesn’t have a “real” definition but is amorphous and subjective. That’s a pretend reality. The idea is you rebel “against the man” who’s got you enslaved under his boot. Somehow this “man” is your oppressor. He oppresses you by giving you a salary, benefits like paid vacation, health care, a stable environment in which to thrive. He takes on much of the risk you would otherwise suffer. If sales suck for the month YOU STILL GET A PAYCHECK. If the economy is in the dumper YOU STILL HAVE HEALTHCARE. That “man” is a real SOB that’s for sure! Why he expects you to actually “work” for those benefits or at least show up. He needs you to make some money so he can give you a paycheck and manage your risk for you. You want Freedom, you want Independence! No “man” gonna tell you what to do! Why Why I’ll save half and put it in low cost index funds till I get 25 times and then and then RETIRE EARLY! I’ll show that SOB! The drama, the pathos, the sanctimony, it’s all so pedestrian. If you retire at 30, you have 60 years of risk and expense left to cover on your own. Pathos don’t pay the bills.

I recently listened to a Podcast that was hawking RE. Nobody on the podcast was retired. Everybody was still working in some fashion. One had been through the ringer in her life and understood the real danger that looms out there. Under-employed, her husband got a diagnosis and she became “it”. She went into Wonder Woman mode and booted herself into financial security while her husband recovered, plus the kids got raised. It’s an amazing story. She stepped into a different river, but she has been scarred in the process. In her success she saw the bottom approach as she plunged toward the sudden impact. Pull up, pull up, and she did, but as a result she’s not in a big hurry to relinquish her security for “freedom” and “independence” because she lived the risk those words imply. Another just retired at 55. He was a well regarded corporate guy who grew weary of being a road warrior. He had a gig fall in his lap where he is a board member for a corporation and writes a blog, so he no longer fight’s the battle but still is employed. At 55, his portfolio longevity risk is 35 years, a damn sight better than 60 years and he’s spitting distance from SS and Medicare. I read on his site actually 55 is somebody’s boundary between retired and retired early. Either way he’s still working. Another writes a high profile financial blog that makes a lot of money. He sells courses and news letters and podcasts, he owns real estate has a stock portfolio, is a physician and group owner. He’s a natural marketeer. A real every day in every way Tony Robbins type. No problem with that except this guy is as far from retired as Pluto is from Sol. He the one with the notion of retirement is squishy. I guess you have to redefine retirement and make it “squishy” to deal with the cognitive dissonance of the paradox. Another is a real estate guru and is selling his knowledge of real estate investing while owning real estate as his business. His gig is “independence”. He perceives himself as independent. Maybe true but independent is not retired, it merely means you have taken back the risk you gave up when the “man” was “oppressing” you. You’re still working. The last is a physician who has made his life into precisely what he wanted it to be. He came to realize being tied to his phone managing hundreds of severely ill patients 24/7 was not how he wanted to live, so he cut back, started a blog and became a speaker and a podcaster. It’s an expression of freedom, it’s an expression of entrepreneurialism, it’s not retirement. It’s just stepping into a different river.

So what’s the point? People look at FIRE like the participants have 2 heads and 4 mouths. On the one hand they are “retired” on the other hand they clearly are working. On the one hand they are betting their future security on something flimsy like a blog or consulting or what ever. They come up with a “rap” that looks nothing like their reality and try to sell it as “reality”. It comes off phony and it comes off like multi-level marketing. People hear that story and understand it perfectly and say “no thanks, I’m not interested, I don’t do Amway” and the FIRE types just can’t understand the lack of appeal for adopting some “wacky theology” and then betting your life on it. I’m like Heraclitus sitting out here on the perimeter looking in to the unconsciousness of it all. I’m not judging any of it, just contemplating it. Contemplating how there are so many opinions on the state of “being” retired and how to get “to be” retired, while no one actually IS retired. I’ll probably do a post on what actually “being” retired is like from a financial perspective. A post about living in the bulls eye not just aiming at the bulls eye. I stepped into the different river and understanding where “here” is not where “there” was predominates. Can’t wait for 2019 to unfold. I’m a year and a half down the river and I want to know what 2 and a half is going to be like.

SOR

When I wrote yesterday’s post I realized there is a fundamental flaw in the FIRE model. Yesterdays post had to do with changing the AA and moving the portfolio onto the efficient frontier, and it’s effect on portfolio success. By eliminating a class of stocks (global) and putting that money into bonds we saw an amazing change in the risk of the two portfolios, defined as % success. Why did this happen? How can selling stocks and buying bonds improve things so dramatically in terms of success?

You read the FIRE literature and all you read is the “magic of compounding”. Compounding has a specific mechanism. You take some “interest” add it to some principal, wait a year take some slightly larger “interest” add that to last years portfolio and the thing grows!

Here is $1000 over 10 years @ 7% interest. It nearly doubles to $2000 and every time you plunk $1000 into a 7% money machine for 10 years it will grow to $1976.15. There is a specific investment called a zero coupon bond that works exactly like this. If you buy a $1000 10 year 7% zero coup in 10 years you will get $1967.15 for your trouble. A bond is a contract that pays out in money and a low risk of failure. This is the magic of compounding! A mortgage works like this. You borrow $200K on a 15 year mortgage for a house and at the end of 15 years you have a piece of property you paid $360,000 for, (excluding tax write off etc.) The property may be worth more or less or equal to $360K, but that is independent of the loan. If you’re the mortgage lender you’re the recipient of the magic of compounding!   A bond’s value can be directly calculated at any time and is fixed. There is a market in bonds, but if you just hold to maturity it is what it is. You’re bond at maturity becomes promised cash. Income on bonds are taxed as ordinary income unless the bond is a special deal like a Muni bond. The bond aspect of your portfolio uses the magic of compounding to inflate it’s value.

A stock is a piece of property. It’s like the house. You pays some money and gets some property and you owns he property. You don’t own money. What sets the value of your property is the market, so the value floats up and down on the market, but that value is not money unless you sell it. If the asset appreciates it’s called capital gain and if depreciates capital loss so it’s taxed in a completely different way indicating it is not using the magic of compounding to inflate it’s value. It’s using the market to set it’s price. Like the value of your house, you hope a stock goes up in value but there is no contract assuring that like with a bond. Stocks offer return based on profits. Basically you take a raw material or service add some value and sell it at a higher price, but that profitability rides on the waves of the economy. Generally economy good, profit good, economy bad, profit bad, but also stock price is based on management’s ability to execute and creative destruction, inflation, the cost of money, the cost of labor, the cost of logistics, aka the cost of commerce. So stocks are risky. There are a lot of variables and variables vary.

When you own a portfolio and you are not adding or extracting you basically own a fixed amount of property. This is an important concept. Regardless of the “value” of a share which is set by the market, if you own 1000 shares you own 1000 shares, same as if you own a house you own a house. This is why in a down market if you don’t sell there is a chance to recovery because the property stays constant. This is why I see little difference in Real Estate and stock investing. Real Estate throws off cash flow, stocks throw off dividends. Real estate can be leveraged so can stocks. Real estate can be depreciated stocks can be tax loss harvested. Real estate can be used as collateral for a loan so can stocks in several forms for example covered calls. The value of real estate is market and economy driven, same with stocks. Some difference like liquidity and carrying charges and efficiency and correlation but more alike than different from my perspective. There are some tax breaks in the law for real estate but without the breaks profits would/will get taxed as capital gains.

When you open a portfolio and start deflating it, now value is being drained from the portfolio. It is no longer a bobber floating on the economic waves but starts to loose value. If the economy is good the value is high and you can slice off a little and sell high. If the economy sucks you sell low, but sell you must because you need some hamburgers to eat. High or low the portfolio has converted some of its property into money. You may say dividends! dividends! When the portfolio was closed those dividends were being reinvested into more property, when open that value is coming out and dividends are still floating on the economy. They may last a while but eventually will falter in a down economy. This is not the magic of compounding. Let’s look at a couple graphs:

The magic of compounding!

The risk of the market



You go SEE SEE the market goes up!! Except when it doesn’t You had to buy hamburgers in the years surrounding 1995 and 2003 and 2009 so sell low. Sell low = bad SOR. What’s the mean?

Not much magic here. Good old fashioned commerce with it’s concomitant risk and FED manipulation and money printing but no magic of compounding. The magic of this chart is you and your neighbor getting up every day and being productive. That’s the magic in stocks. American productivity and capitalism. So that’s why the 80/20 portfolio failed so much more than the 50/50 portfolio. It’s all been “magic” since 2009 but that trend line is calling for it’s pound of revision. In a balanced risk adjusted 50/50 portfolio half the assets are exposed to the compounding magic, in a 80/20 only 20% is exposed to the compounding magic. If you’re 80/20 you best be about protecting policies that encourage the magic of capitalism and productivity.

A Tale of Two Retirements

I occasionally read some other retirement forums than the few blogs I frequent. These are people often actually retired not just dreaming of retirement, people in my boat. Of course there are the experts, and the established pecking order spewing out the boilerplate, a couple retired CPA’s who like to pull rank etc but mostly retired Joe’s just trying to get by. I like to lurk and don’t post much because it threatens the CPA’s and I have better things to do than participate in pissing contests with beam counters. I did that my whole career when negotiating contracts. One of forums, given the recent market events, was about asset allocation in the face of loss. Interesting to see the rationalizations. A lot of brave soldiers standing up for 80% or 90% stock allocations, some complaining about not being able to sleep at night. Many visiting DeNial which is also a river in Egypt. Pretty much: Don’t do anything! Just stand there! and nobody giving permission to get out of the way of the buzz saw.

I was playing with the Monte Carlo calculator in portfolio visualizer and discovered an interesting thing. You can virtually guarantee portfolio success by proper portfolio risking and the calculator gives you a quantitative way to evaluate your decisions. It also frees you from the prejudice of “low cost mutual funds bla bla bla” and then shooting your wad into a BH3 fund because everybody else is doing that. So here we go!

Retirement 1 the BH3 retirement:

Here is how I set up the calculator

This is a 4% WR 30 yr standard format (inflation SORR etc all default) portfolio. I use actual tickers instead of asset classes. I chose the BH3 from the drop down

and proceeded with the calculation. Here is the result:

87% of the BH3 portfolios can expect to survive 30 years. Notice the 10% line 100% of the people who pull the 10% SORR card can expect to be broke in year 27. There’s a 90% chance you won’t pull the 10% or lower SORR so the question is: “Are ya feeling lucky punk?” Here is the failure distribution:

As early as year 9, portfolios following the 10% SORR or below BH3 portfolios start to fail. The BH3 is a 80/20 portfolio with 30% of the 80 in high risk global assets. It does not live on the efficient frontier which means you pay for your return with too much risk. This above graph shows the result of paying to much risk for your return.

Let’s change up the AA a little. Same conditions, same funds, except I jettison the Global fund and replace that 30% with bonds, a classic 50/50 2 fund.

Retirement 2, the 50/50 Efficient Frontier retirement:

The envelope please:

Notice just by jettisoning the global risk, which moves the portfolio ONTO the efficient frontier and adjusting the amount of risk you pay for return survival of 10% and below jumps to 98.43%, everybody on the 10% lines has 1.15M to leave to their kids. Here is the failure chart:

It’s not till year 19 the first hint of a failure rears it’s head. These two portfolios started with the same 1M and used the same 40K/yr WR over the course of 30 years. The only difference was properly risking the portfolio. The idea that you chose some level of “risk” for your portfolio out of thin air is stupid. The idea that you have to stand there and “take it like a man” in a downturn is stupid and this tool gives you a way to quantitatively consider your investments and not be a prisoner of some narrative.

Get ready to have your mind blown!! What would happen if you bough VTSMX BRK.B and VBMFX in a 50/50 efficient frontier portfolio? OMG Mabel he’s breaking ALL THE RULES!!!  No global index fund, quantitatively risk balanced asset allocation, no guessing, an individual stock!!!   Can you believe it Mabel, he owns  an individual stock!!

Bonus blow your mind retirement:

Your survival is better at 98.96% and you die with an extra $225K in the bank at 30 years, or you might need that money for end of life care. Stick that in your “low cost index fund pipe” and smoke it.

Not saying anyone should do this. Full disclosure I do own BRK.B.

Tax Loss Harvest

My portfolio consists of 5 account classes:

  • Taxable (post tax)
  • TIRA/401K (pre-tax)
  • Roth IRA (No tax)
  • Tax Loss Harvest (tax loss)
  • Social Security (taxable annuity)

Each of these fit into and support my retirement cash flow differently. In the taxable account I hold stocks funds and ETF’s which are distributed according various investing styles:

  • US equities
  • Foreign
  • Emerging markets
  • Alternatives
  • Low Beta

Things that throw off dividends and interest that would increase my tax load like bonds real estate and gold are in the TIRA accounts as well as tax inefficient equities.

I’m loading up the Roth with things from my TIRA and I’m transferring the things with highest volatility (risk) first. In a down year high volatility means greatest loss in value so the transfer cost (ordinary income taxes) is minimized and I can transfer the the most property for the least cost. Homey likes that. The least volatile assets don’t change value that much so no rush to move them. In fact since bonds don’t change much and throw off interest, I decided to not move them at all, let them RMD and use that as a retirement annuity income. I’ve written about all of this before. My accounts are invested according to Fama French efficient markets theory which uses the 3 factor long term tilts to try and tease out some extra return. 2 factors are missing in the classic Fama French model Momentum and Low Beta, so I add some momentum and low beta ETF’s and funds to round out the diversity party.

My adviser was reviewing my portfolio and noticed the momentum assets were underwater (as to be expected in a down turn) One ETF is the best in that class and another fund was performing less than optimally so we decided to combine the two. Since the assets are underwater their sale would allow tax loss harvesting. TLH is a way to essentially pre-pay your future capital gain taxes, by applying capital loss to the tax bill. It works a little like depreciation on a property or a business where you can lock in a loss to offset a future capital gain. It’s a very powerful tool. The rule is: the money you get to keep is whatever is left after the tax man pillages the funds so TLH is like hiding some money under the bed. In my case I’ve harvested enough losses by selling in down markets, to offset hundreds of thousands in gains in my taxable accounts. It effectively turns my taxable account into a Roth up to the limit of the harvested loss, and those saved taxes are no joke. You can buy actual hamburgers with those savings. But wait there’s more!

I used the TLH to combine taxable assets with no tax consequence and a future tax savings. Since both funds were down and had losses to harvest I wanted to maximize my take and acquire the loss from both funds, BUT I then wanted to re-purchase the better fund with all of the proceeds from the sale and the IRS doesn’t allow that. If you want to buy the same asset you have to wait 31 days, and suffer any market consequence while you’re sitting on the side line. The other alternative is to invest in some other asset that is substantially different than the first which you can do immediately and stay fully invested. I know… first world problems but then I live in the first world.

So what we did was sell about 100K of the momentum funds, into the rally, and I collected 20K in LTH and put that in the TLH bank to use at a future date. This is why I consider TLH a separate asset class. It is essentially negatively correlated to equities in terms of value. As equities go down my future tax relief goes up. I don’t like equities going down but may as well grab the value if it presents. So my 100K is sitting in cash and a reminder in the calendar to remind us to reinvest in the better ETF at the end of January, I own that ETF in my Roth and TIRA as well so I’m exposed anyway if the market explodes, but not quite as much as I will be in 31 days. I may even have a chance to buy in at a lower cost if the market continues to fade. So that’s the bet. It works like selling a covered put where I bet the market is likely going down or at least not advancing for 31 days. My risk premium is the locked in 20K TLH and my risk is I have to buy back the ETF at a higher price than I sold it for. Since I sold into a 1000 point rally that improves the chances of the trade working out to the positive. Ya ya I know you can’t beat the market, some joker wrote a study, so just buy low cost index funds…

I play a lottery called Lucky Money every week. It’s payout is limited to 2M but it’s odds are 125x better than Power Ball and a ticket is only $1 not $2. So I get 125x better odds for half the money. The elegance of the concept tickles me enough to get me to cough up the buck. I’ve probably revealed too much.