MD on FI/RE

I’ve decided on a Roth conversion schedule.  

$250,000, $250,000, $250,000, $250,000 for a total of 1M over 4 years.  I’m in process now and I have till Dec 31 to get the first conversion done.  This process has turned out to be more complicated than I thought but once understood very do-able.  This schedule does not eliminate some of the cliffs of conversion like excess medicare costs but minimizes them over 4 years.  

The considerations are 

1. Volatility of tax law.  Since the present tax law expires and the politicos seem hell bent on changing the law again it’s time to make hay while the sun shines.  This is why the first conversion are $250K.  No matter what that much will be converted and likely no matter what $750K will be converted before anything could legislatively be done to ruin the plan.  What could ruin the plan you ask?  They could eliminate the ability to convert.  Hopefully gridlock will protect me on all 4 conversions.  By sticking to $250K, as a couple we avoid the extra 3.8% medicare surcharge, but still get 1M converted in 4 years.  
2. My wife and I both own IRA’s which were funded with post tax dollars.  It turns out the government only expects you to pay once, so a % of the Roth conversion will be tax free and the rest will be taxed as ordinary income.  I’ve dutifully saved the 8606 IRS forms each year so I have an accurate legal basis.  Something to consider is each spouses IRA gets treated separately since Roth conversions are per spouse.  My IRA is large.  My earliest IRA contributions were only 2000/yr which was the  max contribution till about the year 2000.  The IRS has a formula by which you determine a percentage of already tax paid money which you can subtract from the gross conversion to give you net taxable money.  The formula (from investopedia) : 

“John Doe, a 30% taxpayer, has a Traditional IRA worth $200,000 on Dec. 31, 2018, of which $100,000 is non-deductible contributions. Doe wants to convert $100,000 of this IRA to Roth. Because Doe has $100,000 of non-deductible contributions in this Traditional IRA, you would think that he could convert the $100,000 of non-deductible contributions tax-free. Unfortunately, the IRS has a special formula that must be followed if you own an IRA with normal contributions.

Here’s how it works:

Tax-free Percentage = Total Non-deductible Contributions divided by
(Sum of year-end value of all IRA accounts + Conversion Amount) = $100,000 ÷ ($200,000 + $100,000) = $100,000 ÷ $300,000

Tax-Free amount of Conversion = 33.3% (or $33,333)Therefore, if John converts $100,000 to the Roth, he will have $33,333 ($100,000 x 33.3%) that is not-taxed and $66,667 ($100,000 x 66.7%) that will be taxed at his 30% tax rate”

That percentage is set each year based on contribution amount, total IRA size and total amount of non deductible assets in the IRA, for each spouse,  once IRA conversion commences.  Because my early IRA contribution was small when I started my percentage is small, about 2%.  When I started the IRS only allowed 2K per year per spouse.  So I will have to pay on 98%.  2% off works for me!  My wife however worked a shorter time and raised our kids as a SAHM so her IRA is much smaller so her % tax relief is much larger, about 9% meaning on every dollar converted she pays, only 91 cents are taxed.  Such a deal!  The 1M conversion is not just my conversion it is OUR conversion but the IRA belong to each of us separately so sequencing the conversions into each spouses Roth accounts matters.  It turns out by converting her entire IRA and by back-filling the remaining from my IRA to reach $250K total we save an additional $4000 in taxes.   So my sequence becomes: convert all of hers then begin to convert mine for a $4000 maximized savings on this years conversion.   I will recalculate next year on a conversion based on my IRA alone.

3. What you convert matters.  You want to convert your highest risk assets first and of those high risk assets convert the ones that are down first.  My TIRA’s are at Fido and Vanguard as are my wife’s and our Roth’s are there as well.  Fido and Vanguard will transfer assets from a IRA to a Roth without a conversion to cash step as long as both IRA and Roth are at their brokerage.  So the funds are transferred and a tax bill generated, slick!  This year Emerging markets and Foreign are down 11% and 9% so these are my first equity’s to convert.  Stocks are property and by transferring the least appreciated highest risk property first you can transfer the most property for the least tax bite.  My conversion order will then be remaining stock, then alternatives, then REIT, then commodities, and finally bonds.  My goal is to end up with most of my bonds still in the TIRA and not in the Roth.  This minimizes the tax bill.  A Roth’s greatest advantage is sheltering capital appreciation as in stocks.  It’s less effective in sheltering assets that don’t appreciate much as in bonds.  The trade off is pay the government now or pay the government later.  Assets with large appreciation potential should be in the Roth ASAP so they can compound over years tax free.  Something like bonds which don’t appreciate much can be RMD’d as an interest bearing annuity, and pay those taxes over time.  BIG NOTE the RMD is still subject to whatever percentage you determine yearly from the non deductible portion when you started conversion so in my case if I RMD $30K I pay on only $29,400 since my percentage is reduced by 2% or so (variable each year).  I’ll take $600 tax free, so it gives me a little Roth like relief even while being a TIRA.  By splitting my assets into TIRA and Roth based on capital appreciation I split my tax bill between paying some now on the aggressive earners with no further tax consequence, and paying some in the future on smaller less aggressive earners as opposed to paying it all at once.  This reduces sequence of return risk early in retirement to some extent.  I am paying my taxes from my post tax account so by having a smaller tax bill for conversion that extra tax money I would pay by converting everything continues to grow in the post tax account.  My goal at RMD is to live on SS + a small RMD which gives me room to grow for quite a while before a jump to a new tax bracket, supplement my income as needed from small donations from my taxable account and let the Roth grow unmolested forever.   

4. By cleaning appreciation out of the IRA you have the ability to control tax brackets for a longer time.  My SS will be about $43K and my wife’s will be about $10K for a total of $53K.  Taxes are paid on 85% of the $53K or  $45K.  The top of the 12% bracket including deductions for age 65+ is 104,000 (26,600 deduction plus 77,400 (top end 12% bracket), so I have $59K of RMD money I can use to fill to the top of the 12% bracket.  If I RMD say $25K my taxable is 45K + 25K or 70K and I have $34K of growth before I hit the next tax bracket.  That probably is 12-15 years of retirement.  Because of the .85% break on SS my spendable income will be 53K+25K or $78K.  I’ll fill in my remaining needs from selling post tax stock or from post tax dividends.  Since I’m in the 12% bracket cap gains are 0%.  A masterpiece in optimization!  (I think).  I’ve run it by my professional adviser and he thinks so also.

Just a snapshot of what post retirement granularity including Roth conversion looks like.  So much for 4% x25, get drunk on the beach.

You can’t control the future but you can control the likely shape of the future. In fact the whole 4 x25 rule is based on this, that somehow the future will look like the past. You only need a subset of the future to look like the past. You need the future to look like the past long enough for your plan to work until you become a carbon donor. Ever notice Curling? In Curling some joker throws a stone down a path of ice towards a bulls eye. Two other jokers have brooms and they slide along with the stone and sweep the way so the stone hits it’s mark. Victory has some component of luck but mostly application of doing what you can do to realize the result, aka risk control. The path of how this ballet plays out is not just accepting chance, but it’s encased in constantly changing the odds. I’m sure much drinking is involved as well perhaps changing the odds in another direction.

Poker is the same. In black jack the house has an 8% advantage. The advantage is due to the fact the house bets last so the player goes bust first. By correctly playing the player can reduce the houses odds to 0.2%, still a loser for the player but barely. The odds change because as cards are played, what’s left in the deck determines new odds with each hand and the fact the house has to live by betting rules. By understanding those changing odds and by judicious betting 0.2% negative goes positive and the player takes the advantage. If you get too good the house won’t play with you.

So retirement is not just abandoning yourself to chance but careful adherence to sweeping the path and correctly playing your cards and correctly betting, EVERY SINGLE THROW OR EVERY SINGLE HAND. The future plays out minute by minute not as an aggregate. Minute by minute is called accounting for sequence of return risk, aggregate is a future value calculator. People have trouble pulling the trigger because they are extremely risk averse. Their brains are wired that way. Your employer takes on the cost of your risk when he hires you. He pays for insurance, half your SS, makes sure all the government forms are filed on time, provides some retirement incentive etc. When you quit, all that risk cost comes back on you. If you have a plan that has dealt with the risk your pretty golden, if you have a plan that is based on some dumb assed formula you read on the internet.. ”At some point, we just have to decide that everything will be alright.” There is truth in that, but the truth is not inevitable and maybe not even probable.

I was playing with this the other day and I decided the formula should be a payout say 100K per year + a risk premium say 20K per year, for 120K per year and save x25 of that number. 3M instead of 2.5M. That would give you living expense plus risk premium expense. This is why people like 3 x33 because that just about equals living plus risk premium. You also have to include taxes based on yearly payouts and filing status etc. Sweep the ice!

I’ve read story after story about how to FIRE.  The formula always starts with “SAVE HALF”  or some similar bromide.   What does save half really mean beyond the obvious application of third grade math?  I was reading an article stating:  “Whopping 62 percent of jobs don’t support middle-class life after accounting for cost of living”  I’ve seen it proclaimed by some FIRE bloggers as if anyone can do this FIRE thing, with a bit of a sneer implying “and if you don’t you’re a dope”.  To save half, means you have to make twice!  Middle class is defined in the article as wages between $44K and $79K.  Professional class is $79K or more.  This means to save half and remain even in the low end of middle class ($44K) you have to be professional class ($88K).  On the high end of the range to save half you must make nearly $160K per year.   An entry level engineer makes $84K in NYC, $59K in Chicago.  Save half kind of implies you have no debt after say 5.5 years of engineering school.

But wait it’s even worse!  It turns out depending on where you live you may be under water even on $44K.  Honolulu has a starting middle class wage of $66K and if you apply the same middle class spread the upper limit would be $118K meaning save half would require remuneration between $132K and $236K per year.  You might say OK Mr. Smarty Pants, we’ll save 1/4 and work longer!  Yes precisely, you will work 9 years longer.  Saving half of $88K @5% for 15 years gets you $1M.  Saving 1/4 of 88K for 24 years gets you the same 1M.  A common scheme I have read espoused by some bloggers is all you need is 15% savings yearly.   15% of $88K is $13K.  That pays you 1M in 32 years.  I guess if you can land a $88K/yr job at 22 you can retire on almost $44K/yr at age 54 assuming you never get fired or laid off, and live in a cheap place.  Does the parlance of a 32 year career fit the fantasy definition of RE?  What is the true longevity of $1M at a 4% withdrawal?  At 54 you have 11 years to Medicare.   At 4% withdrawal ($40K/yr) would put your retirement 10% less than middle class ($44k).  You officially get to retire poor.   OK Mr Smarty Pants, we’ll work longer!  Why yes, yes you will.

In the past decade we have had unusual market stability, artificially induced by the FED and the regime of stress testing of banks.  In my opinion we narrowly avoided a depression in 2008.  We are off the gold standard since largely since the great depression and that allows the government to print money.  Also the FED bought toxic debt and returned treasuries which allowed banks to not go out of business.  The problem is if the debt had been called in 2008, banks would have imploded.  By moving the toxic debt to the FED balance sheet, it was allowed to mature and as it matured it became at least somewhat profitable.  Like healing a wound add protein vitamin C, zinc, and time.  By forcing bond returns low people moved out the risk curve and bought stocks, a lot of stocks.  The forced stability of the FED on the market gave the illusion of safety.  The economy is strong enough for the FED to unwind it’s balance sheet.  Both bonds and stocks have have moved far off their historic mean trend lines.  With the termination of FED interference both stocks and bonds will tend toward the mean, and the name of that game is increased volatility.   Bonds are starting to yield enough return that their inherent safety plus a little dab of yield starts to look attractive in the face of turmoil.    Stocks are inherently risky.  You think something like SPY is pretty safe but did you know SPY tracks only a little over 300 stocks not 500 and it has a large cap tilt.  VTI is even worse.  It’s not 3000+ stocks but about 1500.

I always wondered what would happen in a crash.  If you own SPY and they are forced to sell, SPY would likely no longer track the S&P because the momentum of the selling pressure on the 300 SPY stocks would overshooting would overwhelm the tracking of the instrument.  So your 15% volatility might be greater and increased vol means bigger losses compared to the real S&P or total market index.  Who knows?  A LOT of people own SPY and VTI and a huge heard of sellers is an enormous pressure on price.

Controlling volatility is important in a portfolio, as important as return IMHO.  High return is your friend in expansion but low vol is your friend in a crash.  Lets say you own SPY.  It’s projected return is 9.23% and it’s risk is 14.8%.  Lets say you own a million bucks worth.  Let’s say the market drops in half and my concern about increased vol doesn’t happen.  So your 1M turns into 500K, a 50% loss.  This means to recover to zero you need to make 100% before you reach your pre-loss level.  When you reach your pre-loss level you start compounding again and making money.  Till then you’re merely recovering.  That recoup can take a long time.

Here is a chart of SPY you can see the local max was on 10/8/2007.  It closed at $155.85  That number was not seen again till 3/11/2013.  That means for almost 6 years your money was sitting there under water.  After 3/11 you started accumulating and compounding again.  It’s Halloween, you want even scarier?  

This is the same SPY dating back to 8/28/2000.  Notice it takes till 2007 to recover from 2000 and almost immediately another crash.  This means nearly 13 years of living under water.  If you’re going to make your million bucks with this sequence you’re going to have a tough time.

This is what you made over those 13 years with a SPY account, 2.246%/yr and that was from reinvested dividends.  Say you retired in Dec 1999, with the intention of living off the dividend.  Your net growth/yr over the first 13 years of your retirement is 0.343%/yr.  Freaky eh!  

Imagine you had some bonds say 60/40 SPY VBMFX.   Your return is 7.41% and your risk is 8.93%.  Lets say SPY drops in half.  since your not 14.8% risked but only 8.93% risked (60% of SPY’s risk) your S&P will go down only 30% (1/2 of 60%) instead of 50%.  Your 1M would only drop to 700K not 500k.  That means you only have to get 60% back not 100% as in the first example.   You would get your 60% back about 2 years sooner and start compounding again,  while portfolio #1 is still under water.  If you did that twice say in the 2000-2013 case that would be an extra 4 years of compounding portfolio #1 misses out on.  For sure once portfolio #1 starts to grow again  it will grow faster but the return rate on #1 is 9.23% while the return on #2 is 7.41%  only 1.8% more.  Eventually #1 will overtake unless there is a bad SOR as in the 2000-2013 sequence.  What happens if yet another crash?.  The sequence repeats.    

Let’s look at the 40/60 case.  40/60 has an expected return of 6.53% and a risk of 6.24% (only 42% of SPY’s risk).  Now when SPY goes down 50% 40/60 goes down only 21% (1/2 of 42%).  Your million becomes 790K.  Your recovery to compounding again only needs to go up 42% as opposed to 100%.  This portfolio has the shortest recovery time of all.  Your portfolio is still compounding at 6.53% only 2.7% less return than the riskier portfolio.

Just because you pulled some asset allocation out of thin air does not mean you are wedded to that forever.  It’s not all or none.  You don’t have to go completely flat, you merely have to reduce your risk for a while by using a less aggressive allocation.  You can turn down the volume a bit, you don’t have to shut things off. In addition you can use that 60% bond money when stocks are cheap to buy a passel and be “loaded for bull” on the way back up.  Investing is like playing poker.  The house is slated to win by 8% but by playing correctly you can reduce those odds to almost parity to -0.2%(aka change asset allocation in a down turn).  You can further change the odds by buying low so you can sell high and let compounding work its magic.   How to know when to hold em and when to fold em is problematic.  I use a financial adviser and quant analysis and I’m happy to pay for that.  That’s my strategy.  If the guy gives me an extra 5 years of compounding during accumulation… you do the math.

This article is  an outline of a concept, a different way of looking at a portfolio from a perspective of capital preservation.  It is not a plan.  I do have a specific plan for my situation, but it’s more involved than this article would pretend.  If our interested it gives you a starting vantage point to begin your study.  The bogglehead approach is to simply stand there and take it with the refrain “I’m young I can recover!!” Problem is the young get old and the time to recover vanishes into the mist of mistakes made.  Compounding takes time.  If it’s a good sequence it pays off.  But another way to look at compounding is mistakes take just as much time to compound into failure.

This also points out a problem with FIRE.  Compounding relies on time.  You can wet start your portfolio by over funding.  HUH? Over funding?  It means you save half for 10 years instead of say 15% for 20 years.  Nothing wrong with that right?  What about mistake compounding?  That mistake is merrily compounding but is overshadowed by your exuberant saving profile.  It will manifest in it’s allotted 30 year time frame because it may take a long time for a mistake to become significant,  (Example national debt.  We ignore it continues to grow).  Let’s say you overfund save a lot of money but make a mistake (say running a portolio at 90/10 AA) that mistake manifests in 30 years but you retire in 15 years.  It means 15 years into retirement an over exuberant asset allocation takes its toll.  

Big ERN wrote a series here and here , looking at oscillating your risk profile risk and what he uses as red flags to know when to pull the trigger.  A second point of reference.

It’s no secret I’m a big fan of efficient investing.  Efficient investing means you pay for your return with no more risk than necessary.  If your in a cup game where a ball is hidden under a cup, you want the least number of cups in the game.  3 cups 1/3 odds.  8 cups 1/8 odds.  The bet (return) is the same so what is varying is risk.  Less cups means risk optimization and a greater chance of success.  I play a lotto game every week.  I don’t play power ball or mega million, I play lucky money.  Power ball has a 300M:1 chance, lucky money is 3M:1 so my 1 dollar ticket is equal to 100 bux worth of tickets on the other game.  Lucky Money caps at a 2M payout.  If the cap is reached the excess trickles down to lesser prizes so the $10 dollar payout with much better odds may grow to $15.  I don’t win a lot but I do win sometimes.  I win enough to buy myself a more expensive ticket on another game when that game hits 1.6 billion and the cost of playing for the 1.6 billion ticket is free because it’s from the free money out of winnings from the less risky bet.  Over the years I’ve hit $800-$1000 a couple times so at one buck a week the whole shootin’ match is free.  Playing for free is good risk management.   I could cash out and buy hamburgers, but I already have a source of hamburgers so I’ll risk a little free money.  You never know, plus it’s a hoot optimizing my risk.   Risk management is the driver for my play, not return.  

This is no different with portfolios.  IMHO that is all about risk management as well.  The beloved Harry Markowitz published a paper, the year I was born, on optimal portfolio selection which included risk, asset correlation, return, variance and co-variance.  The zero point or origin is called a risk free asset.  It is an asset where you can park your wealth and be virtually assured of your return.  The risk free asset is typically short term govenment paper called T-Bills.  Your risk and return on any other asset is therefore judged against the Risk free asset. 

Here is a pic of a Bogglehead 50/50 2 fund efficient frontier.  You see the curve sits on a plane.  Every point on the plane represents a risk (SD) on the horizontal axis and a reward (% return) on the vertical.  0.0, 0.0 is the risk free asset (T-Bill).  Every this else is related to this.  You see VBMFX which has a 4.79% return and a 3.4% risk compared to a T-Bill.  You see VTSMX which has a 9.9% return and a 15.19% risk.  Remember when you own stocks and bonds you own property.  What those numbers tell you is when the value of the bond property drops say 50% the value of the stock property drops 4.6 times more, mucho risk. (there is a correlation factor in there yet to be addressed I just want to let the risk nature of two assets to sink in.  To own bonds you can expect to get 4.79% back on your money.  To own stocks 9.9%.  Owning stocks gives you only 2 x the return that owning bonds yields, but at 4.6 times the risk.  You are paying for your return with a hell of a lot of risk.  Note these values are averaged values for each asset from 1997 to 2018.  The calculations are quadratic which means they are not linear but curved, and id you have a curve you can define a maximum point.  The maximum point on this curve is called the tangent portfolio.  It is the ratio of these assets that pays the most return for the least risk.  Those values are 16% VTSMX and 84% VBMFX and you can expect 5.55% return for only 3.58% risk.  Best bang for the buck.  The risk goes up a measly .18% (3.58-3.4) and the return goes up 0.76%.  How many boggleheads kvetch over saving 3 bp on the cost of a fund?  This is a whole 76 bp increased return!  

Notice the provided 50/50 portfolio.  It still lives on the efficient frontier.  You still pay an optimum amount of risk for your reward, it’s just that you choose to own a more risky portfolio in hopes of greater return.  The R/R of a 50/50 is 7.69 risk 7.32 return.  You pay 46% more risk for 31% more return.  The curve is curved because Bonds and Stocks have almost zero correlation so when the value of one is oscillating the value of the other is pretty much static.  The efficient frontier calculator likes non correlated assets because of this because it further reduces risk.  In fact some assets tend to grow in the face of a stock down turn.  Gold is such an asset.

Here is a picture of gold v S&P 500 during the 2008 down turn.  If you owned some gold and S&P, and you needed some money in 2009 what would you sell?  Buy low sell high of course, sell the gold!  This is why I own some gold.  It’s not investing it’s insurance,  it also points out the value of non-correlation.  

The bogglehead 3!:

Boggle heads love their 3 fund.  The rap is all about “diversity”  If you own more piled higher and deeper you are more diverse (right?) so let’s own US International, AND Bonds by golly.  Lets look at that on the frontier:

Remember every point on the plane represents a risk and a reward and the above is the R/R of 50% VTSMX, 30% VGSTX and 20% VBMFX, the vaunted 3 fund.  The return is 7.84% and the risk a whopping 12.27%!  Recall the 50/50 2 fund was 7.32 return and 7.69 risk.  All I can say is DUH owning a 3 fund is stupid stupid stupid.  You pay 63 cents more risk for 7 cents more return.  BUT BUT BUT how can that be Mr Natural?  

The R/R for VGTSX is 6.5% and 17.10, super risky, shitty return.  The correlation between VGSTX and VTSMX is 0.85 an high correlation means the 2 assets act nearly identically as far as response to a crash.  So you own a shitty asset compared to VTSMX (6.5% return v 9.9% return) but your risk is greater (17.1% v 15.19%)  Note these are averages.   Any one year a given class can out perform but on the average… (complete this sentence).  

So there you have it, lesson 1 in efficient frontier.  I may write a follow up about market diversity.

You can play with the calculator yourself 

I recently did a psychometric personality self assessment.  It’s created and published by noted Canadian psychologist Jordan B, Peterson and his university group.  I went to a Peterson lecture concert up in Jax last month with my wife and enjoyed the presentation.  I’m keenly interested in neuropsychology and functional imaging and how that affects lives and especially in the investing arena.  It’s 10 bux for the test so I decided to see what Jordan’s assessment has to tell me.

Peterson is a big brain and is also interested in neuropsychology and I find him quite credible and proliferative.  The study of personality over the years has evolved into what is called the “Big Five”.  These include:

• Agreeableness: Compassion and Politeness
• Conscientiousness: Industriousness and Orderliness
• Extraversion: Enthusiasm and Assertiveness
• Neuroticism: Withdrawal and Volatility
• Openness to Experience: Openness and Intellect

Each of the big five are further refined into 2 more dimensions giving a greater granularity.   Each trait can be viewed non judgmentally as each trait conveys it’s own power and support structure upon society (family, work, friendships, Church etc.) and melds it’s utility into the matrix of life.  As you discover the traits you come to know better “How you are” not just who you are.  My interest especially is with an eye on investment.  What type is a risk taker, what type procrastinates.  What type has a high barrier to investing and what manner of investing suits whom.  Investing at some level is competition and understanding the game and it’s players is useful.  Eventually we will be investing against AI and a comparative analysis of how you think and how an AI thinks will be mandatory.    It also gives some insight into choice of mate and understanding how your traits might mesh with theirs.  Information is power and nothing ventured nothing gained (the test tells me that’s one of my off the scale traits).  The test is available at Understanding Myself.  You are compared to men and women of all ages and strata so if you imagine a 10 dimensional heat map of society you get some idea of where you fit in 10 space.  Peterson’s goal is to give the assessment and then conjoin this knowledge with a self authoring program where you can write your story, and in the act of writing your story you gain significant insight into yourself.  Enough insight that you can start to iteratively make changes for the good.  He has a lot of good ideas to help people empower themselves for successful lives instead of just living in the stew.

I’m open to releasing my results but I won’t because I’m not sure how a preview would affect reliability for someone else taking the test.  Especially for physicians who are very testing savvy.  Some innocence I’m sure improves validity.    You take it only once, as repeated testing adds noise and unreliability to the result.  You can probably take it again 4 or 5 years down the road as personality changes as we mature in our life’s roles.  It’s kind of the basis of for at 20 you’re a liberal because you have a heart and at 40 you’re conservative because you gained in wisdom.   The scores in each dimension is read out numerically and a narrative provided regarding what people along that dimension are like.  I will say many of my scores were extreme, but then I kind of do live on the perimeter, stoned immaculate.  It’s my feature.  I wasn’t sure what to expect but I felt it interesting and the insight useful.  So for the price of a couple flights of craft beer you can get your head shrunk, gain some insight and have a hoot all at once and not wake up with a headache, having to pee like a race horse.

In the book of Mathew in the bible is a parable called the parable of the talents (Mat 25:14-30).  The parable simply stated:  To him who has more will be given, and to he who has not all will be lost.  

The principle is actually a study in risk management.  In blackjack the house is slated to win.  The reason is the player goes first.  If the house and the player go bust, the player loses because he busted first.  This gives the house an 8% advantage.  To he who has more will be given.  The player through judicious betting and application of the rules can reduce the 8% disadvantage to a 0.2% disadvantage, and by understand the history of what has gone before (a deck has only 52 cards so each subsequent hand has a different sequence of return and the smaller deck may be more favorable to the player than the house) a player can shift those .2% odds and be a winner.  Shifting the odds is risk management.  It is complex because one wrong move exacerbates risk as opposed to reducing risk.  Also the SOR needs to work in the players direction.  By never paying for your return with too much risk, you can move from loser odds to being a winner.

Bogelhead is not “the best” portfolio.  If you bought AMZN in 1997, you would be up 24000% compared to 140% for S&P.  Bogelhead is however adequate and it’s systematic, and in that systematization Bogelhead automatically manages risk.  If you own a Bogelhead 2 fund it lives on the efficient frontier and you pay for your return with the proper amount of risk.  If you own a Bogelhead 3 fund it does not live on the efficient frontier and you pay for your return with an excess of risk.   Bogelhead 2 is like the guy with 5 talents.  He risks perfectly, doubles his money and gains stature and gets the last guys talent.  Guy #1 is like a Bogelhead 2 portfolio started at birth.  His starting sum (5) could be provided by starting early with discipline and best risk management.    The guy #2 with 2 talents risks, but not correctly, he doubles his money but gets no extra because he only doubled to 4 not 10.  He is like a Bogelhead 3, risk taken but not optimized.  #2 could have benefited from adding a little AMZN to his mix.   #3 failed to risk.  He did not invest and was penalized.  

We glibly talk about how easy it is to invest and kind of look down our noses at those who don’t.  The presumption is those who don’t are just slovenly or clueless.  About 70 million of the population has an IQ under 85 or has something like schizophrenia.  These tend to compose the “homeless” and are never going to invest.   If you make 36,666 per year take home and have perfect discipline and 40 years of steady W2 can max out a Roth ($36666 * .15= $5500) and if nothing goes wrong, no job loss, no bad SORR, no hurricane Michael, no cancer diagnosis, you can pull 36,666 out of your portfolio for 30 years.  This guy is like the guy with 5 talents.  If you save only 30 years or use a poor risk strategy portfolio, you will have barely half (2 talents).  If you don’t save (1 talent) someone else will be called upon to feed you.  Probably only 40-45% of the people have the possibility do 40 years of Roth maxing out since the median single wage is 44K pretax.  You would have to be amazing on discipline and luck to get this to work.  So only 50% or so of the people have the where with all to engage apart from some employee participation.

I ran across a study looking at how getting cancer affects finances.  It’s pretty sobering.  First let’s look at the chance of getting cancer.  The risk for acquiring cancer for all invasive sites is 39.66%  or 1 in 3.  The risk of dying from cancer is 22% 1 in 5.  So there is a big risk of getting it and a smaller but big risk of dying from it.  

Here is the result from the financial paper:

Results

Across 9.5 million estimated new diagnoses of cancer from 2000–2012, individuals averaged 68.6±9.4 years with slight majorities being married (54.7%), not retired (51.1%), and Medicare beneficiaries (56.6%). At year₊₂, 42.4% depleted their entire life’s assets, with higher adjusted odds associated with worsening cancer, requirement of continued treatment, demographic and socioeconomic factors (ie, female, Medicaid, uninsured, retired, increasing age, income, and household size), and clinical characteristics (ie, current smoker, worse self-reported health, hypertension, diabetes, lung disease) (P<.05); average losses were $92,098. At year₊₄, financial insolvency extended to 38.2%, with several consistent socioeconomic, cancer-related, and clinical characteristics remaining significant predictors of complete asset depletion.

The link above takes you to the original paper.

So?

There was a recent brouhaha over Suze Orman and her attitude on FIRE.  Presented above is a not unlikely scenario.  1/3 got cancer of those  2/5 DEPLETED their entire life assets. 

FIRE is like taking a mortgage on your future.  You and your future own the mortgage.  You pay the mortgage from W2 assets.  In addition you off load your risk of living on your employer.  It’s his job to see you and your family are covered.  His job to match your retirement.  His job to pay for your vacation.  His job to pay for your disability and unemployment insurance.  While you glibly split your W2 into savings and spending.  You feel pretty smug at your “investment prowess”, but your “prowess” amounts to buying some low cost mutual funds and letting the deadly accuracy of American enterprise make you “wealthy”.  You are like a flea on a dog.  You go where the dog takes you.  You can crawl from the tail to the head and think you are so smart, but it’s the dog stupid, it’s the dog not you that is making the progress.

You “retire” early because you notice something about pulling a “number” out of thin air.  Why all ya gotta do is save 25 times that “number” and you can live 30 years off the proceeds.  If you look at this article, you see three faces of retirement.  One with very low risk, one with medium risk and one with high risk.  These risks are expressed by varying degrees of leverage on your future.  As leverage goes up risk of failure goes up.   In 60 year olds case his future was unlevered.  In the 52 year old case moderately levered he needed to make up 15% over 38 years.  In the 38 year old case he was extremely levered.  He had to triple his money, while simultaneously living on his money.  You can create math that supports the RE scenario but you can’t eat math.  You can eat hamburgers.  60 year old is the one with the hamburgers.  52 year old may have hamburgers or maybe Ramen.  38 year old has smoke.  Suppose each scenario gets cancer, 1/3 chance.  Who’s portfolio survives?  The other thing that happens when you retire is you take back ALL of your risk, and just owning that risk is expensive.   Maybe Suze ain’t such a dope after all.

I’m reading a book about middle class failure.  It’s called NOMADLAND Surviving America in the 21st Century.  I’ve searched for FI blog posts about FI failure but find none.  FI is all about travel and travel hacking and minimalism, simple ratios proclaiming assured retirement longevity.  It’s all about starting a blog or some other side gig like real estate.  You know some white collar kinda of “passive income” kind of deal to make you a cool hundred K/yr on the side while jetting to media events.  It’s all about being glamorous and being amazing.  In short it’s all about a narrative that doesn’t include failure.  It’s preached with the fervor of a health and wealth evangelist.  It turns out MMM may not be the first evangelist of minimalism, though he may be the most prominent in FIRE land.  Here is a site CheapRVLiving,   dating back to 1995 this guy spent his life living in a truck and blogging about it.  Pretty minimal.

As I read the book it was full of stories people middle to upper middle class, college teachers, college administrators, accountants, home owners, 401K owners, people with several hundred K in the bank and retirement accounts some pushing a million.  The people are now Workampers, itinerant post 65 year old’s who travel from “gig to gig” like Amazon fulfillment centers.  They walk 15 miles in 90 degree heat a day stooping and lifting to fill pallets with goods to ship to us Prime customers.  They pick sugar beets, and scoop ashes and clean toilets 4 times a day at California campsites and make ten bucks an hour, trying to survive.  10 bux an hour plus a place to park their truck.  Some campsites don’t have showers.  Those are half an hour away.   They get paid for 8 but are expected to do what it takes.  If that’s a 12 hour day so be it.  People lost their dough in 2008.  People got divorced and the savings were split.  Mortgages were due and jobless could no longer make the nut, people just walked away unable to pay.  (I’m 66 and retired).  They drive from place to place, no healthcare, a few bucks for gas, maybe a burrito from Taco Bell living in Vans and Trucks and RV’s.  Entirely different narrative than the FIRE narrative.  It turns out these employers like the seniors because they know how to get the job done.  They are wired to do the task at hand even if their bodies are busted and injured and fried.  They like the seniors because come hell or high water they show up.

It’s a fascinating contrast and so I ask myself what’s the difference?  How can high level executive types wind up shoveling shit in a camp ground instead of swilling stout with MMM at some event?  As I worked through it I think it’s leverage.  People live lives of leverage and they don’t even understand they are levered up.  I wrote an article: “A Graphical View of Retirement”,  and I was struck that the difference in the three scenarios was leverage.  The 60 year old basically had no leverage and could pay for his retirement straight up cash on the barrel head.  He would get some SS likely but he wouldn’t struggle.  He saved for 40 years to cover 30 years.  In the 52 year old’s case his future was slightly leveraged.  He worked only 32 years to cover 38 years.  He was basically bullet proof as well.  He only needed to make a net of 15% on his money over 38 years to compound his money to enough to cover his retirement.  SS would make up most if not all of his shortfall.  The FIRE guy had to cover 52 years, but he only worked 18.  In his retirement he needed his retirement nest egg to triple to die not poor.  Each of these guys has a different level of leverage on the future from 0 to a lot, and each will have a different probability of joining Workampers R Us.  In 2008 people who were slated with retirement aspirations 20 years in the future, were forced to crack the nest egg in the present with no W2 assist on the horizon.  Remember as you withdraw from the nest egg it’s ability to pay you contracts and chances of failure increase.  Their expected age 60 portfolio turns into the age 38 portfolio in a crash and is way underfunded.  People worry about poor return, but this hidden unrealized leverage is just as deadly.  FIRE types talk bravely and glibly about withstanding disaster and how FI gives you “options”, with no experience of failure.  Then comes Hurricane Mike.

It’s about as close as I’ve yet come to failure stories

There are all kind of popular formula as to retirement.  4% x 25, 3.3% x 30, 3% x 33, and so on.  These formula describe withdrawal rate and are based on longevity.  So what’s the risk?  WR in these formula is all about performance.  No one really expresses risk.

Here is a picture (monte carlo simulation) of a $1,000,000 portfolio, in a Bogelhead 3 portfolio, with a 40,000K/yr withdrawal projected 30 years, and no sequence of return bias and using historical inflation.

 

The program runs 10,000 simulations and survives 8,679 times.  If I shorten retirement to 20 years survival improves to 9575 times.  15 years takes us to 9915 survivals.  50 years is 7331 survivals.  

Here is with a 2 year bad SORR in the first 2 years, 4% over 30 years normal inflation.  This is how your portfolio would perform if you retired into a recession, or were laid off because of a recession and decided to retire.

 

You survive 5,914 times out of 10,000

Here is 50 years because you decided to retire early or couldn’t find a job.

You survive for 50 years only 2827 times.

You say BUT I WOULD CUT BACK TO SUPER SAFE 3%!  Here is 50 years at 3%

Better, you survive 6263 Times.  How about if this was a 30 year retirement instead of 50 still retiring into a recession?

Better still!  Your up to 8435 using “super safe” 3% and 2 bad years of initial SORR.  Did you ever read the refrain how FI gives you independence?  You call these last few independence?  Notice the down tick at the beginning of the graph.  This IS a graphical representation of SORR

How  about a Bogelhead 3 @ super safe 3% WR over 30 years with normal SORR? 

9535 certainly safer but super safe?

How about 50 years super safe 3% normal SORR?

8808 successes over 50 years!  That means you fail 1 out of 8 times.

What about 2%  Hell nobody retires on only 2%!

First over 30 years:

Now you’re talking!  9929 successes over 30 years at 2% WR!   What about 2% at 50 years?

9678, almost 97% survival for 50 years at 2% WR normal inflation, normal SORR.  This is why Bernstein says 2% over 30 years is basically bullet proof

These graphs were generated using the Monte Carlo simulator in Portfolio Visualizer.  Monte Carlo does a forward looking simulation of 10,000 probable futures and then statistically orders them in terms of likelihood.  You can decide, but the risk analysis is quantitative forward looking as opposed to “rule of thumb” or historical .  I base my retirement on Monte Carlo. 

No pressure in this post.  Retire at 40?  What the hell!