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.

What Worked in 2018

It’s Christmas Eve and The Dow is down over 4000 points, NAS is in a bear, S&P is flirting with 2300. You can look at this like gloom and doom if you like but I hardly think it’s gloom and doom. Because of political leadership joblessness is 3.7% and applications for work are at a 49 year low. The economy looks like GDP will be over 3%


Tax cuts were passed and taxes simplified and tax revenues despite the cuts or maybe because of the tax cuts are screaming after hitting an all time high in Oct. Welfare and food stamps and government transfer of wealth was down. What worked in 2018 was having a job. What worked in 2018 was the system of American capitalism. Just look at the FIRE blogosphere how many new blogs and podcasts came online and how many get rich books were published and courses and coaches went into business. So many experts so little knowledge, such magnificent marketing but still the freedom to express ones self in commerce was respected and rewarded. What worked in 2018 was the political system. Kavanaugh despite a media and political S-Show was confirmed according to the rules and the rules were therefore validated whether you like or hate the outcome. Presumption of innocence was validated. What worked in 2018 were elections Dems took over the house, dividing government according to the system and the peoples’ will, the same as peoples’ will was worked in 2016. Preserve the political system at all cost.

Would I wish the Dow remained 4000 points higher? Maybe, maybe not. My fear would be less but my reality probably more precarious and deluded. After the 2008 S-Show and slice and dice incredibly levered credit of the Bush the economy was WAY out of whack. Everybody blamed the banks but everybody was at fault, because everybody (except us debt free savers) participated. You can’t have 3 new cars and a boat parked outside of your faux McMansion with it’s second and third mortgage on a cabbies salary and say it’s the banks fault for providing you the heroine. Hank Paulson and Robert Reubin deserve our respect IMHO. Had it not been for them and the fact we can print money and are the world reserve currency, we’d be in deep depression. That trick of moving all that bad paper to the FED balance sheet to give it time to mature was genius. The banks were put in idle living off 2% short term Treasury money while the bad debt matured. It has matured to the point over the decade that it can now be sold by the FED back into the market. The skittishness comes from “no one knows” what price it will bring, but one thing’s sure the market will determine that. The training wheels are off. You can’t heal if you don’t express the pus. Also banks have been returned to their own resources and are no longer in idle. The people and the banks over the ensuing decade have repaired their balance sheets and there is some rationality back in the system so now it’s time for the market distortions to be relieved and for commerce to happen. This means there is now a market in bonds hence the rise in interest rates. The 30 year hyper bull market in bonds which was 90% above it’s mean is over and it will trend back to the mean. Stocks likewise are way above the mean and must revert. The CAPE is proof enough of the perversion. Interest is way low and will revert to it’s mean as bonds and stocks pull back toward the mean. You will actually will make a little for your act of saving money. The process of relieving this distortion sucks but is necessary IMHO. Even to the most ardent FIRE guy it matters. Eventually that FIRE guy will be retired and if things are running 150% over the mean that cool million will be bubble gum money. Starting at something closer to the mean is more sustainable over 40 years. Short term pain long term gain. Would I wish this happened 5 years later? I’m living off cash for the next 5 years so I’m well risked for this scenario and if it’s going to happen, as it must happen, might as well be now. Is it scary? I don’t have the one thing that worked this year, a job, so yes it’s a bit scary. Guess I could always start a blog… OH WAIT I did start a blog… Also in 5 years I’ll be closer to death so I will need less to survive till death. How’s that for Christmas Cheer?

One problem I do worry about is the loss of IP. My wife bought a new Christmas tree this year. It’s a Chinese POS. Poorly engineered knock off of an American design. My Church has the “same design” in their tree done correctly and has been in use for probably 2 decades. The POS tree is going back in January. The US has had an advantage over the past 300 years and that advantage is abundance. Abundant land, abundant water, abundant navigation. the fact the rivers all flow from N to S and then to flow into each other. Things like winning the war of 1812, the Louisiana purchase, the purchase of Alaska, the movement into the West and those territories becoming states. Things like the development of mechanical farming and the blast furnace which allowed rivers of steel aka Railroads to link the East and the West and the North and the South so goods not only could be produced cheaply but the logistics of nation wide delivery became present. Roads and a good education. A common moral reality. All of that and more is what has made us prosperous. The long term GDP runs about 3.22% over decades. Allowing it to be stolen by China or debased by open boarders will only result in our destruction and GDP in the 2’s or less. Nobody’s FIREing on a 2% GDP. You may not even normal retire on a 2% GDP. If you wonder think Venezuela.  If we loose our currency as the reserve currency we will be in trouble as well. Be very clear where’s the butter is on your bread and preserve it’s up-ness. Take nothing for granted.

Like WC Field’s epitaph: All in all I’d rather be here than in Philadelphia. Down here there is no state income tax and I haven’t run my furnace yet this year. Merry Christmas ya’all.

The Year “Diversity” Didn’t Save You

The ditty goes: “in well diversified cheap index funds”. The ditty goes: “when some things are down others are up”

Here is a pictorial of the S&P 500’s year in review. Red is Bear, Orange is negative but not bear, Gray is even, Light green is +, Green is ++, and Gold is golden +++

This is a picture of diversity, the picture of the ditty. I follow this metric of the relative balance between bull and bear stocks in the S&P as an indicator of economic health For the whole year 20% was in a bear market and 20% underwater. 20% dormant 20% up and 20% flying. About 40 stocks of the top 20% accounted for 1/3 of the growth and the FANG (FB, AMZN, NFLX, GOOG AAPL MSFT) was responsible for 13% of the S&P’s price. Let that sink in, because that is the true nature of equity risk. My chart actually over dramatizes the reality but that drama points out the risk. It’s not a bear yet. We’re down 7.5% not 27.5% but the point is the point. Ditty’s don’t save you. But you say “I have a side gig” to which I say good deal, what happens to a side gig in a bear?

I quack a lot about non correlated diversity so here is a picture of non correlated diversity this year.


Natural Gas worked, Wheat worked, VIX worked well, some of the short ETF’s that leverage triple an index in a negative direction worked, but those instruments require expertise to trade. There is nothing cheap or buy and hold about owning them and a wrong move will clean your clock. I’ve traded the VIX through ETF’s I do not recommend.

The world seems ready to roll over. S&P was down 7.46. Nikkei down 11.87, DAX down 18.12, I would say your Foreign assets in your 3 fund didn’t save you. (VGTSX down 18.8% compared to 7.5% for S&P). Real Estate? VNQ is down 10.35% compared to 7.5% for the S&P. Bonds are down, the 30 year down 5.35% and even shorter term government debt typically a safe haven lost money. The 5 year note is down 1.97% as the FED unwinds it’s balance sheet. Cash lost by the rate of inflation. Even TIPS were down. The 3 month The 3 monthT-Bill was up a penny for the year, BONANZA. The 3 month T-Bill is the risk free asset against which the efficient frontier is calculated.

This year demonstrates the risk of a leveraged retirement in a leveraged world in a very real way, and the more equity exposure the more real the demonstration. The farther off the efficient frontier the more real the demonstration. Governments and corporations are swimming in debt and leveraged not all that different from the housing crisis of yore. Peter is being robbed to pay Paul and debt derivatives are being sliced and diced, same as it ever was, same as it ever was. The only way out is through the gauntlet. Santa Claus is not coming. The curves are regressing to the mean. Statistics are pesky things. We’ve been living a charmed 2 SD life buoyed by easy money and easy expectations and government manipulation for 10 years. China is eating our lunch by stealing IP. IP accounts for creative destruction and creative destruction = exponential jumps in productivity and growth in national value. I can’t over emphasize that enough. It’s been the US’s motor for 300 years. If the motor leaves or is snatched away our goose is cooked. “Worst December since 1931” should give every one pause. So far it seems an orderly regression. I think it’s the best we can hope for. Someday “the means” will be obtained, hopefully not by a dramatic overshoot. There is a lot to be learned here.

The robots respond to mathematical representations of the above picture and set about to optimize, maximize gain and minimize loss. We live in a three dimensional world and typically optimize on one dimension, reward, or the fancier of us in 2 dimensions, risk and reward. The robots live in as many dimensions as they like or need for optimization and they scale in and scale out in other words the dimensions aren’t necessarily linear, hence trading the triple short fund in a way that’s not just randomly shooting bullets. They trade and they learn from the trade and hone their skill set. If you think you’re not exposed to that process by being buy and holder, think again. Every “return” consists of an investment component and a speculative component. The VIX is often called the “Fear” index. It is not. It is the chaos index. It makes it’s money from chaos. Wrap your little buy and hold mind around that. You own chaos, it’s called variance and it’s not fixed. The bottom line is as long as your next door neighbor is getting up and going to work every day we will be fine. It won’t be fun, but we will be fine. Your existence as a retired rests on his going to work and adding value to what ever process he performs. While you get cocky about retiring at 30 understand how you depend on him. He deserves your respect. If he quits going to work lay in some Valium because a hard rain gonna fall.

Is Risk Aversion The Seat of Wisdom

I was listening to a podcast by Sam Harris PhD who is an author and controversial type but did his PhD in neuroscience. Although my major in grad school was Biophysics my research in grad school was in Neuroscience in a sort of adjunct bifurcated degree program between Engineering Physics and Neuroscience. I was studying a phenomenon of slow DC wave forms in the brain. AC wave forms (EEG) are common and are in cps (cycles per second) or Hz. These DC wave forms were on the order of seconds per cycle and had independent ipsilateral and contralateral components. The waveform was sensitive to injury, so you could damage the cortex for example in one hemisphere and there would be released a cascade of damage signals over time and the signals were hemisphere independent. My goal was to use this to model strokes since the waveform changes and cascade tracked what seemed to be the same pattern as an evolving stroke, the old “we won’t know how bad it is for a few days”. The “few days of stroke evolution” seemed to be the integral of many discrete smaller stroke-ettes across the hemisphere or sometimes across both hemispheres. The model therefore might be used to create therapeutics that limit stroke-ettes and therefore the severity of the integrated stroke event. This was before CT scan was invented and way before MRI, but it’s advantage was it showed a physiological process not an anatomical process. The research required rat lab access and neurosurgery. I knew how to do it but I couldn’t get funded so I took my EE degree and went out and got a job as an engineer. The book learning part of the degree was rigorous in neuroanatomy and what was known about neurotransmitter distribution at various nucleus and the experience always left me with a deep interest in neuroscience.

I started recently to explore the underlying neuroscience of risk/reward behavior. I also have a degree in psychology and was interested in social psychology which uses game theory (risk/reward) in some experimental models so I knew something about that literature also. In the mid 2000’s the fMRI was developed and you could watch subjects brains light up while presenting them with various “problems” and see what loci seemed to be active in the processing. Risk aversion seems to be in the anterior insula, cyngulate gyrus, posterior medial cortex and ventral striatum among others. The anterior insula sits over the hippocampus which seems responsible for memory management. So it might seem these structures form what I call the seat of wisdom, a place where risk aversion and memory meet at a relatively subcortical level. “DON’T TOUCH THE HOT STOVE!” It only takes once to become wise and there isn’t much rational thought involved. What about reward? That’s widely scattered but a significant center is the Nucleus Accumbens in the basal ganglia. NA’s neuro transmitters are dopamine and serotonin, so when you get reward you get a shot of dopamine and +- serotonin. We all know about the dopamine hit. It turns out serotonin is strongly tied up with hierarchy and pecking order and its “anti-depression” effect may not be anti-depression but to reinvigorate a dormant competition response to try and ascend a social order, which could look like recovery from depression. One other feature is serotonin seems to turn down or off risk aversion.

Psychologists ran experiments where subjects participated in risk/reward games and measured response with fMRI and measured the activity in these nuclei and by using different outcomes could measure risky behavior and risk aversion in gambling situations. Sam Harris’s PhD was on religious belief and he used fMRI to measure believers vs non believers and the same risk aversion nuclei lit up when I looked at his data. Interesting co-incidence? Seat of Wisdom? Rules to live by or not live by? One big point of all of this is these are subcortical structures beyond the reach of pure rational thought. If you look at the white matter there are a lot of paths out of the mid brain up into the cortex and a much smaller amount of tracts from cortex into mid brain, so who is running who?

An example of altered risk aversion is when someone gets drunk. People think drunk people can’t think. but they think just fine. Their reaction times may be off but they can think. What happens with drunk people is they just don’t care. NA gets stimulated and risk aversion gets shut down because of serotonin stimulation into the seat of wisdom. FIRE obsession might be akin to this. You start to save and see your acct accrue interest and it stimulates NA, and it feels good. You like it. In addition the seat of wisdom gets shut down so you move into risky assets. You read somewhere about 4×25 and it’s kind of like a religious belief. You get a good run and since serotonin opens you to hierarchy advancement and shuts off risk aversion you start feeling like the master of the universe and your 50/50 AA goes to 90/10! Now you’re cookin! “I think I’ll start a blog man!” and that further reinforces the neurochemistry and religious belief, but somewhere down in there the seat of wisdom is trying to breakthrough and turn risk aversion back on so you think well maybe not 4% but surely 3.5% or I’ll start a side gig, side gigs pay good and almost never fail! So you do and that’s enough to shut up the seat of wisdom. You chose a buy and hold portfolio (Buffet’s favorite) of cheap index funds and it turns out 2 cheap bond /stock funds live on the efficient frontier so the risk management takes care of itself. The 3 fund isn’t efficient but most of the time it makes money too and you keep plowing money into the portfolio and it seems to grow or in fact grows. Then one day you hit your number you pulled out of thin air and retire on 3.5% because the religion says that’s safe safe compared to those jokers taking 4.5%. You’re still risked at 90% because you’re “comfortable” with that. The problem is as your portfolio grows the safety provided by contribution dramatically diminishes. At retirement that safety is gone once you open the portfolio to withdrawal and SORR and you’re still risked at 90%.

Notice how little of this scenario is based on rational thought and how much is based on sub cortical systems. If anything rationalization is substituted for rational thought.

A little ditty ’bout Jack & Diane
Two American kids growing up in the heart land
Jack he’s gonna be a football star
Diane debutante in the back seat of Jacky’s car
Oh, let it rock, let it roll
Let the bible belt come and save my soul.

Wonder if that plan worked out? Wonder if Jack became a football star and what’s happinin’ with Diane?

Retirement Financing So Far

It’s December and I decided to do a post on what it’s like to live on a nest egg.  My situation is I’m fully retired no side gigs age 67 (next month).  I should have enough money to pay for my retirement and my wife’s to age 100 with no interest beyond inflation on my investments.  I do budget, but I budget in reverse.  I budgeted a yearly amount that is 20% more than I live on, so in case I need more money there is an automatic built in excess cushion in my budget.  If I don’t spend up to that excess it just counts as a bias against any SORR risk I might incur.  In other words if I budget 10k/mo and i spend about 8k/mo so my SWR (and SORR risk) varies downward from safe to safer not vis versa.   So I’m always running “to budget” and not “over budget”.   It means I never have to sweat it when my wife or kids “need” something.  My answer is essentially always yes.

I started winding down my risk profile 3 years ago to a lower risk.  It is recommended in early retirement up through 5 years into retirement (10 total years peri-retirement)  that risk be cut to a 50/50 allocation.  I’m a little over that around 56/44 but close enough.   In the past 3 years I added 5% return/yr to my portfolio, 4.3%/yr in the past 2 years, and -5.8% in the past year.   Part of my risk “wind down” was to take some post tax brokerage stock and turn it into cash (risk free asset in the short term) to live on while I Roth convert at maximum efficiency, so my actual risk based portfolio is closed to SORR since I’m not withdrawing from it right now but withdrawing from the cash pile.  I actually sold at the market high but that was parsimonious and not by design except I decided it was a good time.   

This means I don’t need to sell anything or do anything to my portfolio to live for the next 4-5 years.  I have enough cash to pay my bills and taxes and live my life.  A recession can come or go it won’t matter to my cash flow.   As I spend down my cash my AA will once again automatically rise, until RMD when I will take SS and RMD a small remaining bond based TIRA of about 600K which will keep my income in the 12% tax bracket for a long time.  So I accomplish SORR protection in early retirement and portfolio preservation by risk reduction in early retirement.  When I RMD and take SS, I will then feel free to bring my portfolio risk back up because I will be 5 years in, age 71 and tax streamlined from the Roth conversion.  I will convert a little over 1M to the Roth at a net tax bill of 15 cents on the dollar.  The Roth will grow as a retirement self insurance account for my wife and myself in case of extraordinary expense like cancer care or assisted living or for a legacy for my kids.   My analysis was 5 years of cash is probably excessive but if there is a recession it will prove fortuitous since I sold at market peak.  Having never retired before I wanted my bases covered and had only my estimates of what to expect.   

Thus far this plan has unfolded perfectly.  Certainly a 6% drop this year is unwelcome since I’m as greedy as the next guy, but not at all critical to my or my wife’s well being.  This week I further de-risked my portfolio jettisoning some alternatives and real estate and turning that into  bonds and low beta to reduce my AA  a little closer to 50/50.  Those assets were not performing and especially real estate carries a higher risk than the US market so provides a kind of negative diversity in a down market.   If the market keeps going down, I will start to sell global and emerging markets since they likewise carry more relative risk than the US market.  So my risk management strategy is to sell high risk and turn it into low risk, but stay invested.  I also bought some gold miners with some of that money since gold and gold miners tend to be zero to negatively correlated to stocks in a crash.  Gold equivalents are cheap to buy now, so I buy low, to sell high when the market is in the tank.   I’m still fully invested but my portfolio has somewhat less risk this week than last week and I’m more defended against the bad, which I find desirable in these conditions.  I don’t need a home run, base hits will do just fine.  What I especially don’t need is to strike out.   I’m learning that risk management is the key to portfolio longevity in retirement.  I see some posts about “standing tall” and “taking your beating like a man”  when it comes to portfolio management.   Selling out is stupid but de-risking at least to me makes sense since I’m not replacing my lost dough and poor risk decisions with hard work anymore.  I’m done with work.  I’m retired.

  • Have a retirement plan.  Deflation is nothing like accumulation.
  • Understand your risk and how to vary the risk and the benefit/consequence of that
  • Understand the cash flow as time goes on.  SS RMD and when they kick in etc makes a big difference in the plan
  • Have a budget and spend under budget
  • Have a big enough pile to start
  • Plan for your life till death and then for your wife till her death it makes a difference
  • Understand your taxes including the difference between married jointly and single, the government is coming for them.  
  • There are no easy magic formulas or narrative for actual retirement.  You get to be the author.
  • Retirement self insurance is quite useful since you both are going to die of “something”, and that “something” may prove expensive or even 2x expensive.  Dying is a known unknown but planning, even moderate planning gives some control.
  • Living real life is not living a narrative.  Happiness and peace depends upon living in reality.

Living in a Bayesian Land

Thomas Bayes was born in 1701 and dies in 1760.  He developed a statistical theory called Bayes Theorem.

I have read Bayes Theorem is the most tattooed theorem in the world.  Bayes was a Presbyterian minister and Presbyterianism is nothing if not about determination.  Yet Bayes approach is about probability.  Every other statistician of his day was about calculating the odds.  If you have a box of 20 black and while balls what’s the chance of pulling a black ball?   Bayes OTOH asked the question how to you come to know a better level of belief called the Posterior belief. 


If you have an old belief (prior) and no new evidence you have an old belief (same odds).  If you have new evidence that is reliable evidence then the belief changes and a new belief occurs (posterior odds).  The change in belief therefore is contingent on the reliability of new information.  Therefore you need a prior and you need evidence and the result is not deterministic but statistical.   

Let’s say you’re a FIRE type.  You bought MMM’s BS about “simple math”.  Let’s look a little deeper at “simple math” based on probability of success.  Boggleheads LOVE their 3 fund portfolio there are all kind of stanza written: low cost, you can’t beat passive index, FA’s suck, DIVERSIFY DIVERSIFY DIVERSIFY!    Then you pick a “number” out of thin air and apply simple math say 4% x25.  Lets say the “number” is 1M for easy calculation and conceptualization.   You choose a bogglehead 3 portfolio based on the “internet”.  You wouldn’t know a BH3 if it came up and bit you on the ass but that’s what Joe the Plumber uses and after all Joe is a plumber and knows how to braze copper pipe in a way that doesn’t leak, he MUST be a wizard!  Here are the survival chances of 1M, with 4% WR standard inflation and SORR for 30 years on a BH3:

Note as early as 15 years this portfolio starts to flunk.  You have a 86.87% chance of survival.  It means you’re broke 1/8 times.  It means 1M is not enough for a 4% WR and you need more or a side gig to reduce the WR, aka you need a job in retirement.  Let’s go from a BH3 to  a 50/50 VTSMX:VBMFX portfolio.  Note this portfolio has the same 50% VTSMX AA as the BH3 but reduces risk by substituting risky, highly correlated VGTSX allocation for a greater % of the non correlated VBMFX.  This 50/50 portfolio reduces the risk of the overall portfolio compared to BH3 and lives on the efficient frontier.

Same 1M, same 40K/yr withdrawal, same SORR and inflation, less risky allocation 98.46% success!   You’ll be dead well before this portfolio flunks.  There isn’t a hint of trouble till year 27.   This portfolio is based on the efficient frontier and Bayesian statistical analysis not Joe the Plumber’s dirty thumb nail analysis and MMM’s simple mindedness.   This portfolio is “enough”, survives nearly 99/100 times, and needs no side gig to pay for the added risk of stupid assumptions.  This is the power of quantitative analysis instead of the unproven narrative of internet fever dreams blasted at full volume into the FIRE echo chamber.     Hmmm… maybe Bayes was about probable determinism.   

As I think about this, this example is a systematic way to look at Suze O’s freakout and the recalcitrant FIRE response by reciting the “narrative” like it’s the Apostles’ Creed.  It turns out both formulations of the problem were wrong,  FIRE’s simple minded brain dead narrative and Suze O’s imprecise hand waving risk analysis.  You don’t need  10M and your money won’t survive by paying for your leverage with with too much risk. 

Bless you Thomas Bayes 

The Old Chain Saw

I wrote a post on Dobermanns of the Dow  looking at a particular screen of the universe of DJIA stocks.  The screen uses Return on Equity and Free Cash Flow and some winnowing criteria to knock out 20 of the stocks and leave you with the “best”.   It’s a value play in that the screen is designed to buy low and sell high, but ROE and FCF allow for using quality and not just cheapness as the criteria.  Being a risk adjusted kind of guy I added some bonds for non correlation and put the picks on the efficient frontier.  The result was this:

 A list of 7 DJIA  stocks and a Bond in AA ratios that place it on the Efficient Frontier.  I decided to see what old Mr Monte Carlo had to say about this portfolio, so I stuck the stocks and the bond in the blender and pressed high:


9978 times out of 10,000 the portfolio succeeded over 30 years.  The WR was 4% at normal historic inflation and no SORR stress

I stressed with the first 3 years being the worst 3 years of return.  This would be like retiring in Dec 2007 kind of scenario still with 4% withdrawal and historic inflation

The portfolio survives 9851 times out of 10,000 for 30 years at 4% WR with terrible SORR. 

Here is 5 years SORR worst case stress:

We still survive 9 out of 10 times (9245/10,000) at 4% WR.  Let’s try 3.3% WR, same first 5 first years worst case SORR:


Back over 99% survival (9940/10,000).  What if we go to 50 years of payout?

3.3 WR @ 5 yrs worst initial SORR allows 50 years of benefit success 9 times out of 10.  Pretty amazing!  What if we go back to normal SORR, 50 year payout normal inflation and 3.3% WR?

Back to 9970/10,000 successes, all from 7 stocks and a bond.   Would I buy this?   This doesn’t analyze the Dobermann’s results.  It analyzes 1 year of the screen, the past year 2018 which has been nothing to write home about, in fact it’s underwater.  I need more info but it looks interesting.

The Dope on Burnout and The Race of Life

You read a lot on burnout in Physician land.  There was an administrator at my old hospital who had an MBA and went to med school in the Caribbean and got her MD.  She didn’t do an internship or a residency and she held no license but she still was used as an in road into the physician community by the hospital.  One time there was needed some kind of physician to sign off on some kind of workup in the hospital and I heard her telling her boss the CEO “we’ll just get some physician in the hospital to do it like the Anesthesiologists”, like we were just sitting around on couches waiting to be called to do a H&P on someone.  This kind of points out the typical MBA’s perspective as physicians we be grunts.  It’s a well known fact most physicians will sell their souls for a free ham sandwich from the drug guy.  The MBA’s are jerks but nothing if not masters of manipulation “I’ll give you a quarter to hop on one foot 10x” and so systems develop that are about coercion and doing more with less.  Enter the bell curve.


A physicians life is all about this curve.  Notice its shape 34% is a big area 13.5% less than half of 34 (40%) of that 2.5% less than 1/10 of 34 and about 1/5 of 13.5.  Notice the X axis intervals these are equal.  This means for the effort it takes to go from 0 to 1 you get a 34% return.  From 1 to 2 a 13.5% return a 200% increase in effort from 0 for 40% more return.  2 to 3 a 300% increase in effort from zero for a mere 10% extra return.  It takes a lot of horsepower to get to 300%.  This is called diminishing returns.  To get into med school you had to walk down the curve and as you descended your effort went up.  Then you got into residency and it went up more.  Then you became attending and it went up even more.  You started getting paid for your effort pretty well but still running at 300% takes it’s toll.  The MBA’s would like you to run at 350% so they incentivize you with ham sandwiches and of course you’re a codependent people helping dope and agree to eat the ham.  You think the extra effort is linear but in fact it’s Gaussian it is in no way linear.  Each of us has his/her natural/mental/physical limit.  Each of our families have that as well. 

The solution of course is to walk back up the curve, tell the MBA to go pound sand, he’s just a sniveling drunk anyway, and move back toward 200%.  How many of our colleagues follow this exact path into perdition and how many retrace back to health, because running at 350% clearly is a distorted way to live. 

Another interesting thing happens.  If you watch your P’s n Q’s you can save a little along the way and a little turns into enough.  At enough your 200% effort might start to look like risk.  At some point you’re going to pull the brass ring, so now the question becomes how much risk is too much risk?  At some point you realize every day you practice you are adding only a little dab onto your pile (diminishing returns) and that brass ring is looming somewhere out in your future.  Pretty soon you decide to hell with it all, enough is enough, time to do something else.  You’ve been living a 1 SD lifestyle while making a 2-3 SD wage.  You become used to the security a 3 SD wage provides and freak at the idea of living a 1 SD life on 0 wage, substituting your pile for your wage.  This again becomes a bell curve problem.  One thing to realize you’ve already been living a 1 SD life, so the question really is how much is enough?

Enter the Bell again!


But in this case the numbers start going negative from zero and it becomes a race to understand if portfolio deflation is going to over take all they days of your life.  It’s a weird race, the way you win is to die.   It too is a Gaussian problem not a linear problem, yet linear solutions are often proposed 4 x25 is essentially a linear solution with a small fudge factor (compounding) built it and a big risk factor (SORR, over deflation and longevity) built in.   

Look familiar?   For men we are quite likely to die by 99, we’ve been dropping like flies for years.   For women however maybe 15% on this chart are still kicking at 99 waiting to die, clearly not a linear problem.  Somewhere in this mishmash is parsimony the best result for the least risk.  Since planning for yourself necessarily implies planning for your wife, plan accordingly.  Marriage, it’s a double bell whammy! DING A LING  At least this fleshes out both problems of burnout and retirement deflation risk in terms more akin to reality.  Knowing your enemy is critical to success. (A quote frem Sun Tzu or Napoleon or Julius Caesar or one of them jokers.)

Lemme see if I just max out my pre-retirement accounts and invest in low cost index funds…….  I CAN QUIT MY JOB AT 30, RIDE MY BIKE, BE JED CLAMPETT AND HANG OUT BY THE CEMENT POND!!!  whee doggie  It’s shockingly simple, shockingly I tell ya!