I’ve been watching youtube video and have discovered Raul Pal and Real Vision Finance (Also). He is talking about in a clearer way my concerns. In my opinion he is right on. We are heading into deflation, not growth, not recession. Recession is about the business cycle. It’s a temporary downturn that later reverts to an upturn. In America we expect the down turn 30% of the time and the upturn 70% of the time. As long as that happens we grow. Growth has been spurred by consumption. The FIRE movement turns its nose up at consumption, as if “those people” are lepers the Jones keeper uppers. It’s the Jones keeper uppers that support the business cycle so when you are turning up your nose at these folks you are turning up your nose at economic growth and economic growth is how you expect to pay for your hamburgers in retirement. The Jones are the golden goose.
The boomers are retiring and one thing happens when boomers retire consumption plummets. The reason unemployment is low is boomers are quitting more than the economy is booming. It is the reason we ave low unemployment AND low inflation. People leaving the workforce explains that. People own a ton of equities. Equities are directly tied to consumption, and equities have been leveraged by corporations buying back shares using debt. There is a corporate debt bomb out there of greater impact than the 2008 consumer debt bomb. so expect a huge crash aka a huge reversion to the mean as the leverage gets un-levered. What this means if the market is riding 90% above the mean, when it reverts literally 45% of the dough especially equity dough is going away permanently. You can expect a 45% permanent (or possibly decades long) hair cut on your portfolio. With permanently curtailed consumption the motor that drives growth will no longer pull the train. It’s happened in both Europe and Japan. If it happens here China is also hosed.
I retired normally at 65, so I have less time to live, and I have a pretty large portfolio and a small WR of under 2%. If my assets permanently fall in half my WR only goes to 4% and I have only about 20 years for my portfolio’s survival. I have further reduced my equity risk into other non correlated assets like gold bonds and cash and some BTC so my exposure to the leverage in equities is muted. Imagine if you are 45, heavily invested in equities and retired and have a 45 year horizon and only half the money and still have kids to send through school, or not because no one will be able to afford it. Imagine you’re sitting on a 1M property or a 1M apartment building and can only rent for 1/3 of the break even or sell for 250K. That’s what could happen with permanent deflation. People will dump their homes and move into cars and trailers. This happened in 2008. Excess leverage will eat your lunch. The problem with deflation is it’s near impossible to re-ignite inflation aka growth. This is a graph of the Nikkei, Once 45,000 now hovers around 10,000
Watch this video and consider deeply the consequences. If you are FI, are you still FI with a 50% hair cut? If you are FIRE can you survive twice the time on half the money? I find this guys argument entirely credible.
10 Replies to “Demographics”
Wow. Excellent food for thought yet again Gasem.
My radiology colleague and I were just discussing corporate debt this morning and how it is going to impact the future economy.
There are a lot of scary things about these videos on the real visions website. Definite food for thought. I’m strongly considering selling some stock, buying gold miners and buying more bonds. Stocks are running twice what the trend line predicts in price. Everything always regresses to the mean eventually, so why are stocks so high and do they deserve to be that high? Corporate leverage. The corporations used debt to buy back stock and jack up the price. So it’s like thinking you are some real estate tycoon who owns 50 properties but 75 properties worth of debt Suppose consumption falls off because of retirement as spending becomes less in retirement. What will happen to the debt service? What will happen to the stock price?
We’ve always “gone up” but part of that is because of baby boomer economic efficiency and consumption and personal debt. No job no economic efficiency from them anymore, no job, no more acquisition of debt, no job, no debt, no desire to consume = reversion to the mean as the gas gets let out of the balloon. It will be made much worse by some dimwit like Warren getting in power.
Thanks for the thought-provoking (even if terrifying) post and video.
Making predictions is difficult – especially ones about the future.
I share your concerns about the debt loads of companies and individuals.
Too many young FIRE folks seem to think stocks are guaranteed to keep rising.
Japan and history teach us otherwise.
A recession is guaranteed, when and how deep are not, but there are systemic and demographic issues for sure that are beyond the business cycle. I’m in the 3rd year and it becomes a race between when SORR would be most devastating and when that risk tails off and the portfolio starts to behave more like a savings account and less like a levered account.
I did some analysis on SORR. It’s typically reported to matter for like 10 years but my analysis looked at various retirement lengths and it matters a % of the retirement length, not an absolute number so 10 – 15 years is relevant on a 30 year retirement but it looks like 20 – 25 years is relevant on a 50 or 60 year retirement. From papers I’ve read they discuss 5 years before and 10 years after retirement as the period where reduction in risk it most relevant on a 30 year retirement.
In my case for example I’ve had a good 5 years prior (2012-2017) and a very good 2+ or so years peri and after (2017 to now), where I have acquired about 5 or 6 extra WR above my living expense. That accumulation of excess WR is the equivalent of portfolio insurance. In my case I basically pulled that excess WR out as cash a few months ago since the market is up (sell high), which reduces my over all risk profile and closes my portfolio to withdrawal for 6 years. As the 6 years pass I’m just about 15 years into SORR’s window of effect (5 years before and 10 years after).
I also cut back some on the AA of the portfolio from 75/25 to 66/34, which means if equities drop in half my portfolio only drops 30% not counting the cash I’m living on. In 3 years SS kicks in, further reducing the drain on my WR and allowing my portfolio to remain closed even longer before I start withdrawing. So I’m pretty well positioned even if equities drop in half (the Japan scenario) and SS gets cut 25% to not run out of money. If the market does crap and I’m still Roth converting, I’m likely to Roth convert as much as I can even to all of it. Since the stocks would become cheap, you can convert more of the TIRA for the same tax bill and I already have the cash on hand to pay that tax bill. That would further reduce year to year taxes essentially to whatever SS generates and would save my wife’s tax bill once I die. If the market drops in half I’ll also tax loss harvest the brokerage, reducing any taxes on that front. So there are economies yet to apply, so turning down the risk too much may be over kill.
None the less it’s videos like this that gets one off the couch and planning.
I’m also concerned with demographic trends. The millennials don’t seem positioned to take up the slack as boomer 401k and pension funds sell assets to fund their income needs. Add to that low/negative rates, the Fed needing to unwind its book, and corporate equity buybacks propping up the markets. Eventually the music stops and some of us will be left standing. Income inequality will will lead politicians to promise more entitlements when we can’t pay for the ones we currently give out. SS gets cut, Roth distributions may get taxed, and income tax rates go up. Maybe inflation is allowed to run its course while the economy slows. I remember a bit of the gas lines of the 70’s from when I was a kid. The Japan example is scary and I’m hoping American exceptionalism and reserve currency status will keep our economy a target for capital inflows preventing Japanification.
I’m also diversified into gold, bitcoin, and cash. I’m not sure how defensive to get with the AA when I have 10 years or more until retirement. I’m about 70/30 now and thinking I should head towards 60/40. How do you think about this? Leaving potential gains on the table will mean lower quality of life later on.
At what age do you plan on retiring? A closed portfolio works like thermodynamic state functions from Chemistry days. It’s path is not relevant. It’s feature is: it starts somewhere and it ends somewhere and the difference between start and end are the delta. The problem with early retirement is it ignores human capital. A human has human capital that is available to spend over 60 or 65 years of life. Education is a multiplier of human capital and what you acquire in the first 1/3 or 1/2 of life. It changes the slope or rate of accumulation. Portfolio deflation is what occurs when the rate of accumulation changes and money starts being extracted. A portfolio largely does not consist of money, it consists of property that is convertible to money. Human capital does not consist of money. It consists of activity performed and time spent being converted to money. That value once earned is converted to property. You either buy crap, pay debt, or put something in the portfolio.
Since the goal is the delta between portfolio start and portfolio end, when you quit is entirely dependent on reaching that delta, but your human capital is limited so at some point that goes away PERIOD. If you made a big enough pile before your human capital peters out you can begin withdrawal converting your property into money. One thing to note is withdrawal is not bang bang. You are not one second accumulating and the next spending. What you are doing is changing the slope of accumulation. Properly planned accumulation lasts till the day you die, just the rate changes. THIS IS AN IMPORTANT POINT. A well planned portfolio accumulates throughout it life. This is why it’s important to plan out every year of life until death. By mapping accumulation and the slope changes caused by spending and loss of human capital, you have a numeric understanding of the state function.
You should for example be able to say what your retirement is going to cost from the day you quit and change the slope. Upon my “official retirement” in 3 years when I start collecting SS my retirement will last a possible 20-22 years and the cost of that is 2.7M. My wife is younger so including her cost 3.4M covering 29 years. If you had 3.4M and made enough interest on it to pay for inflation in very low volatility assets like tips and bonds and the rate of withdrawal is constant you have “enough” That is the definition of enough. If you instead intend to live 50 years in retirement 5.8M is “enough”. So if you retire 20 years early and shit can your human capital you better have made a huge pile. “Enough” is not a guess, it’s entirely calculate-able and this is the exact calculation that would be done if you saw a professional, and didn’t just plan your retirement based on the opinion of some plumber or book selling guru with a mustache.
The problem with owning property is it’s value is market dependent. On any given day your property is worth more or worth less, so if “enough” is at risk, “enough” becomes a variable that is market dependent. The need is still constant say 3.4M, but whether the need can be met becomes variable. So now the game becomes multi dimensional along a X and a Y axis and the game becomes non linear X and Y are related by a quadratic function, a curve, not a simple line. Every point on the curve has 2 ordinates return and risk, complexly related. Risk itself is a variable. What if taxes go up? What if you or your wife get cancer or Alzheimer, or a double whammy one of each. Suddenly 3.4M could become 5M in end of life and medical care. One thing is for sure every one is going to die
So how do you judge? I use Monte Carlo analysis. The Monte Carlo is a statistical engine that list probabilities of success for a given set of parameters. Let’s look at 70/30 vs 60/40 US stocks US bonds. A 70/30 under normal circumstances has a 96% chance of survival pulling out 4%/yr. A 60/40 has a 97% chance of survival. What if the stock market dropped in half permanently? The you would have in the 70/30 case? In a 3M portfolio the bonds would be 900K and the stocks would be 1.05M so your permanent portfolio would now be 1.95M not 2M and your AA 54/46 does this survive 30 years? At the same withdrawal the survival goes down to 67%. Doing the same calc on 60/40 loss of half the equities gives a 43/57 AA and the chance of survival for 30 years goes up to 75%. What if you were close to SS age and could immediately add say 20K of SS? Survival goes up to 93% in the 60/40 case and 92% in the 70/30 case.
The point is the calculation is complex. A 50% permanent loss in equities is a huge bad SORR but if every thing else works like SS it’s survivable, but in this example you weren’t RE and you didn’t have a 50 year time horizon. The probability of the 54/46 (70/30) surviving 50 years I estimate at 66%%. Since in this 50 year RE scenario SS doesn’t kick in for 20 years. The likelihood of a 50% permanent equity default is small but real. The likelihood of normal market action is probably more likely, who knows? So what you need is a trigger. Maybe if the FED drops rates under water it might be time to take some off the table. The rest of the world is basically under water on interest. US banks have a PE of about 12 European banks are 9 and Jap banks are 7 or 8. There is no reason for EU or jap bank PE’s to rise since you can’t make any money under water, so guess who’s going to fall, and guess what they are taking with them. That’s what happened in 2008. I don’t know the fed has enough snot to be able to pull it off again.
I was listening to this guy Raul Pal and he’s all gloom and doom and I was listening to Janet Yellen and she’s all peaches and cream so I think the fed action is the switch. They clearly screwed up in Dec but that action won’t play out for another year. Moving some to bonds and shortening the window of retirement, thereby reducing risk and decreasing WR (since your pile at retirement is bigger)is the way to go but maybe not yet quite today. I’ve made a plan on what to sell, and what to buy to reduce my risk and the associated tax consequence, so I can pull the trigger since I know exactly what to do. I haven’t pulled it yet. Still more thinking to do.
My perspective is not to focus on gains it’s to focus on survivability. I could care less if I die with 10M in the bank. The only thing I care about is that my wife dies after I die and she dies with adequate money in the bank aka not broke and not forced to live in some broken down state run medicaid nursing home with looney toons howling at the moon all night long.
Very interesting read. How would you approach this potential scenario if you were younger?
I’m 30 and would like the option to RE by 50-55. Of course I’m still young and conventional wisdom says to have an aggressive split and ride the waves for the next 20 or so years. But, I have been debating that for ever since I first saw a few of the RVF videos. I’m trying to work through it these are just doomsday videos to mostly be ignored or if we should reanalyze our entire retirement strategy as the scenarios they predict would decimate all our conventional investment strategies for decades considering the Fed has essentially no room to react.
How do you hedge against that but still play the game? Do you go from 90/10 to 80/20? 75/25? 70/30? Stuff it all in a mattress?
If only my crystal ball was working…
That is the question, what to do? There is a book by Neil Howe called the 4th Turning. What Howe describes is the cyclical nature and characteristics of generations. Generations exist in quartets and each of the 4 cohorts are distinct. In recent history the 4 gens are Greatest, Boomers, GenXers, Millennial and each gen produces unique economic consequence. After the 4th gen the cycle repeats. So we are 8 years into the 4th turning right now and have another 16 years to go. Billionaire Ray Dalio has a similar but different understanding. He believes there are 2 cycles to the economy, a short business cycle that oscillates every 10 years or so, and a long business cycle that lasts 70-100 years. 1929 was 90 years ago this month. If 2008 was a 80 year equivalent of 1929, 2019 maybe a 1937 equivalent. It took a world war to get out of 1937. Those cycles may be just interesting or they may be real, but clearly the market is cyclical, and just as clearly we are headed into some kind of downturn. GDP is not crashing but its no longer accelerating. It’s acceleration or deceleration (the second derivative of growth) that determines where we are heading, recession v expansion.
Another sign is ISM numbers which describe expansion or contraction around the world. ISM around 2015 was coordinated in expansion around the world in 2016 because China pumped 800B into their economy and the markets sucked up all that stim. Markets now are all coordinating into recession or depression world wide. China Asia Europe Australia South America Russia and US are decelerating to various degrees or in frank recession. Just like the expansion was world wide I expect the contraction to synchronize world wide. The US may not do as bad as say EU or Japan but we have significant head winds.
The rule is buy low sell high or sell high buy low. This does not mean you go from 100% VTI to cash. When the downturn happens it’s very dangerous to be in stocks especially index funds. Once the herd turns the stampede to the door will be ridiculous, and fortunes will be devastated if 100% in stocks. IMHO based on quantitative statistical analysis one spread across 5-6 asset classes, stocks bonds, cash in an interest account, gold, BTC and maybe real estate. In addition one should be aware of tax advantages such as tax loss harvesting assets that are down. Owning TLH is a separate diversifier. The correlation between each of these assets is close to zero, so when stocks crash cash bonds BTC and gold are essentially unaffected or may actually rise in value, so a loss in stocks is offset by a gain in gold which tends to stabilize the portfolio. This is called diversity. By owning several non correlated asset classes a concentration in any one won’t kill you.
You also need to diversify according to tax consequences/ If you follow the old “max out your pretax” you’re a dumb ass, unless you understand precisely how and when those pretax taxes will be paid. THEY WILL BE PAID and they will be paid according to the governments rules. If you make more than 100K/yr ordinary income the government considers you to be rich and the tax code is designed to screw the rich. The rich pay more than their fair share by a lot. If you own a 3M IRA you better understand the IRS going to bone you and as things get tighter they will bone you harder.
Another drag is demographic. As boomers retire that will be a hit on GDP and productivity and lower productivity means lower stock prices. In addition boomers are going to be forced to sell their pretax portfolios which are mostly in stocks at about 5%/yr and turn that into cash which will them be taxed at a progressive rate. The government forced sale will be a drag on stock prices so there are a lot of headwinds coming down the mountain.
I’ve read several economists that expect US investors may do no better than 3% return over the long term. The problem with FIRE is people are expecting 8% and that rate of return causes people to leverage their future If you future value 1M @ 4% WR and 8% you’ll have 5M in 30 years. At 2% over inflation you’ll have 180K. That’s a demonstration of leverage. If the government raises your taxes likely you won’t make it. So that’s the problem with FIRE. It presumes the return will be like it’s been over the past 10 20 or 30 years but that’s highly unlikely IMHO The longer you work the less levered you become and the more likely to survive till you die. The more diversified you are the less draw down you experience in a crash as well. So IMHO unless you make and save a ton of money retiring early is a BAD idea given the present state of affairs. If you read PoF’s recent article he talks about 25x but his actual savings was 36x and he has several income producing businesses on the side. This is a far cry from the 4 x 25 mumbo jumvo of the boggleheads.
What to do? Buy a rational well diversified portfolio like the Dalio All Weather or my modification. Keep a budget to understand how much you will need BEFORE you can retire and work backward from your death to see how much money you need. If you retire at 60 on 100K and inflation is 2% at 90 you will need 181K for the equivalent buying power. Each year the amount you need goes up 2%, so work backwards. 181K + 177K + 174k + … all the way back to 100K will yell you how much your retirement will cost for 30 years. My 20 yr age 70 retirement will cost 2.6M starting at age 70 so that’s what I need to have or rationally need to generate. From that data you can also estimate taxes and add effects from SS etc. That’s a rational number based on a real budget.
If you make a lot you can keep working backward till the amount you own passes the amount you need plus you can add in some leverage if you like. I wrote a 4 part series on this. This whole site is devoted to not dying broke and the real risks of retirement, so just work your way backward and see what you see and use what you think makes sense. The idea retirement is easy peasy one size fits all is a myth. It takes work and planning