BiggerPockets Money Podcast

BiggerPockets Money Podcast 120: Are FIRE Naysayers Bad at Math? Yes. with Michael Kitces

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Michael Kitces joins us today to talk about early retirement—and how the recent stock market movement affects the FIRE community and the 4% rule.

We spend a lot of time on the 4% rule and take a look at a graph illustrating what Michael discusses. Basically, there is an ultra-high probability that you will come to the end of 30 years with MORE money than you started with and an extremely LOW chance you’ll spend it all. In fact, only one time does the retirement fund hit zero—and even that isn’t until year 31!

Since the FIRE movement is based on the 4% rule, we wanted to hear from Michael, the Research Nerd Supreme, on his feelings about it: “Historical safe withdrawal rates aren’t based on historical averages. They’re based on historical worst-case scenarios,” he said.

Yes, we’re seeing some pretty big movement in the market, and yes, it can make you think. This episode provides powerful reassurance that “every little thing is gonna be alright.”

If you are worried about your financial future, if you have money or want more, this episode is a can’t-miss, absolutely must-listen edition of BiggerPockets Money.

Click here to listen on iTunes.

Listen to the Podcast Here

Read the Transcript Here

Mindy:

Welcome to the BiggerPockets Money Podcast, Episode 120 where we interview Michael Kitces from Nerd’s Eye View blog and the XY Planning Network.
Michael:
The problem or the place where I think we get ourselves into trouble is when we focus so much on the retire or the retire early, we create this binary state. I’m working until I have enough and I never have to work again. And we don’t think of it from what I think is a much better framework of the FI framework, which is I’m going to accumulate enough money to get to the point where what I decide to do with my time is no longer dependent on money, which is very, very different than saying, “I don’t have to work anymore.”
Mindy:
Hello, hello, hello and welcome to the BiggerPockets Money Podcast. My name is Mindy Jensen and with me as always is my laugh in the face of sequence of returns risk cohost Scott Trench.

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Scott:
I don’t know, I’m going to have to be pretty withdrawn in response to that.

Mindy:
Oh my God, I quit. Okay. From Episode 120. Now Scott and I are here to make financial independence less scary, less just for somebody else and show you that by following the proven path you can put yourself on the road to early financial freedom and get money out of the way so you can lead your best life.

Scott:
That's right. Whether you want to retire early and travel the world, just navigate this coronavirus market crash and maybe recession. Or go on to make big time investments in assets, it's like real estate. We'll help you build a physician capable of watching yourself towards your dreams.

Mindy:
Welcome to the show today, Scott. I am super excited for Michael Kitces to be on because I have been following him for quite a few years. I saw him speak at FinCon like FinCon 14 or something. I’m so excited to have him and I’m super, super excited to introduce you to him because you really seemed to enjoy his writing.

Scott:
I really enjoyed this episode. This dude is an absolute master of the craft of early retirement, retirement withdrawal rates. He has done the original research. He has written about it at length. He’s got 20 years of experience putting it into practice with clients. I mean we just sat back and let him go and good God, he was amazing. So this is one of my favorite episodes of all time, I think.

Mindy:
But I think that Scott’s introduction of him doesn’t really do him justice because not only does he have all of those things, he also can translate it into easily digestible information. He’s not using all this jargon and industry specific terms that nobody else understands. He uses regular words. He talks about concepts that make sense. You can’t listen to him and say, “He’s lying or that’s not really real, that’s not going to work.” It works. He’s living proof that it works. He has a client roster of people that it works for. This show is fantastic. And if you think, “Oh, I’m not sure if I want to listen to it.” Yes you do.

Scott:
And by the way, for those of you who don’t know, we do also put these shows on YouTube. So if you want, you can see my slightly messy home office studio and horrible haircuts and Mindy’s mattress and dinosaur on the YouTube channel. Just type in BiggerPockets and it’ll be one of the recent videos.

Mindy:
Yes, Scott and I are recording from home, different homes. Scott and I don’t live together. I am recording from my home office, which also doubles as my guest room. So yeah, that’s the mattress behind me. We have a beautiful new studio that we moved into week before-

Scott:
That’s right. We just [crosstalk 00:03:38]. We spent months building out our new office and we opened it and that week is where we have to close it. Oh well, yeah.

Mindy:
Yes. So some day we will be back together in person in our brand new studio, but for now we’re just recording from home.

Mindy:
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Mindy:
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Mindy:
Michael Kitces is the co-founder of the fee only CFP directory called the XY Planning Network and the brains behind the Nerd’s Eye View blog. Michael, welcome to the BiggerPockets Money podcast. I’m super excited to have you today because we are going to talk about some things that are very, very pertinent to our listeners.

Michael:
Fantastic. I’m looking forward to it. Thank you Mindy for having me out. I’m excited about the conversation today.

Scott:
So Michael, I have a question for you. Is the 4% rule broken in light of the coronavirus and the recent market drop and do we have to completely reimagine retirement in general as a result of all this?

Michael:
No.

Mindy:
From Episode 120.

Scott:
All right that’s it.

Michael:
Great joining you. No. I mean obviously the like this is the topic of the conversation that’s out there, right? We’re watching market declines, we’re watching portfolios going down. People who’ve already retired or pulled the trigger on fire are watching the portfolio going down.

Michael:
Maybe they even started at 4% now they’re looking, going like, “Okay, I started at four, now it’s five plus because the market went down. So the denominator of my fraction moved against me.” And some of these questions start cropping up. Like, “Is this broken? Is this wrong? Am I going to change? Am going to go back to work?” If I was getting close to fire, do I have to go back to the drawing table and not look at this the same way again? So I mean, they’re all great questions to ask. So the starting point to this that I think often gets missed in the discussion around things like the 4% rule is just to understand where the number actually came from in the first place, which I find isn’t often well understood.

Michael:
And even I know the fire community talks a lot about the Trinity Study, which came out in the late 1990s which community, all these different Monte Carlo analysis and came up with this number that seems reasonably safe. And I’m a big fan of that sort of analytical framework, but it’s not very helpful for us intuitively. Nobody knows how to mentally visualize a 98.7% probability that a 4% rule works. So here’s where it really came from, the first time the 4% rule came forward was actually in a study back in 1994 from a gentleman named Bill Bengen. Bill was a aerospace engineer, turned financial, advisor absolutely appropriate given this field of study and what he ended up doing research on, and-

Scott:
It is rocket science.

Michael:
It is rocket, it was created by a rocket scientist, but it doesn’t actually have to be rocket science. So you have to look at this in context. So when Bill was doing his work in the early 1990s, we were more than a decade into a raging bull market. Stocks had been going up double digits for well over 10 years. There was a horrific crash in 1987 within 12 months the market was higher than it had been before the crash. So it was basically just a blip that people hardly paid attention to. Certainly from the long-term spending perspective.

Michael:
So the market was raging upwards and if you pulled out industry or even consumer publications at the time, you would find discussions that would say things like a reasonably safe conservative spending rate is 7% to 8% of your portfolio. That was viewed as safe because again, the market had been doing 12% to 15% a year for 10 years. So when the market’s doing 12 plus eight is like, well I’d seems absurdly conservative but okay I guess maybe I’ll do that.

Michael:
And so in that backdrop where everyone's talking about 7%, 8%, including there's a famous article where Peter Lynch Magellan's talking about 7% as a conservative rate because he was a conservative investor. In that backdrop, along comes Bengen and what Bengen said is, "Well look, I can put the math into a spreadsheet and show you off market's average set at 12%." You can spend 7% or 8% adjusting for inflation and it does fine.

Michael:
The problem though is even if markets average that over long periods of time, they don’t necessarily do it in straight lines. They bounce up and down and they do sometimes bad stuff fall by good stuff. And so what Bengen says, “Look, I’m going to take this rule of thumb where everybody wants to spend about 7% or 8% and I’m going to look historically at what would have happened if you actually started out your retirement spending a number like 7% and then got the actual sequence of stock and bond returns that happens through your 30 year retirements and adjusting your spending for the actual inflation that occurred.”

Michael:
And what he found was it works on average. But when you actually looked at all the different 30 year periods in the 1900s, through the century, it turned out it failed quite frequently.

Michael:
And so the question then became, well, okay, so seven works on average, but it doesn’t work if you get a bad sequence, right? Like you retire on the eve of the Great Depression and it works on average, but you run out of money before the good returns show up. How much lower do you have to ratchet it in order for this to work? And so what Bill ended up doing and where the origin of this 4% number actually came from, Bill created a chart that said, “I’m going to look at every single 30 year retirement period going all the way back to the early 1900s and I’m just going to see what withdrawal rate would’ve worked for every single 30 year period we’ve gotten our market history.”

Michael:
Some of them are high, some of them are low, some of them are in the middle. And so if you want to pick a safe withdrawal rate, which was what Bill’s goal, if you want to pick something that should be sustainable, pick the lowest bar on the chart. That was it. Look at every single 30 year spending rate that’s ever worked. Take whatever literally the worst one was we’ve ever seen and pick that. And so if you make that your number, one of two things happens, either we get another scenario that’s bad as anything we’ve ever seen in history, in which case you should still make it through just barely because that’s where the number came from. Or you’ll get anything better than the worst case scenario in history, in which case one of two things happens. Either A you die with a bajillion dollars leftover or B in the real world at some point you sit down and say, “Okay, we’re ahead of what we actually expected. I think we can raise our spend.”

Michael:
And so when Bill looked at all these different rolling 30 year periods throughout history, what he found was the worst case scenario was a withdrawal rate of about 4.15%. Bill rounded it to 4.1, we collectively rounded it to four, and that’s where the 4% rule came from. It was the one rate that worked in the worst historical market sequence we could find.

Scott:
And when was that market sequence? Just for reference to people who are interested.

Michael:
So this is evolved a little bit. The original data set that Bengen used, the worst case scenario was retiring essentially right on the eve of the Great Depression in 1929. Now, there’s a couple of different data sets out there that have market history. Bill was working with what was the Ibbotson data set, which is now owned by Morningstar. That basically goes back to the early 1920s.

Michael:
He couldn’t look earlier than the 1920s and he actually couldn’t look later than the 1960s because if you want to run a 30 year time period and Bill was running the study in 1994. He couldn’t tell you what happened if you retire in the late 1960s because we didn’t have 30 years yet.

Michael:
So we’ve replicated this study since and done it with broader data sets. If it’s got a bigger data set, Schiller publishes a data set that a lot of people use. There’s one or two others out there as well. And so when we do it with broader data sets, you actually find there’s really three different time periods that all come in with a number remarkably close to this 4% number. One is retiring on the eve of the Great Depression, 1929, the second is retiring right before the financial crisis of 1907. Big economic boom, the growth West of the country, big real estate boom, big growth to the economy.

Michael:
Then all of a sudden there was a shock to the system. We had a financial crisis. The financial crisis actually started in small towns and it caused small town banks to fail. This was the era of bank runs, like where people literally ran on the bank, pull it all the money before the bank failed. The small banks caused the midsize banks to fail. The midsize banks caused the large banks to fail and so it was very similar to 2008, a full blown financial crisis in the system. The only difference was the 1907 version started on Main Street and rippled up to Wall Street. The 2008 one started on Wall Street and rippled down the Main Street. So we had these three periods, right before the financial crisis of 1907 where we had this 15 to 20 year period with mediocre economic growth, terrible market returns, and really low bond returns.

Michael:
The eve of the Great Depression in 1929 and then retiring in 1966 which was a bear market year in the market. And ultimately, so 1966 the Dow is approaching 1000 for the first time. It had a pullback when sideways in 1973, it hit 1000 for the second time. Then the 73, 74 bear market came. It took until 1982 to materially break 1000. So if you retired in 1966, you spent 15 years waiting for the stock market to get back to the day that you retired on top of double digit inflation in the 1970s.

Michael:
And so that became the third time period that triggered a 4% number. The average of the whole historical series is about six to six and a half. So for anyone would ever wonder, like well what’s the average safe withdrawal rate that would have worked in history? It’s about six to six and a half. But the point of Bengen’s framework was if you want to pick a ‘safe one’, start with the worst ones and work up from there. And so it was essentially this three way tie between 1907, 1929 and 1966.

Scott:
Nice. And you have personally replicated this study, is that right? Is that what I’m understanding?

Michael:
Correct. Correct. So Bill originally did it with the data set that only found the 1929 year. We replicated it originally with the Schiller data and then have actually done it with some other data sets as well. We all generally come back to about the same number. It wobbles by maybe 0.1 or 0.2% just depending on what particular stock and bond proxies you use because we don’t have the most robust market data back in the 1800s and early 1900s. So there are a few assumptions that have to be made for some of the really early data. But everybody that replicates this tends to converge back on a very, very similar number right in this 4% to 4.5% range.

Mindy:
Okay, so you’re saying 4% to 4.5%, I’ve heard three and a half to four. I’ve read Bengen’s study. That was mind blowing and we’re going to include a link to the actual study as published I think in Life Magazine in the show notes today, which can be found at biggerpockets.com/moneyshow120. We’re also going to include a link to your article called how has the 4% rule held up since the tech bubble and the 2008 financial crisis which you published in 2015. There’s a graph in there that is mind blowing. It’s called terminal wealth after 30 years of following the 4% safe withdrawal rate all historical years.

Mindy:
And if you are a visual learner, this puts to rest all of the, “Oh, does it work? Are you sure it’s going to work?” My eyes are terrible so I’m having a hard time seeing this one little thing at the end. There’s very few times where you don’t have the same amount of money that you had when you started. It’s mostly you have significantly more in some cases nine or 10 times what you had. And then there’s one case that goes close to zero but doesn’t look like it hits zero.

Michael:
And that’s where the safe withdrawal rule comes from. So for those who obviously can’t see because we’re listing, you just envision a chart that’s got about 100 different squiggle lines because we literally just said let’s look at every historical 30 year period we’ve ever had for retirement and we’ll just do 4% in all of them and see what happens.

Michael:
There’s about 100 different squiggles. We started someone with $1 million just to make the math nice and round and easy. Obviously it’s a 4% rule so you can do 4% or whatever number you want. But we started people with $1 million, they finished with as much as 9 million. On average. So there are, it’s, I say them 50% of the time. The median value is more than double their wealth. Almost 3X where you started. So 50% of the time you start at one you finish with almost three on top of a lifetime of spending.

Michael:
96% of the time you finished with the original million. And once, one line, one little tiny squiggle cruises down to zero at the very, very end. If you had a 31st year, you would have gone below the zero line. And that’s why we have the 4% rule because that one last squiggle would have run short. So it wouldn’t have worked in all the historical sequences if you didn’t protect against that one worst squiggle.

Scott:
Can you explain the portfolio that you’re assuming for this?

Michael:
Sure. So these are very simple, straightforward portfolios, large cap US stocks, intermediate government bonds.

Scott:
Got it.

Michael:
That’s it. You can pick Vanguard total market would actually be more diversified than these studies and a total bond index would actually be more diversified than these sites. This was just US large cap and intermediate government bonds. And we do find, when you look at some of the followup studies that have been done, there’s no question.

Michael:
I mean today’s marketplace, we are more diversified than this, right? We own large caps and small caps. There’s a lot of bond types. We’ve got domestic, we’ve got international, we can buy alternatives like gold and commodities and real estate. You can buy real estate directly. None of that was even in these original studies, primarily because sort of being like I’m half financial adviser, half research nerd. So the research nerd to me says I don’t have any good data to go back on. Like I can’t tell you what the 100 year safe withdrawal rate would have been if we had been buying REITs 100 years ago because I didn’t have REITs 100 years ago. And I don’t want to just make up the data.

Michael:
So when we look at sort of these questions like what happens with modern diversification relative to the historical numbers, what we find is the withdrawal rate is clearly higher, debatable how much. Most folks that I know that do research in this space, including some of the work we’ve done, we tend to come to numbers more like 4 and half…

Michael:
This is including some of the work we’ve done. We tend to come to numbers more like four and a half to 5% with a little bit of fuzziness. Even Bengen, the guy who made 4% rule, he was also a practicing financial advisor through the financial crisis, through the tech crash. He didn’t use 4% with his clients. He used four and a half.

Mindy:
He used four and a half, okay?

Michael:
He used four and a half, because he was actually the first one to publish… Gee, even when you just put small cap stocks in, so you get a little bit more diversification from the small companies over the large companies, your withdrawal rate actually lifts up closer to four and a half than four.

Mindy:
Something that Mr. Money Mustache said is, it’s not like you’re going to go to sleep one night and be fine, and then wake up the next morning with nothing. If the market is going to go down, you’re going to get some sort of warning. If your portfolio is going to go down and looking at your back to your graph, the one time that it goes down to zero, they had warning around…

Michael:
Oh, like 15 and 20 years worth of warning. I mean the reality even for how these play out. Look, I mean as much as we talk about these numbers, like you’re spending four so if there’s a terrible market crash and your portfolio takes a big hit, like now you’re spending five.

Michael:
If I’m going to spend down at a 5% rate of 100% of my principal, like this is pretty straight forward, five into a hundred, like it takes me 20 years to actually run out. So you have a bit of runway to realize, oh maybe we should make an adjustment here.

Michael:
And so absolutely true, this doesn’t come as a surprise. I mean I know in realtime bear markets always feel surprising. I’ve been through several of them through my career. This one was certainly more dramatic and faster. Technically we still haven’t even gone down, as of when we’re recording, as much as the financial crisis pulled the market down.

Michael:
But the financial crisis did it over 18 months. This one’s run over about 18 days. So certainly it feels a little more colorful and dramatic and we’ll see how much the terrible unemployment ripples through the rest of the economy. We may or may not be done with the turmoil at least economically market-wise.

Michael:
But you’re still only spending 4% or maybe five because it’s a larger percentage of your smaller number. You’re not actually moving your dollars that much from year to year. There’s a whole lot of time for you either (a) to recover, which is why at the end of the day. We can have these terrible drawdowns, be spending at 4% and still be fine because 96% of the money didn’t get spent every year, was still invested to grow and recover.

Michael:
And even if you end out going down more of a dangerous track, it doesn’t happen fast. It actually happens pretty gradually. So your spending rate is four and it’s four and a half and it’s five, and there’s a market pullback and it’s five and a half, and then it kind of gets to six plus. Even at six plus, you got 16 years before it runs out.

Michael:
But you can at least look at that and say, okay, now this probably is not a good idea. Maybe I need to make some kind of adjustment to handle the next 15 or 20 years.

Scott:
And you’re talking about 4% of scenarios is where this discussion begins to take place even, right? At 96% of the time, you’re not even having this discussion because you’re ahead of the curve.

Michael:
Correct, and to be fair 96% of the time we finish ahead of the curve after the 30 year cycle is run. We dip below the line more than 4% of the time, cause we can get some lousy timings like this. I mean if you just retired at the beginning of the year, it’s not feeling great right now. You are certainly below the line from where you started. Same thing if you retired in 2008, same thing if you retired in 2000.

Michael:
But we published some studies around that as well. Like what happened if you retired in 2000 on the eve of the tech crash, you’re doing just fine. Your withdrawal rate actually looks better than it did in any of the 4% scenarios. Even through what we’ve been through, you’re so far ahead because you were only spending a few percent and the market recovered pretty quickly at the end of the day.

Michael:
If you retired on the eve of the financial crisis in early 2008, you were still trending far ahead of any of these 4% scenarios over the first 10 years of your retirement. Yes, the drawdown was dramatic, but even at four plus percent of spending, more than 90% of your portfolio was still left when we got through the crisis, and a giant 10 year growth cycle came for the decade of the 2010s.

Michael:
So I think we sometimes underestimate how little of your portfolio you’re actually spending from year to year, which is actually the point as to why the 4% rule survives, even when markets can go down 40 plus percent in a bear market. (a) Diversification, (b) you’re not actually pulling that much in any particular year.

Scott:
Yeah. It’s like another way of looking at it is 4% is you’re spending one 25th of your portfolio in a given year, right? So if you just meet inflation, it’s going to last you 25 years. So it’s so close to that that it’s remarkable there.

Michael:
And there are scenarios that come out. One of the versions of what do you do if you actually are on the decreasing path? Like you just kind of pull the ripcord and say, hey, we’re just going all into bonds. We’re going all into trades, Treasury inflation-protected securities. I can get more growth and I can do the exact math of how much inflation adjusted spending I can go from here, and if that covers my 10 or 20 or 30 years left on earth, God bless.

Michael:
Now it gets a little bit harder though and probably worth reflecting, getting back to Mindy’s comment earlier, it does get a little harder if you retire younger. Cause our time horizon gets longer and certainly the simple math of it, like the four percent rule as Bengen did it. That was a 30 year retirement cause Bengen worked mostly with retirees who were 60 something, so 30 years seemed like a good reasonably conservative number, fine assumption of baseline.

Michael:
But if you have the opportunity to retire earlier or much earlier, you’re kind of immersed in the FIRE movements and were much, much earlier. We’re not talking about 30 year time periods. We might be talking about 40, 50, 60 year time periods. And to be fair, that does pull the safe withdrawal rate down, not as much as you’d expect. What we find, even when you start pulling out to 40 or 50 year time periods, you essentially go from a 4% rule down to a three and a half percent rule.

Michael:
So getting back to your earlier number, Mindy, of three and a half, that’s largely where it comes from. If you’re going to stretch out the time period, you do need to spend a little bit less because if you get a bad sequence, you do need a little bit more buffer so that if you get a bad start, you’ve still got enough money left for when the good sequence finally shows up and then that carries you through for the long run.

Mindy:
Okay, well let me pose a different scenario. So last week, we interviewed a set of five guests at various stages of their early retirement, including somebody who retired in January. And when we asked him, is there anything you would’ve done differently, knowing now what you know then? He’s like, I would have done it sooner. Oh, okay. That wasn’t what I was expecting at all, so I thought that was lovely.

Mindy:
But one of the groups that we interviewed, one of the couples was Kristy Shen and Bryce Leung from Millennial Revolution who are self-proclaimed, the most pessimistic people on the planet. They decided that when they were going to go for financial independence, they were not going to trust the stock market even though – their story is fascinating. They like tested it for three years and saw that it worked while they were still working.

Mindy:
So in addition to their nest egg of $1 million to cover their $40,000 a year spend, they have what they call a cash cushion of five years of expenses in a savings account, and instead of selling, because they retired in 2015 right when the Canadian, they’re Canadian, so the Canadian stock, oil crash or whatever.

Mindy:
So right when they retired they had to start dipping into their cash cushion right away. They’ve since recovered of course, cause it’s been five years since that. And now they also have something called the yield shield, which I don’t really understand nearly as much, but they have higher yielding assets like preferred shares, corporate bonds, Reeds, and dividend stocks. And by doing so they raised their portfolio’s yield from two and a half to 3% so they can avoid selling in a down market.

Mindy:
Do you think five years of cash expenses is too little, just enough, too much? And what do you think of their yield shield?

Michael:
We have these conversations routinely. As I said earlier, half of my world is doing this nerdy research and publishing about it. We write about it on our site, but I’m also in an advisory firm and we do this for our retired clients live in practice including having these conversations and folks who have read about strategies like cash buckets.

Michael:
Our industry largely calls these bucketing strategies, just kind of like carving up my money. Here’s the longterm money. It can be aggressive, cause I’m going to touch it for a long time. Here’s my short term spending money. I’m going to put that aside in cash cause you don’t want volatility in your near term money.

Michael:
So I’d answer this two ways. There’s the psychology answer and there’s the hard math answer. So the hard math answer is at the end of the day, it hurts more than it helps. Five years of cash hurts more than it helps. The growth in yield and return that gets lost when you’ve got five years of cash, which for a lot of people in just hard dollar terms, I mean if I’m spending three and a half, 4% of my portfolio, like five years worth of cash could be 20% of my assets in cash.

Michael:
So holding 20% in something that generates no return for the once or twice a decade market pullback is too much of a drag for what you give up relative to the actual buffer value that you get.

Michael:
So there’s a couple of studies out there. We can actually give one in the show notes if someone wants to look at some of it. We’ve recapped some of this research. What you find in practice is anything more than about a two year cash bucket, you start dragging more in just the low return of cash than you get back in the buffering effect.

Michael:
And the primary reason for this, or I guess sort of the asterisk that I would put to this, this presumes you otherwise have a diversified portfolio in the first place. If you are a very aggressive investor and everything is in stocks and real estate and growthy oriented stuff, cash buckets definitely help. They do help the buffering.

Michael:
But for folks that hold, I’ll just call them, broadly diversified portfolios like I got some stocks, I got some real estate, I got some bonds. The truth is the bonds already do the heavy lifting of this what happens if the market goes down, and specifically here we’re talking about good old-fashioned government bonds. The things people buy when there’s a flight to safety, when scary stuff is happening like for the past few months, 2008, 2000, 1973. There’s an extremely consistent pattern when recession is on, the Fed cuts rates, we stimulate the economy, it drops rates down, it causes government bond prices to rise and basically every recession like clockwork, number one performing asset class when you’re heading into the recession, is government bonds that virtually always end up up, usually up quite significantly.

Michael:
And so the truth at the end of the day is where as long as we’ve got a diversified portfolio, I don’t need to go dip into my cash. I don’t need to build up a bunch of cash and then dip into my cash in order to do this. I can do it with my good old fashioned government bonds that granted for the past five to 10 years have been lousy returns. But so is cash, and…

Scott:
In the past couple of weeks, they’ve done really well, to your point.

Michael:
And that's the point. Like once every five to 10 years when everything else is going horribly, government bonds end out with these shining moments and usually the longer term the bonds the better because they benefit more from interest rate cuts for all those familiar with the dynamics of bond math.

Michael:
And so when we get these long duration government bonds in there, it becomes the thing that goes up when everything else goes down which means I don’t actually need to hold zero return cash. I can at least hold, well these days like two or 3% government bonds, but two or 3% government bonds for the past 10 years with a big chunk of my portfolio, suddenly it’s like 20% to 30% of additional cumulative growth I would have had that I didn’t actually need cash for. That I give up by using cash, but I still get all of the benefit of, oh my gosh, what am I going to sell when I need to sell something in a downmarket?

Michael:
The answer is the bonds. That’s actually why we have them and even the second caveat to that is it’s also actually okay to sell stocks. You still have 96% of them invested. You don’t actually lose that much even if you had to sell the stocks.

Michael:
But once you’ve got a diversified portfolio in there with the bonds, the reality is the cash doesn’t actually help. It produces more drag than benefits because the bonds already do the heavy lifting work that you needed in this scenario, and while they don’t give you much of a return the rest of the time, that’s kind of the point.

Michael:
If your biggest problem is government bonds are giving you a terrible return, it’s probably because everything else in your portfolio is growing, in which case you don’t have a 4% rule problem, you’re going to be spending five, six, seven, 8% in the first place.

Scott:
Absolutely love it. Now I’ve got a question on the cash cushion. If suppose I do have a two year cash cushion, have you ever done any modeling around how that impacts the 4% rule? Does that drop it from four to 3.8 or how does..?

Michael:
So here’s what happens when you start modeling the kind of the shorter term cash buckets. From an aggregate sort of safe withdrawal rate impact, it’s basically a wash. You don’t see a material lift, you don’t see a material decline.

Michael:
What ends out happening, just like wearing my research nerd hat, it becomes almost entirely dependent on exactly what your assumptions are for the cash. There are ultimately kind of a few key assumptions that start cropping up just when you try to model this and evaluate it.

Michael:
The first is what are your transaction costs to buy and sell stuff or raise cash in the first place. Now this has gotten easier in a world that’s like trading commissions have collapsed down to zero but it wasn’t that long ago when I was going to pay $5, $10, $15, $20 a trade.

Michael:
And so there came a point where as I’m doing my ongoing spending, accumulating a cash bucket actually helped, not actually because it was a buffer in the bear markets, but because it reduced how often you were generating transaction costs in the first place.

Michael:
So if I built up six months or 12 months or two years of cash either because I started collecting my dividends and interest and I wasn’t reinvesting them, or I was pulling capital gains distributions for mutual funds, or like once every two years I did a big sale so I wouldn’t have to do a bunch of little sales along the way. You could actually see a bit of a lift in sustainable withdrawal rates but not actually because the cash buffer was helping you in the bear market because it was buffering your trading costs. Again, less of an issue now that we’re sort of dropping to zero commission world, but that was a factor for a while.

Michael:
As well as just what you’re getting on the cash still has a bit of an impact. We’ve seen this I think particularly highlighted over the past few years depending on what money market funds, ultra short term bond funds, bank. Online bank I use. Like I could get a yield anywhere between about 0.1% and almost 2% just depending on where I move my cash around the economic system.

Michael:
And that won’t make or break your retirement, but it is actually a material factor and so being able to cash shop your yield up. Look if you can figure out how to put the cash somewhere that generates almost as much as your government bonds were getting anyways. It helps.

Michael:
It’s still not as good as your government bonds because your government bonds don’t just give you the yield. They go up when everything else goes down and there’s a flight to safety so you don’t quite get the same diversification effect. So to the extent you can clip up a little bit more yield on your cash, it certainly helps as well.

Scott:
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Mindy:
Okay, so I am fairly anti-bond. I don’t feel that I’m old enough to be in bonds and Scott is even younger than I am and I don’t feel like he should be in bonds either, but I’m not the boss of him. At what point do you start looking at bonds? Like what age range or income level or level of financial whatever?

Michael:
So I’ll answer this two ways cause it also actually gets back to the piece we didn’t talk about of the second reason why you do hold, even things like two, three, five years cash buckets.

Michael:
So when I look at this sort of question of how much do I hold in stocks and bonds, to what extent do I own bonds? Ultimately this is kind of a risk trade off. And so I’d encourage you think of risk in two dimensions.

Michael:
So the first is what I’ll call your risk capacity. So how much capacity do you have given your current financial situation to own risky stuff where something bad might happen and it might take a while to recover? So our capacity for risk is primarily driven by our time horizon and the need we actually have to use the money.

Michael:
So if I’ve got a really giant time horizon and I’m not retiring for a long time, or maybe I am retired, but I withdraw very, very little off of my portfolio, I don’t need much in bonds because I’ve gotten enough, in the true sense, capacity to just ride this stuff out.

Michael:
At some point, my capacity begins to change. My time horizon gets shorter, maybe I’m in retirement, I’m withdrawing material in retirement. Certainly when we get older in retirement and our time horizon shrinks a little bit more, that mixture starts to change. We often talk about this with clients as I call this our retirement red zone.

Michael:
So as we’re building up, as we’re leading into retirement, we hit this red zone. It’s about five to 10 years before your retirement transition, until about five to 10 years after your retirement transition. Where your portfolio will be the largest cause we’ve been building it up for this moment, which means bad markets hurt the most and become the most prone time where if a bad market comes and you are within a few years of retirement, or you just got a few years into retirement. I can materially derail the timeline of your planned retirement.

Michael:
And so when we get into those retirement red zones, we may look at a little bit more of a build-up of bonds or even cash, but not necessarily as a permanent shift. So I call this the bond tent strategy. So as I’m approaching retirement in the red zone, I’m going to build up an extra allocation of bonds, like a little…

Michael:
… approaching retirement in the red zone. I’m going to build up an extra allocation of bonds, like a little teepee tents over my head. I’m going to build up the bond allocation as I approach retirement. I’m going to then work the bond allocation back down as I go through the first 10 years of retirement because one or two things is going to happen in the first 10 years of retirement. Things go badly and I’ll be thankful I had the bonds, or things will go so well that I’m already so far ahead of percent of the 4% rule that I don’t actually worry about what happens here. I don’t need a bond buffer anymore. It’s not necessarily a permanent cash bucket, but we can actually take shelter in the bond tent as our capacity for risk changes. That’s the first dimension.

Michael:
The second I want to touch on is our tolerance for risk, the truer sense. We throw around the world risk tolerance a lot, but, most of the time, when we talk about risk tolerance, we’re actually talking about risk capacity. We say things like, “Young people have a lot of risk tolerance because they have a long time horizon.” It’s actually not true. You have a lot of risk capacity because you have a long time horizon. Some people just don’t like risky stuff. If you don’t like risky stuff, I don’t care whether you’re 72 or 27, don’t own risky stuff because you’re not going to enjoy the ride.

Michael:
Life is short, and this kind of gets back to the comments earlier about the five-year cash bucket. Do I need that mathematically to make my 4% rule work? No. Technically, it probably actually drags it down a tiny bit, but if I don’t have the tolerance to ride the waves that it takes to push a 4% rule with the moderate growth portfolio and I have to own something more conservative because that’s where my comfort with risk is in the first place, then, yeah, you’re going to own a cash bucket. Now, I might dial my withdrawal rate back to three and a half instead of four because you’re just not owning as much growthy things in the first place, but if that’s where your comfort is with risky trade-offs in the first place, that’s where your comfort is with risky trade-offs.

Michael:
My grandparents retired, and they had a wonderful, comfortable retirement solely based on their savings, and my grandfather refused to ever buy a stock in their household because his uncle lost all his money in the Great Crash of 1929, and he’s still retired. They built their money in CDs and bonds. They probably had to save a little more. They might’ve had a little bit more dollars in retirement if they’d be willing to take some risks because it did work out, but they live their lives. They built their conservative portfolio. He never owned a stock in his life. They still retired. He had his home in New Jersey and a little place in Florida, and they enjoyed their lives.

Michael:
You don’t have to ride the roller coaster. You do get some potential to build more wealth. Risk generally gets rewarded with some speed bumps along the way, but you have to view these through both lenses. The capacity answer is there is a case to be made for building a bond tent when you’re in the retirement red zone, 10 before, until 10 after. From a tolerance perspective, own what you need to own to sleep at night or you’re not going to enjoy your retirement anyways.

Scott:
When I think about the 4% rule, most of the people listening to our show. I think, are probably going to be more than 10 years from traditional retirement age, hopefully less than 10 years from retirement, but when I think about this and I think about the 4% rule, I imagine, and I’m thinking back to an old Mr. Money Mustache article here, that kind of shows, “Hey, it assumes that you don’t have any cash. It assumes that you don’t have other types of income, like Social Security coming in.” Right?

Michael:
Absolutely.

Scott:
It assumes that you don’t change your spending, because, obviously, we’re all hopefully spending much less given that we’re all quarantined now than we did a few months ago, and we can go out and about, do things. It assumes no substitution for goods. It assumes no inheritance. It assumes you don’t spend less as you age and get older. It also assumes you don’t have a cash cushion.

Michael:
Well, it assumes you don’t get bored and start doing something and end out with a side hustle that makes you some money.

Scott:
That’s right, yeah.

Michael:
See, you actually don’t need to spend as much in the first place.

Scott:
Just kind of walking through that, how do you think about this for someone who is 35 and has gotten to the 4% rule. How do they need to be thinking about the situation where, “Hey, you just stated it’s a 3-1/2% rule, but, in practice, what’s a helpful way to frame this for someone in that situation who’s worried about a situation like precisely what we’re going through right now?

Michael:
There are a few things that I would give to think about. First, I do think at least when you’re just going to conservative baseline, if we’re starting there, I would pull my 4% number down to a 3-1/2, at least just from fewer, kind of the math of what it takes to run super long time periods where stuff like this does happen pretty much about once a decade like clockwork. We manage to inflict a recession on selves once every 10 years, and we’ve managed to inflict a really bad one on ourselves once every 30 years or so. This stuff happens, and we do need some cushion to be able to deal with that, but there are a couple of levers. I think of this like levers. In fact, we did a recap study on this a couple of years ago. I’ll make sure you guys get it in the show notes, as well, of just all the different levers that you can actually pull to move that 4% rule number up and down.

Michael:
One of them is time horizon. If I’m going to go 40+ years, it’s really more like a 3-1/2 rule. If I’m already in my seventies and I’m just praying I got 20 years left on Earth, it’s really actually a 5% rule, not a 4% rule. Diversification gives us a bit of a lift. Taxes give us a little bit of a drag. Fees and expenses give us a little bit of a drag. Spending flexibility gives us a little bit of a lift. There’s actually a lot of different levers that we can start pulling to move this number up and down, at least if you’re using a safe withdrawal rate framework. We’ll give your listeners … It’s a copy of some of the research of how much you can pull those levers. They’re basically all sort of half a percent to 1% levers in either direction.

Michael:
Here’s the key point that I would give, though, particularly in the fire context. The part that I see that most often is not fully understood and appreciated, including by folks we actually work with in our firm who are living their retirement and living their early retirement.

Michael:
The first is we basically give ourselves no credit at all in the research for the ability to adapt our spending. You sort of highlighted earlier in the discussion that, even in these bad scenarios, you may literally see this 15 years out that your spending rate is 6+ percent. This probably isn’t going to be sustainable, but the safe withdrawal rate research, for better or worse, assumes that, like a blind lemming, you will keep marching for the next 16 years straight off the cliff that you could see from miles away and never once make any kind of change or adaptation.

Michael:
I’m not saying that to knock the researchers. I’ve published some of this, but we have to start with some simplifying assumptions if we’re going to publish the research study, but it doesn’t reflect real life, which is, at some point, things change, and we start making adjustments. Now, the longer we wait, the more dramatic the adjustment is. The faster we change, the smaller the adjustment is. If you view this not as I got to pick the right number to march at for the next 60 years because, if something goes wrong, I might fall off the cliff in the 58th year out of 60.

Michael:
If you had said and assumed this more like a flight plan, I’m in DC, I’m going to California, I’m fairly certain I need to go west, if you just point the plane towards San Francisco and walk away, when you come back in a couple hours, you’re going to be in San Francisco plus or minus about 500 miles in either direction, depending on where the wind blew you. You followed a flight plan. It was important, but if you actually want to end up in San Francisco, you’re making constant mid-course adjustments as the winds hit you throughout.

Michael:
The safe withdrawal rate research gives us no credit for making adjustments as the winds knocks us back and forth. As it turns out, it doesn’t even take much of an adjustment to get back on track, as little as, “Hey, you know what? Rough year. I’m going to not take my inflation adjustment this year,” which sounds like a ridiculously small thing. I don’t see very many people in practice who say, “Well, I used to spend $5,000 a month, but since inflation was 1%, I’m going to start spending $5,050 a month instead.”

Michael:
We hardly even notice these adjustments in practice, but if I commit that I’m not lifting my spending up for inflation, just keep them withdrawals coming to my account, exact same thing they were last year, and that becomes my new baseline. That doesn’t just trim a couple percent on my spending this year. It trims a couple percent on my spending every single year for the rest of my life because it becomes my new baseline. I can actually trim huge portions of lifetime spending with give ups that are so modest, you hardly notice it from year to year and actually get us back on track. The most straightforward thing that we get is you just start making adjustments, and they don’t have to be huge. The pilot doesn’t fly all the way out until we’re crossing the Nevada border and then make a hard left to get back on track towards San Francisco. Every couple of miles, we’re tweaking the steering wheel to make sure that we’re on track, and the more regularly you make small adjustments, the more manageable they actually are, they’re minimally disruptive and it keeps you on track.

Mindy:
Okay. You just said, “Constant mid-course adjustments to stay on track.” How frequently, in this just 30-year timeframe, how frequently are you recommending that people look at their portfolio? One of the favorite things that we say here is, “The person with the best returns are the dead people who never touch anything.”

Michael:
The framework that I like to look around, look at this, is what I call guardrail strategies. I’ve got little
kids. Think of going to the bowling alley where you get the guard rails, you get the bumper lanes. Well, at least when I was growing up, they were inflatable bumpers. Now, it’s metal guard rails that pop up out of the alley and go back down again because everything’s mechanized, but when I go bowling with my kids, and my little one goes up there and rolls the ball down the lane, one of two things happens. She throws it fairly straight, rolls down, hits the pins, she does her little dance all excited, or she rolls it, it goes slightly askew, hits a bumper, bounce off the bumper, goes back to the middle lane. She is equally happy cause it hits the pins at the end and she won. We can put guardrails in place. It’s not like she goes down the lane, walking next to the ball and taps it with her hand every time it’s drifting off. I just need some guardrails to keep from going so far off track that I land in a gutter.

Michael:
Straightforward way to think about this is you can monitor your ongoing withdrawal rates for your portfolio as a series of guardrails. Great. You’re aiming at 4% as a baseline rule. If your spending goes above five, take a haircut. If your spending goes below three, you’re actually so far ahead, give yourself a raise. As long as I’m reasonably in the zone, I don’t need to get overly active here, but I want to look fairly frequently. As we look at this in practice with a lot of clients, usually we’ll look annually. I think once a year is sufficient. Again, we’re only talking about making what might be a couple of percent spending change, like, “Hey, I’m not going to take my inflation adjustment, or maybe I’ll trim my spending by 5 or 10% for a few years.” These are not ultra dramatic things where I got to go in there the day the market declines and immediately cut my spending because, if I’m spending 3-1/2% a year, I’m spending 0.3% a month. You do not need to make adjustments for withdrawals that small when 99.7% of your portfolio remains invested every month.

Michael:
To me, just it’s so important to keep the context of where these numbers come from, how much you really need to move them, how long it really takes before you’re materially off track, how much room you have to make adjustments. It doesn’t mean you can fly blind. You do need to look and be prepared to make some adjustments, but it turns out even the adjustments are much more modest than most people realize to stay on track. Now, if you want to start spending 7 or 8%, you’re going to have some bigger adjustments if things go the wrong direction, but the whole point of the research is that it ameliorates that risk.

Michael:
Strictly speaking, from a purist perspective, 3-1/2% is supposed to work if you literally never make an adjustment. You could have retired on the eve of the Great Depression, coming out of the gate at 3-1/2% and gone for 50 years, and you still had money left over at the end. Even these kinds of mid-course adjustments are conservative because, hey, there’s always a risk that the future will literally be worse than anything it’s ever been in the past. These are not guarantees. These are just we’re ratcheting down to worst case scenarios as our baseline.

Scott:
One of the things, an observation I have, and I don’t know if it’s a question, but I have interviewed a lot of people in the fire movement over the years. I’ve been obsessed with this. I’ve met lots of people, maybe not quite as many as Mindy, but I have never, ever met someone who has retired, fired early in life, on the 4% or even the 3-1/2% with no cash cushion, no expectation of other earnings, and no other types of buffers. Why do you think it is that, in spite of all of the research that you just nailed over the course of the last hour in great detail, people still don’t trust it at all? I’ve never met a single person that is relying exclusively on the math that you just defended in a very detailed way here. Have you met someone who relies exclusively on that in early retirement, no Social Security, no pension, no other buffers, no cash? Why do you think it is that people aren’t doing that?

Michael:
At the end of the day, I think the answer's pretty simple and straightforward. It's fricking scary to pull the cord and say, "I'm tapping out on all income potential for the rest of my life." It's pretty natural to want to start building in buffers. We even see this with people just … I'll call it normal retirement. They're coming into this in their late 50s, 60-something. It's often Social Security. Many of them will plan for Social Security, the ultimate buffer that we even see almost all retirees plan for. The dollars are always there, and it's never in the plan, the equity in the home, like, "At last resort, I can take out a mortgage, I can get a reverse mortgage. I'm very happy to play it off my house. I can go back and get some debt and extract some equity out of that." We don't put it in the plan. It usually sits there in reserve.

Michael:
I think part of it, it’s scary, so it gives us some comfort, these sort of dynamics of our tolerance for risk and just our comfort for risk. That stuff’s real. Our species has learned that there are two types of people, those who are prudently conservative and those who don’t procreate. They’re like, “Natural selection works pretty good over enough years that the people who are persistently not prudent at some point kind of get weaned out of the herd, and the ones who make some prudent conservative bets from time to time usually last long.”

Scott:
Or they have too many. Never mind.

Michael:
Some other problems. That’s another discussion. So great. Just it is part of how our brains are wired. I mean, just at the most basic level to … These things, don’t put all your eggs in one basket. We go back the Talmud 5,000 years ago, you will spread your wealth between business lands and cash. It essentially was the diversified portfolio 5,000 years ago, and it hasn’t changed much since then. We hold maybe a little bit less cash now and a little bit more stocks.

Scott:
A little less cattle.

Michael:
A little less cattle, unless that’s your business, and then you own more of it. These dynamics, I think, are just part of what’s hardwired in our brains around finding some level of comfort with don’t put all your eggs in one basket, have a buffer, have a cushion, have something to fall back on. It just becomes natural for us. The way we tend to get there, like, “How do I pull the cord? Okay, I’m pretty darn confident in the numbers, but, just in case, I know that the Social Security is out there, and I actually am not even counting on it. So if that shows up, that’ll be my extra thing.” It might not even be that I’m discounting Social Security, but I kind of know it’s the extra safety valve, or it’s the equity in my home, or it’s my ability to adjust my spending, or it’s my ability to go back and work more. I could work, at some point, in the next 50 years if I had to.

Michael:
My concern actually, in particularly for a lot of people in the FIRE movement, and I’ve even seen this just for more traditional retirees that we work with, as well, I think there’s a secondary challenge that it’s our problem that we’ve created for ourselves that, to me, the retirement, in general, and the fire movement as an extension of it, has become too much RE and not enough FI. Retirement, like idle life, this sort of dream of retirement of luxury where I never do anything, have any obligations for the rest of my life, is not the natural state of human beings. We need a reason to get up in the morning.

Michael:
What we see in practice when people retire, isolationism increases, depression increases, divorce rate increases after retirement. There’s actually all sorts of bad stuff that happen after retirement. It’s not because retirement’s bad. I’m not trying to scare anyone away from retirement. It’s because not having purpose and a reason to get up in the morning is not actually good for most of our mental states. Eventually, that gets expressed in our physical states, as well. There are a subset of people who find ways to occupy themselves and can be totally happy puttering around the house because they’ve got a purpose when they wake up in the morning. It might not be money or anything, they’ve got a purpose.

Michael:
My father retired early. He’s been doing it for a long time. He is the family genealogist. He wakes up every day to do genealogy. That’s his thing, but the problem or the place where I think we get ourselves into trouble is when we focus so much on the retire or the retire early, we create this binary state. I’m working until I have enough and I never have to work again. We don’t think of it from what I think is a much better framework of the FI framework, which is I’m going to accumulate enough money to get to the point where what I decide to do with my time is no longer dependent on money, which is very, very different than saying, “I don’t have to work anymore.”

Michael:
What concerns me about it and the pattern I’ve seen play out with just one retiree after another, having done this for 20-odd years now, is they spend years and years doing the work, saving up the dollars. For many of them, the last few years are not particularly enjoyable work. They’re done. They’re ready to be done. They don’t like their job anymore or their boss or whatever it is, but they stick with it because we got to get to that number where I don’t have to work anymore, and then they retire.

Michael:
They’re like, “This is amazing. I get to play golf all the time and do all the things I wanted to do,” so they go play a whole bunch of golf, and then they come into my office six months into retirement, and he says, “I can’t stand it anymore. I’m playing golf with my same four buddies three days a week. I can’t stand Joe’s stories anymore. He tells the same three stories every week. I’m bored out of my mind, and I need to find something to do,” and then he ends up going back and work in his old industry or a new one or starting up a business.

Michael:
I travel extensively because a part of my world is speaking at advisor conferences and teaching this to other advisors. The number of Uber drivers I end out riding with who are retirees who were bored at home and did it because they needed something to do every day, and the key to this is not just that it’s really important not to underestimate that you might still find you want to do some things with your time and that you might even end out making some money at it, it’s that if you knew and you planned for the fact that you were going to make money at it, could have done this a long time ago.

Scott:
That brings me up with the next question there that was on my mind, which is given all that we’ve discussed and just how conservative the 4% or 3-1/2% rule truly are, how great your odds are of accumulating excess wealth with those things, and on a practical sense, the fact that basically everyone who retires or-

Scott:
And it’s the fact that basically everyone who retires or actually implements and stops relying on their major source of income has multiple backup strategies outside of the three and a half or 4% rule. Are we as a group in the FIRE movement doing a disservice to the community by using that as the rule of thumb? But because it is too conservative.

Michael:
I don’t know that I would necessarily frame it as doing a disservice, because look, well I was going to say the worst case are. So the second worst case scenario of this is, turns out you saved more than you need, the markets don’t blow up. You accumulate more than you needed and you have the great misfortune of spending more money than you ever expected for the rest of your life. Not the worst problem to have, right? And I think that’s part of why we tend to anchor to conservative devise numbers anyways. If this goes badly, I should be okay. And if this goes well, I’ll figure out how to spend the extra money. I’m okay with that problem.

Michael:
So I don’t think it’s a disservice, because I think getting people to a point where they’re comfortable to make the transition and their worst case scenario is, maybe I’ll end up with more money to spend later. It’s not a horrible thing. We’re pretty adaptive to the upside as well, you’ll figure out how to spend the extra money. The part of this that just bothers me is someone that sits across some clients and has these conversations are the people who spend way longer than they should have doing work they can’t stand in a place that they’re miserable. Because they’re trying to build up to this moment where they’ll never have to do that work again and can retire.

Michael:
And in essence, the problem that occurs is we confuse in our heads, “I can’t stand this job and I need to never do it again,” and, “I don’t want to ever work again.” If you spend long enough in a job you hate, you actually forget what it’s like to be in a job that’s kind of cool that you enjoy. And particularly in a retirement context or a FIRE context or what to me is really just mostly the FI part where we’re really just talking about financial independence to do whatever you want with your time, regardless of money. You may or may not actually end up making some later is if you plan for that it drastically changes the math of the whole thing. If I just came to the table and said, “Hey, what if I merely earn half of what I wanted to earn, like I take a 50% pay cut.” You also just cut your FIRE goal in half.

Michael:
Because I only need half the dollars now that I needed before. And particularly for a lot of folks that I see that go through the FIRE process, their spending is way, way lower than their earnings, right? That’s how we get a lot of money that we can save. So, if I’m saving 50% and I’m only living on half of it. If I earned half of what I save, which is a quarter of what I currently earn, I only need a fraction of the amount of money to FIRE off in the first place. And so if you came at this and said something as simple as, “Could I go out there and find something at some point that I could earn two grand a month as a side hustle?” You don’t even have to do it right away. Take a couple of years to get there.

Michael:
If I could do something on the side that earns me just that little bit of extra dollars on the side, when I’m looking at this at a three and a half percent withdrawal rate, that’s the equivalent of adding almost $1.4 million into my retirement nest egg. Excuse me, I did the math wrong. It’s about 700,000 at two grand a month. So if I’m willing to just have some side hustle on the side that I even spent a few years building up to, it lops $700,000 off of the FIRE goal that I need. Which means you can take that job you can’t stand and get out of it a lot faster and go find something else that you like doing even more. And what you may even find out and what just we see over and over again is, when you find work you actually enjoy and are good at it usually ends up having some pretty good upside for you. And you may not even make it more and more money.

Michael:
And the moment you don’t like it, fine, peace out, leave, go find something else. It’s not like I’m trying to figure out how to get back to a job that pays six figures, get back to a job pays two grand a month on a part-time basis. And I lop $700,000 off my FIRE goal. So the piece that worries me about this is it’s great to say I can always go back to work as a safety valve, right? I’m going to shoot for my three and a half percent withdrawal rate number and get my nest eggs to that point and then I’ll pull the FIRE trigger. Because I always know I can go back to work, or get social security, or tap my house, or adjust my spending, or all the other things Scott that you pointed out as the levers we can move.

Michael:
But the one that bothers me just at kind of a human level are the people that spend way longer in the work that they can’t stand, trying to get to a point where they never have to work again. Because we confused in our heads, “I don’t like this work so I want to never work again.” When all we really saying is, “I don’t want to do this work anymore. I’d like to find something that is better fit for me and I don’t care if I earn a fraction of the amount, because I only need a fraction of the amount to make FIRE work at a much lower dollar amount.”

Mindy:
There is no, I can’t even put into words how freeing it is to leave the job that you wake up in the morning and you’re like, “I can’t even imagine I have to go back to work today. I hate my boss. I hate my job.” And then moving to a job that you do love. I have been in both situations, I’m at a job that I can’t believe they pay me to do this. This is so much fun. I’m so blessed to be here. I would almost do it for free.

Mindy:
And the difference in my happiness is just immense. I used to be just a completely miserable person and now I’m so much happier. So if you’re listening and you have a job that you hate, but you’re sticking with the ticket to FIRE, Michael and I both give you permission to find something else.

Michael:
Yeah. And recognize, if you just commit to find something that is half of what you make now or heck, a quarter of what you make now, you might find that if you were just ready to do that, you actually could pull the trigger today.

Mindy:
Yeah.

Michael:
You might actually already be there. And then the only thing you have to figure out, which is still an important challenge is how are you going to sustain that? It’s not just about going back to work for a few years. Like you are committing, you’re going to keep doing it for a while. But what you’ll find, I’m sure Mindy, you’ve found a similar effect. It turns out once you’re doing the work that you like and you keep doing it for a while and start building this as your next new career or thing or whatever it is, sometimes the dollars actually start adding up and the income gets better as you go.

Mindy:
Well, you’re doing something that you enjoy. Your bosses see this and they give you raises. I mean, that’s how it’s been in my …

Michael:
But the distinction, and just, I know it’s a mindset shift for people. If we spent too long in work we didn’t like trying to earn raises that we just felt we had to get in order to get to this moment in the first place. Just understanding the mindset shift of, once you’re mostly there for FIRE and you only need a little bit of dollars, you may still need some. You got to plan for some level of work, but you can go find the work that you like. You don’t have to worry that much about the salary requirements. Like I need something, but you’re going to be a pretty flexible employee. And if it turns out something you don’t like, it’s cool, go find something else.

Michael:
Because we’re really not actually wired for 168 hours of downtime every week. We tend to want to wake up and do something and so if your worst problem is, “I found a passion but I’m not sure I can make money at it.” There are a whole bunch of sites out there that help you turn your passion into a side hustle. You got like 40 odd years to figure out how to make a little bit of money at it.

Scott:
Love it.

Mindy:
Okay Michael, you were just talking about side hustles and let’s talk about making smart money moves during this market. Someone who does have money to invest currently, let’s say they have X, how do you recommend that people add that into the market right now? Because there are people who want to take advantage of these sale prices in the stocks. Dollar cost averaging is what a lot of people refer to this. How frequently should people be putting money into the market, and how frequently should they be putting it in over the course of regular life?

Michael:
So, this is really another one of those things. There’s sort of there’s the mathematical answer, there’s the psychology answer to it. The odds on mathematical answer at the end of the day is on average markets go up more than they go down. So if you don’t actually have a functioning crystal ball, your best odds are just put the darn money in as soon as you can for as much as you can. Because it goes up more than often than it goes down.

Michael:
That’s just kind of the math to it. Anything you do to drag it out when markets go up more often than they go down increases the odds that you end out like. Now that’s the pure math nerd perspective. Then there’s the psychological reality, which is if I put in all my money today and then the market tanks again next week because there’s more bad news, I’m going to freak. Or I just, I’m going to regret it and wish that I had had a little more to put in now. And so if you want to manage your regret avoidance, dollar cost averaging is a fantastic regret avoidance vehicle, right?

Michael:
If I spread it out, it will hurt a little bit less. Worst case scenario markets go down a little more, I buy a few more shares, right? That’s how the sort of the dollar cost averaging math works. Because markets go up more often than they go down, on average you’re dollar cost averaging by buying shares at higher prices and get few of them, that’s why lump sum still work better all else being equal.

Michael:
But if that’s not where you are sort of mentally, psychologically, because you’re going to regret it if you pull the trigger and then find out that was the wrong time, then spread it out. Because from the flip side you’re not going to hugely damage yourself by spreading it out. If it turns out markets go up a bit more, they might go down a little bit more. There’s certainly a wide range of uncertainty, and so we can manage to some of the uncertainty and regret avoidance by spreading it out.

Michael:
So where do we end out in practice with most people who have kind of sizable dollars that they’re moving into markets? Most commonly what we end up seeing, monthly basis anywhere from about three to 12 months depending on how much dollars you have and how much you’re spreading it out. Just faster than that you’re going to start second guessing yourself. Because you hit the button on Monday instead of Tuesday, spread it out more than that. Particularly in volatile markets like this, you’ll start regretting that you spread it out a little bit too much.

Michael:
So if you’ve got a bunch of dollars, you want to put it in, you’re afraid … You want to, but you’re afraid now is not the time. But it might be the time, but it might not be the time, but it might be the time. We could get ourselves wrapped up in this pretty quickly, three to six months, 12 if you’re really concerned. And you’re otherwise just optimistic about investing for the long run will probably smooth you out enough to manage the regret of what if it turns out that the timing isn’t right.

Michael:
And look, times like the financial crisis. I think we’re a good example, right? I mean, I remember going through this in the fall of 2008 when similar to recent weeks, depending on which day you put your money in or rebalanced your portfolio, it was swinging 10% in a day, right? And we had a few of those recently as well. That was all about heck at the market bottom. Did I get into the S&P when it was at 660, or 680, or 710, or 720? It’s a 2,500 plot. The answer is, wherever you got in there, it all kind washed out after 10 years. You made a zillion dollars because the market roughly three X’ed.

Michael:
So in the moment, when the things get volatile our time horizon gets really short, right? It’s kind of the fog of war effect in the markets, we tunnel vision in and you can’t see very far ahead. So we start fixating on the short-term piece. And so if we want to manage the regret avoidance, the short-term piece, spread it out over a couple of months, you’ll sleep a little better at night. But I can tell you almost certainly when you go back 10 years and 20 years from now and you look back, you’ll hardly be able to see on that chart the little blips of the different prices that you got in on. Because just the chart gets a whole lot bigger once you spread out the time horizon again.

Mindy:
Okay. Well I’m really glad I asked that, because the way that you explained it makes me feel a little silly now for wanting to time the market. Time in the market is better than timing the market.

Scott:
Yep.

Michael:
And you know what? If you actually can perfectly time the market, timing in the market is pretty fricking awesome.

Mindy:
Well, yes.

Michael:
It is a glorious thing. But if it was that straightforward to do, someone would borrow a billion dollars and turn it into 10 billion. Because why not do this with other people’s money if you can do it that magically? It’s a lot harder in practice. A lot of us have to try it a few times and get humbled by the market before we’re ready to surrender that. So if that’s what you need to do, that’s fine.

Michael:
Take 10% of your portfolio and try this out for a spin and see if you can do it. If you can do it, you’ll make some money and you’ll feel great. If it turns out it doesn’t go so well, at least you dollar cost average in the other 90% and you can run yourself a little race if you want to. But at the end of the day it always seems obvious in hindsight. It never turns out to be that obvious in real time.

Michael:
And so because trying to time the market in practice becomes pretty punishing to people. That’s where we usually end up falling back to then just get it in there. Because in the long run these things tend to mostly wash out. And if you’re really concerned about regretting that you pulled the trigger at the wrong time in the short term, space out a bit so you feel a little bit better and you don’t have to become as worried about exactly which day did you hit the bottom.

Mindy:
Okay. That sounds like a really great place to end. This whole episode was fantastic. I’m super excited for this to come out. Just to note, we did record this on Thursday before the show airs on Monday, so if any big wild swings happened after Thursday afternoon, we didn’t know about them. So, and I do not have a functioning crystal ball.

Michael:
Nor do I, although I really wish I did.

Mindy:
Same.

Michael:
Well to be fair, I’ve kind of got a really foggy, hazy one. I can see a little bit of future shapes, tends to go up more than it goes down. These things turn average out in the long run, but it’s not so great in the short term, unfortunately.

Mindy:
Yeah, yeah. Mine doesn’t work in the short term either. Okay Michael, tell people where they can find you, everywhere they can find you.

Michael:
Oh goodness. So I’ll kind of give you three places. All the research that we published around this stuff is the Nerd’s Eye View blog at kitces.com, K-I-T-C-E-S, unfortunately did not inherit the most spellable name, but it is unique. So if you see it, it is me, so kitces.com is the blog where we publish a lot of this retirement research. I’m also co-founder of a group called the XY Planning Network, which does financial planning for people in their 20s, 30s and 40s on a fee only, mostly advice only basis. So if you’re looking for help, we have almost 1,200 advisors that do this for a living. And then I’m also involved in a private wealth management firm called Buckingham Wealth Partners based in St. Louis. But we have almost 40 offices across the country doing this for people that want to work with someone in a deep ongoing relationship around this whole holistic picture.

Scott:
Yeah, and I’ll have to check out those last two, but I spent extensive time on your blog this week-

Michael:
Excellent.

Scott:
… and just awesome, awesome, awesome stuff. You can tell if you’re listening to this show how polished you are at all of your thoughts. That’s just all the backed up even more on your blog and the visuals are great. The studies are great.

Michael:
Excellent.

Scott:
It’s original research. It’s really fantastic stuff that I know I’ll be, as I continue to write and develop my philosophy I’ll be citing and reading a lot of and referring back to.

Michael:
Well I appreciate that Scott, and we’ll make sure we get just at least a couple of good starter links for your listeners in the show notes. Or if you just want to follow up on some of these themes that we’ve been talking about, a few good places to start in reading through that.

Scott:
Absolutely.

Mindy:
Yeah, perfect. Okay Michael, thank you so much for your time. I really appreciate it and I know this is going to be hugely helpful to pretty much anybody who’s concerned about, “Oh, is 4% going to be enough?” Look at
that chart. In fact, I’m going to cut and paste that chart into our show notes-

Michael:
Excellent.

Mindy:
… because that is so powerful. Look at all these times that it works and look at this one time that you go to zero, in year 31.

Michael:
In year 31.

Scott:
This is like there’s these trolls sometimes that like to say things like, “Oh, but dah, dah, dah, dah, dah, sequence of return risk. Or dah, dah, dah, dah, dah, that it hasn’t been tested through the great recession. We won’t know until 30 years from now. And it’s like at every turn you’ve got like article in detail about why it works right now and will work in the next 30 year period.

Michael:
Well just if you want to keep the context, at the end of the day from the peak in 1929 to the trough in 1932 the market went down almost 89% and the 4% rule worked.

Scott:
Yeah.

Mindy:
Yeah, this is another quote-

Michael:
So when we look at these like the market’s down 20 or 30% or it went down 40 something in the great recession, we’re not even in the same neighborhood of the stuff that still failed to break the 4% rule. Now again, that was a portfolio with government bonds, because the diversification effect is important. That’s not a pure stock portfolio, but we’ve written out a lot worse and it’s still not a guarantee that the future can’t somehow be worse and more broken than anything we’ve ever seen in the past. But we don’t give enough credit sometimes to how horrible investment markets have actually been in the past that we’ve still survived through.

Scott:
Yep.

Mindy:
Yes. And I have one more quote and then I’m going to let you go. This is from your article. It says, “Historical safe withdrawal weights aren’t based on historical averages. They’re based on historical worst case scenarios.” I mean that you just said 89%, that’s a little bit bigger than what we’ve got now.

Michael:
Absolutely. Again, the average safe withdrawal rate that would have worked in history is about six to six and a half. So the fact that we’ve gone from six and a half down to four or even three and a half for a longer time period, you have already taken a 40 plus percent haircut just in case you get a bad sequence. So we don’t need to ratchet down further, we’d taken the haircut to defend against sequence risk. That’s how we got to the 4% number.

Mindy:
You can’t mic drop on a podcast because it just reverberates a bit.

Michael:
I can do it on the video version.

Mindy:
Yes.

Michael:
You just can’t see it. You have to kind of see where the swoosh of the hand.

Scott:
He’s literally dropping his mic now.

Mindy:
Mic drop. Okay. He is Michael Kitces. The other guy is Scott Trench and I am Mindy Jensen and this was episode 120 of the BiggerPockets Money podcast, and we are saying, “Stay the course.” I don’t know of anything clever to say Scott.

Scott:
Me neither.

Mindy:
Okay, bye.

Michael:
Bye.

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In This Episode We Cover:

  • The origin of the 4% rule
  • 3 different time periods that trigger the 4% number
  • Safe withdrawal rates
  • The bucket strategy
  • Key assumptions when modeling or evaluating the short-term cash bucket
  • The right time to start looking at bonds
  • Constant mid-course adjustments
  • What a retirement red zone is
  • Bond tent strategy
  • The guardrail strategy
  • Smart money moves in this market
  • Dollar-cost averaging
  • And SO much more!

Links from the Show

Tweetable Topic:

  • “It gets a little harder if you retire younger.” (Tweet This!)
  • “Not having purpose and a reason to get up in the morning is not actually good for most of our mental states. Eventually, that’s expressed in our physical states as well.” (Tweet This!)
  • “I’m going to accumulate enough money to get to the point where what I decide to do with my time is no longer dependent on money, which is very different than saying, ‘I don’t have to work anymore.'” (Tweet This!)

Connect with Michael:

The BiggerPockets Money Podcast is for anyone who has money… or want to have more! Join BiggerPockets Community Manager and Podcast Director Mindy Jensen and CEO Scott Trench weekly for the BiggerP...
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    Bill Hines
    Replied 4 months ago
    Disappointed that it wasn't stated by Michael what asset allocation percentage this is based on. Talked about asset types, but not percentages. Any idea? Great show otherwise!
    Ryan Runchey from San Jose, CA
    Replied 4 months ago
    Hi Bill Hines, Please see the link in the article: https://www.kitces.com/wp-content/uploads/2014/11/Kitces-Report-March-2012-20-Years-Of-Safe-Withdrawal-Rate-Research.pdf "Safe Withdrawal Rate Baseline: 4% - 4.5% with a 'balanced' asset allocation (e.g., equity exposure of 40% to 70%). Consider a 3.6% base withdrawal rate with an expectation of sustained lower economic growth." This in-depth article says the study focused on a 50-50 allocation but explored others showing that 40 to 70% equities worked well, too. Please see the link in the article: https://www.kitces.com/blog/the-ratcheting-safe-withdrawal-rate-a-more-dominant-version-of-the-4-rule/ "In point of fact, the historical initial withdrawal rate that would have worked for a 60/40 portfolio over any particular 30-year time horizon has varied between 4% and 10%, and the median is close to 6.5%." Michael talks about starting with a 60-40 tilted towards equities.
    Ryan Runchey from San Jose, CA
    Replied 4 months ago
    I also would like to see the exact studies which include funds and allocations; if we are overlooking the resources, please kindly reshare the links to the in-depth resources. thanks!
    Ryan Runchey from San Jose, CA
    Replied 4 months ago
    Dang... can't see how to delete my comment... there's tons of links in the article! thanks
    Daniel Huffman
    Replied 4 months ago
    Awesome episode! One of the most informative and easy to listen to podcasts I've ever heard. Definitely a thorough and convincing presentation of the research on the 3.5-4% SWR.