035 - Sequence of Return Risk ERN

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0 - 87 Jonathan Mendonsa Welcome to the choose F-I radio podcast for those of you who are listening for the first time my name is Jonathan and my co-host name is Brad. Together we are a pharmacist CPA combination out of Richmond Virginia. The ChooseFI podcast is a podcast by the F-I community for the FI community where fi stands for financial independence. We host a twice week show on Mondays and Fridays. On Monday we tackle a new topic or idea that can help us get to our goal of FI faster and on Fridays we crowd source feedback from our community which allows us to go deeper into each topic along the way we try to feature thought leaders from the community and explore the infinite number of ways that people tackle this amazing journey. Welcome to the ride and enjoy the show. OK welcome to the show. Today we have big earn from early retirement now joining us in the studio and we're going to be talking about sequence of return risk. This is an episode that's long overdue it's one that we've been promising you for a long time. It's one that we were very concerned because we wanted to make sure that we got it right. And frankly Brad and I understood from the beginning that this is one that was above our pay grade. It's not one that we can handle on our own so we needed to bring in an expert. And Frankly there is nobody better to handle this concept than big earn from early retirement now. Now he has a 17 an ever growing part series on how to do this math how to understand and incorporate it into your life. And today our goal is to take that amazing article series and turn it into a conversation so we're glad you're here to join us and I have Brad here with me in the studio. How you doing Brad.
87 - 113 Brad Barrett I'm doing well Jonathan this is a long awaited episode and I think it should be a wonderful one and we're really going to approach this from the point of view of novice's. We're going to put ourselves in the shoes of the audience. So this should be a very thorough explanation from a step by step point of view from a novice point of view of everything that big Ern teaches about safe withdrawal rates on his Web site. So again there's no better person to go through this. And with that Ern Thank you. And welcome to the show.
113 - 121 Big Ern Excellent. Thanks for having me. This is my first podcast ever and I'm glad it's here. It's one of my favorite podcasts ever.
121 - 158 Jonathan Mendonsa That is amazing. Thank you so much. Yeah we were super excited to have you contribute to Paul's case study really several months ago now and we've been just itching to get a chance to jump into this ever since that because you essentially changed the playing field by talking about the realities of first of all just the 4 percent rule and what that would mean for Paul but then expanding it to the idiosyncrasies of Paul's specific case with having Social Security be a reality for him. I don't know why but a lot of us in the FI space for whatever reason just forget that Social Security is out there we just Or we just kind of ignore the fact that we may have our own unique circumstances which may change the playing field slightly.
158 - 217 Big Ern That's right. And I mean you could say that well maybe people are very conservative. They say there is a chance that it will be cut but it won't be cut by 100 percent. Right. So you'll still have some money in retirement from Social Security and the one reason why people could completely ignore it is if they say well maybe in retirement my expenses are going to be higher. So I'm talking about health expenses and nursing homes and stuff like that so I'll dedicate all of that Social Security income to that to that higher expense so in that case you could rationalize ignoring social security but I guess the average person should not and then and then again it depends on your personal parameters. How old are you when you retire if you're very young. You have to discount that Social Security number by by a lot so it may not make a big difference for you. But if you're in your early 50s or maybe maybe mid 40s. Social Security could make a big difference in the end the safe withdrawal rate.
health, socialsecurity
217 - 234 Jonathan Mendonsa So I think probably the way we should approach this is first of all just introduce big earn an early retirement now to our audience for those that haven't discovered the joys of math let's just open this up how did you discover the FI community and what really got you excited about this concept.
234 - 283 Big Ern Right so I was already in the in the club. I was already thinking about early retirement for a long time before before I even heard about the fire community. So it was already in the back of my mind and it was good to find people like Mr. Money Mustache and go Curry cracker. So I liked reading what they have to write but I thought I could also add something because I've always been a math geek and I happen to work in finance too so I thought I can I can add something to the discussion. I like doing simulations I like doing big spreadsheets. I like large scale computer programs to do lots of loops over different or different simulations. So I like to do a lot of the calculations for myself just to see just to see for myself and to understand the mechanics behind it. And I thought since I do it for myself anyway I might as well publish it for others to see to.
283 - 331 Jonathan Mendonsa This is this is really cool you're going to probably get a kick out of this. I think you're speaking to an extremely friendly audience because in our community the icons are in many cases the geeks it's the people that really have spent the time to create the spreadsheets and then share them what I think. So hilarious though is that while I identify 100 percent with what you're saying my idea of doing the Excel sheets is learning how the sum feature works on Excel. In the meantime you're doing graphics and simulations of arithmetic versus geometric returns and doing volatility drag and all these other sorts of really crazy high level stuff. So it's a lot of fun to see and also realize that while I was really impressed with how I was able to do a future value calculation on my Excel sheet you've kind of taken it to the next level on everything across the board so I'm definitely a young Padawan when it comes to excel.
331 - 384 Big Ern Yeah yeah thanks. So the other thing I'm pretty sure I'm not the only one who thinks about it that way. So sometimes in order to understand complicated stuff or complicated plans it helps you to write it down. Right. It's. It's one thing to think about it imagine you you just read and study for an exam as like 20 years ago and you just read the material you can read for a whole day and then at the end of the day you can well how much have you really remembered. Whereas if you take notes and you rephrase and you distill something like a day worth of studying into a few pages of notes that is much easier to remember it and to understand it and that's how I view blogging too. So it's obviously a lot of planning just doing the planning in your head is not working very well. You have to write down your plans to understand what's going on. And so especially this whole 4 percent rule mechanics. So all of that made perfect sense to me. But I definitely want to look more into the details and do my own calculations.
384 - 427 Brad Barrett Yeah that makes sense and we're certainly going to get very in-depth into the 4 percent rule and all your articles so. But I'm actually more curious about the origin story of Big Ern so You know you said and we don't generally do this with our guests you know we'd like to really get into the meat of it but I'm really curious about you. So you said you've been thinking about early retirement for a while you know predating finding Mr. Money Mustache and a bunch of these other blogs like tell me about your origin story. So you graduated from university. You went to your first job. Did you fall into the trap of spending money. Have you always been a saver. Obviously you were fantastic with math and at a completely different level from most people. Did you conceptually understand this just intuitively or you know just talk me through your thought process.
427 - 445 Big Ern Yeah sure. So I grew up in another country. I went to college there and it was a great deal. I could go to college there for free. I had a little bit of a student loan but I didn't even need the money so I basically invested the money then paid it back and actually had a positive net worth when.
college, college-loans, networth
445 - 464 Jonathan Mendonsa Can we just pause for just a second. Like your heart blood of the FI community this is what gaming things out actually looks like while everybody else is racking up 40 to 60 grand. of student loans the second gen FI pitch. Absolutely has to be. Yeah go get all the student loans but then figure out how to do it for free and then invest it. Or rather go get all the scholarships but then figure out how to do it for free and then invest it.
2ndgenfi, college-loans, scholarship
464 - 537 Big Ern Right. So the good news was so I went to college in my hometown and I lived with my parents and I had some student loans. And yeah I mean I didn't need the money. I live with mom and dad didn't pay rent. I didn't have to pay for food. I kind of paid for basically incidentals and tuition was very cheap. And so it's not unlike say the American public university or a definitely a private university tuition here. And so again I had a kind of the mindset that I don't want to get into debt and I because I grew up I wouldn't say that I grew up poor but I grew up lower middle class. I would almost thank my parents for being not so financially educated and sophisticated so they never got into debt and I never got into debt. There were there were no credit cards back then and it was almost it was almost a religious belief that you spend less than what you make. And even if you are a poor student and even if you think about it you are a student and you realize that in the future you will make a lot more money. Right. Why not go into debt. Why not smooth that consumption stream go a little bit into debt and pay it back later. It seems like the rational thing to do. But to me it just seemed a big no no. So no matter how poor I was I always wanted to save a little bit on the side. So this is just out of principle.
college, college-loans, debt, mindset
537 - 555 Jonathan Mendonsa So at what point did you decide early retirement could be a reality for me. Because that is not a I mean everybody is telling you 60 year time line you're going to retire at 60 or 65. How did you decide maybe 40 is the new 65 maybe 30 is the new 65 maybe this alternate choice is going to be a reality for me. What was that lightbulb moment.
555 - 604 Big Ern I mean I was wanted to do a little bit of early retirement say instead of 65 percent to 60 to 60. So that was always in the back of my mind and basically over time I walked down this number. And so for a while I thought OK I'm going to save a million dollars by the time I'm 50. So that was my my aim for a long time. And then fast forward I came to the U.S. for graduate school. I worked here for a few years in academia but then moved over to Wall Street. And after that I realized two things. First of all a million dollars isn't what it used to be and nobody has job safety until age 50. So you probably want to increase your saving a little bit lower the target retirement date. And then also shoot for a slightly bigger number just to have a cushion there.
604 - 647 Jonathan Mendonsa Well we're glad you made the choices you did and it's going to give us the opportunity today to discuss really the technical meat and since that is what you have spent. I would say probably hundreds if not thousands of hours researching and then essentially using your own words distilling on paper. We can all benefit from that work. And then today hopefully turn it into a conversation. So today we wanted to talk about a portion of your series called The Ultimate Guide to safe withdrawal rates. And we're really going to focus today on sequence of return risk. So I know that we touched on this on another episode that we did recently but I'd love to. First of all just get you to kind of essentially unpack the problem for us why do we need to be concerned in the context of the 4 percent rule. Why do we need to be concerned about sequence of return risk.
647 - 733 Big Ern So it's amazing because it took me until apparently episode 14 to even to even write a whole post on sequence of return risks. But obviously the sequence of return risk that is the big gorilla in the room. That's the that's the reason why people run out of money. It's not so much that average returns are so low especially if you are comfortable with say exhausting your networks over your retirement. You don't even don't even need a particularly high average return. So you may imagine somebody offered you something like two or three percent real return for sure for your entire retirement horizon then nobody ever has to worry about the 4 percent rule. You can just exhaust your capital you live off the income and the principal and your money should last for 30 40 50 or 60 years. And the only reason really why people run out of money is that they get unlucky and the first five to 10 years they have very low returns and that exhausts the capital by enough that there's no point of return. Then obviously you could you could argue would anybody ever really run out of money because they wouldn't run out of money. But then after 10 years or so they realize that we have to really really cut expenses by say 50 percent or do a side hustle. So that's what I noticed that the failure probabilities they are 100 percent correlated with having some bad luck early on and it's not so much related to the average return over your retirement horizon.
733 - 756 Brad Barrett So Ern two questions you use the term real returns in there. Right. And you know we want to really break this down for the audience. So we're going to ask stupid questions if you don't mind. So define what real returns are and then as you said secondarily early on in your retirement so I guess define like as far as sequence a return risk what years you would be concerned about there being low returns or a downturn et cetera.
756 - 867 Big Ern So real returns everything I calculate is all done to adjust for inflation. And the easiest way to do that is to do all of my calculations with real returns. So I take the I mean I have data on equity returns and bonds returns and right off the top I take out the inflation rate from that. So where are all my calculations are done in real dollars. So I mean when when I tell you somebody starts off with a one million dollar portfolio and withdrawing $35000 a year then that $35000 in actual terms would then be adjusted for inflation. And when I say that somebody ends up with only 80 percent of the initial portfolio after after 30 years I mean $800000 already adjusted for inflation so. So that's where I'm coming from everything is in is in real dollars. So all the calculations here are kosher and are adjusted for inflation. And if anybody wants to do something where say I want to adjust I want to adjust my expenses for a little bit less than inflation say I want to walk down my expenses a little bit because I consume less as I age I can do that too. But I will do that at the back end and not at the front end. So and then the second question what is that interval of time where you should be worried about drawdowns. And yeah I mean I would say it's probably around the first five years maybe 10 years. So you don't you don't have to worry about say 1987 you had a very big drawdown in October. S&P went down by 21 percent but then it recovered very quickly. So it has to it has to be multiple things has to be an extended drawdown. It has to be deep enough and extended enough say say something like a recession something like 2001 ior 2008 or the or the Great Depression in the 1930s. So just just one little bit of a drawdown over the first five years is not going to make a big difference.
867 - 916 Brad Barrett OK. Yep. That all makes perfect sense and I guess what I want to set up for you is just something like bare bones simple right. And this might be a little weird but just bear with me here. So someone comes to you and says hey earn I have $40000 a year of expenses you know in 2017. I've heard there's this 4 percent rule right. So 25 times my annual expenses. One million dollars. I have you know $1 million. Let's just for argument's sake, split between 401K and regular taxable savings I want to retire because I heard that on the Internet. What is what is your response. Talk me through like what you would say to that person what they have to consider what they And let's just say again for argument's sake they are 40 years old. OK so I guess I come up to you at a cocktail party I know you're Big Ern and I say that. What do you respond to me.
401k, tax
916 - 1030 Big Ern So I like the 4 percent rule. Conceptually. I think I think it's good to have one round number and one rule of thumb. But what I noticed in my research is that you can't just pick one fixed number and that works all the time. So for example in today's environment we have relatively expensive equities, very low bond yields and you probably want to give that 4 percent a little bit of a haircut. I don't know if you guys use that term to haricut because it's a kind of a financial term so we we. So if you give the you give the 4 percent rule a haircut that means you have to reduce it a little bit to account for the fact that we are not in an average equity and bond valuation regime. And so there's these there's two two dimensions where we have to make adjustments to that 4 percent rule of thumb and that's one is over the time series in different years. We would have to start with a different safe withdrawal rate because sometimes equities are very cheap. Then you can probably scale up that 4 percent and make it 5 percent or 6 percent. And then in some years say the late 90s early 2000s you probably want to reduce it all the way maybe to 3 percent or 2.8 percent. So there's that time series variation of what should be a sustainable withdrawal rate. And then there's obviously also idiosyncratic factors. So your personal factors how much do you expect in pensions. Do you get a government pension that's inflation adjusted do you get a corporate pension. That's probably a lot less generous and then it's not inflation adjusted. How old are you how many years do you have to bridge to Social Security does your wife get Social Security. So all of these make so much of a difference. That is again. So that four percent rule is really only the starting point. You have to look a lot more into the details, both into where we are right now with equities and bonds and then where you are in your personal finances too.
pensions, socialsecurity
1030 - 1050 Brad Barrett All right so obviously there are a lot of factors and it just can't be as simple as the 4 percent rule and ride off into the sunset. But going with this. We're at a cocktail party like where can I game all this out. Can I enter all this information in. What kind of research would I have to do to figure out will this work for my life. Is that something that's available. Are there resources you recommend.
1050 - 1110 Big Ern So I have in part seven of my series. I posted a Google sheet where you can enter your personal information what is your retirement horizon and then you can enter these additional supplemental cash flows over the next say 60 years so you can you can start your Social Security's a twenty five years into your retirement. You can enter the numbers as percentages of your portfolio and then you can see what would be the the historical safe withdrawal rates what would be the failure rates of say the 4 percent rule or are the three and a half percent rule. So there are some resources out there. C Fire Sim obviously has some simulation tools. Not sure if C Fire sim can is really that user friendly where you can enter specific amounts that start at a certain time and then the wife's pension starts and then your Social Security starts and then your wife's Social Security starts. I mean I can do that all in that spreadsheet. I'm not sure if there are many other places on the Web where you can do that.
1110 - 1128 Jonathan Mendonsa Alternatively if you want to use my Excel sheet you can take all of your expenses on a monthly basis and you can add them up and down at the bottom it'll give you a total. So that's there to we'll put those side by side use which ever one is more useful for you.
1128 - 1138 Brad Barrett I'll go with Ern on this. So Ern part 7 we will we will link to that in the shownotes. for everybody out there and people can just answered their own information and just use that going forward right.
1138 - 1153 Big Ern Yes. And then the the one thing you have to do is this is the one clean sheet you cannot edit that yourself. You first have to save your own copy before you can make changes for obvious reasons because I don't want people to mess with my formulas in there of course. Yeah that sounds great. That's a wonderful resource.
1153 - 1224 Jonathan Mendonsa And just to our audience we're going to link to that in the show notes but if you end up thinking that would be useful to you definitely go check that out. And if you use it please give big Ern your feedback. Let them know whether or not it. It's that sort of feedback that allows. I know at a personal level it allows me to iterate what I'm building and I'm sure he would appreciate hearing from you as well. So we want to explore sequence of return risk and we're going to try to just maybe set up this very simple case study that will allow us to illustrate a few different points and we're going to start with maybe the year 2000 so I believe at this point and this is kind of predating my investment time line a little bit but the tech bubble has gotten your investment vehicles to the point where you now have a million dollars and you pull the trigger on your Fi date and you retire in the year 2000 and then everything just falls apart and watch your one million dollar portfolio descend down to somewhere in maybe the 400's something or something along those lines and you're now drawing your expenses which you're withdrawaling 40 thousand dollars a year earn. Help us explore with this particular very simple maybe overly simplistic case study help us explore how sequence of return risk would affect this poor unfortunate individual that pulled their FI trigger at this exact time.
1224 - 1337 Big Ern Right. So the good news is that from the previous peak say in 2000 or 2001 the equity market eventually recovered again in 2007 so you get back to a new high. But the problem is if you used your portfolio not as a buy and hold but you were making withdrawals from your portfolio. During that time then you have taken withdrawals right at the wrong time when the when the portfolio was down. And so that means even though the equity market had recovered by 2007 you are now down to say $750000 in in 2008 and that's when the next recession hits you. So that's 2008 or 9. Yet another walk down to a maybe around $500000. So that means if you had started in 2000 with the 4 percent withdrawl rule you would now be down to somewhere around $600000. And the problem is that when your portfolio is down to $750000 or $500000 and you keep withdrawing these $40000, your effective withdrawal rate is now no longer 4 percent. It's 4 percent relative to the initial portfolio value but it's much higher. It's 5 percent, 6 percent is probably around 8 percent at the bottom and that means even though the equity market recovers again you have compromised the portfolio so much that you're now much much down relative to the initial portfolio value, even though a buy and hold investor obviously would have not just recovered but would have probably doubled the money by now. And it's because you were making these withdrawals at depressed prices so that the cost of selling shares at a low price and selling more shares when prices are down the most and then missing the recovery on these additional shares. That's basically the distilled version of a sequence of return risk and that's why even though the average returns might have looked decent during that period of time your portfolio is very much compromised by now.
1337 - 1384 Jonathan Mendonsa So that's perfect. That's exactly what I was looking for. And at the same point I think that gives us a platform in which we can explore three different scenarios because sequence of return risk isn't bad for everybody depending on where you are on your FI plan can actually be a lever that allows you to accelerate your results and there's three different scenarios that I know you talked about in this article and we touched on one of them the early retiree that pulled their trigger right at 2000 and then there's the saver and then there's the buy and hold investor and all of us at some point will fall into any one of those categories just depending on where we are with our own personal timeline. But I think it would be interesting to hear you explore with those three different scenarios and we've covered the first one the early retiree but with the other to the saver and the buy and hold investor. How sequence of return risk can affect you depending on what scenario you fall in.
1384 - 1476 Big Ern Oh sure. So you take the flip side of this. So instead of selling shares when prices are depressed imagine you buy shares when prices are depressed and you take that exact same case study. But instead of withdrawing money you take a person who starts with zero dollars at the beginning and then start saving. That person is going to get this effect from most of what some people call dollar cost averaging. Right. So you buy equities at very depressed prices I have some techs lots from 2009 where I bought the S&P 500 index at around 700 points and I still have those. So imagine the return on those investments. So the good news is that if you are a saver during those drawdown periods you actually make very very good returns. You actually beat the buy and hold investor in terms of the internal rate of return. So that's a lot of people in the FI community. They actually benefited from these drawdowns. So there is essentially a zero sum game between the saver and the retiree because if you take the cash flow say you take a retiree who started with a million dollars in 2000 and you take big Ern who started investing in 2000 with zero dollars and you imagine that what I invest is exactly the same amount of what the retiree takes out and our two cash flows would add up to exactly a buy and hold investor. So that means that if the retiree is doing worse than the buy and hold investor then I. By definition I have to do better than the buy and hold investor. So in many ways these recession they have actually helped me personally even though it would have been a horrible time to retire during that time.
indexfunds, savings
1476 - 1484 Jonathan Mendonsa So I want to contrast a couple of things here. Help me understand what is the position in this scenario of the buy and hold investor what is he doing as opposed to the saver.
1484 - 1557 Big Ern OK. So I mean the buy and hold investor that is the one pure case who doesn't care if there is a drawdown in between or not. So the buy and hold investor worries for for the most part purely about what is the point to point return. And some people would argue not well but what about dividends. Right. The dividend flows that is reinvested. But I already take that into account so basically every return that I calculate is already ready to price return plus the dividend yield. But anyway so the buy and hold investor if the S&P 500 doubled during that time and you didn't have any additional cash flows into the portfolio or out of the portfolio then you don't care about what is the sequence of return if you had the bad returns early on the good returns early on the buy and hold investor is shielded from sequence of return risk so it's only the savers and the retirees that feel the sequence of returns. Now of course you could say that obviously the buy and hold investor may still worry about a draw down early on because you might lose your nerve and sell your stocks. But say if somebody in 2000 started with a million dollars and as a buy and hold investor between now and then and didn't open their statements and didn't do anything stupid didn't sell the stocks at the bottom they should not worry about sequence of return risk.
1557 - 1604 Jonathan Mendonsa OK so to overly simplify these things there are three different scenarios are your but so starting with 2000 essentially to maybe today or just 10 years later the buy and hold starts with a million doesn't touch it essentially doesn't open anything. Ten years later it is what it is. There's there's no activity there. The saver starts with nothing in 2000. And as all of this stuff is happening they're actively plowing money into the like the VTSAX or the stock market and they are accumulating the gains and they're benefiting because their money is going farther because they're buying at depressed prices. And the other scenario was the retiree in this case the person that was having to draw down. And unfortunately because of the depressed prices they were having to draw out more than they really wanted to in terms of a percentage of their net worth. Those are the three scenarios.
indexfunds, networth, stocks
1604 - 1625 Big Ern Exactly. And it's in some way it's a zero sum game right because the to the retiree and the saver they add up exactly to the buy and hold investor. So. So they can't all do both the retiree and the saver. They can't both be on the same side of the buy and hold investor. So one person is always doing better and the other person is always doing worse than the buy and hold investor.
1625 - 1630 Jonathan Mendonsa Yes and the retirees angry when the savers happy and the saver is happy all the time.
1630 - 1631 Big Ern Yeah. Yeah.
1631 - 1696 Brad Barrett I want to go back to scenario one for a second because if I was in the audience I would be asking more questions so I'm going to try to do it to you if you don't mind. So OK we set up that scenario where they retired in 2000 with a million dollars. Hypothetically it went down to 500000 in 2001 and they had $40000 a year of expense. Talk us through the thought process of that early retiree at 41 years old at that point that was we said they retired at 40. So now they're at an 8 percent withdrawal rate. They have a $500000 nest egg. They're taking out $40000 a year. Now I assume just based on no math whatsoever that I would be in trouble. But that's obviously with no information whatsoever. But talk me through that person and then talk me through like OK there are corrections all the time. The stock market goes down 10 percent it goes down 15 20 you know whatever it is. Right. Like talk me through when should someone be worried. And I think that's what people really want to know. The math is going to be beyond most people even a lot of smart people but people need to know just kind of back of the envelope. What do they need to think about as far as sequencing of returns and withdrawals.
1696 - 1841 Big Ern So I mean the first thing that I wanted to point out I do all these calculations and then people could criticize me and they have criticized me and I know where they're coming from. What nobody would really do this because what I calculate is somebody takes these 40000 dollars out from the portfolio every single year stubbornly right completely non-responsive to what happened to the portfolio and then you see what happens. You iterate that forward and then you see if they run out of money and when they run out of money and of course you could argue nobody nobody in their right mind would ever do that. But I mean forget about it so imagine somebody is down to $200000 would you still take out $40000 a year. Of course not. So somewhere along the way you would have already adjusted. What do you do. So the good news is that probably in the real world nobody will ever literally run out of money because you would already make adjustments way before you get into, probably way before you even get down to half of your portfolio. And obviously you see your portfolio drop to nine hundred thousand eight thousand seven hundred thousand dollars. I mean I would probably argue that if you are down to seven hundred fifty seven hundred thousand dollars that you probably want to at least temporarily reduce your withdrawals. So in that sense what I'm calculating is that stubborn $40000 a year what you would be doing in the real world would be at some point you would then reset the clock and say well now I'm down to $700000 so take that. Times 4 percent and now I'm down to twenty eight thousand dollars and the $12000 shortfall. I have to make that up somehow. I can probably make it up through a little bit of less spending. And the other way would be a side hustle. So that's that's how this should work in reality. So in some sense it boils down to what do you define as a failure in the simulation. In my simple calculations that are just using the stubborn 4 percent and then you keep the same withdrawals in real terms. The failure is you run out of money. Of course in real life the failure is not a zero-one thing. It is a question of well do I have to reduce my withdrawals. And for how long do I have to do that. And I have some simulations for that too. There are some very simple to follow rules think that's parts nine and 10 of the series where you make adjustments to your withdrawals. If your portfolio is underwater and by the way you also do the opposite. If your portfolio performs really really well you can also increase your withdrawals because you don't want your portfolio to grow from $1 million to five million dollars because that means you haven't really withdrawn enough money.
1841 - 1865 Brad Barrett Yeah I love the real world applications there. That's hugely helpful. So you would say on average let's say again we retired and the stock market went down 10 percent. That's not something that someone should be like catastrophic we worried about right. That's fairly right within the realm of reason but you're arguing 20 25 percent in the first year or two. That's something that you might need to really sit down and reconsider the real world. The implication is that am I hearing you right.
1865 - 1910 Big Ern Yeah yeah. And again you probably want to think about well what happened here. Is there really a recession where earnings are now down. This is something that would permanently drag down the profitability of the economy. Yeah I would probably I would probably take down the withdrawal amount. If this is something like say the Brecks had happened or we had these in 2015 we had some of the volatility due to Chinese devaluation. And I think the stock market went down pretty significant percentage but I asked myself well is how fundamental is that really to the U.S. economy so even even if the stock market is down by 10 percent it doesn't really mean that future profits of the U.S. economy will be down by 10 percent so you probably can take it down by much less than the 10 percent drop in the stock market.
1910 - 1963 Jonathan Mendonsa I love what you've done you've taken it and you've made it more applicable it allows you to use it and also to appreciate the information that you have on your Web site more because now it adds some balance to that. So I just love your perspective. I love how you brought in some of the global economics into this story. Very very cool stuff really. In our community we have so many different options with how we can be flexible because our lifestyles already so much less than that of just your average person day to day Ern when I was preparing to do this. I obviously spent a fair amount of time reading through the ultimate guide to the safe withdrawal rates and one line particularly stood out to me as just highlighter asterisk. Bullseye Let's talk about this and that line said if you're if you're unlucky you can get screwed twice by sequence of return risk. Let's say let's explore this poor unfortunate person that's getting screwed. Not once but twice by sequence of return risk. Who is this person.
1963 - 2081 Big Ern OK. So I mean as I said before there is this zero sum feature between the saver and the retiree. And then depending on how the returns fall you could do better than the buy and hold investor. Or you could do worse than the buy and hold investor. But it doesn't always have to go in the same direction. So I was looking for any 30 year window where the first 15 year window was hurting the saver and the second 15 year window was hurting the retiree and that would be our candidate for getting screwed over twice because the first 15 years this is when this person is adding to his or her portfolio. This is the accumulation phase and then the second 15 year window is when you start to draw down your portfolio. So basically what I was looking for is when does the saver get hurt by sequence of return. If you have astronomical good returns during the first 10 years and then the last window or the five years towards the end of your accumulation you will have very underwhelming returns. And the reason why that's a problem for the saver is that you had very good returns early on but that's when you had relatively little invested in the market. Right because the last five years of your accumulation phase that's where the meat is that's where you have you're on average that's where you have the biggest portfolio value. So during those last five years you have poor returns and then also the first five years of your retirement you again have poor returns. So that's I mean the good news is that it took me quite a lot of time to find that 30 year window where you can get screwed over twice but there is a window like that. I mean think about it. So imagine 10 years ago let's say eight years ago you started saving for retirement right at the bottom. So we could have another cohort like that in the making. So the last eight years were very good for stocks. If say the next five years are underwhelming then. So those would be the last five years before we retire. So it's possible that there could be a record right now. So who wants to retire in five years. They could look a little bit like that. So that's that's why I pointed out this this case study.
2081 - 2088 Jonathan Mendonsa So I guess the example you have here in 1959 was that the sweet spot or the or the rotten spot for this.
2088 - 2094 Big Ern Exactly. So sweet spot from an academic point of view but obviously very rotten for this for this core audience.
2094 - 2119 Jonathan Mendonsa And this person is getting like 20 percent rates of return but they only have a couple of grand in the market. And then as they get up to the point where maybe they have 20 30 thousand one hundred thousand they get just no returns exact and then write as they need the money every tanks and they have negative returns or they have very very low returns continuing for the first five years and they just are wondering why would anybody invest in the stock market. Why would anybody do this. Worst idea ever.
2119 - 2137 Big Ern Yes yes yes. So. And it's bad timing and it's just bad luck it's not even timing right. Because I mean you are young when you're young and you do your retirement contributions when when you have the income so there's not even a matter of timing. It's just literally bad luck. And so that that's that that's all you can do.
2137 - 2170 Jonathan Mendonsa OK. All right. Well noted and cross my fingers retire in 1959 I'll retire in 1959. There's your takeaway There's your actionable point. I think the next place for us to go with this conversation is to talk about how to alleviate sequence of return risk. Now some of it as we just said is just luck. There's just there's just time there's time in there's time out. But if you know what the problem is there's ways to soften it at the margins. And so I think where we'd like to take this next is what can we do to soften the margins of sequence of our term risk.
2170 - 2214 Big Ern Sure. So actually I haven't really written that that blog post yet but I can I hinted at it in part 16. So I mean obviously a sequence of return of the reason why you have poor returns or good returns is all driven by equities is not so much driven by bonds even though obviously some diversification benefit but it's mostly done because of the equity risk equities they have the big drawdowns during the recession. So obviously you have the one level that you could use as you start retirement with pretty good sized bond portfolio. So you use that as a diversify and then you reduce your bond share over time. And so that that would be one reason to alleviate some of that sequence of return risk.
2214 - 2224 Jonathan Mendonsa One of the tools that I know you've teased has been this idea of using the Bhogle heads and endorsed VPW rule. Do you want to talk about this idea of fixed versus percentage withdrawals.
2224 - 2312 Big Ern Yes sure. So I mean there are obviously different ways of modeling that. But as I said in the beginning the whole idea of just set it and forget it and making withdrawals no matter what happens to your portfolio is a little bit silly. I think it's a good starting point to see what would be what would be reasonable rates but in practice nobody would literally do that. So and what people have proposed is well why not just take say a 4 percent rule but you do 4 percent every year you withdraw exactly 4 percent of the portfolio value at that time. So you could do that as a fixed percentage every year. You could also account for the fact that obviously as you age you can even withdraw a little bit more than 4 percent because your entire horizon is shrinking. So that's what the VPW rule does. So. And you can provide the link on the Bhogle heads forums so they have a formula for adjusting days this time varying withdrawal rate. So that depends on your portfolio allocation and your age and your retirement horizon. And I think it's a nice tool. It will guarantee that you will not run out of money literally just like in that fixed withdrawal case. But the problem is that obviously your withdrawals year over year can become very volatile. In fact they will become roughly as volatile as your portfolio if you have the stomach to do that and you can have the same kind of drawdowns in your consumption as you could face in the stock market. I think that's probably the way to go.
2312 - 2326 Jonathan Mendonsa And then the second idea that you had that is really interesting. I've never really read anywhere else. It definitely sounds like some advance stuff. But this idea of literally mortgaging your retirement do you want to just we don't need to go super individual but do you want to unpack that idea for us.
2326 - 2442 Big Ern Well the one idea and by the way this is this is to to reduce sequence of return risk for the savor. This is not for the retiree. This is just entirely for the saver. And so what people have pointed out is that if you have this risk of potentially having higher returns early on and you mostly miss out on the high returns early on in your accumulation phase because you haven't really invested a lot of money. One way would be is to invest in equities on margin. So you actually mortgage some of your future 401k contributions and you I mean there are some people for example physician on fire has a post on that where you I mean some people are just simply front load their 401k contributions on in January so you make your entire 401k contributions for the year all in January. I mean that would be there would be one form of doing that because you already invest 401k contributions that you were planning to do for the rest of the year. And then there's this concept of mortgaging your retirement is taking down a little bit further and you say that well instead of investing my 401k contributions over the next 10 years and I do it all piecemeal by piece meal I am going to front load that the entire 10 years now that that definitely takes a lot of stomach and I personally don't recommend that I threw that out there as an as an extreme case. But that definitely tells me that a lot of people are very proud of paying down their mortgage with accelerated payments. So the lesson from this mortgage your retirement is maybe you don't want to go and invest in equities on margin but maybe you don't accelerate your mortgage payments and you plow every last dollar that you have you plow that into the stock market early on and think about the mortgage later. So don't pay down your mortgage faster than you have to. That's the way I draw the conclusion from that research. I personally would not recommend going into equities when you are young and doing that on margin.
401k, mealplan, stocks
2442 - 2475 Jonathan Mendonsa Yeah I'm sure that many people when they hear anything about doing equities and margins feel like this pit in their stomach turn over. But I like the pivot that you made on that and talking about how you're increasing your risk of sequence of returns by paying down your mortgage instead of making this other choice and I know it's a battle that is constantly waged between the psychology of being able to have extremely high levels of cash flow early on in your life by not having a mortgage versus the math that tells you that by not having more invested you're just sacrificing the potential gains in your future.
2475 - 2538 Big Ern Right. One other thing about the mortgage pay down. So because what you would be doing is imagine you plow every single last dollar of cash flow into the mortgage and nothing into the stock market. Yes sure you pay down your mortgage but then when you're done with your mortgage then you have all of this extra cash flow which means that you would concentrate your investments into equities into a shorter time window and you have very high flows into the stock market all through out a shorter time window. And everything we've learned about sequence of returns is that the problem is that you could have bad luck with picking exactly the wrong time window to invest in equities. And by spreading it out as far as you can and by making the equity investments spreading them out over multiple business cycles you would alleviate some of that sequence of return risk. So that's why I personally I don't recommend paying down a mortgage early if you are young try to get a high as high an equity share and as high an equity portfolio as as possible as as early as possible. And so forget about paying down the mortgage very early in life.
2538 - 2577 Jonathan Mendonsa So this is perfect and it's actually something we see on a somewhat regular basis is people that remind us that Dave Ramsey actually asked his callers many times if he had a paid for home would you go out and borrow money at 3 percent to invest. And I think what Big Ern is basically saying here is yes then you would do it to avoid sequence of return risk. And while Braddon I don't think either of us would actually recommend going out and borrowing money at 3 percent because there's nothing tied to that. I can definitely see the beautiful compromise there when talking about the mortgage. And this is not the final discussion on that. But if you want to know what the case looks like from the other side this is where you start with that. I think this is a compelling case that Ern is making.
2577 - 2604 Brad Barrett So Ern I'm always curious how people react in their real lives. So there is the theory and there's reality and it sounds like you're falling. Your reality comes pretty close to the theory. Especially there with the mortgage. Talk me through your thoughts on front loading since you did mention that a couple minutes ago. And also like what is your investment portfolio look like at a high level like what percentage of equities and those things tell us you know the real world of what Ern has going on.
2604 - 2689 Big Ern It's actually I have to I have to admit that with my current portfolio size whether I front load my 401k contributions or not I don't think it really makes a difference. So personally I don't really do a lot of the front laoding anymore. If I look at my portfolio size it doesn't really matter anymore if I put the whole eighteen thousand dollars into the 401k plan on January 1st or if I spread it out over the 12 months. So I have to admit as of whether it's laziness or convenience I'm actually not even doing that personally but I think in general it's a very good idea. And then so in terms of the earned portfolio I mean I'm obviously very equity heavy. And so I have relatively little invested in bonds in retirement plans. I'm pretty much a 100 percent equities. I also have pretty significant home equity which we will liquidate. So we are going to sell our apartment eventually when we move to a lower tax state. And then I've started to invest in real estate a little bit through the private equity funds. So that's multi-family real estate. And then I also like to do a lot of other exotic investments and we're one of them would be options trading. So that's not something that I developed a little bit of a niche. And so I'm selling put options on equity index futures and this would probably be a whole block opposed maybe a whole episode almost on its own but I also on the side I'll do a little bit of exotic and nonstandard investments.
401k, indexfunds
2689 - 2711 Brad Barrett And then we basically tell people to just stay the course and continue investing month after month year after year. You know as long as they're in their earnings and accumulation stage like. Do you ever look at the economic realities or the more in-depth information that many people either might not have or might not have the expertise for. Like do you look at that and adjust your equity portfolio accordingly.
2711 - 2760 Big Ern So yes I do. So for example some of these more exotic investments they came up because I think that especially going forward they may not be as much of a equity expected return as I hoped for. I mean this is this goes back to this whole Jack Bogle discussion. But I also concede that I think it's a really bad idea for retail investors to try to time the market. It's very hard and I don't want to do it. In fact I mean it's not like I'm shifting money out of equities. I'm still investing in equities. I still kept the existing equity investment that I have. It's simply that I started making new investments more into some of the exotic investments. So it's just part of it is for diversification and part of it is I'm getting a little bit more pessimistic. on unexpected equity returns.
2760 - 2815 Jonathan Mendonsa Well let let's talk about that so I got an open letter from Matt to our Facebook group and it comes down to what you're discussing and he says I've been pondering our ongoing dialogue which I would boil down to this in my estimation the fi community is greatly modeling consecutive 8 percent year over year returns while its forefather Bogle is calling for 4 percent over the next 10 years which is supported by Shiller's P or Cape ratio being at its second highest in history 29 versus its historical average of 17. So Bogle is essentially urging investors to temper their expectations accordingly at least for the more short term period of time. I'd be interested in getting your perspective on that essentially what I heard you just say is you've already hit your number through equities and you're making a diversity play with some of these more exotic vehicles and the place that you would still recommend that the retail investor which is our community start is with what we've been talking about over and over again which is just index investing.
2815 - 2918 Big Ern Right. First of all I hope that you put the link for the Bhogle interview. That's actually when I read that I was really amazed because here's one guy who is the icon and the idol off passive investment and so he suddenly tells us well well there is some bad time varying equity expected returns. Take that for a while to let that sink in. And but again if you look at what Bogle says in general he does not say you should use this to start timing the market. He doesn't say run for the hills and sell your equities and invest in well in what else anyway. So say we do want to invest in bonds because Bond returns are also very low at least for Bond returns. The bad thing about Bond returns is they are low and there is no upside at all. Right so the treasuries are paying something like 2.3 percent over the next 10 years. There is no upside so you buy your buy one 10 year bond you're going to make 2.5 percent not more and not less over the next 10 years. So obviously Bogle doesn't say that we should now sell stocks. I mean in fact we should stay the course and we will have a little bit lower than expected returns lower returns than we've got used to. But what Bogle says is that it's going to take these 10 years to normalize equity valuations again. And then the good news is ones equity valuations are normalized again where profits have grown and the stock price has grown a little bit less than profits that the Cape ratio or the P E ratio depending on what measure you prefer. That will have normalized again. And once that normalized again then we can go back again to to these 8 percent expected return for equities. So is this is this is just a temporary thing. And if we make it through those 10 years then everything will be good again after 10 years hopefully.
2918 - 2980 Jonathan Mendonsa Perfect. I love first of all how you're so structured your thought process in this article series. I think it's the perfect parallel story line to the JL Collins stock series this 17 or 18 or 20 part ongoing series on the safe withdrawal rates. It's a must read for anybody who's gone down the rabbit hole to fi. And what I love is this line in part 17 and you said the only thing more offensive than the 4 percent part is the word rule. And in this article you made the pitch that while. Sure. Let's go ahead and leave that in place. Let's call it the 4 percent rule of thumb and that's where I wanted to bring this thing to a close because it so perfectly parallels what Brad and I have been preaching for some 50 odd episodes which is that you don't have to base this on some fixed number you live in reality and in reality there is some flexibility there's some variables that can't be accounted for by just having this one 4 percent rule although I love it. We do have something to point to. It's a starting place it's not a finished play so I'd love to get your thoughts on how we can start with 4 percent and how we can adjust from there.
2980 - 3061 Big Ern Right right. So for a first of all I came up with this great analogy so let me go through this analogy. So for example on our smartphones now we all have driving directions right. So you say you want to go from my home to the airport I want to know how long is it going to take me to go to the airport. And that commute time is going to be very dependent on what time of the day I leave what weekday I leave. It's even dependent on whether I'm a fast driver or not so fast driver. And so the analogy of the 4 percent of the original 4 percent rule would be. So imagine we we take 24 people and we send them off to the airport and the first person goes at 1 am the second person goes at 2 a.m. and so on the 12th person goes at noon and the 24th person goes at midnight and then we take some kind of an average of these 24 people. And that might be a pretty good rule of thumb if we don't even know yet what time of the day or what or week day we're going to the airport. But that average commute time is going to be completely useless if you already know that you will go at 4 p.m. during rush hour. So just like just like that example we can't have a 30 minute rule for going from my home to the airport. It has to be more customized than that. And the same is going on with the with the safe withdrawal rules. So it has to depend on what are our expected returns for equities and bonds and it has to depend also on these on these idiosyncratic factors.
3061 - 3133 Jonathan Mendonsa That's perfect. And so I know in context you've already mentioned several of these we've talked about being able to make adjustments for equity and bond valuations. We've talked about making adjustments for these idiosyncratic factors like your age social security pensions. I think that is the piece that when people are just looking at a number they don't want to talk about. But in the context of what we're trying to accomplish which is to have a conversation which is to attach real lives and real examples to this we can we can do that. And what you then can find you know where you are in age in life lifecycle you can find a model of someone that has a similar situation to yours and find out what they're doing because although there's not one single answer for everybody for every scenario there are tools that are examples that you can use and incorporate in your life to get your ultimate success and to make these numbers work for your specific situation. So I think that basically kind of brings that accomplishes what I wanted to get out of this discussion specifically with the 4 percent rule and what we should be thinking about as we approach 2018. But I know there's so many other questions. Brad and I we can't just let you go we've been wanting to do this for so long. We want to know your thoughts on several other just kind of wildcard questions and this is a side for the hot seat. So we have the hot seat as well.
3133 - 3134 Big Ern All right.
3134 - 3140 Jonathan Mendonsa We're going to skip that but we did have a couple of other kind of tandem questions to throw at you if you would be willing to tackle these.
3140 - 3142 Big Ern Oh yeah absolutely. Go ahead.
3142 - 3177 Brad Barrett Yeah. Jonathan could see me furiously writing things down during the episode. This is a wonderful opportunity to get to speak with you. So yeah kind of random but just bear with me. So we're talking about Bogles prediction of 4 percent returns over the next 10 years. There are many people in the community who hope to reach fi and potentially retire early in the next 10 years. What what worries you about someone in that specific instant is it these lower returns. Is it sequencing return risk and even other wildcards we're talking about health care Social Security like talk us through how if someone came to you and said All right this is my scenario what would you advise them.
healthcare, socialsecurity
3177 - 3295 Big Ern OK. So I mean in some ways somebody who is pretty far detached from retirement say they are planning retirement in five to 10 years. They would. Again the sequence of return risk they would benefit from basically a stock market crash. As soon as possible. Right. So because they want to they want to have that same advantages that I had when I left grad school. I graduated right around at the 2001 market crash so I contributed to my 401k at rock bottom prices so the people who are planning retirement in maybe 10 years from now I guess the worst thing that could happen to them is again getting screwed over by being that 1959 cohort. You get good returns early on and then right when you retire that's when the right before you retire that's when you have your weak returns. But then I mean obviously also a lot of the other things you mentioned is basically the political risk right. And that's something that we don't really have a good handle on it at least for us for the stock market for the bond market. You can come up with some kind of a risk model right. You can. People have looked at well what does what is the standard deviation of returns for equities and bonds so there is something measurable. And we have a sense of what is high risk what is low risk. We have a sense of yeah. I mean every once in a while you get a you get an x percent drop in the stock market and you just have to. This has happened before and that will happen again. But for the political risk it's very hard to assign probabilities and risk to that right. What happens to what happens to the Affordable Care Act. What if you have what have you have tailored your retirement budget to these generous subsidies from Obamacare. And what if they go away at some point. So that's I mean these are all risks. And unfortunately they are very hard to quantify. That is very hard to quantify what is the retirement cohort that is, that might see their Social Security cut. So it is very hard to quantify that. And these are some of the things that I worry about.
401k, socialsecurity, stocks
3295 - 3306 Jonathan Mendonsa OK. Here's an alternate wildcard question for you. So you have negligible net worth and you inherit a $100000 windfall. And what do you do with it.
3306 - 3325 Big Ern I think that the retail investor doesn't want to get into timing the market. And so I mean I would just I would just invest the windfall in the stock market. And because you're again you're starting out you want to get that equity that equity exposure as high as possible as quickly as possible so I would still invest in the stock market to.
3325 - 3328 Jonathan Mendonsa Dollar cost average or front load.
3328 - 3357 Big Ern I wrote an article about that. In fact if you could if you are just worried that while but what if I invest just right the day before a big drop if in fact that's even on my mind. And that's even on my mind for for for smaller investments than $100000 if that's if that's on your mind. I mean I am Yeah I mean do the dollar cost averaging. If if that calms your mind. But again I mean there's research out there that shows that you don't want to do the dollar cost average.
3357 - 3371 Jonathan Mendonsa Because if you're driving to the airport at 4 p.m. on the right I think I would dollar cost average over 12 months or maybe 24 months. I think that's probably I would be try and I think I would.
3371 - 3418 Big Ern Yeah. And so one compromise would be to lower that opportunity cost because if you if you have access to credit and you say you know $100000 arrives next month well maybe already invest a little bit today or do it. So take it out of your emergency fund if you have one and then do then do another one third installment. When the money arrives and then another one third installment the month after it arrives. And that way some kind of a compromise you spread out the investment you lower the risk that you invested just at the wrong time. But you don't have to. On average you don't have the opportunity cost because you do a little bit before the windfall arrives and you invest a little bit after the windfall arrives. So that's kind of the best of both worlds. I have a blog post on that too.
3418 - 3458 Jonathan Mendonsa Well yeah we'll definitely link to it. Give me the link by email we'll put it in the shownotes. One other one for you just a wildcard here so we consider ourselves first generation fire but in many cases many of us have parents that were existing outside of this construct have not been exposed to it and did not have a plan and maybe they have passively accumulated some amount of net worth maybe $200000 or $500 somewhere in that range. It's not traditionally what we would consider enough to cover all of their expenses but they have something. Let's just say $200000 and now they know that we are into personal finance and that we have all these ideas and they want our input on what they should do with that 200 K and it's all over the map. And where would we recommend they put it.
3458 - 3513 Big Ern So I've actually had examples like that where people asked me and asked me exactly that question. So my first response would be first of all get rid of all of your high cost high expense ratio mutual funds. I have seen some pretty pretty jaw dropping portfolio allocations that were recommended by financial planners or the the local guy at the at the local bank. And so basically De-clutter your portfolio. And sometimes it's hard to de-clutter because if he's in a taxable account you could potentially look at generating taxable capital gains. But certainly in retirement accounts I mean that has to be de-clutter. And it can be declared without tax consequences doesn't move it over to a Vanguard or Fidelity or Schwab go into index funds. Of course the allocation stock vs bond. That would depend then on the on the age and the preferences. But yeah I mean there's basically the first step is always check you or check your expense ratios.
indexfunds, stocks, tax
3513 - 3553 Brad Barrett All right and my last question here and we could pepper you with this stuff all day but I will stop with this. As you know someone again comes up to you at some cocktail party they say they're 40 years old and they read this blog right and they want to retire they've been diligent savers they have let's say $40000 a year of expenses they have 30 times saved up to 1.2 million. And but you know what they plan to live to 95. Right. That's fifty five years. I mean and their question is is this really realistic is it real. And like you know is it just math. Do you tell them hey I've done the math 10 ways to Sunday and it just works. You know what you tell that person in just a minute or two to actually explain what that looks like in the real world.
3553 - 3624 Big Ern So I mean the good news is at 30 x you are in a very good shape. So I mean some people would accuse me you know he's against the 4 percent rule so he's he's overly conservative. But I would actually say that's a 3 percent safe withdrawal rate, that might that might almost be too conservative. So if somebody has 30 x, 30 times expenditures as a net worth, capital markets over the very long term they have returned 3.3 percent in real terms. So equities on average have returned over 6 percent. So if you have a you have a high enough equity share and you don't do anything overly irresponsible with your portfolio where say you have a big drop in equities and you shift out of equities and into bonds, sometimes retire investors have a bit of a problem of overreacting to equity volatility. But if you if you don't do anything irresponsible and you just stay the course and you you stay invested especially because you have a very long horizon. You want to know you want to have a high equity share then 3 percent or 3.3 percent safe withdrawal rate is is not crazy and is actually a very good very good number to start.
3624 - 3627 Jonathan Mendonsa So is 3.5 percent kind of your mental number that's where you land.
3627 - 3695 Big Ern Yeah so three points. So I guess my mental number is say three point two five percent for something completely barebones where you completely write off Social Security and you don't consider it. And then I add a little bit from from Social Security and then I end up at about three and a half percent. So that would have performed very well in the historical simulations. And then I did the kind of the back of the envelope calculations for the Bhogle scenario it would handle very well in the Bhogle scenario is not too high not too low. And with a three and a half percent withdrawal rate you would draw down a little bit of your portfolio over the next 10 years and so say you start with a million dollars you might end up with say $900000 after that. But keep in mind that the whole idea of Bogle's exercise is that this is an adjustment period. So after 10 years now the PE ratios now the Cape is back to something more normal. And now we can again apply the higher expected equity returns. So all you want to do is don't withdraw too much and don't draw down your portfolio too much over the next 10 years and then you should be fine.
3695 - 3706 Jonathan Mendonsa Well we have extracted every single little bit of juice that we thought we could get from you and you're like a shell of a person I'm sure over there. But if you have the energy I would like to invite you to tackle our hot seat. Are you ready for this.
3706 - 3708 Big Ern All right let's get going.
3708 - 3713 Jonathan Mendonsa OK.
3713 - 3741 Speaker In a world drowning in debt and rampant consumption. Trapped by the chains of lifestyle inflation. These questions highlight the secrets of those who are broken free. Welcome to the choose F-I hot seat.
3741 - 3742 Jonathan Mendonsa All right we're back.
3742 - 3746 Big Ern All right. Great.
3746 - 3750 Brad Barrett All right Ern first question your favorite blog that's not your own.
3750 - 3804 Big Ern So I would. OK I'm going to throw two at you and I'll throw at you physician on fire and the retirement manifesto and you've already you've already interviewed physician on fire. I think he's a really good guy has a great blog great content very productive writer. But in case you haven't already looked at the retirement manifesto and you haven't interviewed him already or he would be you would be a great guy for this. He has a great blog and we have a few things in common so he's an option trader too and we so we have some some exchanges over that and we talked on the phone before and it was a very good writer and he recently had a had a feature in the Business Insider of how I became a 401k millionaire. It's a it's a great it's a great blog and he has he has great content is a very nice guy. So if you if he's not on your shortlist are ready I think he he could be could be a good guy for you for you to interview too.
3804 - 3810 Jonathan Mendonsa Why. I am an official follower of him on Twitter so I will reach out to him.
3810 - 3838 Big Ern But then again I mean physician on fire. I mean we have some things in common in terms of high income and we plan a little bit of a higher fire. I think it's called the Fat fire approach. So as our our targeted spending is a little bit higher and we have some of the same challenges right you spend a lot of time in graduate school and is you a little bit late to the game. So even though he's in medicine and I'm in finance we actually have a lot more in common than you think.
3838 - 3871 Jonathan Mendonsa What I love about our community is that we're not limited to one plan you just we're just we just follow the math and people make radically different choices based on their own desires their own socio economic situations. But because they're doing it from a platform where they understand how the math works and how to get the math to work for their specific situation we can have this conversation we'd all be dogmatic and say that you have to live on $20000 a year. I am perfectly comfortable talking to people that are making a choice to live off eight times that but they're still operating from the same baseline which is really cool and it expands the conversation.
3871 - 3872 Big Ern Yeah exactly.
3872 - 3881 Jonathan Mendonsa All right. Question number two which is essentially a follow up on this your favorite article of all time and you can either reference one of your own or somebody else's.
3881 - 3897 Big Ern Ok so I have a small blog so I have to blatantly self-promote that a little bit. So I guess I would have to go with the safe withdrawal series part one because that's kind of put my blog on the on the map and I got a lot of search engine traffic from that. So that started it all.
3897 - 3922 Jonathan Mendonsa So nice. Yes. And we will do our best to promote that because we're big fans and we think that what you've done really does add value to something that frankly Brad and I could never have done. We could. We are not capable at any level. No matter how much time we were willing to put in we could not have put that together and I don't think there are very many people that could have done that. So we will absolutely be linking that on our show notes because it's now a is it an 18 part series or 17 percent.
3922 - 3925 Big Ern It's 17. Yes.
3925 - 3953 Jonathan Mendonsa So we touched on some of the highlights but we do encourage our audience if you really want to understand this stuff and find a central place where you can go through each of these different complicated aspects but in a way that is engaging and makes sense definitely go check out this series. And frankly I'd love to just have two parallel storylines one with the stock series from JL Collins on the left hand side and the one with the safe withdrawal rate series on the right. They really do go well together it's like milk and cookies. I mean you just can't separate them.
3953 - 3959 Big Ern Thank you. Thank you. Well just being mentioned in the same sentences as Jim. That's that's makes my day. Thank you so much.
3959 - 3994 Brad Barrett All right. Number three your favorite life hack. It would have to be geographic arbitrage because I milked it every way I could so I was going to college for free in my home country then coming to the U.S. for grad school. This is where the good places are to go to grad school for economics. There was a very lucky decision Geographic arbitrage So we plan to move out of state and move to a cheaper location with lower housing prices and lower income tax hopefully no income tax. Geographic arbitrage is everywhere. Everybody can apply. Everybody should apply it it's a very powerful tool.
college, geoarbitrage, hotseat-lifehack, tax
3994 - 4001 Jonathan Mendonsa Definitely a full episode. We're researching it now to figure out how we want to tackle it. But you're absolutely right. Question number four your biggest financial mistake.
4001 - 4077 Big Ern So the good news is that I don't think I ever made any any disastrous mistakes I never went into debt. And so and then even some you know some investments that didn't work out. I mean I sometimes you know you go for lunch you come back from lunch and you lost $30000. But that's just that's just because the stock market went against you and it's not a mistake right. It's the risk you are taking. Investing in risky assets. And that's that's why you make the excessive returns. But I would think that the worst mistake is that I was a little bit complacent about my savings rate earlier in life after after my first job I thought well OK I have this is a relatively easy goal of making a million dollars by age 50. And so I calculated OK this is my savings rate and I could have gone much higher than that but that's because I didn't know about Mr. Money Mustache and go Curry Kracker and then all the big thinkers in the Fire community. And I thought I was saving something like 25 percent of my income and I thought hey I'm doing great. I'm doing much better than the average American but I guess I could have reached the place where I am right now. Maybe a few years earlier if I if I hadn't been so complacent early in life. But again I had a positive savings rate throughout my life. It just should have been a little bit higher.
savings, stocks
4077 - 4083 Jonathan Mendonsa I feel like that really ties into the next question and we may just be replaying that. But the advice you would give your younger self.
4083 - 4145 Big Ern Yeah I mean that that advice. But the other advice I would give to younger self or or young people in general today is don't get fooled by how people get affluent because we are we have this mentality say off of American Idol where in order to get rich and famous you need this one big break. But of course most people especially in our community they didn't get rich because they made one lucky investment decision. It's a process of many years of investing diligently. And if I look at my net worth today it's not like I can't pin that down to one single decision or one lucky break or one. One lucky investment in some startup that suddenly made me rich. It's all it's all the long process of small investments regular investments. Staying the course when when the equity market is down and in fact investing more in the equity market is down because equities are cheap. So this is how we got rich. It's not it's not one lucky break is a long process. Yeah
4145 - 4157 Brad Barrett and that is the perfect summation of the FI mentality in general. So yeah I absolutely love what you just said. That was perfect and Ern our bonus question is your favorite purchase that you made on Amazon.com last year.
4157 - 4204 Big Ern So I would have to go with. So we bought a video editing software and I think it is pretty cheap or something like $70 or so and then when my wife does is she would look at our vacation videos and usually for every occasion we have something like an hour or an hour and a half of raw footage and she distills this down into somewhere maybe eight to 10 minutes 12 minutes max and makes a video out of that and makes it look good as some some background music and and we look at that every once in a while and you know it makes you happy makes it gives you gives you a smile on your face. And you you can. Little bit relived that vacation experience and that is definitely definitely the best best $70 spent in a long time because we get so much out of that.
4204 - 4220 Jonathan Mendonsa Alright Ern well that basically brings us to a close we like to finish up. First of all. Thank you for your time being so generous with it. But also how can people get in touch with you. We have a growing audience and many of them have been requesting this particular conversation for weeks if not months. How can people get in touch with you.
4220 - 4249 Big Ern Well they can go to our blog. It's early retirement. Now Dot. com And I hope that people don't just don't just go to the blog but they also sign up for the for the e-mails and I promise you you will get exactly one email per week and that's the announcement of the New Blog Post on Wednesday so there's no spam mail there's no nothing commercial coming ever. So again make sure you visit early retirement. Now dot com and sign up for a free e-mail updates.
4249 - 4278 Jonathan Mendonsa OK. Absolutely wonderful episode. And I just I cannot stress how excited we were to have Ern come on and share his time and his expertise with us. First of all I'm excited about the Friday around at this week just because to get a chance to take all the information that we were able to explore today and then go into it with even more depth and talk about our lightbulb moments and share it with you. It's a very rewarding process and so I don't have a whole lot of else add to this except the fire spreading my friends. And we'll see you next time as we continue to go down the road less traveled.

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