William Bernstein: The Real Math on Retiring Early

[brooklynguy]

Since William Bernstein gets a lot of love and respect around here, just thought I'd share this piece by him in today's Wall Street Journal:

http://blogs.wsj.com/experts/2014/10/13/the-real-math-on-retiring-early/

His outlook on the viability of the 4% rule for the coming decades is pessimistic, to say the least:

Thus, a 60/40 portfolio can now [only] be expected to provide a five-decade safe 2% stream of inflation adjusted retirement income.

My two cents are that this is just another talking head making predictions about the unknowable future, albeit a well-informed talking head whose views on investing I generally greatly respect.

[waltworks]

Long-winded way of saying "stocks are kinda expensive right now and bond rates suck too. Let's assume it stays that way forever! Oh, by the way, I'd like you to pay me to manage your money."

Dumbass.

-W

[Cheddar Stacker]

Yeah, not his best work. Short, and very doomsdayish. Oh well, the sun will rise again tomorrow I guess.

[deborah]

I think he has a few very valid points.

• The 4% rule probably won't work for the future - As the 4% rule has only worked for a couple of countries, and some others have the 0.6% rule, this is a fair comment. The US was nowhere near the top of the heap a century ago - why should it stay there? Argentina was one of the top ranked countries then, and where is it now?
• Actuaries have consistently predicted people dieing 4 years before they do for a long time. True
• As a couple, one of you will probably live for a very long time. True
• You lose your financial soundness as you get older. True

He doesn't say what to do about these things, and they should be on everyone's radar, particularly if you retire early.

[Scandium]

First he talks about how early retirement will last 50+ years, then

At the moment, stocks are priced to produce, at best, a 3.5% real return

OK, so what? "at the moment" != 50 years last I checked. In 5 years it might be opposite. In fact 5 years ago it was.


Let me write his next article:
" The future might not be like the past, or it may. It could be worse. Or not. Q.E.D"

[foobar]

First he talks about how early retirement will last 50+ years, then

At the moment, stocks are priced to produce, at best, a 3.5% real return

OK, so what? "at the moment" != 50 years last I checked. In 5 years it might be opposite. In fact 5 years ago it was.


Let me write his next article:
" The future might not be like the past, or it may. It could be worse. Or not. Q.E.D"

Exactly. Use someone else estimates (http://www.rickferri.com/blog/investments/portfolio-solutions-30-year-market-forecast/) and you get a more optimistic picture. And of course the person retiring at 50 might not need 50 years of money. They might need 20 years. When you turn 70, SS replaces 2/3s+ of your income (i.e. my check is supposed to be 2200/month even if I retire at 50. Wife is about the same). Or if your in the bad sequence of returns world, just cutting spending by 25% and life is back to being good.

Bernstein has been very conservative since 2008. That might match your world view but the odds are he has swung way too far to that side.

[waltworks]

I want to hear more about how 1914 Argentinia was at the top of the country rankings!

I kid, I kid.

The other elephant in the room of course is that "retirement" in his mind consists of 100% non-profitable activities. I am certain that there will come a point in my life where I'm simply not a productive member of society in any way (hopefully a few seconds before my death, but being honest, it could be sooner than that) but when I'm 45? 50? 65? I'd like to think I'll retain the ability to do *something* of value. In fact, I'd be pretty surprised if "retirement" meant "income from work drops to zero" for pretty much anyone on this forum.

-W

[arebelspy]

In fact, I'd be pretty surprised if "retirement" meant "income from work drops to zero" for pretty much anyone on this forum.

I think you're inclined to think that because it sounds like it's the case for you.

Personally, I hope to never have earned income again after I FIRE.

I assume that's the same for most, though that's because I'm biased the opposite as you.

The truth is probably somewhere in the middle.

[Clever Name]

Why on earth would an early retiree hold 40% of their portfolio in bonds?

[wtjbatman]

Bernstein's book Rational Expectations goes a lot more in depth about the topic of expected future returns. For some reason his ideas don't come across as well in a 6 paragraph article on the WSJ.

[deborah]

In fact, I'd be pretty surprised if "retirement" meant "income from work drops to zero" for pretty much anyone on this forum.

I think you're inclined to think that because it sounds like it's the case for you.

Personally, I hope to never have earned income again after I FIRE.

I assume that's the same for most, though that's because I'm biased the opposite as you.

The truth is probably somewhere in the middle.

I don't think I'll earn income again. Well maybe I will - at the moment I'm not teaching my hobby, but since retirement I have, and I might again. And maybe I'll earn other income from my hobby. But it's not on the radar.

[brooklynguy]

In fact, I'd be pretty surprised if "retirement" meant "income from work drops to zero" for pretty much anyone on this forum.

I think you're inclined to think that because it sounds like it's the case for you.

Personally, I hope to never have earned income again after I FIRE.

I assume that's the same for most, though that's because I'm biased the opposite as you.

The truth is probably somewhere in the middle.

I think it's a safe bet that most of us want to have the option to never work again (pretty much the definition of financial independence), and view the ability to return to income-generating pursuits as simply part of the safety margin.

[God or Mammon?]

I think Bernstein is one of the most thoughtful out there in the world of finance

[foobar]

Why on earth would an early retiree hold 40% of their portfolio in bonds?

Because they fear a 10 year down market at the start of retirement. For a 65+ year old it makes a ton of sense to have a 60/40 or even 40/60 portfolio. For a 50 year old retiree, you pretty much have to be comfortable with 70/30 or 80/20. You might have a few more sleepless nights but you need to take the risk.

[Cheddar Stacker]

Bernstein's book Rational Expectations goes a lot more in depth about the topic of expected future returns. For some reason his ideas don't come across as well in a 6 paragraph article on the WSJ.

Yeah good point. The article was really too short for any real depth or explanation which is likely why I thought it was crap.

I don't plan to "earn" any money in retirement, but I plan to pile on the passive income in multiple ways.

[hodedofome]

The 4% rule is based on past data and could be data mined/overly optimized. A more dynamic rule is probably more robust.

As in, the safe withdrawal rate should be based on the current yield for treasury/investment-grade bonds. Or something of that nature.

[Bob W]

Isn't it hard for "Financial Advisors,"  "Talking Heads," and "Newsletter writers"  to make money if their only advice is --- "Buy as much S and P 500 Vanguard funds as you can and only sell them if you need the extra money?"  lol   

I'm all for the low information diet on this one.   Buffet says the best economic years are ahead of us.   I tend to believe that as we have barely scratched the surface of our productivity potential. 

[Gone Fishing]

One of the many effects of aging is becoming over-conservative.   That said, I am aiming for a 3% withdrawal rate.  If I turn out to be wrong (over-conservative), I should have plenty of time to make up for it, as in spending it. If I turn out to be overly optimistic, I have some time to correct for that as well.  Extremely early retirees (under 50 or so) have much less risk in the fact we can reasonably expect to still be employable 10+ years into retirement.  A 65 year old can not have this expectation. Thus we can afford to take on more risk with our investments which translates into a smaller 'stache.

[johnhenry]

Isn't it hard for "Financial Advisors,"  "Talking Heads," and "Newsletter writers"  to make money if their only advice is --- "Buy as much S and P 500 Vanguard funds as you can and only sell them if you need the extra money?"  lol   

I'm all for the low information diet on this one.   Buffet says the best economic years are ahead of us.   I tend to believe that as we have barely scratched the surface of our productivity potential.

I agree with you about us barely scratching the surface of our productive capability as a nation and a planet.  But that doesn't necessarily translate to economic prosperity for those involved or even most responsible for the increased productivity.

[Jack]

Why on earth would an early retiree hold 40% of their portfolio in bonds?

Because they fear a 10 year down market at the start of retirement. For a 65+ year old it makes a ton of sense to have a 60/40 or even 40/60 portfolio. For a 50 year old retiree, you pretty much have to be comfortable with 70/30 or 80/20. You might have a few more sleepless nights but you need to take the risk.

Extremely early retirees (under 50 or so) have much less risk in the fact we can reasonably expect to still be employable 10+ years into retirement.  A 65 year old can not have this expectation. Thus we can afford to take on more risk with our investments which translates into a smaller 'stache.

The other issue is that an extreme early retiree needs to take on more risk because his portfolio is expected to last 40, 50 or even more years, and is therefore more dependent on gains (vs. contributions) compared to a "normal" portfolio designed to last only 30 years.

(If you don't believe me, go to Firecalc and see which stock/bond ratio has the best chance of success over a 50-year time horizon, and how that compares to the best ratio over a 30-year time horizon, with everything else held equal.)

[foobar]

One of the many effects of aging is becoming over-conservative.   That said, I am aiming for a 3% withdrawal rate.  If I turn out to be wrong (over-conservative), I should have plenty of time to make up for it, as in spending it. If I turn out to be overly optimistic, I have some time to correct for that as well.  Extremely early retirees (under 50 or so) have much less risk in the fact we can reasonably expect to still be employable 10+ years into retirement.  A 65 year old can not have this expectation. Thus we can afford to take on more risk with our investments which translates into a smaller 'stache.

You have more time to spend more but you never get back those years you spent saving. It is all about the risks you want to take. The more you work, the lower your financial risks but the higher you time ones. Finding that balance is very personal choice.

The problem with figuring out employment is that right now I make lets say 20x as much as I would get from jobs that I would be qualified for in 10 years. Is it worth 1 extra year now to avoid the risk of having to work 15 years in the future? Well since I like my job, the answer is yes. If I hated my job, it would be a tough call. 

[arebelspy]

The problem with figuring out employment is that right now I make lets say 20x as much as I would get from jobs that I would be qualified for in 10 years. Is it worth 1 extra year now to avoid the risk of having to work 15 years in the future? Well since I like my job, the answer is yes. If I hated my job, it would be a tough call.

Right.  And the question becomes what is the probability of having to work those extra years.

And since you're delaying ER by a year, it's not only the extra money you make at your higher paying job now (1), it's the money your stache earns in that year (while not being drawn down on) (2), and the fact that you need to fund one less year of ER (3).  All three reasons make a good case for OMY syndrome.

[brooklynguy]

Right.  And the question becomes what is the probability of having to work those extra years.

And since you're delaying ER by a year, it's not only the extra money you make at your higher paying job now (1), it's the money your stache earns in that year (while not being drawn down on) (2), and the fact that you need to fund one less year of ER (3).  All three reasons make a good case for OMY syndrome.

There are often-overlooked costs on the other side of the tradeoff, too (even if we stick to a purely financial cost-benefit analysis).  The biggest one that springs to mind for me is that every OMY of my sedentary desk job may lead to exponentially higher health care expenses in the future.

[Beric01]

The problem with figuring out employment is that right now I make lets say 20x as much as I would get from jobs that I would be qualified for in 10 years. Is it worth 1 extra year now to avoid the risk of having to work 15 years in the future? Well since I like my job, the answer is yes. If I hated my job, it would be a tough call.

Right.  And the question becomes what is the probability of having to work those extra years.

And since you're delaying ER by a year, it's not only the extra money you make at your higher paying job now (1), it's the money your stache earns in that year (while not being drawn down on) (2), and the fact that you need to fund one less year of ER (3).  All three reasons make a good case for OMY syndrome.

I don't know about you, but for me having to spend even one additional year doing something other than exactly what I'd like to be doing speaks against the OMY syndrome. I would prefer to cut back my expenses in case of a long-term market downturn rather than spend additional time working.

[arebelspy]

The problem with figuring out employment is that right now I make lets say 20x as much as I would get from jobs that I would be qualified for in 10 years. Is it worth 1 extra year now to avoid the risk of having to work 15 years in the future? Well since I like my job, the answer is yes. If I hated my job, it would be a tough call.

Right.  And the question becomes what is the probability of having to work those extra years.

And since you're delaying ER by a year, it's not only the extra money you make at your higher paying job now (1), it's the money your stache earns in that year (while not being drawn down on) (2), and the fact that you need to fund one less year of ER (3).  All three reasons make a good case for OMY syndrome.

I don't know about you, but for me having to spend even one additional year doing something other than exactly what I'd like to be doing speaks against the OMY syndrome. I would prefer to cut back my expenses in case of a long-term market downturn rather than spend additional time working.

Oh hey, I'm in complete agreement.  In fact, I'd go further: you should quit right now if you don't like your job, FI or not.  ;)

I love my job.  I also really look forward to FIRE.

That's when OMY stuff becomes tough.

[foobar]

Right.  And the question becomes what is the probability of having to work those extra years.

And since you're delaying ER by a year, it's not only the extra money you make at your higher paying job now (1), it's the money your stache earns in that year (while not being drawn down on) (2), and the fact that you need to fund one less year of ER (3).  All three reasons make a good case for OMY syndrome.

There are often-overlooked costs on the other side of the tradeoff, too (even if we stick to a purely financial cost-benefit analysis).  The biggest one that springs to mind for me is that every OMY of my sedentary desk job may lead to exponentially higher health care expenses in the future.

 The fact that you choose not to exercise is a personal choice not a financial one.:) The studies also show that a big financial cushion when your older has been linked to much longer life expectancy so you can argue working another year or two will enhance your health.

Yes the OMY is because towards the end the numbers start changing rapidly. You have 20x (a pretty safe 5% SWR if your willing to pass up on inflation adjustment in bad years) becomes 25x with a 2 average years (a pretty darn safe 4%) which in another 2 years is a 30x (i.e. a crazy safe 3.3%). Is it worth 4 years of your life? Again it all depends on job satisfaction versus need for income. Personally my 20x savings would become a 30x the day I decide I don't like my job. Thats the good part of having an absurd amount of fat in the budget:)

[brooklynguy]

The fact that you choose not to exercise is a personal choice not a financial one.:) The studies also show that a big financial cushion when your older has been linked to much longer life expectancy so you can argue working another year or two will enhance your health.

Yes the OMY is because towards the end the numbers start changing rapidly. You have 20x (a pretty safe 5% SWR if your willing to pass up on inflation adjustment in bad years) becomes 25x with a 2 average years (a pretty darn safe 4%) which in another 2 years is a 30x (i.e. a crazy safe 3.3%). Is it worth 4 years of your life? Again it all depends on job satisfaction versus need for income. Personally my 20x savings would become a 30x the day I decide I don't like my job. Thats the good part of having an absurd amount of fat in the budget:)

The research is starting to show that no amount of exercise can undo the harmful effects of sitting for extended periods of the day, but your overall point is well taken.  These types of factors are difficult to quantify, and for most people it will come down to how much you want to increase your safety margin vs. how much you want to be free of your job.

[foobar]

The fact that you choose not to exercise is a personal choice not a financial one.:) The studies also show that a big financial cushion when your older has been linked to much longer life expectancy so you can argue working another year or two will enhance your health.

Yes the OMY is because towards the end the numbers start changing rapidly. You have 20x (a pretty safe 5% SWR if your willing to pass up on inflation adjustment in bad years) becomes 25x with a 2 average years (a pretty darn safe 4%) which in another 2 years is a 30x (i.e. a crazy safe 3.3%). Is it worth 4 years of your life? Again it all depends on job satisfaction versus need for income. Personally my 20x savings would become a 30x the day I decide I don't like my job. Thats the good part of having an absurd amount of fat in the budget:)

The research is starting to show that no amount of exercise can undo the harmful effects of sitting for extended periods of the day, but your overall point is well taken.  These types of factors are difficult to quantify, and for most people it will come down to how much you want to increase your safety margin vs. how much you want to be free of your job.

Most of the research I have seen suggests that just walking ~5 mins/hr is enough to counter act most of the bad stuff (it doesn't help with preventing weight gain issues).  I find drinking water constantly is enough to make me get in that walk:) And if your company will spring for it, the adjustable desks are awesome.  I found standing for 8 hours to be too rough (yeah that sounds pathetic:) but going for an hour run after standing for 8 I could tell my mechanics were off) but doing 2 hours shifts worked well for me.  YMMV

[waltworks]

http://well.blogs.nytimes.com/2014/09/17/sit-less-live-longer/
http://well.blogs.nytimes.com/2013/10/30/the-marathon-runner-as-couch-potato/

And:
http://well.blogs.nytimes.com/2014/09/17/sit-less-live-longer/?_php=true&_type=blogs&_r=0
http://well.blogs.nytimes.com/2012/10/17/get-up-get-out-dont-sit/

Money quote:
"The health consequences of this sedentariness are well-documented. Past studies have found that the more hours that people spend sitting, the more likely they are to develop diabetes, heart disease and other conditions, and potentially to die prematurely — even if they exercise regularly."

-W

[firedup]

Personally, I hope to never have earned income again after I FIRE.


me too!!!!!!!!

[2lazy2retire]

Why on earth would an early retiree hold 40% of their portfolio in bonds?

Because they fear a 10 year down market at the start of retirement. For a 65+ year old it makes a ton of sense to have a 60/40 or even 40/60 portfolio. For a 50 year old retiree, you pretty much have to be comfortable with 70/30 or 80/20. You might have a few more sleepless nights but you need to take the risk.

Not everyone agrees - especially apt in an early retiree situation
"Overall, the results show that rising equity glide paths from conservative starting points can achieve superior results, even with lower average lifetime equity exposure. For instance, a portfolio that starts at 30 percent in equities and finishes at 60 percent performs better than a portfolio that starts and finishes at 60 percent equities. A steady or rising glide path provides superior results compared to starting at 60 percent equities and declining to 30 percent over time."

Full article
http://www.onefpa.org/journal/Pages/Reducing%20Retirement%20Risk%20with%20a%20Rising%20Equity%20Glide%20Path.aspx