Live: Today Only
Vol #90: July 22, 2022
I’ll bet that recently you didn’t buy something you wanted to.
Not just in the “I want a Ferrari/Rolex/Beach House'' sense, but maybe skimping on an extra trip to the ballpark or taking a vacation closer to home that doesn’t require a flight and rental car.
The cost of these goods has dramatically increased. Beyond the headline inflation numbers of over 9%, baseball games in particular have risen at 2-3x the rate of inflation. Maybe I’m to blame for enjoying those luxury suites our friends and trading partners would buy even though I couldn’t name a single Blackhawk or Bull.
Consumer confidence has tumbled over the course of the past 6 months. Whether it’s inflation that’s hitting your pocketbook or squinting to look at your brokerage statement, consumers around the world are buying less things.
Like most things with markets, this is a vicious positive feedback loop of emotional response. Stocks go down on rising oil costs from the war in Ukraine, and parents are buying HotWheels instead of PowerWheels. Demand contracts, earnings forecasts go south, and look out below for your short puts.
With most limbic behavior, there’s a tendency to overreact. Seeing the panic and fear blasted 24/7 on CNBC and across Twitter, even being remotely close to the markets you’re surrounded by apprehension and start to check your wallet. Maybe you shouldn’t go for that stretch house with the pool in this environment, but don’t hold on so tight that you end up missing out.
@Punk6529 has a great thread on Twitter about how money and wealth are a claim on other people’s time. The fruits of your savings and investments are meant for spending; to further your values and increase the happiness of those whom you care about.
There’s a saying that if you’ve never missed a flight, you’ve spent too much time in airports. I wouldn't exactly say that if you’ve never gone broke, you’ve been saving too much money; but the extremes always bear questioning.
While there are often rising costs like healthcare later in life, the utility of money drops dramatically after we pass a certain age. If you don’t take that surf trip to Costa Rica this year, there are only so many more opportunities you’ll have for it. At the extreme, if you die with more than a penny in your bank account, you’ve failed at fully optimizing life.
That’s a scary thought, because the risk of dying with < $0 is far greater. We only have one chance, and preventing calamity is the number one objective of wealth managers.
While it’s a noble goal to have a legacy or endowment to pass on to your children or passion projects, the cynical truth is that we feel more regrets from the things we didn’t do or the time that we didn’t spend with loved ones.
The operative question here then is how to thread that line of maximizing enjoyment while minimizing risks of failure. As you’d expect, I like to start with the extremes to understand what the bounds are (e.g. dying with $.01), and then come up with a system to help manage the process in a cold and unemotional manner.
The “Safe Withdrawal Rate” is the Holy Grail of personal finance. This is the percentage of your wealth that you can comfortably spend each year to feel confident that you’ll have enough. It’s a function of your age, health, asset mix, expected future returns, inflation, and risk tolerance. Easy peasy.
The famous Trinity Study came up with the number 4%, and advisors have clung to this for its simplicity. The idea is that over a 30 year horizon, given historical returns, a mix of stocks and bonds is “extremely unlikely” to be exhausted by withdrawing only 4% each year.
A popular movement has grown in the last decade for people looking to “FIRE” (Financial Independence, Retired Early) and leave the cubicle slave life to live on a beach in Bali. The younger you are, the more this percentage matters. As markets have dropped this year, there is no lack of snark towards bloggers touting this lifestyle. 4% of $1M is $40k a year, but if your budget just got cut by 20% as your Google RSUs crumbled, you're down to only $32k a year and might need to sell your surfboards.
If you FIRE’d in December 2011 with a comfortable number, the next decade would have treated you extremely well. Not so much in December 2021. Such is the capriciousness of market timing.
It happens at a micro level too. If you took quarterly withdrawals of 1% (in reality slightly less given compounding), there would be a big difference if you sold some of your portfolio down on June 1st or July 1st of this year. If you had $1M on June 1st, you’d have taken out $10k. That same portfolio invested in the S&P500 would have only taken out $9200 on July 1st.
A portfolio that is 100% invested in the S&P 500 is probably not the best exposure for someone who is living off their distributions, but it highlights just how much timing can come into play. The blogger who FIRE’d when the S&P 500 was at 4700 is probably spending too much, and when we clench our purse strings at 3775, we’re at risk of spending too little.
Path dependency is a very real factor when it comes to managing your investment distributions. Since we can’t control when we’re going to get sick, or might need to head to a nursing home, the natural reaction is to play it safe. Fortunately there are a few relatively cheap products like permanent term life insurance or long term care insurance that help mitigate those actuarial risks so you can focus on enjoying the most precious commodity of time.
An interesting technique that foundations use is a rolling average of the account value over several quarters. Instead of taking out 1% a quarter and risking snapshot timing, take the average balance over the last 4/8/12 quarters and base your distributions on that. You’ll be taking less out as the market rallies, but you smooth over the bumps.
Letting Mr. Market decide whether or not you can take a vacation is the worst kind of boss. Our individual timing and opportunities are mostly independent of the direction of the market, yet maximizing those precious moments is the best possible use for money.
Finding the right withdrawal rate is not just about having enough, it’s about making sure you’re spending enough.