In light of the poor performance of the US stock market in 2018, many folks are talking about the danger of planning your retirement based on average returns (or worse, the improved returns of the last 9 years) only to run into a sustained “bear market” where their returns to match the expenses they planned for when they retire. The industry has a name for this – “Sequence of Return Risk.”
The fact is that the market returns you get in the first 10 years of retirement have a dramatic impact on the overall performance of retirement funds. If you get stuck in a bad market at the start, it is very difficult to climb out of it. For those who have recently retired, this 10 months could be devastating, especially if this market continues. Forbes as a good article on ways to manage sequence of return risk.
We are still 19 months away from FI, and since the typical time it takes for a market to get back to where it was is 18-24 months, I think we’ll be OK. For right now, I comfort myself with the idea that right now, there are a lot of stocks “on sale” that I am dollar-cost averaging in my purchases, while I continue with the plan. Hopefully you all have the fortitude to stick with your plan as well.
Other articles about Sequence of Return Risk
Mr. 39 Month
Like so many others in the United States, I’ve been busy with the Thanksgiving holiday. Mrs. 39 Months and I traveled south to visit my family for the weekend, so I’ve been offline a great deal.
For many folks, the holiday is a time to meet again with our loved ones, to argue and revisit old feelings and emotions, and generally to eat well. Afterwards, the American tradition is to run out and spend massive amounts of money (and sometimes to go into debt) to over-consume on “sales items” that are for sale on black Friday. In the end, for a member of the FI community, it is a very interesting time.
One thing that always amazes me is the key word for the holiday, “Thanksgiving”, seems to be forgotten by so many people. One of the pillars of the Stoic philosophy, and the FI philosophy is to be grateful for what you have, and to not be envious of others. For envy is a real killer of peace and contentment in life, and a real obstacle to achieving your FI goals.
So in the interest of readers, I’d just like to list a few of the things I am grateful for during this Thanksgiving season. I am grateful for:
So what are you grateful for?
Mr. 39 Month
Image of Thanksgiving from EGuide Magazine
One of the first steps to getting yourself on course, financially, is to create a budget. Aaahhhh!
I know, many people hate the idea of budgeting, can’t make one, can’t follow one, etc. There are also a large number of FI folks who have been able to move towards FI without keeping strict budgets. However, I would suggest to you that even these people started out by getting a handle on what they were making in $, what they were spending in $, and what the difference was. This is the same as going through the budgeting process and creating a base budget.
I find budgets to be very helpful, though I don’t stick to one religiously. I have an idea of what I’ve spent in the past, build a budget at the beginning of the year, and then track how I am doing against it monthly. Typically I blow past the budget on some items, and under-spend on others. I also adjust as the year goes on, to try to stay within my revenue goals.
So how I go about creating a budget? Like most folks, I started with my actual spending and my paychecks. Remember, the key thing for a budget is to get to where Revenue – Expenses = surplus (what is left over to save/invest). If you are getting a negative number, then you need to either increase your revenue (side hustle?) or decrease your expenses (ex. Cut out the expensive cable bill).
Looked at my paychecks and determined my take home pay. I had already adjusted my W-4 (the tax withholding form) with my employer so that I was getting taken out almost exactly what needed to be taken out to not get any money back at the end of the year (i.e. I might owe a little). Why give the government an interest free loan? I also checked how much I was putting into my employee 401K, for reference in tracking my investments. So I knew what I was getting every 2 weeks in pay. I then multiplied that by 26 (# of paychecks in a year) and divided by 12 (# of months in a year) to get a monthly revenue number. After doing all this, I arrived at 3 months of revenue = $15,603.96
For this, I turned to my bank and its electronic statements (or you could use the paper statements they can send you). My bank lets you easily download the last 3 months of your bank statements, showing you how much you spent on each transaction, as well as each deposit. With this information I had a key decision to make: How did I want to classify each expense, so that I could determine how much I was spending on it each month? It doesn’t do much good for a budget to have too many categories (it gets hard to track) but you should have enough so that you can make decisions about spending (what to cut back, what to add to, etc.)
After review, I chose the following categories:
With that I created a spreadsheet and determined what I had spent on that for the last 3 months:
|Home Mortgage, taxes, insurance||($5,950.47)|
|Total Variable Expenses||($14,700.61)|
So revenue of $15,603.96 and expenses of $14,700.61 gives me a surplus of around $900. OK, a good start. Please note that I gave myself an allowance of $1,000/month for my personal use (gas, lunches & snacks, tolls, etc). This money was already taken out of my revenue above, and I tracked it separately. That is why you don’t don’t see that in the expenses above.
With that in mind, I created a budget for the remainder of the year that looked like this.
|Salary from Work||$4,733.31|
|Gas & Electric||($313.83)|
Note that my revenue went down, because I put more money into my company’s 401K savings plan.
At this point, I had an idea of how much I needed to spend each month. All I had to do was track it monthly, see how I did, and make potential adjustments.
|Salary from Work||$56,619.50||$62,816.57||$6,197.07|
So I ended up making about $6K more than expected (didn’t account for pay raise) and spent about $2K more than expected. I could then make additional adjustments for the new year.
Overall, it’s a fairly flexible budget. I make enough money and have a sufficient emergency fund to be able to account for the minor ups & downs, and can make adjustments as things go.
So how do you guys budget?
Other Links to budgets:
If you remember in some of my previous posts on draw-down strategy and the Power of Zero, I talked about using money from my “fun money” value investing account to do a Roth conversion on a significant portion of my regular IRA funds. The objective would be to reduce my 401K amount and reduce my Required Minimum Distributions from them by transferring money to Roth’s now, while the tax rates are so low.
I’ve been bouncing back & forth on this because of my job situation (somewhat sketchy) and the potential impact of getting let go. If let go, I would be due a significant (six-figures) deferred payment, which would shoot me past the 24% tax rate. I’d rather not hit that.
Now that it seems secure, I traded in my two value stocks, Gilead and Cia Saneamento Basico – both of which were in negative numbers for the year. I’ll be able to offset some other stock gains, get out of the value investing business (which I apparently suck at) and convert money to the Roth. A triple win!
Mrs. 39 Months has her regular IRA & Roth at Troweprice, and I have mine at Vanguard. Both of them make it relatively easy to convert money from their regular IRA to their Roth IRA with a few clicks of the mouse. I rolled them right into the exact same index funds that they had previously, so hopefully, no harm/no foul.
The one issue for both of them is the default is that you want taxes taken out of the money you shift over (rather than paying the taxes separately). This would cause you both to lose the money from your IRA and potentially force you to pay a 10% penalty due to early withdrawal before age 59-1/2. Make sure if you do this that you pay attention to the questions you are asking and don’t pay your taxes out of the money you are transferring.
I think I may do this one more time, in 2019, based on the job situation. Then I’ll be in pretty good shape as I cruise to my FIRE date – July 2020!
Mr. 39 Months
One of the nice free tools that are available on the internet is the FIRECalc tool (see list to right). This tool allows you to put in a variety of data and variables, and try out different scenarios to see if you meet your goal, based on historical performance. The tool uses stock market history and your portfolio choices to try and predict how well you should do for a certain period of the future.
While not perfect (nothing is) it is a good first step towards exploring your goals and how close you are to FI. I will be discussing other tools in the future, but this is an excellent first start.
When you open the FIRECalc page, it provides a description of the model, what it does, how to navigate, etc. It is here where you start, putting in your annual spending, your portfolio value (401K, IRA, 403b, etc.), and the number of years you expect to be “retired.” The program will use this as a basis for determining your success.
The next tab is where you put in “other income” during retirement, above and beyond your retirement assets. Here is where you would put in your Social Security or pension benefits.
The next tab is the “not retired” tab, where you can put in how many additional years you intend to work before acting on your early retirement plan. It also provides a place to show the additional money you intend to invest during this time.
The spending models tab allows you to input the plan for inflation, how your spending power will go (i.e. adjusted for inflation, high expenses to start and less as you grow older, using a percentage of your portfolio, etc.) This lets you look at a variety of options on how you plan to spend, to see if you can achieve your goals.
The next tab is for your portfolio. Here you can use a consistent historical average, or provide your own asset allocation. Again, this allows you to look at the range of options and “play” with them to see how it would affect the result.
There is an optional tab for portfolio changes, lump sum additions to your portfolio (like inheritance, home sale, etc.)
The last tab shows a variety of investigation options you can get from the result, including changes to your allocation, delaying retirement, and spending levels. Just another set of options to play with to further analyze and refine your plan.
Once you are done entering all your information and options, just click on the “submit” button at the bottom to get the results. It will determine, based on the period it studies, how often your plan will succeed or fail, and will provide the lowest, highest, and average portfolio balances for you at the end.It should give you a “big picture” view of how your plan worked out. Now you can go “tweak” some of the entries to see how you might do.
Good luck, and I hope it provides you with some good news!
Mr. 39 Months
I think this post is going to be similar to a lot of FIRE posts in early November. The stock market, bond market, and every other market in the US got crushed near the end of October, and almost everything went down. Ouch!
Retirement Accounts: Remember, my allocation for these is:
So for the month, I’m down about 5.5%, with the big losers being the S&P500, Small Cap and International . My Bonds and REITs were down , but not as much.
My 401K/Deferred account at work is down even more, -7.6%. This is primarily due to it not having a REIT option, so since it is heavier with stocks, it suffered more.
Dividend Income Account: Allocation:
This account didn’t suffer as much. Part of that is its high weight in bonds & REITs (which didn’t suffer as much) and part of it is that the stock picks, especially Verizon, actually were up. Overall, its only down -2.8%
Value Investing Account: Allocation (remember I refocused this at the beginning of February):
Gilead was down -11.7%, USAA was down 9.8%, and Vanguard value was down 5%. Surprisingly, Cia Saneamento (which has done terribly for the entire year) was up 25.8%! Very odd.
So what do you do after such a shellacking? I stay the course. For 2017, I had a tremendous year (the market was up 19%), so I got to reap the benefits of that. Now in 2018, with rising interest rates and the FANG stocks of the S&P getting hammered, it looks like its going to be a null year. You have to be willing to take the good with the bad.
How did you do in October?
Mr. 39 Months