Dear Jonathan, I echo the sentiments of so many... Through your careful thinking translated into exceptionally clear writing at the Wall St. Journal and at Humble Dollar you have educated me and countless others. Thank you. I'm devastated to learn of your diagnosis, but very hopeful you will beat the prognosis and have more time to spend with the ones you love.
Stelea99, Thanks for your reasonable question/comment. For clarity, I wasn't asserting I personally had always achieved a 1% real return on risk-free cash equivalents, only that I thought this was a reasonable aspiration I would be happy to achieve. Your question inspired me to do a very crude analysis of historical annual real cash returns from 1947-2022. In this analysis, I loosely estimated the average prime rate in each year and included the average CPI inflation rate in each year. Then, I made the very challengeable assumptions that the best risk-free cash returns for the year might have been 70% of the average prime rate OR prime rate minus 2 points. I generally selected whichever of these yielded the lower cash return except when the cash return would have been zero or negative. I made another challengeable assumption of an average 25% marginal tax rate on the cash return to calculate the after tax return and then subtracted the inflation rate. Across the 76 years analyzed, 38 (half) of the years generated negative real returns after taxes and inflation. The worst individual year was 1947 when inflation was quite high (14.4%, perhaps due to post World War II effects), but the prime rate was only 1.75% resulting in, according to my methodology, very negative cash returns after taxes and inflation. The worst decade was the 1970s when my calculated real returns after inflation were negative in every year. And 2021 and 2022 were pretty bad also. I freely acknowledge my analysis is crude and contains readily challengeable assumptions and methodologies. Still, it does suggest to me that generating a real return on risk-free cash cannot be easily achieved consistently over time - although I wish this were possible. I would be happy to share the spreadsheet I created with you or any other HumbleDollar reader, but I'm not sure how to do that. If you or other have any interest, perhaps Mr. Clements has a way to either post the spreadsheet or otherwise share.
This seems a smart strategy. I've not invested in I bonds, but the ability to choose when to recognize their taxable income seems an argument in their favor.
You are right. Based on Jaime's comment, "Except for a few people who can take the mortgage interest deduction", I did assume the mortgage interest would not yield a separate tax deduction. But certainly with a large enough mortgage and/or a high enough interest rate, large mortgage interest payments could cause a person/couple to itemize instead of using the standard deduction and deduct mortgage interest at the margin.
Personally, I feel more comfortable with no/minimal debt, but "rationally" it depends on the rate of interest you're paying on the debt and the after tax interest yield you would otherwise achieve on the money you could use to pay down the debt. For example, if you are lucky enough to have a 3% mortgage and are in a 25% marginal tax bracket, a 4% risk free (insured) CD would yield 3% after tax and you'd "break even" investing in the CD versus paying down the mortgage. In this example, if you could earn more than 4% risk free, investing in the CD would return more than paying down the mortgage. However, if you could earn less than 4% from the risk free CD or your mortgage rate were above 3% (new rates today are about 7%), paying down your mortgage would be a better "investment". Of course, there's an alternative school of thought that you shouldn't pay down your mortgage because you could earn more investing in the stock market, but since the stock market isn't a risk free investment, that's an apples versus oranges comparison and a separate asset allocation/risk tolerance discussion.
My wife's care of her father has shown me elder care can be extremely challenging. You seem to have done an outstanding job; I'm sure your father would be proud.
Fair point Larry Sayler. If your needs are fully met with a 3% withdrawal rate even when you reach an advanced age and are happy leave an inheritance, certainly there's no reason to withdraw/spend more. My 1/potential years left "RADAR" suggestion was about how much you COULD conservatively withdraw not MUST withdraw. By the way, your grandmother substantially "beat" the life expectancy game. With those genes, I can understand why you might also be conservative!
I agree that withdrawing 3% of the average of the last 3 years assets is straightforward, which is helpful. However, I wonder if that would be an appropriate withdrawal level for all ages? For example, if you were age 95 with (presumably) relatively few years remaining, withdrawing only 3% might be too low unless your objective was primarily to leave an inheritance. What I wrote Mr. Clements about in 2016 and I still think is appropriate, albeit slightly more complicated, is to:
Estimate how long you (or YOU or your spouse) will live and the risk you are willing to take of outliving your estimate. This can now be accomplished in a couple of minutes using this link from the American Academy of Acturies and Society of Acturies:
https://www.longevityillustrator.org/
This shows that there's a 50% chance that EITHER my wife or I will live 31 more years. But there's only a 10% chance either my wife or I will live 40 more years. Because I wouldn't want to take a 50% chance of running out of assets whereas taking a 10% chance seems more reasonable to me, I use the 40 more years estimate.
Divide 1 by the number of years remaining to obtain that year's withdrawal percentage.
In the case of 40 remaining years, that would be 2.50% because 1/40=2.50%.
While 2.50% seems quite low versus the 4% "rule", the withdrawal percentage would increase over time. Next year, planning for 39 more years that either of us may live, we could withdraw 2.56% (1/39=2.56%). The year after that would be 2.63% (1/38 more years = 2.63%). And so on...
I call this approach "RADAR" for Risk Adjusted Drawdown Asset Rate. Of course, each situation will have complexities such as wanting to take out a higher asset percentage before starting to draw social security, etc. However, I think the basic principle of adjusting your asset withdrawal percentage based on your estimate of how much time you (or you and your spouse) may have remaining is sound.
You mentioned how difficult it can be for companies to handle things that are out of the ordinary and gave as an example the ATM machine that issued a $100 bill instead of the requested $20 bill. I had the same thing happen to me, but when I went inside the PNC bank branch to exchange the "ill-gotten" $100 bill for a $20 bill, the $100 bill was gladly accepted and I even received a nice thank you note in the mail a week or so later. Certainly, it was a much happier experience than the one you describe.
Mr. Clements, Your suggestion to withdraw a fixed percentage of your year ending balance reminds me a bit of a suggestion I made to you in 2016 (you wrote about it in your newsletter of 4March2016 in an article called "Betting Your Life"). This suggestion was to decide how much risk of outliving your assets you were willing to take. That risk would determine your projected age of death and, based upon how many years away you are, your withdrawal percentage would be 1/the number of years remaining. You called it the 1/n approach. For example, a 65 year old man may on average live to "only" 82, but maybe 10% of 65 year old men will live to age 95 (30 years more), so if he only wants to take a 10% chance of outliving his money, at age 65 he could withdraw 1/30 (3.33%). At age 66, he could withdraw 1/29 (3.45%), and so on. Of course, there are nuances - the older you already are, the older you are likely to be at death - so you should periodically reconsider your life expectancy. And if you're not yet collecting social security or another expected future annuity, you might withdraw a bit higher percentage until those annuities kick-in. Still, this RADAR (Risk Adjusted Drawdown Asset Rate) approach may be useful for some, if you can find the necessary mortality probability tables for individuals or for couples which is not easy.
Comments:
Dear Jonathan, I echo the sentiments of so many... Through your careful thinking translated into exceptionally clear writing at the Wall St. Journal and at Humble Dollar you have educated me and countless others. Thank you. I'm devastated to learn of your diagnosis, but very hopeful you will beat the prognosis and have more time to spend with the ones you love.
Post: The C Word
Link to comment from June 15, 2024
Stelea99, Thanks for your reasonable question/comment. For clarity, I wasn't asserting I personally had always achieved a 1% real return on risk-free cash equivalents, only that I thought this was a reasonable aspiration I would be happy to achieve. Your question inspired me to do a very crude analysis of historical annual real cash returns from 1947-2022. In this analysis, I loosely estimated the average prime rate in each year and included the average CPI inflation rate in each year. Then, I made the very challengeable assumptions that the best risk-free cash returns for the year might have been 70% of the average prime rate OR prime rate minus 2 points. I generally selected whichever of these yielded the lower cash return except when the cash return would have been zero or negative. I made another challengeable assumption of an average 25% marginal tax rate on the cash return to calculate the after tax return and then subtracted the inflation rate. Across the 76 years analyzed, 38 (half) of the years generated negative real returns after taxes and inflation. The worst individual year was 1947 when inflation was quite high (14.4%, perhaps due to post World War II effects), but the prime rate was only 1.75% resulting in, according to my methodology, very negative cash returns after taxes and inflation. The worst decade was the 1970s when my calculated real returns after inflation were negative in every year. And 2021 and 2022 were pretty bad also. I freely acknowledge my analysis is crude and contains readily challengeable assumptions and methodologies. Still, it does suggest to me that generating a real return on risk-free cash cannot be easily achieved consistently over time - although I wish this were possible. I would be happy to share the spreadsheet I created with you or any other HumbleDollar reader, but I'm not sure how to do that. If you or other have any interest, perhaps Mr. Clements has a way to either post the spreadsheet or otherwise share.
Post: That Elusive 1%
Link to comment from September 19, 2023
This seems a smart strategy. I've not invested in I bonds, but the ability to choose when to recognize their taxable income seems an argument in their favor.
Post: That Elusive 1%
Link to comment from September 19, 2023
You are right. Based on Jaime's comment, "Except for a few people who can take the mortgage interest deduction", I did assume the mortgage interest would not yield a separate tax deduction. But certainly with a large enough mortgage and/or a high enough interest rate, large mortgage interest payments could cause a person/couple to itemize instead of using the standard deduction and deduct mortgage interest at the margin.
Post: That Elusive 1%
Link to comment from September 19, 2023
Personally, I feel more comfortable with no/minimal debt, but "rationally" it depends on the rate of interest you're paying on the debt and the after tax interest yield you would otherwise achieve on the money you could use to pay down the debt. For example, if you are lucky enough to have a 3% mortgage and are in a 25% marginal tax bracket, a 4% risk free (insured) CD would yield 3% after tax and you'd "break even" investing in the CD versus paying down the mortgage. In this example, if you could earn more than 4% risk free, investing in the CD would return more than paying down the mortgage. However, if you could earn less than 4% from the risk free CD or your mortgage rate were above 3% (new rates today are about 7%), paying down your mortgage would be a better "investment". Of course, there's an alternative school of thought that you shouldn't pay down your mortgage because you could earn more investing in the stock market, but since the stock market isn't a risk free investment, that's an apples versus oranges comparison and a separate asset allocation/risk tolerance discussion.
Post: That Elusive 1%
Link to comment from September 19, 2023
My wife's care of her father has shown me elder care can be extremely challenging. You seem to have done an outstanding job; I'm sure your father would be proud.
Post: Promises Kept
Link to comment from September 7, 2023
Fair point Larry Sayler. If your needs are fully met with a 3% withdrawal rate even when you reach an advanced age and are happy leave an inheritance, certainly there's no reason to withdraw/spend more. My 1/potential years left "RADAR" suggestion was about how much you COULD conservatively withdraw not MUST withdraw. By the way, your grandmother substantially "beat" the life expectancy game. With those genes, I can understand why you might also be conservative!
Post: Our Exit Strategy
Link to comment from July 19, 2023
I agree that withdrawing 3% of the average of the last 3 years assets is straightforward, which is helpful. However, I wonder if that would be an appropriate withdrawal level for all ages? For example, if you were age 95 with (presumably) relatively few years remaining, withdrawing only 3% might be too low unless your objective was primarily to leave an inheritance. What I wrote Mr. Clements about in 2016 and I still think is appropriate, albeit slightly more complicated, is to:
- Estimate how long you (or YOU or your spouse) will live and the risk you are willing to take of outliving your estimate. This can now be accomplished in a couple of minutes using this link from the American Academy of Acturies and Society of Acturies:
- https://www.longevityillustrator.org/
- This shows that there's a 50% chance that EITHER my wife or I will live 31 more years. But there's only a 10% chance either my wife or I will live 40 more years. Because I wouldn't want to take a 50% chance of running out of assets whereas taking a 10% chance seems more reasonable to me, I use the 40 more years estimate.
- Divide 1 by the number of years remaining to obtain that year's withdrawal percentage.
- In the case of 40 remaining years, that would be 2.50% because 1/40=2.50%.
- While 2.50% seems quite low versus the 4% "rule", the withdrawal percentage would increase over time. Next year, planning for 39 more years that either of us may live, we could withdraw 2.56% (1/39=2.56%). The year after that would be 2.63% (1/38 more years = 2.63%). And so on...
I call this approach "RADAR" for Risk Adjusted Drawdown Asset Rate. Of course, each situation will have complexities such as wanting to take out a higher asset percentage before starting to draw social security, etc. However, I think the basic principle of adjusting your asset withdrawal percentage based on your estimate of how much time you (or you and your spouse) may have remaining is sound.Post: Our Exit Strategy
Link to comment from July 19, 2023
You mentioned how difficult it can be for companies to handle things that are out of the ordinary and gave as an example the ATM machine that issued a $100 bill instead of the requested $20 bill. I had the same thing happen to me, but when I went inside the PNC bank branch to exchange the "ill-gotten" $100 bill for a $20 bill, the $100 bill was gladly accepted and I even received a nice thank you note in the mail a week or so later. Certainly, it was a much happier experience than the one you describe.
Post: Aftermath of a Scam
Link to comment from March 11, 2023
Mr. Clements, Your suggestion to withdraw a fixed percentage of your year ending balance reminds me a bit of a suggestion I made to you in 2016 (you wrote about it in your newsletter of 4March2016 in an article called "Betting Your Life"). This suggestion was to decide how much risk of outliving your assets you were willing to take. That risk would determine your projected age of death and, based upon how many years away you are, your withdrawal percentage would be 1/the number of years remaining. You called it the 1/n approach. For example, a 65 year old man may on average live to "only" 82, but maybe 10% of 65 year old men will live to age 95 (30 years more), so if he only wants to take a 10% chance of outliving his money, at age 65 he could withdraw 1/30 (3.33%). At age 66, he could withdraw 1/29 (3.45%), and so on. Of course, there are nuances - the older you already are, the older you are likely to be at death - so you should periodically reconsider your life expectancy. And if you're not yet collecting social security or another expected future annuity, you might withdraw a bit higher percentage until those annuities kick-in. Still, this RADAR (Risk Adjusted Drawdown Asset Rate) approach may be useful for some, if you can find the necessary mortality probability tables for individuals or for couples which is not easy.
Post: The Long Game
Link to comment from February 4, 2023