Those of us on Medicare pay Part B (medical insurance) and Part D (prescription drug) premiums directly to Medicare. If you receive Social Security like Patti and me, your premium is deducted from your gross Social Security benefit. This post describes the premium increases you’ll pay in 2022 and the income thresholds from your 2019 tax return that you filed by April 15, 2020 that can trigger higher Medicare premiums.

 

I use the income thresholds stated now as a guide to my final tax planning that I do this week for my 2021 tax return. I’ll sell securties in about ten days to get the cash for our Safe Spending Amount for 2022 (SSA; see Chapter 2, Nest Egg Care.) I get a close estimate of my total income – Adjusted Gross Income – for 2021. I’ll have a good idea of how close I am to the current thresholds that trigger higher Medicare premiums. But I won’t know in detail since there’s a lag: my total income on our 2021 return will  determine if we will pay premium increases  in 2024, and those thresholds won’t be announced until November 2023. But if I stay under a current threshold, I’ll be under a future threshold.

 

 

You also need to plan where you will get your cash for your spending. You want to estimate your total income for the year, and you want to compare that to the income thresholds just announced. You don’t want to carelessly cross an income threshold on your 2021 tax return that would result in higher Medicare premiums in 2024.

 

== Part B: 14% increase ==

 

We all pay at least the same minimum Part B premium, which increased 14% from about $148 per month to about $170 per month – to a total increase of about $260 per year. That’s not a deal breaker for all of us with a nest egg, but that $22 increase in cost is more than the cost of living adjustment from Social Security for the average recipient. The minimum Part D premium you pay is based on the plan you’ve chosen. These are two good detailed explanations: here and here.

 

== Triggers of higher premiums ==

 

Your your MAGI – Modified Adjusted Gross Income – on your 2019 tax return (You’ll filed that in the spring of 2020. ) determines if you pay more Medicare premiums for 2022. Five thresholds result in greater Medicare premiums. Each threshold is a tripwire. Cross a tripwire by $1 and you pay the added premium. For this next year, a person with REALLY HIGH income in 2019 who blew by all five tripwires will pay about $6,000 more; $12,000 more for a couple.

 

 

This year Medicare inflation-adjusted the thresholds of income that trigger higher premium payments and states it will adjust the thresholds for inflation in the future. This is a new, good process; thresholds did not adjust each year, meaning that inflation alone was pushing us towards higher premiums.

 

== Current thresholds are my guide ==

 

I use the current thresholds as a guide to my tax planning now for my 2021 return, even though I know they’ll inflation adjust in future years. I’ll calculate our Safe Spending Amount (SSA) for 2022 in less than two weeks. I’ll finalize my plan as to where I will get the cash that I’ll have by the end of December. I have three sources for cash. Each source has a different tax consequence. My choices determine our MAGI for our 2021 tax return. I may be able to adjust the source of our SSA to avoid crossing a threshold that would result in higher premiums. See recent blog posts here and here.

 

 

 

Conclusion: This week Medicare announced premium increases for 2022. The increase was 14% for the base, Part B (medical insurance) premium. That’s greater than the 5.9% Cost of Living Adjustment for the gross Social Security benefits for 2022. All of us who receive Social Security and are on Medicare will see less than 5.9% net increase.

 

Medicare also announced the income levels on your 2019 tax return that can trigger higher premiums that you would pay in 2022. Cross a threshold or tripwire by $1 of income and you can pay $1,000 or even $1,000s more. I keep those tripwires in mind for my planning now on our 2021 tax return. I can adjust our taxable income when I decide my of mix of three basic sources for cash for our upcoming annual Safe Spending Amount (SSA).

I’ll rebalance back to my design mix in the first week of December. I want to review my choice, since the math has changed slightly as I described in last week’s post. I will now apply my choice of mix of stocks vs. bonds to our total portfolio, not the ~95% portion that I describe as our “Investment Portfolio” in Chapters 1 and 7 in Nest Egg Care [NEC]. I decided on 85% mix of stocks. To some, a mix of 85% sounds risky. The purpose of this post is to explain that I think that my choice of 85% mix of stocks – coupled with my spending rate – is NO RISKIER than any other mix I might consider.

 

The discussion in this post is similar to the discussion on mix in Chapter 8, NEC, but I use a more detailed spreadsheet rather than results from FIRECalc to show why my choice of 85% mix of stocks clearly makes sense.

 

== The basic conclusion of this post ==

 

Any mix of stocks can give you the exact same predictability of a minimum, acceptable future portfolio value. You have to spend a little less now to hit the target with a greater mix of stocks. But you gain an advantage from a greater mix of stocks, because you can expect MUCH GREATER future portfolio value in all but the Most Horrible sequences of stock and bond returns in history. MORE portfolio value is a good thing; it means you can spend or gift more during your lifetime and at death.

 

== Three critical assumptions ===

 

You have to buy into three critical assumptions to agree with me that 85% mix of stocks can be just as safe as the conventional mix of 60% stocks that is most often recommended to retirees.

 

1. Risk is the uncertainty of the end point you want to achieve. The end point we want when we are retired is to have enough portfolio value that allows us to spend to truly ENJOY and know we won’t outlive our money.

 

Here’s a football analogy. You want your favorite football team to hit a minimally acceptable scoring margin at the end of the game. You don’t care about quarter-by-quarter scoring, the number of first downs, or other game statistics. We just want to know that a minimally acceptable end result is – as close as possible – totally predictable.

 

2. You use worst case planning to eliminate the uncertainty of market returns. You assume the worst sequence of returns imaginable. If your team hits your target of minimum scoring margin playing in the THE WORST playing conditions ever, you know it will only be better in all other playing conditions.

 

3. You use the actual Most Horrible sequence of stock and bond returns in history as the worst sequence of returns we could ever imagine. It’s really bad. We don’t have to imagine or construct a worse sequence. It’s the coldest white-out blizzard in history. And your team wins by the desired scoring margin.

 

Example: Patti and I decided that we wanted 19 years of Zero Chance of depleting our portfolio at the start of our plan in December 2014; see Chapter 2, NEC.) The endpoint was enough portfolio value at the end of the 18^th year to allow a full withdrawal for the 19^th year in 2033. That’s our minimally acceptable scoring margin.

 

We used the Most Horrible sequence of returns ever. That’s our white-out blizzard. We use a Retirement Withdrawal Calculator, and we found we would hit our target at a constant-dollar withdrawal or spending rate of $44,000 per $1 million initial portfolio value – we lable that as a 4.40% spending rate. (See Chapter 2, NEC.) Yes, that’s not exactly the same as truly knowing that we won’t outlive our money, since we both could be alive or one of us could be alive after 2033, but we also know the actions we can take during retirement to extend the Zero Chance Years beyond 2033. (See Chapter 4, NEC.)

 

== You lock in with three decisions, not one ==

 

Most financial planners talk about risk in terms of one decision: your mix of stocks vs. bonds. But you eliminate risk – the uncertainty of not having an acceptable portfolio value in a future year – by three decisions: your spending rate (a constant dollar amount relative to your starting portfolio value), your investing cost (the overall expense ratio of the securities you own); and your mix of stocks and bonds.

 

You can hit the exact same minimally acceptable target of portfolio value in future year by a mix of those three decisions. In this post I fix investing cost at 0.10% (You are invested almost solely in index funds.) I can then find the tradeoff between spending rate and mix that hit the exact same target for portfolio value.

 

A slightly lower spending rate and a greater mix of stocks hit the EXACT same endpoint of portfolio value in a future year. Given that you’ll have greater portfolio value with greater mix in all other potential sequences of return, you want to favor slightly lower current spending and greater mix of stocks.

 

== The numbers ==

 

I use the same spreadsheet and Most Horrible sequence of returns in history to track portfolio value over time that I used in recent posts starting with this one. You sell bonds solely for your spending in years when stocks have cratered, and you don’t adjust back to your original mix of stocks vs. bonds. I set the base case at 75% stocks for this post; that’s the minimum mix of stocks that I think you should consider.

 

I use the example of 20 years of full withdrawals for spending. That means I want enough at the end of the 19^th year for the withdrawal for the 20^th year. I set the target for portfolio value at the end of the 19^th year as $60 relative $1,000 initial portfolio value. That $60 will ensure a full withdrawal for the 20^th year, but there won’t be enough for a withdrawal for the 21^st year.

 

I show two spreadsheets here that hit the $60 at the end of the 19^th year: 1) for the base case of 75% and 2) for 85% mix of stocks. A 3% lower spending rate at 85% stocks hits the target.

 

I ran spreadsheets for a wide range of mixes to find the the spending rate for each that precisely matched the end target. The first table is the summary of stock mixes and spending rates the precisely hit the desired target. The second table shows the tradeoff of lower spending amount vs. future portfolio value at expected returns for stocks and bonds. See both of these tables on this pdf.

 

 

What do these tables tell us for this example for 20 years?

 

1) In no case does a mix of less than 75% make sense. At lower than 75% mix of stocks, you have to lower your spending rate and your expected portfolio value will be less. That’s a losing combination: worse now and worse in the future.

 

2) At mixes greater than 75%, you have to spend less now but your expected gain – averaged over all future years – is about five times more than your lower spending. I like those odds.

== 15 years ==

 

I run the same exercise for 15 years of full withdrawals for spending. I get a similar answer. I can hit the exact same desired minimum portfolio value at 85% mix of stock by spending a little less than if my mix was 75%, for example. And I have the potential about 3 times more in portfolio value than I give up in current spending. That’s less gain potential than for 20 years solely due to fewer years of compounding of returns.

 

== It’s a value judgment ==

 

The Safe Spending Rates (SSR%s) that I provide in Appendix D, NEC are lower than those I obtain from my spreadsheet, as I describe in this post. For example, I post 4.30% SSR% for 20 years, and the spreadsheet shows that is 25 years of full withdrawals. See here for more detail. That means if you stick to the SSR%s posted in NEC, you are more than safe for the number of years you pick and you therefore are free to pick any mix of stocks vs. bonds.

 

 

I chose 85% because it feels right to me to hold three years of bonds as insurance. I can solely spend bonds for three years when stocks crater. I’m just uncomfortable with holding fewer than three. It is rare event to have three years when stocks crater in a retirement period, but as we see in the sequence starting in 1969, those Horrible years can come in bunches.

 

 

Conclusion: Your financial risk is the uncertainty is outliving your money. You can lock in a minimum-acceptable portfolio value in a future year that guarantees you’ll have enough for a full withdrawal for spending. You lock in with your decisions on spending rate, investing cost, and mix of stocks vs. bonds. This post shows that you can slightly lower spending rate and increase your mix of stocks and hit the exact same, safe future portfolio value in the face of the worst sequence of returns for stocks and bonds in history. Safety is locked in with a number of choices. You should always favor a greater mix of stocks, since you gain the potential for far greater portfolio value at all but the Most Horrible return sequence imaginable.

 

This is a good time of the year to reassess your choice of mix of stocks vs. bonds. The purpose of this post is to convince you: you should not have less than 75% mix of stocks for your total retirement portfolio. The safety of your financial retirement plan can decline if your portfolio is less than 75% stocks. That conclusion counters conventional wisdom, which argues that a portfolio with more bonds is always safer – more conservative – than one with less bonds. This post explains why less than 75% stocks – more than 25% bonds – is the wrong decision. (I address your planning decision on mix of stocks vs. bonds in Chapter 8, Nest Egg Care [NEC] and in this post.)

 

== Good time to reassess ==

 

This is a good time for me to reassess my mix of stocks and bonds. I rebalance my portfolio the first week in December, but the real reason is that I should use a different math to calculate my mix of stocks vs. bonds.

 

I altered the logic of how to use bonds for withdrawals for spending in this post four weeks ago. The right way to use bonds is to think of them as insurance. You use your insurance – sell only bonds for your spending – in years when stocks have bombed. I recommend that you want to have enough insurance – a big enough amount of bonds – to absorb at least three explosions that could tear your portfolio apart. Those big hits seem to occur every 20 or 30 years.

 

 

The post showed I should pick a mix of bonds based on my total portfolio. In Chapter 7, NEC I thought about using bonds differently. My choice of mix only applied to part (most) of our total portfolio. My choice of 85% mix for my “Investment Portfolio” is much closer to 80% of the total.

 

 

== Risk: the relative uncertainty of an end result ==

 

I hope we are on the same page as to how to think about risk to measure the impact of greater or lesser mix of stocks vs. bonds. I’ve covered this thinking before. I argue risk is the predictability of an endpoint result, not how you get there: let’s look at who wins most often and by how much; let’s not worry about the score inning-by-inning. All of us just a few basic choices of how to get to the best end point: invest in stocks, in bonds, or some mix of stocks and bonds. Which choice gives us the best end result?

 

The endpoint for someone in the Save and Invest phase of life is different (How to do I invest for MORE?) than for us retirees in the Spend and Invest phase off life (How much can we spend and not outlive our portfolio?)

 

== My base case ==

 

I use a base case in this post. I picked the target of a guaranteed 20 years of full withdrawals for spending. I use an investing cost of 0.10%. I use 75% mix of stocks. I test those three decisions against the Most Horrible sequence of stock and bond returns in history to find the spending rate that equates to 20 years of full withdrawals. I use the spreadsheet math that I introduced in this post; it uses the tactic of solely selling bonds when stock returns are -10% or worse.

 

 

I iterate to hit a fixed amount at the end of the 19^th year that is a bit more than what I think the final withdrawal rate will be – I picked $60 relative to an $1,000 initial portfolio. I iterate and find the precise spending rate that hits that target amount. That is $47.318 per year relative to a starting portfolio value of $1,000: 4.7318% Safe Spending Rate (SSR%). This is the spreadsheet for 75% mix of stocks (top half); I also show the spreadsheet for 70% mix of stocks (bottom half) .

 

== Less than 75% stocks is less safe ==

 

The question is, “What happens when I lower the mix of stocks? Does that target $60 at the end of the 19^th year increase or decrease?”

 

 

The result is WORSE when I lower the mix of stocks. Each time I decrease the mix of stocks – increase the mix of bonds – portfolio value at the end of the 19^th year declines. At 70% mix, portfolio value declines at the end of the 19^th year to less than the desired withdrawal of $45.7. That small change in mix calculates to a decline that equates to the loss of one year of a full withdrawal for spending. That’s NOT GOOD.

 

As I lower the mix of stocks, the portfolio value continues to decline. The declines are small, and you do not lose another full year for a full withdrawal. The conclusion is that a mix of stocks that is less than 75% – a mix of bonds greater than 25% – harms the safety of your financial retirement plan to the point where you can lose a full year of withdrawal for spending.

 

Why is this? Why isn’t the opposite true? The reason is that returns for bonds returns in this period were worse than the really horrible sequence of stock returns. Both had long periods of cumulative returns: -10% for the first 14 years for stocks and -33% for the first 14 years for bonds. -33%! I always want to assume THE WORST future to drive my spending rate and choice of mix of stocks vs. bonds. The worst case shows we can’t count on bonds to save the day when stocks crater, and a mix with more bonds is not the answer to improve future portfolio value.

 

== Same basic result for 15 years ==

 

I ran this same exercise to see the effect of mix on the value at the end of the 14^th year to ensure a full withdrawal for the 15^th spending year. That’s a tougher test than for 20 years since that’s just two years after hitting all five years when stocks bombed -12.7% or worse.

 

The result is a bit different in that portfolio value improves slightly with a lower mix of stocks, but the changes are not meaningful. Lower than 75% mix never results in one more year of safety – never adds enough in 14 years to get you to a full withdrawal for the 16^th year.

 

== And ten years ==

 

I ran this for ten years. That’s an even tougher test with four stock explosions in the first nine years. I come to the same conclusion: lower than 75% mix for stocks never results in one more full withdrawal for spending. More bonds are not buying you a meaningful measure of safety.

 

== You won’t have MORE with mix less than 75% ==

 

After you’ve made your plan decisions and locked in on safety – e.g., 20 years “guaranteed” of full withdrawals for spending – we retirees want to see how our choice of mix affects future value when stock and bond returns are more normal. In all cases, a lower mix of stocks results in lower future portfolio value. Over a 20-year period, the difference is staggering as I describe in Chapter 8, NEC.

 

 

Conclusion: I built a spreadsheet that tracks what happens to portfolio value for a given set of inputs: spending rate, mix of stocks vs. bonds, and investing cost. My sheet uses the Most Horrible sequence of returns for stocks and bonds in history. That single sequence is the severest stress-test to judge the safety of your decisions for your financial retirement plan.

 

YOU SHOULD NOT HAVE LESS THAN 75% MIX OF STOCKS. (I examined 10 years, 15 years, and 20 years.) In my example for 20 years, less than 75% mix of stocks – more than 25% bonds results in enough of a decline in future portfolio value that you lose one full year of withdrawal for spending. That’s a BAD thing.

 

The results are a bit different for shorter retirement periods, which are impacted more by the bunching of Horrible Years of stock returns. A lower mix of stocks added portfolio value, but never enough to add one year withdrawal for spending.

Inflation has been 5.9% over the past year based on the way Social Security (SS) calculates its Cost-of-Living-Adjustment. (See here for how SS calculates.) That’s the most since 6.1% inflation in 1990. (See here.) The purpose of this post is to describe what that 5.9% means for us retirees. It’s pretty straightforward: inflation slashes the real value and real return rates on our portfolio, but portfolio returns for the year are on track to handily beat inflation. We nest eggers are on track for a real increase of our Safe Spending Amount (SSA) for 2022. (See Chapter 2, Nest Egg Care[NEC].)

 

== The basics ==

 

• Social Security gross benefits will increase by 5.9% to ~maintain the same gross spending power as in prior years. Your net monthly payment you receive will be affected by the increase in payments for Medicare premiums that are deducted from your gross SS benefit. Those premiums haven’t been announced yet.

 

• Your SSA for 2022 will almost certainly increase by more than 5.9%. You are on track to earn more in real spending power than you withdrew for your spending in 2021. When that happens, you always calculate to a real increase in your SSA.

 

For example, Patti and I withdrew 4.85% in the first week of last December for our spending in 2021. We have less than five more weeks before my calculation of our SSA for 2022 on November 30. We have earned 13% real portfolio return over the past ~11 months. Assuming stocks don’t crater over the next few weeks, we’ll have the fifth real increase in our SSA out of the past seven years. These increases in our SSA are getting out of hand!

 

 

== Other effects of inflation ==

 

Patti and I have a component of our income for spending that does not adjust for inflation. I have a small monthly payment from a defined benefit plan from an employer in the early 1980s. The payments have been the same each month for nearly 12 years now. Year after year, the spending power of those dollar payments decrease. My pay decreased in real spending power by ~ 6% this year. The cumulative decrease in spending power from 2010 has been -22%.

 

 

While stocks gained in real value this past year – returns were greater than inflation – my bond portfolio declined sharply in real value. My nominal bond return is about -1.3% so far. With 6% inflation, that nominal return translates to about -7% real return. (That’s bad, but not wildly unusual: real bond returns have been -7% or lower twice in the last 20 years.) Stated differently, the real value of my bond portfolio fell by 7% this past year.

 

But the fall in the real value of my bond portfolio is offset quite a bit because I owe 6% less in real spending power on the money I’ve borrowed. The benefit of owing less in real spending power roughly matches the hurt of the decline in the real value of our bond portfolio.

 

Patti and I have a mortgage and a HELOC; I started our current 30-year mortgage in the summer of 2020 to take advantage of the low rates. Our total loan balance is not far off from my total bond portfolio. The real amount that I owe – our mortgage + HELOC loan balances – fell by 6% this year because of inflation.

 

How do I tap that? I only get the dollars that will increase my total financial assets to offset the real decline in our bond portfolio if I refinance in the future. I’d be converting the increrased dollar value in our primary non-financial asset to financial assets – dollars we can spend or invest.

 

Our home may not have increased in real value this past year, but it increased in dollar value due to inflation. If our house was valued at $400,000 last year, it is likely valued at 6% more or $424,000 this year. The dollar amount that we owe on loans remained the same or slightly declined with principal payments. Therefore, the ratio of my loan balance to the dollar value of our home is declining.

 

Someday, let’s say in 2028, a bank will be willing to lend me the same percentage loan amount to appraised value that I had in the summer of 2020. When I refinance, say at the same real mortgage value measured in spending power that I have now, I will get many more dollars that I can spend or invest after I’ve paid off the current mortgage. I’ve repeated this feat a number of times over the years. We always net more dollars to invest or spend after we’ve paid off the old mortgage.

 

  

Conclusion: Inflation over the past year has been about 6%. That’s the most since 1982. Your gross Social Security benefit will increase by 5.9%. Your Safe Spending Amount or your “pay” from your next egg will increase by more than 6%. Your overall portfolio return is more that the rate of inflation. You will earn back more than you withdrew for your spending for 2021. You will have more portfolio value measured in real spending power than when you withdrew for spending last year. When you earn back more that you withdrew last year, you will always calculate to a real increase in your SSA.

Hello from Montepulciano, Italy. Patti and I have been in Tuscany for 12 days now. This is the second of two international trips we wanted to take in 2021. I usually write blogs to post ahead of time when we are traveling, but I didn’t for this week’s post. So, this post simply describes what it is like to travel in Italy at this time of COVID-19.

 

Patti and I booked a self-guided walking tour through this company: Girosole. A driver met us at the Rome airport and drove us about 2 1/2 hours north to Siena where we stayed four nights. One half day was a guided tour of Siena. One half day was a guided tour of San Gimignano, about an hour away. Then we transferred south to Montalcino, and we basically walked east through San Quirico d’Orcia and Pienza to Montepulciano. Very scenic. We had not been to this part of Tuscany before. The weather was good for walking. The highs have been in the 60s. I’m not sure we could have done this earlier in the year. It would have been too hot for us just a few weeks before.

 

For most all of the pandemic, Italy has had the highest cumulative death rate of wealthy western countries. Unfortunately, the US just this week surpassed Italy’s cumulative death rate. We’re number one where we would have wanted to be last.

 

To get into Italy you have to have proof of double vaccination and a negative NAAT-PCR test taken in the US within 72 hours of arrival. We landed in Rome at 3 AM our time on a Monday, so we took our test Friday morning at the drive-through at CVS and received our results the next morning. You also have to complete a passenger locator form. These steps were basically the same as for our recent trip to the UK.

 

Italy has strict rules to prevent the spread of COVID-19, much stricter than any state or city in the US. You must wear a mask to enter any public space: airport, museum, church, store, hotel, or in any restaurant before you are seated. Our driver wore a mask, and we had to wear a mask. You must present proof of full vaccination at each hotel, museum, and restaurant. All employees wear masks.  Everyone we see complies without complaint.

 

The proof is in the pudding. Italy’s rate of new cases is about 1/5th of the US. Its rate of new deaths is about 1/8th of the US. 71% of Italians are fully vaccinated. This compares to 58% in the US.

 

Patti and I feel safer here than at home: we don’t feel comfortable indoors at restaurants at home. I still stay away from our favorite coffee shop where I’d routinely meet friends.

 

 

Conclusion: Italy has strict rules to prevent the spread of COVID-19. From what we observe, compliance is very high. The payoff for Italy is low rates of new cases and new deaths relative to the US. Patti and I feel safer in Italy than we do at home.

 

You probably are using too low of Safe Spending Rate (SSR%) for your calculation of your annual Safe Spending Amount (SSA). (See Chapter 2, Nest Egg Care (NEC).) My schedule of age-appropriate Safe Spending Rates (SSR%) is too low. (See Graph 2-7 and Appendix D, NEC. That means 1) you could pay yourself more than you’d calculate using the data and steps in NEC; or 2) you can take consolation that your plan is even safer than you thought; you have more years of guaranteed full withdrawal for your spending than you may have originally planned for. The purpose of this post it to explain how I conclude the age-appropriate SSR%s I display NEC are too low.

 

== Review: our plan and SSR% in late 2014 ==

 

Patti and I picked 19 years – her life expectancy then – as the number of years we wanted for ZERO CHANCE of depleting our portfolio. (See Chapters 2 and 3, NEC.) I put our inputs into my favorite Retirement Withdrawal Calculator (RWC), FIRECalc, as I describe in Chapter 2, NEC. I iterated the spending rate that gave me 19 years of full withdrawals for spending in the face of the Most Horrible sequence of returns ever. That was a spending rate of $44,000 per $1 million initial portfolio. I can run the same inputs in FIRECalc today and get the exact same result of 19 years. That’s not a surprise, since no sequence has supplanted the Most Horrible sequence from six years ago, the sequence of returns starting in 1969.

 

== What’s different now? ==

 

I assert I have a more accurate spreadsheet for that Most Horrible sequence than FIRECalc’s. The first four of these have a small cumulative effect; it’s the last factor below which I described in last week’s post that makes the significant difference.

 

• I use a better data source for real – inflation-adjusted – bond returns over time. FIRECalc’s default for bond returns in any year is “Long Interest Rate”, and that’s not the same as annual real return rates that I get from the most recent version from this source.

 

• I use the average of Long-term and Intermediate-bond returns for the sequence of bond returns. I think this is more representative of what an investor will own when he our she invests in bonds. Patti and I own a US Total bond fund – IUSB – which holds Short-term, Intermediate-term, and Long-term bonds – more than 13,000 of them.

 

• I lower the default input for investing cost to 0.10% from FIRECalc’s 0.18%. The 0.18% may have been appropriate for the expense ratio for index funds years ago, but fund costs are much lower now. For example, the total weighted expense ratio for Patti and me is about 0.05%

 

• Last week I showed the effect of a better withdrawal tactic than assumed in basically all RWCs: sell solely bonds when stocks crater and rebalance your portfolio in normal years to the resulting stock vs. bond mix – not back to your original design mix. In the example I showed, that tactic adds several years of safety to your financial retirement plan.

 

== 4.40% is 22 years of full withdrawals ==

 

I use the same inputs to my plan in December 2014, and my spreadsheet shows that 4.40% SSR% gives 22 years of full withdrawals for spending, not 19. My original plan was safer than I had planned for! This is the spreadsheet.

 

== 19 years of full withdrawals is 4.70% ==

 

Our decision for 19 years of ZERO CHANCE to take a full withdrawal for spending was appropriate: in Chapter 4, I show the chance of 1) one of us being alive after 19 years and 2) riding along a Most Horrible sequence of returns that deplete a portfolio in a future year is about 1 chance in 50. (And that’s without taking corrective actions during retirement; we would know very early if we’re riding on a Horrible sequence.)

 

I iterate the constant dollar spending amount in my spreadsheet until I get to 19 years of full withdrawals. That’s 4.70% SSR%. That’s about 7% more ((4.7-4.4)/4.4) than I used to calculate our spending from our nest egg in our first spending year – 2015. This is the spreadsheet.

 

== What are the implications? ==

 

I could argue that I should revise the Graph 2-7 and the data Appendix D to reflect greater age-appropriate SSR%s. The line on Graph 2-7 would shift upward. But I don’t plan to make this argument. I don’t want to argue with the calculations in FIRECalc; I just conclude that FIRECalc errors by being too conservative. I have more confidence in using the current age-appropriate SSR%s in NEC; I have more confidence that WE AREN’T GOING TO RUN OUT OF MONEY!

 

 

Conclusion: I used the results from FIRECalc to calculate age-appropriate Safe Spending Rates (SSR%s) in Nest Egg Care. I now conclude those rates are conservative.

 

I built a spreadsheet that perform the exact same math as FIRECalc to the track portfolio value year-by-year for a given sequence of returns and set of inputs, such as spending rate, mix of stocks vs. bonds, and investing cost. I assert my improvements result in a more accurate tracking and understanding of the risk of failing to be able to take a full withdrawal for spending in a future year. I find that FIRECalc is pretty darn conservative. When I used FIRECalc for my plan inputs in late 2014, it told me I should use 4.40% SSR% to lock in 19 years of ZERO CHANCE of full withdrawals for our spending. (I would find the same 19 years with those same inputs today.) My more accurate spreadsheet says I should have used 4.70% – that’s about 7% more.

 

I have a new rule I recommend for selling bonds for your spending. The rule results in a safer financial retirement plan. It can add several years to your ability to take a full withdrawal for spending. The purpose of this post is to explain the rule: in most years, I will sell stocks and bonds for the upcoming year and rebalance back to my design mix of stocks. In rare years – when stocks steeply decline – I will solely sell bonds and use the resulting mix as my design mix from that point on.

 

I build this tactic into my action plan if stocks have declined steeply over the past 12 months – that’s the period of December 1 to November 30 for Patti and me.  I sell securities for our spending the the first week of December for Patti and me. I  calculate our Safe Spending Amount (SSA, Chapter 2) on our total portfolio. I no longer set aside a Reserve that I describe in Chapters 1 and 7, Nest Egg Care (NEC).

 

Reminder: bonds are insurance in your financial retirement plan. You’ll sell a greater amount of bonds when stocks perform poorly relative to bonds. You’re selling more bonds to give stocks time to recover. That’s it. You aren’t holding bonds to somehow smooth out peaks and valleys in the total value of your portfolio over time.

 

== Two weeks ago ==

 

Two weeks ago, I compared two approaches to selling bonds.

 

• The “usual” (Usual) approach is to sell stocks and bonds for your spending in proportion such that you get back to your design mix of stocks vs. bonds at the start of each year. If you picked 80% as your design mix, you’d sell the amount of stocks and bonds for your spending that gets you get back to 80% start of each year. You’re getting back to your full complement of bond insurance at the start of each year. This is the approach I’ve followed for the last six years.

 

• With a “Bonds first” (Bonds First) approach, you set an initial mix – let’s say 80% stocks – and then sell bonds for your spending until you’ve depleted them. You’re not really viewing bonds as insurance in this approach: you’re depleting them year-by-year unrelated to good or bad stock returns. After a few years your portfolio is 100% stocks. I showed that Bonds First provides the same level of safety as Usual – both provide the same number of years of full withdrawals for your spending in the stressful example I displayed.

 

== Test another alternative ==

 

I made up another rule to test. This is a “hybrid” (True Hybrid). 1) Use Usual in most all years: sell stocks and bonds for your spending such that you have rebalanced back to your original design mix before the start of each year. 2) Use Bonds First – meaning you solely sell stocks for your spending in a year where stocks have gone off the rails; I arbitrarily pick -10% real decline or worse return for stocks as off the rails requiring an emergency action. 3) But then use the resulting mix – a greater portion of stocks – as the new design mix. Rebalance back to that mix, not the original design mix in future years.

 

 

== Result: two more years of safety ==

 

I use same spreadsheet from two weeks ago to tell the story. That’s the maximum stress test that shows the weaknesses and strengths of decisions you’ve made for your financial retirement plan. The spreadsheet uses the Most Horrible sequence of stock and bond returns in history – starting in 1969. I use the same initial choice of stock mix of 80% that I used two weeks ago for the comparisons. I’m using a time horizon of about 20 years.

 

 

True Hybrid is superior. It gives two more years of full withdrawals for spending than Usual or Bonds First. That’s a meaningful improvement.

 

I get the summary information and conclusions from the detail of three spreadsheets.

 

#1. Usual is the reference case: sell stocks and bonds for your spending such that you are back to your design mix (80%) at the start of each year. (This the same base or reference case from two weeks ago.)

 

#2. “Not quite True Hybrid.” The rule is to sell only bonds when stocks decline by -10% or worse. That will result in a mix of more stocks at the start of the next year: 83% in our example. But in this option, you rebalance back to your initial design mix (80%) at the start of all other normal years. This isn’t significantly better than #1.

 

#3. True Hybrid is #2 with the refinement that you do not rebalance back to your initial design mix at the start of all other years. You use the resulting mix after you’ve solely sold bonds for your spending – 83% after the first year in our example – as your new design mix. Stick with this mix in the future. This could change again – to an even greater mix of stocks – if you hit another year of -10% return for stocks and therefore only sell bonds.

 

You may or may not use up all your bond insurance, depending on the number of craters that you hit. In spreadsheet #3, you would use up all your bond insurance – have a 100% stock portfolio – after hitting four HUGE craters in nine years! That’s a VERY UNUSUAL number of craters.

 

Mentally, I’d be Okay with True Hybrid and 100% stock portfolio in the future. With True Hybrid, I’m using bonds in the way that makes more sense  to me: when I really want to avoid the damage of a steep drop in stocks.

 

== What’s happening ==

 

What’s happening with True Hybrid? You’re solely using your insurance in a very unusual year for stock returns, and you are not renewing it back to its full value after that year. You are implicitly assuming it is rare to hit a year of -10% real return for stocks. It is rarer to hit two and very rare to hit three throughout your retirement. You’ve hit a Most Horrible year. You’ve used some insurance. Don’t buy more insurance. Move on, expecting it will be rarer to hit another crater. Keep a bit more in stocks to give yourself the benefit when they recover, and they will recover. The result is a healthier portfolio.

 

Hopefully none of us see a year when stocks crater and we have to use this Rule. If you calculate your Safe Spending Amount (Chapter 2, NEC). for the upcoming year on the same day that I do – immediately after November 30 each year – you don’t have to remember how to execute this rule. You’ll see that in my post the first week of December.

 

 

Conclusion: You can improve your financial retirement plan by the way you sell bonds for your spending. I show an approach that results in a safer plan. 1) You solely sell bonds for your spending when stocks have gone off the rails: I use -10% real return as a guideline. 2) you rebalance thereafter to the mix of stocks vs. bonds that results from this action. In the severest stress test, this approach added two years of ZERO chance of depleting a portfolio. That’s a big improvement.

I just read this headline (I’m writing on Wednesday afternoon.) that the Senate may agree to increase the debt ceiling. That would avoid a government shutdown, no payments of Social Security and, potentially, the default of US payments of its debt obligations: interest on billions of US Treasury Notes and Bills: Republicans are expected to back a bill to avert a shutdown …. That would avoid what I think would be a DISASTROUS event: the loss in faith and trust in dollar. I give my opinion as to what a US default might mean.

 

== Money is a fiction =

 

Years ago I read the book Sapiens: A Brief History of Humankind by Yuval Noah Harari. I learned a lot. I originally saw videos before the book was translated to English in a course at Coursera. I no longer find the course. I think these are the same videos from 2013.

 

Only mammals have a neocortex – “new bark” covering over our older, more primitive brain. Humans have a very large neocortex and the ability to imagine much more than any other mammal. Our ancestors in Africa needed to imagine. Those that first had this capacity could see reality, go back to their band, describe place where they just saw a dead elephant. They could imagine how to cooperate to be able to scavenge meat and keep other predators away. Those best at this found more food, lived longer, and had more off-spring. That’s part of evolution.

 

Our brain builds imagined realities largely based on stories. National boundaries, basic human rights, corporations granted the rights as individuals, and rules and laws are imagined realities that guide how we act. Our economies would not work if corporations didn’t exist in our imagination. They need capital to grow. They tell a story of how money you invest with them will be used to fuel their imagined growth. We imagine how much more valuable this company will be in the future, and we invest.

 

Money is an imagined reality. A fiction. It did not exist before the advent of agriculture. Money is something that is valuable, because I think you think it is valuable. You think money is valuable because you think I think it is valuable.

 

Almost all money in history stamps or prints images of famous dead people to give an image of importance, trust and value. We imprint images of the power-center of government on our money. We state on our paper money, “This Note is Legal Tender for All Debts, Public and Private.” Sounds good, but what the heck does that really mean? The implication is that our US government backs our money.

 

This is a great podcast about how money is an invented, imagined reality, “The Invention of Money” from This American Life. This first episode tells how a change in the story about money changes its value: “The Lie that Saved Brazil.”

 

== The story if we don’t pay our debts ==

 

If the government defaults on its obligations, we’re changing the story that gives value to money. That different story can convince others that our money is not that valuable. I remember that banks failed to pay interest on overnight lending in September of 2008. The trust that banks had in other banks was shaken. Paul O’Neill, former Secretary of the Treasury in 2001-2002, was quoted in our local paper as saying our economy “could have evaporated” at that point. I’ll never forget that word, EVAPORATED.

 

 

Conclusion: Money is an imagined reality – a fiction. Governments go to great extent to build a story as to why you can trust their money. My stomach churns when US politicians talk about not extending a somewhat arbitrary debt ceilings for legislation they’ve already passed. They’re playing with FIRE. They run the risk of changing the story as to why money has value. That could be a DISASTER for all of us.

My friend Jay sent me an article years ago that argued the best withdrawal strategy for retiree was “Bonds first.” You set a constant dollar withdrawal amount for spending and an initial mix of stocks and bonds. You sell bonds for your spending until you’ve depleted them; that then leaves you with a 100% stock portfolio that you’ll then sell for your spending. This differs from the normal or “Usual” strategy that one can evaluate in a Retirement Withdrawal Calculator (RWC) like FIRECalc: all RWCs assume that you rebalance back to your target mix of stocks vs. bonds at the start of a year. The purpose of this post is to examine “Bonds first” to see if that tactic gives the same safety – the same number of years of full withdrawals from a portfolio in the worst-case sequence of returns – as the “Usual” process of rebalancing back to your design mix of stocks and bonds. Conclusion: it does.

 

== The attraction of Bonds first ==

 

“Bonds first” recognizes that stocks generally outperform bonds. By selling bonds first from your portfolio, you’re allowing stocks to compound in value. When you start selling stocks only, you’ll have greater portfolio value than if you were selling them year after year. For example, stock returns have far outdistanced bonds for the three years of the six year since the start of our plan at the first of 2015. The math that gets me back to my design mix of stocks vs. bonds for the start of the next year told me to solely sell stocks for our spending. And then it told me to sell more stocks to buy bonds to get to my design mix. That means I’ve foregone stock returns and have a lower total portfolio value now than if I had previously sold “Bonds first”.

 

The disadvantage of “Bonds first” is that it is very hard to get in your head that you should ever be 100% in stocks when you are retired and withdrawing from your portfolio for your spending. I find it IMPOSSIBLE. I would go crazy if I were 100% in stocks no matter how much I had. I hate the thought of having no bonds to sell in a year when stocks crater. It’s worse than that: I can’t imagine how I would feel if I was 100% stocks and withdrawing, say, 5% from my portfolio each year and saw my portfolio decline to LESS THAN HALF its value in real spending power in 24 months. That happened in 1973-1974! That happened in 36 months in 2000, 2001, and 2002!

 

== We use an RWC to judge ==

 

We use an RWC to judge the safety of our decisions for our financial retirement plan. An RWC shows how a portfolio fares over time for sequences of returns that the RWC constructs. For a set of inputs, an RWC tells you the number of years you can count on for a full withdrawal for your spending. The fewest number of years will be result of the worst case or Most-Horrible sequence of returns that the RWC constructs.

 

The actual Most-Horrible sequence of returns since the 1870s starts in 1969. I described that sequence here and here. It’s really Most Horrible. The worst seven-year return period for stocks starts in 1969. The worst seven-year return period for bonds starts a few years later. The poor returns in that sequence, coupled with your on-going withdrawals, shrink a portfolio to its tipping point, less than half its initial value. It spirals to depletion even when returns turn to be well above average.

 

The “Usual” RWC uses a fixed mix of stocks and bonds. The RWC rebalances a portfolio back to its design mix at the start of every year. You can’t use the usual RWC to examine a different approach like “Bonds first”. The only way to do that is to build a more detailed spreadsheet that allows you to pick what you want to sell for your spending each year and start the next year with a revised mix.

 

I built a basic spreadsheet I described and link to in this post. I altered it for this post to track stocks and bonds separately. I can input “Bonds first” and calculate portfolio value year-by-year.

 

== The test ==

 

I want to compare “Bonds first” to “Usual”. Does “Bonds first” match “Usual” in the number of years of full withdrawals for spending?

 

I input the following into my spreadsheets: initial $1,000 portfolio value; mix of 80% stocks and 20% bonds; total investing cost of 0.10%; and an annual withdrawal amount for spending of $44 in constant spending power. All returns are inflation-adjusted.

 

== The two options ==

 

Option 1: This is the base case, the “Usual” way all RWC’s work. I assume a portfolio is rebalanced to its design mix after the annual $44 withdrawal for spending for the upcoming year. You see that spreadsheet here.

 

Option 2: I use the expanded spreadsheet, and I withdraw “Bonds first.” The first $44 withdrawal comes from the starting balance of $200 of bonds (20% of the $1,000). In the example, I consume the bonds in about 3¼ years. You see that spreadsheet here.

 

== The comparison ==

 

I display how many years a portfolio provides a full withdrawal for spending for the two options:

 

 

“Bonds first” for all practical purposes has the same safety as “Usual”. The portfolios have almost the same amount at the end of the 20th years, basically just enough for a full withdrawal for the 21st year, but they don’t have enough for the 22nd year.

 

I don’t display the results from other inputs to the spreadsheet, but I’d reach the same conclusions over a very wide range of spending rates, mix of stock vs. bonds, and investing cost. I find no case where “Bonds first” is significantly different in terms of safety than the “Usual”.

 

 

Conclusion: This post examined if you should consider a tactic of “Bonds first” as an approach to deciding what to sell from your portfolio for your annual spending. Is that approach as safe as the “Usual” approach of rebalancing back to your design mix every year? I judged the effect on a portfolio using the Most-Horrible sequence of returns for stocks and bonds in history. I find found that “Bonds first” and “Usual” result in the same number of years of full withdrawals from a portfolio in the worst-case sequence of returns.

For many years I fiddled annually with my stock portfolio. Decades ago, I would spend hours and hours trying to pick winning stocks. Years ago, I would spend hours trying to pick winning, actively managed stock mutual funds. I stopped all fiddling for the last seven years when I started our financial retirement plan: I concluded that fiddling was adding uncertainty to my future returns: we don’t want to add more uncertain to an already uncertain future. Stick with broad based, low cost index funds. But this past month I could not resist fiddling with the ~20% of my portfolio that is bonds. Patti and I now own three US bond funds, not just one that I’ve held for more than six years. The purpose of this post is to explain my thinking.

 

 

== Bonds are insurance ==

 

We all hold bonds as insurance against steep declines from stocks. (I’m a broken record in saying this, but most folks just don’t get this concept.)

 

You get the same basic insurance value with almost any mix of broadly diversified bond fund. This post shows that both Long-term bonds and Intermediate-term bonds outperformed stocks in their ten worst years by an average of 27 percentage points. Those Horrible Years for stocks are the years when you collect on your insurance: you will disproportionately sell – or even solely sell – bonds for your spending needs. You’re giving stocks time to recover before you must sell them for your spending.

 

Patti and I hold 5% bonds as a Reserve and 15% in the balance that I call my Investment Portfolio (See Chapter 1, Nest Egg Care [NEC].) To simplify, I have about 20% bonds in total. Our spending rate is nearing 5% (We are older.) We have, at minimum, four years of spending as bonds. We could, if stocks cratered, live off bonds for at least four years, giving stocks four years to recover. (Patti and I could easily spend less than our current annual Safe Spending Amount [SSA; see Chapter 2, NEC] and extend those years. Our SSA now is +30% greater in real spending power than in 2015, the first spending year of our plan.)

 

Here’s the extreme example: Stocks declined by 37% real return in 2008. Obviously, you don’t want to sell stocks when they’ve declined that much. You would have sold your Reserve (bonds) at the end of 2008 for your spending in 2009. (Long-term bond returns were +25% real return in 2008!) At my mix, you’d have at least three more years of spending as bonds: you could sell only bonds at the end of 2009 for your spending in 2010; you could do the same at the end of 2010 and again in 2011 for your spending in 2012. Let’s assume that you’d be out of bonds, and at end of 2012 you would have to sell stocks for your spending in 2013. But by the end of 2012, stocks had clawed back all their decline. You would not have sold stocks at a value lower than their value in January 2008.

 

 

== Better returns? ==

 

I changed by view from this post. I decided to chase a slightly better returns from bonds:

 

The expected return for Long-term bonds is 3.1% and it’s 2.2% for Intermediate-term bonds. My choice of total market bond fund, IUSB, and the average duration of all of its holdings (5.8 years for 9,747 different bonds!) means it’s really an Intermediate-term bond fund. Since all broadly-based bond funds have the same basic value as insurance, shouldn’t I invest more in Long-term bonds for the added expected return?

 

 

The 0.9 percentage point difference in returns cumulates to 7% more from Long-term than from Intermediate-term over the past 6.7 years. Had I invested in only Long-term bonds, I would have expected to have about 7% more bonds than I do now. That’s not peanuts for Patti and me. I should not dismiss that dollar difference for Patti and me or for those who will ultimately benefit from our portfolio.

 

Those long run averages from 1926 both have ~45 year stretches of 0% real return. Maybe the comparison of returns shouldn’t be from 1926 to the present. Maybe I should compare returns after the nadir for bonds in the mid 1980s. I can draw a line point-to-point over the last 20 years on the graph above – from 1990 through 2020 – and see that the lines are steeper than those long-run averages. That means the annual return rates have been greater than the averages from 1926. I find that Long-term bonds have outpaced Intermediate-term bonds by an average of 3.7 percentage points per year over the past 20 years. If I assume those return rates over the past 6.7 years, I’d have about 26% more in bonds than I do now. Now were reaching a serious dollar difference.

 

 

Finally, I can compare returns for a specific Long-term bond index fund and IUSB over the past 6.7 years. I pick VCLT from the short list I displayed in this post: the ETF for Vanguard’s index funds of Long-term Corporate bonds. (Its expense ratio is .05%, a shade less than that for IUSB.) If I had solely been in VCLT, my return would have been +5% more per year on average, and I’d have about 40% more in bonds than I do now. I certainly can’t dismiss that!

 

 

No one knows what the future will bring. Prices of bonds move in the opposite direction to interest rates. Long-term bonds are more sensitive to increasing interest rates than intermediate term bonds: prices of bonds will fall more than intermediate bonds. Interest rates will increase with inflation, and inflation has increased. Is this the exact worst time to hold Long-term bonds? I don’t know. I said the heck with thinking about timing, and decided to sell some IUSB in our retirement accounts to avoid any tax consequences to hold VCLT. In essence, I’m adding more Long-term corporate bonds than IUSB already owns. Patti and I now have VCLT as 20% of our bond holdings.

 

== Is FBND better than IUSB? ==

 

I generally DISLIKE actively managed funds. Morningstar lists funds that it judges are in the same category of “Core-Plus” total market bond funds. FBND is one I find in that prior post that has bettered IUSB over the past few years. FBND started just about the time that IUSB started, in mid-to late 2014. Its expense ratio is 0.36% compared to 0.06% for IUSB. That’s a 0.30% mountain it must climb every year just to match IUSB, but it’s beaten IUSB by an average of .5 percentage points per year over the last 6.7 years.

 

 

 

I decided to sell some IUSB, again in our retirement accounts, to buy FBND. Our total bond portfolio looks roughly like this now:

 

 

My plan is to stick with FBND for at least three years. FBND has the highest expense ratio of any fund I own, but since I own so little relative to the total (about 6% of the total), I still will have a total weighted expense ratio of less than .07%.

 

 

 

Conclusion: I’ve been very good about not fiddling with our portfolio. I did not make a change in more than six years. But I fiddled and added two bond funds (ETFs) to my portfolio. I added the index fund VCLT for a greater weight of Long-term bonds than I get from my Total bond fund, IUSB. I added FBND as a direct alternative to IUSB, since it has performed better over the past six or seven years. In my view, these changes do not harm the safety of my portfolio, but they may add a bit of return over time. The power of compounding tells me means that a slightly better return could add a relatively significant dollar amount over time.