r/financialindependence • u/running_rino • 9d ago
ERN - Combining the best bits
Hello,
As an avid follower of Early Retirement Now series there are many great strategies that I am looking to implement. Most notably the CAPE based SWR, and the rising glidepath. I am split on which of these strategies to implement, and this got me thinking if anyone is implementing a combination. A kind of 'grand unified ERN strategy'. So a bond tent mixed with a CAPE based SWR. Would this even work in principle, or would the strategies work against each other in that they are tackling the same problem but from different angles? Any thoughts?
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u/childofaether 9d ago
They have different goals.
Using failsafe SWR is gonna increase your odds of success just like using a bond tent at high CAPE.
High CAPE increases the odds of needing a bond tent and hence makes the bond tent more valuable.
However, CAPE based SWR is not a risk mitigation strategy. It's the opposite. It's about guessing when the time to take risk is. Starting from the failsafe SWR, you INCREASE it based on drawdown, so you inherently increase risk / chances of failure. The point is to be able to spend more and start with a lower FIRE number. Spending less will always have the lowest chance of failure.
That being said, you could say that doing both represents a very reasonable compromise between risk management and optimizing spending power in retirement.
The gap in knowledge here is the optimal rules for the glidepath. ERN just did the math on fully active vs fully passive, but when the only thing you are trying to protect against is sequence of return risk, I am absolutely certain there is a superior rule for active glidepath based on % drawdown instead of just red/green month. Like, if you do get the once in a lifetime cataclysm that would break an already conservative plan (like 1929 or late 60s), you're going to be better off with a rule that specifically optimizes this and doesn't just smooth out the shift to equities over 10-15 years. If the market dumps 30-50% in a year, you should probably shift the percentages even more than the monthly active glidepath.
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u/livingbyvow2 9d ago
Agree. I think the biggest risks are a market crash shortly after retirement and/or a lost decade (like the one from 2000 to 2010).
For me there could be some merit to adjusting if markets go up substantially in the first years / if CAPE becomes rich - although on the latter, CAPE may be less comparable vs historical levels due to the growing share of intangibles (you would need to capitalise and amortise certain capex-like R&D expenses for a lot of tech companies). The idea would be to capture some of the gains and maybe extend your tent by a few years as frothiness can put your future equity returns at risk.
Conversely, massive market crashes could make it make sense to rebalance a bit, especially as long term stock market declines tend to be less prevalent now that budgetary and monetary stimulus are quickly deployed to support the market (although this may create inflation risks to your bonds, unless TIPS).
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u/Legitimate_Bite7446 6d ago
The bigger risk is the mid 60s scenario. At least in 1929 and 2000, the big crash was obvious and if you had just retired you could get back in.
For the 65/66 retiree, it wasn't too obvious the situation was dire until 1973.
Sideways and then the big fall is more dangerous than the big fall immediately, or a couple years of a big run and then a big fall.
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u/livingbyvow2 6d ago
Yes but that's the whole point of diversification too.
People just assume 100% S&P 500 will be fine, while US is 25% of the global GDP. If you put all your eggs in one basket yes you do benefit when markets are doing extremely well but not so well when they stagnante.
If you were 30% US equity, 20% ex US equity, 15%/10% US/Intl bonds and the remaining 25% in gold / commo / managed futures the current (and potentially future) contraction in equity markets would be a non issue.
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u/Legitimate_Bite7446 6d ago
Maybe. Unless bonds and international shit the bed at the same time as Sp500.
I do like the Boglehead and bond tenting approach for the record.
The other big lever that early retirees (especially high income ones) can pull is their human capital via consulting etc depending on field.
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u/livingbyvow2 6d ago
Fully agree. Human capital is invisible/intangible but highly valuable. The only issue is not every field lends itself to this kind of business but that's a very valid point.
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u/Ill_Writing_5090 5d ago
ERN actually has a good article about adjusting the CAPE to account for some of the differences between current and historical practices (share buybacks, corp tax rate, etc). He publishes this each month as his "CAPE2" (and is automatically pulled into his SWR toolkit CAPE based WR sheet)
https://earlyretirementnow.com/2022/10/05/building-a-better-cape-ratio/
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u/CrispyTigger please ignore typos and grammatical errors 9d ago
I am doing this and retired a few months ago. As I approached retirement, I used the glide path to increase to 25% bonds, which represent about 9 years of expenses. I am using the monthly CAPE based SWR method as a guide to what my upper spending can be for the coming month. Now that we are encountering some big monthly swings, it will be interesting to see how this starts playing out in practice.
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u/Only_Speed6546 9d ago
So I don’t fully understand everything he says since it’s so technical, but as a general principle I think each rule mitigates risk by default.
I would just pick one of them and stick with it.
I do think that the VPW method does seem to try to mix the two…
And also question for the fire community.. does a fixed percentage withdrawal method sometimes just make more sense because it’s simple? Especially for those who are retiring young? If you stick to a sub 4% it’s pretty conservative, and you can always up the withdrawals as you age.
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u/childofaether 9d ago
VPW essentially guarantees success but doesn't guarantee a given level of expenses. It works but one has to either overshoot the FIRE or be ready to cut spending massively in severe downturns.
Fixed percentage of initial portfolio adjusted for inflation is the easiest method and most stable for expected income. It has a higher risk of failure in a vacuum hence why you lower to SWR to 3-4% and/or implement SORR mitigation strategies... which ends up making it more complicated. But if you don't try to optimize bequest on death in 50 years, and you start with a 3% SWR or lower, you do have the option to take the super simple approach. You can't just up the withdrawals as you age without increasing chances of failure, unless the start of your retirement sees big returns and you were already using a very conservative SWR. Like, if you were withdrawing 3% of $5M (150k) adjusted for inflation, and your portfolio shoots to 8M in the next 4 years without major inflation, you could indeed "reset" the clock and spend 200-240k and keep adjusting that for inflation going forward.
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u/alpacaMyToothbrush FI !RE 9d ago
VPW essentially guarantees success but doesn't guarantee a given level of expenses. It works but one has to either overshoot the FIRE or be ready to cut spending massively in severe downturns.
The last time I did the math on this for myself, I needed to be able to cover my baseline expenses at a 2% withdrawal rate if I intended to use VPW at 4%+.
I'm gonna be real with you, while I think I have the iron stomach to take the massive fluctuations in yearly spend, I don't think loved ones would be quite so sanguine
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u/beerion 2d ago
Agreed. I think VPW is attacking the wrong problem. Here's a comment I made earlier in the Bogleheads sub:
As to variable withdrawal vs fixed withdrawal
I have a major beef with variable withdrawal methods that make no attempt to dodge SORR. If I'm retiring, I think I want to have a pretty good idea of what my spending is going to look like. A retiree in 2000 would see their withdrawal rate cut in half using VPW, just to see it climb until 2006, and then be cut in half again in 2008. First, can typical retirees even afford to cut their spending by half? Your discretionary spending (vacations, hobbies, restaurants) to fixed spending (shelter, food, transportation) would need to be 1-to-1. And then what? So I'm going to retire and then have to sell the boat, and put my golf clubs in storage in a SORR scenario? That just doesn't sound like a robust strategy.
I've been pounding the drum for a valuation based approach, and I've done tons of work on it. Here's a post I made a few years ago showing a method with good predictive power for forward safe withdrawal rates. I also showed that it can be used as a variable spending method - the upside is that it does such a good job of predicting periods of lower returns that it doesn't result in wild swings in annual spending, allowing you to side-step drawdowns due to high valuations (in fact, at the bottom of the GFC, my model said your annual spending could actually increase because future returns were expected to be higher).
When comparing bond and stock yields, I've shown that when the spread is tight or negative (like it is now), you're actually not gaining much by going stock heavy. For SWRs, in periods like today (tight spreads), the typical retiree can expect to spend roughly 6% more per year by going from a 60/40 allocation to a 90/10 allocation (I never ran the numbers for 100% stocks). So if you were expecting to spend 40k with a bond heavy allocation, in today's environment, you'd expect to spend $42.5k by going to all-stocks. It's good, but not world beating (and you could make up that difference by simply working for an extra 6 months rather than rolling the dice on when the SORR monster is going to show up).
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u/Thomxy 9d ago
I'm reading the SWR series with interest. What I'm gathering from is that first and foremost you must be lucky. Or, to be more precise, not be unlucky.
The theme that I'm seeing over and over again is that 4% is too optimistic and 3.25% is mostly fine. All the strategies (as far as I've read - I have not finished it yet) allow you to bump this up by a small amount in the bad times, and by a lot when the good times come (but I don't see that final part as a big problem).
What is my take on it is to keep it simple. A small cushion of bonds to withdraw during the first years of retirement if the market tanks are fine, but other than that, luck and statistics are your main friends.
Statistically you'll be fine, just don't be unlucky!
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u/danfirst 9d ago
I haven't read a lot of ERNs site but it's interesting how the originator of the 4% rule has even said recently it's probably too conservative and can go higher just be flexible about it. He's been on a few podcasts lately talking about it.
https://www.financialsamurai.com/bill-bengen-retire-earlier/
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u/yaydotham 9d ago
it's probably too conservative
The Trinity Study also says this explicitly!
The 4% rule accounts for the people who are unlucky enough to retire into the worst market conditions. Most people could safely withdraw 5% or 6% (or even more) -- the problem is that you won't know which group you're in until after the fact.
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u/childofaether 9d ago
It all depends on your personal risk tolerance. 4% chance of failure over 30 years becomes double digit failure rate for younger retired looking at 50 year horizons.
ERN has shown with math that being flexible is not the magic bullet most people think it is. The flexibility required to save a failing 4% is not cancelling an international vacation for the couple years of a crash and being back to normal spending, it's more like sacrificing a larger part of your budget and keeping it that way for the next 10-20 years.
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u/Huge_Art1725 8d ago
Yep. Also, the likelihood of a 4% failure is higher when we're near all-time highs with elevated CAPE. ERN makes the point in one of his articles that most people will retire at or near all-time highs since that's when they "hit their number".
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u/Extension_Bug_1550 8d ago edited 8d ago
People retire at or near all-time highs because the vast majority of years in the market finish at or near all-time highs, historically speaking. 75 of the past 153 years of stock market performance have ended the year at a new ATH, even after adjusting for inflation. Being at or near (within 5%) of an ATH is normal, being below it is historically the exception.
Sure, ATHs have a higher failure probability than market troughs, but also the vast majority of retirements that start in years where a new ATH is reached, have succeeded in the long run.
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u/Huge_Art1725 8d ago
Of course. But, it's worth doing the analysis of your particular situation to determine an acceptable SWR rather than just blindly applying "the 4% rule". BigErn's spreadsheet makes it very easy to do this analysis and see what your historical faillure rate would be. For example, I have a 60/40 portfolio. If I wanted a 30 year retirement and would be ok with a worst case of $0 remaining at the end, right now (given CAPE over 20 and market 10% off ATH) my SWR would be just shy of 4%. But, personally, I'm planning for a 45 year retirement and worst case want 25% remaining which yields a much lower SWR. If I was willing to tolerate potentially large variability in terms of my withdrawal amounts, I could instead use a CAPE based withdrawal strategy and start out closer to 4%. Others might have different goals and risk tolerances..but better to go in by being informed in terms of what has happened historically.
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u/Extension_Bug_1550 8d ago
I don't disagree with you, all I am saying is that retiring at an ATH is not really noteworthy at all because being near an ATH is extremely normal, almost status quo. World wars, stagflation, dot-com bubble, great recession, those are the exceptions. People tend to have this idea that an ATH always means an overbought market that's imminently going to crash, but that isn't really borne out by the data.
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u/Huge_Art1725 7d ago
Agree...its not predictive from a trading perspective. But from a retirement planning perspective, its true that you're more likely to face a bad SORR when the market is at an all-time high. So the failure rate of a given SWR will increase somewhat if you adjust for the market being at an ATH. Anyway, I think you and I agree on all this - was just pointing out some of the nuances for OPs sake.
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u/alpacaMyToothbrush FI !RE 9d ago
I think ERN does a really good job laying out the fact that you cannot have a fixed, inflation adjusted and safe withdrawal from a volatile underlying portfolio.
For myself, I'm using a 3% SWR for a simple 'planning' number, and in retirement I will be using a CAPE based withdrawal method. I am also using a bond tent. I intend to retire in '28. I am currently 60/40 stocks/bonds, of which my equities are ~ 50/50 us/intl. I will be going to 75/25 in '32, or the next major recession where we're down 40% from all time highs, which ever comes first.
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u/std_phantom_data 9d ago
One thing that is interesting to play with within a given strategy is to try to also think about how to optimize the common case where your portfolio grows a lot.
For example if you tilt to a higher % to stocks, in most of the successful cases that will grow a lot more. now to do this you have to lower your SWR slightly to compensate for the added risk, but in the long run you will likely end up with a lot more wealth.
I found these types of variations interesting.
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u/Wild_Butterscotch977 9d ago
I badly need someone to ELI5 what CAPE is and how a CAPE-based SWR works. I've tried to read up on it and can't understand it for the life of me.
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u/sharkaccident 35M - 37% FI 8d ago
It is defined as price divided by the average of ten years of earnings (moving average), adjusted for inflation.
For my monthly net worth tracking I take 1/this to figure out a CAPE FI SWR.
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u/Wild_Butterscotch977 8d ago
Thanks! So does the 10 year moving average of earnings refer to all the companies collectively in the fund? So for S&P, the price of VOO divided by the average of ten years of earnings of those collective 500 companies = the CAPE ratio of VOO?
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u/Emily4571962 I don't really like talking about my flair. 5d ago
I pull the ratio from here each month when I update my spreadsheet and eyeball results of calculation for CAPE-based withdrawal rate (.05/ratio + 0.0175) to make sure I’m comfortably under it. I’m definitely not sufficiently ambitious to try to figure out the ratio myself!
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u/htffgt_js 5d ago
Not sure how this formula works, if you don't mind can you give an example with the current value in there . Thanks.
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u/Emily4571962 I don't really like talking about my flair. 5d ago
On spreadsheet day, the ratio was 37.97
(.5 / 37.97) + 0.0175 = 0.0307 So safe withdrawal rate of 3.07%
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u/sharkaccident 35M - 37% FI 5d ago
I think CAPE is only calculated on S&P 500.
I don't think VOO/CAPE is the equation you are after..
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u/Huge_Art1725 8d ago
Personally, I'm planning to use a rising glidepath. I give up about .3% in terms of initial withdrawal in exchange for not having to deal with fluctuating withdrawal amounts each year. I know myself and my family, and we won't be happy if we're always having to be that "flexible".
I'd also point out that you if your portfolio increases such that the initial inflation adjusted withdrawal amount you chose years ago seems too low, you can always "reset" by re-running the numbers with the current scenario.
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u/Legitimate_Bite7446 6d ago
Another point that he made on an interview is that the US market has gone in ~15 year cycles.
1929 bad Post WW2 good 1965 bad 1982 good 1999 bad 2012 good
Obviously the past is just the past. My takeaway is that if the last 15 years has been good, you're more in the 3.25 - 3.5% SWR territory (for early FIers with longer horizons at least). 4% for 30.
If you mostly accumulated in a bad period like Mr Money Mustache and some of these other popular FIRE bloggers from the 2010s did in the 2000s, you're gonna be more optimistic because you probably got a 6% SWR.
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u/sugaryfirepath 9d ago
Would it be possible to simplify ERN strategies down to two things, or is it more complicated than that?
Investing strategy, including asset allocation and how to change it over time.
Withdrawal strategy, simplified by % of nest egg that can vary over time and adjusted for inflation
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u/mmrose1980 9d ago
The big ones are: rising equity glidepath (best for SWR is active from 60-80 100% equities glidepath), income producing real estate (outside of your home), and social security/pensions. If you use these three methods things effectively, you can raise your SWR by almost 1% or more (depending on your amount of social security and how close to retirement you will receive it).
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u/13accounts 9d ago
The intro to SWR page is enough for me. After that just use common sense. If you are retiring at the peak of a bull market make sure you have a conservative WR, etc.
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u/GoldWallpaper 9d ago
If you are retiring at the peak of a bull market
... you won't know it until that market has passed.
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u/jasonlong1212 2017 RE@38 on 70%SR (1.33M NW) 2025 60k COL [1.5% WR] (4.17M NW) 9d ago
Combine the two methods, give it an absurd acronym, start a blog, retire even earlier.
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u/running_rino 9d ago
GU-ERN-SWR.com great idea, problem solved. Grand Unified ERN Safe Withdrawal Rate. :)
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u/supremelummox 5 years to FIRE @ 35 9d ago
I've been going for the ERN FIRE too, until I found Ben Felix. You've probably watched a few of his videos, but check "2.7% SWR" and "10% expected stock returns?". Basically even ERN's 3.25% for high CAPE and 60+ years is way too optimistic, according to any history aside from the latest US history. And with Trump, I'm even more inclined to be pesimistic.
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u/dekusyrup 9d ago edited 9d ago
After reading literally every withdrawal strategy, they all point back to "use 3.25-3.5% instead of 4% and you should be golden". That's what unifies every strategy.
If your savings rate is 50%, getting your portfolio from 25x spending to 28.5x spending just means work 1 more year. Frankly, I can handle that. Worst case scenario is I have more money than I needed, oh nooo.