Podcast: PhD on FIRE: Safe Draw Down Rates with Karsten Jeske aka BigERN

Episode 6 of the NewRetirement podcast is an interview with Karsten Jeske (also known as Big ERN).  Steve and Karsten discuss Karsten’s mega financial background and his journey to financial independence.

Karsten Jeske

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Full Transcript of Steve Chen’s Interview with Karsten Jeske

Steve: Welcome to the sixth podcast for NewRetirement. Today we’re gonna be talking with Karsten Jeske, live in studio, here in Mill Valley, California about his journey to FIRE. Financial independence/Retirement early. Which aligns with the two main themes of our podcast: Make the most of your money and time. Our goal is to help people who are planning for retirement or financial independence, with financial insights, stories, and ideas for making the most of their lives.

So Karsten was an anonymous blogger at Early Retirement Now for about two years until coming out this past March, when he also announced his retirement, or financial independence in his early 40’s. He’s not your typical blogger, though. He’s a big German guy, ergo his moniker Big ERN, early retirement now. He’s got a PhD in Economics from the University of Minnesota, he’s a CFA charterholder, and he’s worked at the Federal Reserve bank in Atlanta, and he currently works in the research department of a large investment manager here in San Francisco. So full disclosure, he does a lot of pretty technical quantitative work on topics like safe drawdown rates, which I like a lot, having read his blog. And now that he’s retired, I’m gonna try to rope him into helping us with some of the math behind our systems. So we’ll probably have a discussion about that later.

So, Karsten, thanks for joining us, and I’d love to learn just more why you started out as an anonymous blogger.

Jeske: Working in corporate America, it’s helpful to stay anonymous, right? Been working for my company for 10 years now, and people say all sorts of bad things about corporate America. They say they’re exploiting workers, and catering to shareholders only, and then laying off people. My experience was actually pretty good, and corporate America in my experience was they want to keep you there, they want to make you happy, they want to keep you happy. They pay you pretty good money, they pay you bonuses, they give you some other perks like window offices and travel to conferences. And if you sent any signals to your employer that you were on your way out, you’re going to lose some of these perks. So that’s why I preferred to stay anonymous until right before retirement. It’s a little bit like a poker game, you don’t reveal your hand until you’re ready to show it.

Steve: And once you announced that you were gonna retire, which probably surprised a lot of people, were there any unusual repercussions that happened?

Jeske: No, not at all. Is a very positive response. Obviously they try to keep you there, they ask you, what can we do for you to make you stay here. The issue for me wasn’t, “Oh, pay me more money, and then I will stay.” I guess there could have been some amount of money that they could have paid me to entice me to stay longer, but I guess that was probably not in their budget. Overall they were pretty positive and supportive. Even though I initially requested that I’m going to be leaving in probably late March, early April, so we found an agreement where I stay a little bit longer, so I will insure proper transition of my duties. I could have left earlier than that, but I think I owe that to my employer after a very good time there. So now I’m gonna stay until June. There’s no way back now, so as I’ve set things in motion, there’s no renegotiating. I’ll be out there in June.

Steve: Interesting. Did anyone figure out your identity before you revealed your identity?

Jeske: No. No, nobody figured out my identity. Nobody from the FIRE community figured out who I am, and nobody from my personal circle of friends or relatives figured out that I’m big ERN. It was quite amazing, because I did this for two years. I’ve done podcasts with my real voice. I’ve never shown pictures of myself. I’ve never been to conferences and shown my face there, so I guess that helped. I was lucky, and knock on wood, I was never found out. Then, obviously, when I told everybody, then yeah, it was even more of a shock to some people, obviously.

Steve: Why did you choose to pursue FIRE?

Jeske: It came about in stages. Funny thing is, when I was really young, maybe 30 years ago, that was around the time when my parents generation were talking about retirement. Some of them talking about early retirement. I would hear these discussions and aunts and uncles they would talk about retirement, “Oh, and I can get this kind of a deal from my employer, and then they phase me out and I retire early at 90% of my current salary, and I don’t have to work anymore.” That stuck with me. Then one time in school, a teacher asked the class, “What do you look forward to in life?” People responded. My response was, “Retirement.” Everybody was laughing at me and not with me, but at me. Of course I got the last laugh, because I’m probably the earliest to retire. And that teacher, I checked, he’s still working so … In some ways, maybe a seed was planted back then but –

Steve: And this is in Germany?

Jeske: This is was in Germany, yeah, yeah. The retirement age at that time was 65. I thought, okay, well, early retirement would be 60 or 55. Then, of course, I walked that number down over time. The point where I became very serious about not just early retirement but also financial independence was when I transitioned over from the Federal Reserve to work in corporate America. That was in 2008. I started in March of 2008, the same week when I started was when Bear Stearns failed. And then six months later, you see people walking out of Lehman Brothers offices with their boxes in hands. That kind of stuck with me. You really come to realize that your job is not permanent. I set the foundation that I don’t want to … First of all, I don’t want to work forever, and I also want to have that insurance that I’ll be financially independent and there’s different degrees of financially independent, right? You can not work for one year, or two years, or three years. Obviously, now with 10 years worth of savings from my current job I’m actually decided to retire altogether, so.

Steve: Right you’re doing it two decades before or more, before traditional retirement. I’ve seen your blog, and we’ll dive into this, but you obviously feel very confident that you have a high probability of being able to sustain yourself and a young family for 40, 50 years.

Jeske: 50, 60 years potentially.

Steve: I mean, that’s amazing.

Jeske: My wife is in her 30s, so that’s kind of mind blowing, it’s twice the length of the traditional retirement.

Steve: In terms of your journey on this path, any resources that you found really helpful in terms of getting educated and figuring out how to go about this.

Jeske: Funny thing is, when I started getting interested in stocks and investing, so that was basically 90’s, there weren’t really that many resources. In terms of resources, I would say obviously I enjoyed having access to online trading platforms, doing my own investment decisions, index investing. So in terms of resources, I wouldn’t say that there was any particular resource that helped me particularly. Of course, I could always claim that I’m in the industry. In that sense my number one tool is that I studied this stuff. That’s probably the resource.

Steve: But it wasn’t Mr. Money Mustache, save half your income, passively invest it.

Jeske: Exactly. Actually in some way, I am very fortunate that I heard about all of these guys relatively late. I found out about Mr. Money Mustache, and Go Curry Cracker, and Jim Collins and everybody, I think it was only in 2016. So two years ago when I started my own blog. In some way it would’ve been depressing to find out about these guys 10 years before you are ready yourself, and you see how other people achieved this already. In some way it’s good, because it inspires you, but in another way, it’s also hard to see other people, they are there already, and you’re still struggling. Especially, I mean think about the first few years of saving for retirement. It’s like watching paint dry. It’s relatively slow progress, because everything depends on your savings rate. And you get maybe a little bit of capital gains. Of course the later stages, that’s when you could almost stop saving and just let the money grow. Of course, you don’t wanna do that, because you wanna stay in this groove of being relatively frugal. Not overly frugal, but relatively frugal and keep contributing more. In that sense, the whole blogging world and the tools and the whole inspiration from that, that came relatively late to me. In some way, some of their tools and some of their philosophy I had in some way already invented independently. Right? So it was index investing, passive investing. Don’t overreact to market fluctuations, just stay the course. A lot of that I had, fortunately, known independently already.

Steve: Right, right, right. And it’s cool that you kind of came to the same conclusions doing it yourself. So, before I move on, what’s next for you? Now that you’ve got this huge amount of time in front of yourself, right? And complete freedom, right? That’s pretty interesting.

Jeske: Yeah, yeah. We are gonna travel a lot. When I’m done with my job here in San Francisco in June, we will go on some extended trips. We’ll do a cruise in the Caribbean. We’ll fly to Europe for two months. Then in September we’re gonna come back to the US, I’m gonna attend the FinCon in Orlando. Then fly back West and be here only for a few days and then fly to Asia. So my wife is from the Philippines, so we’re gonna visit some of her relatives in the Philippines. Visit Australia and New Zealand on the way. Thailand, Cambodia. Some of the South Pacific Islands.

Steve: So you’ll be a total nomad. Are you gonna own a house or rent a house? I guess now. Not for the time being.

Jeske: I forgot to mention that. So we already sold our condo. We’re currently living with relatives. One week here, one week there. Then we do another week in Tahoe for skiing. Because I’ve already announced my departure at work, so … I mean, they still need me for certain things, but it’s less stressful for me now, I have a little bit more flexibility. So in between, when we’re back in San Francisco, we’re staying with relatives. Later for May and June, we’re gonna have an AirBnB in the East Bay. Because that’s a longer stretch, I don’t want to stay with relatives for a whole month or one and a half months. Right now we’re nomads and we will be. So we saved the rent. We spent that on travel. And then when we come back from the trip in late 2018, early 2019, we’re gonna go house hunting. Crazy thing is, we don’t even know yet where. We’re still debating that. It has to be obviously more affordable than San Francisco. Because just the way our numbers are right now, it’s enough for a comfortable retirement in most of the places in the country. Most of the places on planet Earth, but probably not San Francisco, because it’s too expensive here. We’re still shopping around, what’s a place that has good tax environment, good healthcare, and then also good schooling, because our daughter is four years old. She will start school in 2020. We’re still debating where to move.

Steve: That’s interesting. You know, I know Darrow Kirkpatrick from Can I Retire Yet? He retired I think in his early 50’s or at 50. He sold his house and is now renting, I think he’s in New Mexico now, but he’s essentially trying different places, and same thing. He’s older, right? But, you know. Lives efficiently, enjoys his life, but gets a lot of pleasure out of things like hiking and mountain biking and stuff like that. I wanted to dive into, I think one of the big topics on your blog is safe withdrawal rates. I know you think a lot about this because you’ve got this really long time horizon, and you think about it very technically and quantitatively. I wanted to ask you about that from two perspectives. One is your own perspective, as an individual, how you look at it and think about it for yourself and your family and hedging risk and stuff like that. Secondly I wanna dive into some of the lessons you’ve taken from case studies. But why don’t we start first with how do you look at it and think about it and frame this issue up.

Jeske: The reason why I got interested in this whole safe withdrawal mechanics is that I realized that that is probably one of the hardest problems in finance, in the mathematical portion of finance. Saving for retirement is relatively simple, because you contribute every month, you max out your 401k, you do some additional savings. Everybody’s worried about a stock market crash, right? Everybody’s worried about the next 10%, 20%, 30% drop, 50% drop like in the global financial crisis. And that is a lot easier to digest if you’re still working, because you could tell yourself, “Okay, I’m gonna invest more money, and if things go well then stock market goes up.” If the stock market crashes, I mean of course that’s undesirable, but at least if you stay the course and you contribute more, you could argue that you have this advantage from dollar cost averaging. So you buy more shares for the same amount of money and then you have to believe that the stock market sometimes overreacts on the downside. If you think about how people were running around in 2009 in March, and the S&P 500 was below 700 points and people were saying it can go all the way down to 200 points, and this is the end of the world. This is the end of corporate America. If you kept a clear head and you said, “Well, you know, this is probably overreaction. We’re not gonna have another Great Depression over this.”

If you stayed the course during that time, things worked out pretty well, because you bought at the low point of the stock market, and you contributed more and can you imagine that tax lot that you invested in, in March 2009, where that is right now. But things then reverse if are retired. Because now you’re taking money out. Now you have a reason to be worried about the stock market going down and overreacting on the downside, because you would be withdrawing more money when the market is low, and you would liquidate more shares the lower the market drops. That is much more of a concern for the retiree and less of a concern for the saver. Obviously, granted, I think there are also a lot of savers who threw in the towel at the bottom of the market and then got out and still haven’t gotten back in. But again, if you stayed the course, as an investor and as a save, the stock market drop would have been a lot less scary.

Then if you’re a retiree, that is something that can sink your retirement, and this is what’s called sequence of return risk. Because as a buy and hold investor you don’t really care what is the order of returns if they’re low first or high later. All that matters is the average cumulative compound return of your asset no matter what’s the sequence of the returns. But then if you save or if you retire and you withdraw money, then the sequence of returns will matter and then you should be scared about a stock market drop early on in your retirement. That has been on my mind, and this is why I started writing the blog and obviously I read some other research on this.

Obviously, something else that’s also compounding this problem is that right now we are at or near the high for the stock market. Equities are relatively expensive, so that is another element that should make you nervous if you’re a retiree or close to retirement or just a recent retiree. Stocks are expensive. Bond yields are low. In some of the research that you read out there in the world, and this is not just the early retirement world. This is the traditional retirement research. So the Trinity study or some of the work that Bill Bengen did. So what these guys do is, they look at what a failure probability is of say the 4% rule. They look at all the possible starting points, some start, some do their studies, they start in 1926 and then they look at the 30 year windows. How would you fair. What is the safe withdrawal rate over this window, over this window, over this window. And of course they take the average over all possible windows.

But that’s a little bit bad comparison because we’re now in a world that is not representative of the average of all the different windows. We should look at what happens closer to the peaks. If you condition on not taking the average failure rates of the 4% rate over all the windows that they looked at, but you look at only the starting points when stocks were similarly expensive and bond yields were similarly low, then you get much higher failure rates. It’s actually … That enticed me to do some of my own research, because I saw, “Okay, well, nobody is doing it the way I prefer it, so I have to do the work myself.” So that’s how I got started doing some of this work on the safe withdrawal rates.
Steve: What I liked about what you were doing was, not just Monte Carlo modeling but historical backtesting, where you were like, “Yeah, let’s look for a similar environment.” Having said that, have you adjusted your own approach given the current conditions, and the fact that you’re heading into a very long, yeah –

Jeske: Right, yeah, yeah, you have to.

Steve: Okay.

Jeske: That’s exactly what I did. I tried to understand what would be the adjustments you have to make. People say, okay …. If somebody says, “Okay I’m eight years old now, and I want to retire in 30 years. What target should I pick?” I would say, “Yeah, absolutely, use the 4% rule because I have no idea what will be the situation 30 years from now.” Something like the 4% rule, then you can again look at this, people call it the unconditional mean, the unconditional safe withdrawal rate, because I don’t know what will be the conditions at that point. But I already know certain things that should lower my safe withdrawal rate. I know that I will have to live for somewhere between 40, 50, or 60 years on that money. We are now at a time when equities are relatively expensive, bond yields are relatively low. So I gave that 4% rule a haircut, I call it 3.25% as a safe withdrawal rate without any additional income, say from Social Security.

Some people are actually a little bit overly conservative. They say, “I’m completely gonna discount the prospect of getting Social Security.” I think that’s a little bit too conservative. Even with Social Security I don’t get back to 4% again. So I’m no down to something like maybe 3.5%. And then people, “What is the difference? It’s 4%, its 3.5%.” Doesn’t look like a big difference. But if you look at historical simulations, there is a big difference. Think about it this way. Small changes in say a saving plan over 45 years can make a huge difference when you retire. Just add another $1000 to your savings every year, or a few hundred dollars per month, that can blow up to some astronomical sums over 45 years. So think about if you go from a 4% withdrawal rate to a 3.5% withdrawal rate, that can make all the difference. You could end up with millions of dollars with a 3.5% withdrawal rate, and you can run out of money with a 4% withdrawal rate. Some people think that, “Well, it’s only .5% difference.” No, it’s not .5%. It’s .5 of 4, that’s more than 10% difference in your withdrawal rates. Just these few thousand dollars a year and you compound them over 60 years, that can make a huge difference over the long term.

Steve: Yeah. That’s really interesting. I think that with regard to what we’re doing, trying to factor in more of these ways of modeling and letting people explore this. Not that everyone is gonna dive into this level of detail. I think this is one of the big challenges. Well, hey, if I have a PhD in Economics, and I have the emotional makeup to look at this abstractly, I can make some pretty good decision and retire … How old are you? 43?

Jeske: 44.

Steve: 44, retire at 44, I’m done! So that’s good. But for most people they can’t. How do you help people get more comfortable and confident that they’re making more optimal decisions, more efficient decisions. Just what’s kind of interesting is, we were talking to Allan Roth earlier, and he comes out at roughly a 3.5% safe withdrawal rate for a 30 year retirement horizon. And you’ll have a 90% chance of success. This is for a certain scenario over that time window, but if you start extending that time window longer or cranking up your drawdown rate a little bit, it changes down to 70%. What risk do you wanna take as you look at this?

Jeske: Very small changes are gonna compound to very large differences in the final asset value. And again, I can see also that some people would say, “Well, you’re really too conservative with this. I can show you examples in the past where somebody withdraw 4% and then after 30 years your one million dollars would have grown to five million dollars.” Unfortunately that’s usually the cohort that started at the bottom of the recession, that started in 1982 at the bottom of that recession or in 1975 at the bottom of that recession or 1932 at the bottom of that recession. But that is not representative for today. It’s a little bit like saying you want to go to the airport and you want to find out how long is it gonna take me. If you already know that you’re gonna leave in rush hour, you want to plan a little bit more and then somebody’s gonna say, “But I found one guy who left at 2 am to go to the airport and he made it in 12 minutes.” Yeah, that’s great, but that’s not a representative, a person is not a representative sample for us.

Steve: When we think about what we’re doing, we think about maps sometimes, and the idea of zooming in and out. And I know Google Maps is pretty cool, you can essentially say, “Hey, I wanna leave at a certain point in time.” And it’ll say, “Oh, if you wanna go to Tahoe Friday afternoon at 2 o’clock it might take you five hours.” If you’re willing to go Saturday morning at 6 am, which we’ve been doing, you might get there in three hours.” I think some similarity as when you’re looking at historical backtesting and other people that are trying to do the same stuff. Okay. Good. I know you’ve done a lot of, well not a lot, a set of case studies of different people, and I would love to talk to you about some of the lessons that you’ve taken away. One of the things you noted was safe withdrawal rates are all over the map depending on the user.

Jeske: Right. It depends on the age. The younger you are, the lower should be your safe withdrawal rate. It’s multiple, multiple aspects that determine that, right? You have a longer lifespan, you’re further away from Social Security. I actually found a lot of case study volunteers, and they seemed to have pretty generous Social Security benefits and pension benefits, so some of them had significantly above 4% safe withdrawal rate, so that’s good. I’m not the person who says that everybody has to be below 4% because I don’t like the 4% rule. I mean you should make the adjustments to your safe withdrawal rate, but you should do it in a way that is consistent. So if you’re already 52 years old, and you’re expecting a nice government pension that’s inflation adjusted, and you expect Social Security, and you have to worry less about, say, Social Security cuts for example. The younger you are, the more likely it is that you fall into that generation that, “Okay, you’re gonna be the first generation that gets lower Social Security benefits.” Or, “You’re gonna be the first generation that has to work until age 69 instead of 67.” The older you are and the closer you are say to age 55, the more you can either make it with a 4% rule or maybe even go above 4%. I’m the first to admit that.

But then are also other people who say that, “You know, yeah, I will get Social Security, but I have a family history of some illness. Not only do I not want to factor in Social Security, but actually I want to also factor in some additional costs. Once I turn 80, I might be in a nursing home.” And then, well, guess what, then you are way below 4% safe withdrawal rate. I mean, obviously, there is a lot of idiosyncratic variation of these safe withdrawal rates. At any given point in time, you have a lot of variation among people, and then obviously even for one particular person, depending on when you retire, do you retire in 2010? Or in 2018? So there’s again a difference in safe withdrawal rates depending what are equity valuations.

I wrote this one post, and my quote, the money quote from that one was, “The only thing more offensive than the 4% part is the word rule in the 4% rule.” There should not be a rule. It’s a rule of thumb. You start with that and then you have to make your own idiosyncratic adjustments depending on your personal situation and then also where we are in the business cycle. In fact, if you are retiring at the bottom of the recession, you can probably go higher than 4% right? You probably wanna go 6% because now you know equities are beaten down, they will recover soon.

Steve: 6% maybe later. I mean, I don’t think you wanna be drawing down more aggressively in the beginning, do you? Or –

Jeske: Again, I mean, if you’re super conservative, you probably don’t wanna do 6%, but I have this one cute little rule that I use. You look at the CAPE ratio, and you invert the CAPE ration. So right now it’s about 30. So that means for every dollar of earnings, you have to pay 30 dollars to own a share of the S&P 500. With the earnings, we mean the 10 year rolling average earnings, inflation adjusted. That means there’s only an earnings yield of about 3.3%, but during some of the recessions you went all the way up to something like 10% earnings yield, so the CAPE went down to 10. So then that means that, unless there’s some kind of a structural break in earnings, where earnings, because you look, in the CAPE, you look at the backward-looking earnings –
Steve: What’s the long term CAPE? Sorry.

Jeske: Well there is no long term CAPE. That’s the problem, right? The long term average if you take the really long horizon is something like 15. So right now we’re about twice that. But there’s a lot of research out there, and I think even Robert Shiller himself concedes that over time there could be some shift on what should be the equilibrium CAPE. I think that the equilibrium CAPE is no longer 15.

Steve: Any idea of what you think it should be?

Jeske: I think it should be definitely higher than 20.

Steve: But you should still be looking at a 30% haircut.

Jeske: Uh, yeah, yeah, absolutely. Again, I would not say that, “Oh, the CAPE has to go back to 15, and we are looking at a 50% drop in the stock market anytime.” My personal view is that, yeah, we’re a little bit on the expensive side. There’s also this effect of, we’re gonna roll out the really, really weak earnings from the global financial crisis. This is a 10 year rolling average. And we are now, so we have these two years of really, really bad earnings from the global financial crisis –

Steve: From 2008 to 2010.

Jeske: From 2008, -9, -10, probably too. So once we roll that out, just automatically without much happening, if earnings just keep growing a little bit, the S&P’s not gonna do double digit returns, it just does single digit returns. Given that, just automatically we’re gonna roll that out and we’re gonna drop by about 10%. Maybe even 15% in the CAPE. Just from that rolling that out. In that sense we should always take this CAPE of 30 plus with a bit of a grain of salt.

But then there are also some other reasons. One is, there’s now different accounting standards that would lower the earnings a little, so it would exaggerate the CAPE ratio. And then there’s also, one could make the case that very early on, companies did not retain as much of their earnings. They paid out almost their entire earnings as a dividend, and that means that they had less power to grow their earnings internally. Earnings per share only grew roughly at roughly the rate of nominal GDP. Now it’s actually possible for companies on the per share basis, maybe not on the aggregate basis, but on the per share basis, to grow a little bit faster because they retain more of their earnings and they will find ways to reinvest capital internally. What that does is that it means that the earnings per share can grow a little bit faster than nominal GDP. That means if you take a very long term moving average, that that moving average over 10 years, because it’s not increasing over time, you take the average of that, the average is gonna be a lot lower than the current earnings on average.

So there’s a few technical and mathematicals, I don’t wanna get too deep into that, that’s almost a whole episode on its own, but there are a few reasons why the CAPE can be sustained at a little bit higher level, and it doesn’t have to go all the way down to … I mean, it went into the single digits, right? In the ’80’s.

Steve: How can normal people apply some of this more active analysis to their own situations that you see out there.

Jeske: I have a few posts where I come up with a relatively simple rule, a simple formula. You look at the CAPE yield, and you translate that CAPE yield into how much you can withdraw per year. Again, you don’t have to … I mean, obviously you probably want to understand qualitatively what is behind that, and it’s basically what you would do is, that if equities are very expensive, you would lower your withdrawals, and then as equities get less expensive, you can increase your withdrawal rate. What that would do is, imagine you start with an initial withdrawal rate, say 3.5% and then equities take a nosedive. They go down by 20%. So what do you do with your withdrawal amount. Imagine, you still keep withdrawing 3.5% of that, it means that your withdrawal amount also goes down by 20%. That’s kind of unappealing.

The other extreme would be you don’t do anything to your withdrawal. You keep it constant, but because your portfolio value went down and you still withdraw the same, so now you’re gonna withdraw more. You’re gonna withdraw probably around 1.2 times 3.5, probably around 4.2%. There’s also a way in between, where you say, “Well, equities are now a little bit cheaper, so I can actually sustain a little bit of a higher withdrawal rate. So my portfolio value went down by say 20%, but I’m gonna jack up my withdrawal rate by a little bit more, say maybe, I’m gonna multiply my withdrawal rate by 1.1. So the net effect of that is that yeah, you’re gonna withdraw a little bit less, but you don’t do it 1 for 1 with your portfolio value, you would maybe only half.

So I played around with these different rules, and so I found that actually, that that half is a pretty good mid point. It helps you when equities go down. You would lower your withdrawals a little bit, it helps a little bit with your sequence of return risk. But it also helps you when your portfolio does really well, because then, you don’t want to under withdraw and then … Of course, it’s a good problem to have, right? You end up with too much money when you die, but you may not want that so you also want to withdraw more money if things turn out really well. So that also helps you in a way, so it’s basically to adjust in just the right so as not to overshoot and undershoot with your portfolio value.

Steve: Yeah, I know. I know there’s some work that gets us … As Michael Kitces has pointed to, that’s like, the reality is for savers, most of them actually keep accumulating money, and they retire at 60, they’ve got a million to two million bucks, and then they live ’til 85, pass away, and they’ve got three million dollars. (laughs) They’ve totally underutilized all this savings.

Jeske: Right, right, right. But, again. The analogy is, imagine you get a rental car and you prepay the gasoline. You will return the car with too much gasoline. You’re gonna give a gift to the rental car company. But running out of gas three miles before the airport and being stranded and then missing your airplane, that is a risk that you don’t want. There’s kind of an asymmetric risk. Having too much money is a good problem to have. It’s a problem, but it’s a good problem to have.

Steve: Running out of money is a much worse situation (laughs).

Jeske: (laughs) Especially at age 84, right?

Steve: So we were talking to Allan Roth about this, I’ve always been, “Oh, well, you know, you can buy deferred annuity and hedge your longevity risk.” Which does work, but I think it depends on how far away you are. His point was, “Well, yeah, but you can’t buy an inflation indexed annuity today, outside of Social Security. If you’re really looking way into the future, you really don’t understand what the purchasing power of that thing’s gonna be. You gotta really discount that—”

Jeske: Yeah, I couldn’t agree more. In that sense these deferred annuities that are completely nominal, it would be a total nonstarter for me for exactly that reason. You hedge your longevity risk, but there’s so much uncertainty about what is the CPI at that point. So it makes it kind of useless.

Steve: Right, right, right, right. His point was, which I think probably more people will do, is buy it synthetically by essentially deferring Social Security, and that’s the most efficient annuity you can buy. And hopefully more and more people are getting that message, because the number of people that used to claim Social Security at 62 used to be tremendously high. It is now coming down. More people are claiming it later, which is good. And I think as people look forward and say, “Oh, well, jeez, I might live much longer, healthier lives.” I think more of them will say, “Alright, I’m gonna just push it ’til 70.” And they should do it, at least for folks that are the highest income earner in a married couple. I think that makes a huge difference. In terms of the positioning assets for tax efficiency, I know you think about this as well, any rules of thumb for people? Our audience by the way is mostly 50 plus, but also, we’re interested in enabling the FIRE community as well, but I think for most of users, it’s more traditional retirement.

Jeske: Yeah, there’s a standard rule. You try to keep the assets that generate ordinary income. That would be bonds and REITs, because REIT dividends would be taxed as ordinary income. So you try to keep that in deferred accounts. So 401k’s or IRA’s. And then try to keep as much equity exposure in your taxable account. People are always getting nervous about that, because then they say, “Well, imagine I have a 60/40 portfolio and I have only equities in my taxable account. And then all my bonds are in my 401k and now I want to withdraw. Obviously for every dollar I want to withdraw it’s 60 cents equities and 40 cents bonds, so how would I do that?” And then of course, what you would do, is you would withdraw it out of the taxable account before you reach 59 and a half. For some people 55, but for most people 59 and a half, and then you do the rearrangement inside the 401k account, and as much money is fungible.

You don’t have to keep 60/40 in the taxable account and 60/40 in the tax deferred account to make this work. You can reshuffle the money and keep a constant 60/40 allocation. For the really advanced planners, you would also keep track of, obviously, when different accounts should be weighted differently. For example, if you have a million dollars in your taxable account, and that has a cost basis of a million dollars, you can take 1 dollar out of there and all zero taxes, whereas if you have another million dollars in your 401k and you’re being taxed at 20% marginal tax rates, that’s only worth 80 cents. So that million dollars in that other account in that 401k account, is only worth $800,000. So if you wanna be really, really careful about this, you would have to weight your accounts different, so you’d basically have to weight them times one minus your marginal tax rate. If you’re really strict with your asset allocation and you say, “Well, I want to have really a 60/40.” Your 60/40 might look slightly different because you have to take into account that your 401k account is actually … It’s almost like the government owns –

Steve: Yeah, part of your –

Jeske: 20% of your 401k account, and you just don’t know it yet. But they do. Of course, it’s a little bit more of hacking possible. Because the tax rates are not exactly flat tax rate. So you can still play around with the different kink points in the tax code. Well now we have the $24,000 tax free and then the next $77,000 at 12%, so yeah, there’s some wiggle room you can still use, but technically speaking if we had just one average tax rate for ordinary income and one average tax rate for capital gains, you would have to do some re-weighting in your accounts there.

Steve: Oh and by the way, this is the argument for what we’re doing. We think people should have a living plan. You’ve got your, that looks at everything, so I’ve got my pre-tax, post-tax assets. I have real estate, whatever. Things that produce, if I have rental houses, stuff like that. Kind of looking at the whole picture. We’re factoring in things like required minimum distributions, but I think your point about weighting’s pretty interesting. Looking forward at what your needs are, how you’re gonna intelligently draw these things down and basically have it automatically update when, okay, we have a new tax regime. Boom. We can automatically look at everyone’s plans and upgrade them. If you’re looking at a time horizon of 20, 30 years, I think the one constant is change. That’s what we can all expect. We don’t know exactly what the future holds, but we know it’s gonna be different than what it is right now.

Jeske: And probably higher tax rates in the future. That’s probably the only thing that you can bank on. Yup.

Steve: Yup, yup. I think also, just as a side note, what you’re doing, you’re moving around, you’re looking, you’re essentially shopping for better state taxes. You could potentially do that internationally. And if you were a real crypto enthusiast, maybe like, “Well, maybe I should put all my money into (laughs).” The IRS is being smart about that right now, so … (laughs)

Jeske: People ask me about cryptocurrencies. Full disclosure, I’ve never invested in cryptocurrencies. Yeah. Yup.

Steve: Morgan Housel, we had on the podcast, wrote this really good post about bubbles and how they form, and the momentum behind them. You look at … I mean, I have friends that are in the Bitcoin space, and I heard about Bitcoin when it was below a dollar, like 30 cents, we’re talking about in Silicon Valley. I was like, “There’s a Bitcoin thing, da, da, da.” Right? It was kind of there for a long time. Then, it started going up, and it, you know. So it’s like, “Oh, it’s at 4,000. Oh, it’s at 8,000. Oh, it’s at $12,000. Oh, it’s at 16. Oh it’s at 20,000.” And then you’re seeing these things like, “It’s a crypto party, everyone’s putting their money in crypto,” and you’re kinda like, “This is not gonna end well.” (laughs)

Jeske: (laughs)

Steve: And what’s it trading at, 7, 8,000 now? Now there’s more headlines like, “Oh, it might go to zero. Or we’ll see.” I think there’s definitely value in the blockchain and stuff like that.

Jeske: Oh absolutely. There’s a distinction between the blockchain and each particular currency. So my concern would be that the first iteration could go the route of the Palm Pilot. Nobody has a Palm Pilot anymore. And it takes another innovation to make it mainstream. So then the first iteration will disappear. I don’t want to invest $6,700 in one Bitcoin right now. (laughs)

Steve: Alright. Well I think that’s it. So Karsten, thanks for being on our show. It’s great live, face to face. This has been pretty cool. Davorin Robison, thanks for being our sound engineer. Anyone listening, thanks for listening. Hopefully you found this useful. Our goal at NewRetirement is to help anyone plan and manage their retirement so they can make the most of their money and time. We offer a powerful retirement planning tool and education content that you can access at NewRetirement dot com. And we’ve been recognized as Best of the Web by groups like the American Association of Individual Investors.

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Do it yourself retirement planning: easy, comprehensive, reliable

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Take financial wellness into your own hands and do it yourself retirement planning: easy, comprehensive, reliable.

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