A couple of years ago, I played with this Software-as-a-service called Timeline.

It allows an adviser to put their client’s case throught the system and give an idea whether the client’s resources is enough for them to have a conservative retirement.

They allow the adviser to model based on both Monte Carlo and Historical Withdrawal Rates.

You can read Making a Portfolio of $500,000 last 60 years on a 5% Initial Withdrawal Rate and The Permanent Portfolio Might Do Worse in Retirement than the Traditional Equity Bond Portfolio to see Timeline in action.

The CEO of Timeline, Abraham Okusanya, from time to time writes well written research articles on retirement planning.

This week he published a post called No , QE didn’t break the 4% rule.

One of the fears that we have is that with very low bond yields, many smart folks commented that the 4% rate is no longer safe.

Perhaps the reason Abraham took an interest in this narrative now is that the Glit is currently having a negative real yield.

The withdrawal rate study is figuring out the highest you can spend, in the worst-case scenario.

Abraham’s point is that for the UK, 4% is not the worst-case, to begin with. He replicated a 30-year retirement through 1915 to now with a 50% equity 50% bond portfolio, factoring 1% in advisory + total expense ratio fees and this is what he has gotten:

Abraham did not mention this, but I think this is a 1 million pound portfolio.

Every bar on this chart shows the highest withdrawal rate that a retiree can spend on.

For example, in 1915, the highest a retiree can spend in the initial year so that he or she can have inflation-adjusted income that last for 30 years is close to 26,000 pounds a year. That is like 2.6%.

Another example is that if the retiree decide to retire in 1922, he or she could start with a 124,000 pounds a year spending instead. That is like 12.4%.

With this table you can see in the past 106 years which are the tough periods in the UK.

Abraham’s point is that in the worst year, which is the 30-year starting in 1948, the highest safe rate that you can spend is closer to 25,000 a year or 2.5%.

The past 106 years in the UK contains periods of Negative Interest Rates

The important point is that, during this 106 years, there were already many periods of negative interest rates.

This is not new.

Abraham layered the US and UK government bond yields out.

This chart is a gem because… if you tried looking for these yield data and you could not find it, it means this is just that valuable.

There are a lot of periods of negative yields and you realize that they occured during the World War 1 and Spanish flu period, the World War 2 period, the 1970s oil embargo high-inflation period, the European crisis after the GFC.

The 2.5% safe rate factored in these periods of negative bond yields, but also the periods where bond yields hit 45% a year in 1922.

Abraham also published some of the worst calendar year real returns for UK bonds in history:

We can be worried about negative bond returns, but UK have like 100 years of history and they have had some really challenging years of negative bond yields.

This is not something new.

Summary

My suspect is that many still don’t understand how withdrawal rate study really work and the significance of its study.

Morgan Housel mentioned that we learn the wrong things from history. The lesson may not be “don’t buy internet stocks”, or “don’t buy Tulip bulbs”.

The lesson here to me is that in the body of history that we have, there were many adversities such as wars, high inflation, negative bond yields, low returns. These are not new.

The link to the safe withdrawal rate is that, it is a historical study that factors in all these evidence of history.

With that, hopefully, you understand what does that 2.5% withdrawal rate signifies.

Do Like Me on Facebook. I share some tidbits that is not on the blog post there often. You can also choose to subscribe to my content via email below.

I break down my resources according to these topics:

1. Building Your Wealth Foundation – If you know and apply these simple financial concepts, your long term wealth should be pretty well managed. Find out what they are
2. Active Investing – For the active stock investors. My deeper thoughts from my stock investing experience
3. Learning about REITs – My Free “Course” on REIT Investing for Beginners and Seasoned Investors
4. Dividend Stock Tracker – Track all the common 4-10% yielding dividend stocks in SG
5. Free Stock Portfolio Tracking Google Sheets that many love
6. Retirement Planning, Financial Independence and Spending down money – My deep dive into how much you need to achieve these, and the different ways you can be financially free
7. Providend – Where I work doing research. Fee-Only Advisory. No Commissions. Financial Independence Advisers and Retirement Specialists. No charge for the first meeting to understand how it works

A good rule-of-thumb to estimate whether you have accumulate enough to retire or not is based on a magical 4% Safe Withdrawal Rate.

This percentage was first came out based on the research of Bill Bengen in the 1990s. Back then, he became a financial planner not too long ago and his client have a problem of figuring out

1. How much they need to accumulate so that they can retire?
2. How much they can spend monthly or yearly so that they would not run out of money?
3. How to structure their portfolio?

His research was borne out of necessity but it became a rule of thumb that many in the Financial Independence Early Retirement (FIRE) space use to determine how much they need to build up towards.

This week, there were two good interviews on this subject.

Bill Bengen, now having sold off his financial planning practice, happily retired, spoke to Michael Kitces on his podcast. Karsten from the great blog Early Retirement Now spoke to Morningstar’s The Long View.

If you are someone who is accumulating towards FIRE, or financial independence, or retirement, you can gain good insights from these two interviews.

I treat these interview as a quick way to gain concise thoughts from thought leaders who have done either a lot of research, or are very experience practioners.

While they cannot go too in-depth as compared to their writings, you can hear certain important things that they emphasize on that would have been lost in the many articles they have written over the years.

Some interesting points I gathered:

1. Bengen held the view that in today’s low-inflation environment, we might be able to withdraw as high as a 5% initial withdrawal rate and things would be OK
2. Both Karsten and Bengen highlight the strong correlation between market valuation and what is a safe initial withdrawal rate to withdraw
3. Bengen highlighted that you could withdraw more if you have pension sources
4. Bengen is quite an active manager for his client’s portfolio
5. Karsten specifically talks about what made portfolios fail to last long in negative sequences
6. While he is an advocate of a diversified, index portfolio, Karsten also dabbles in uncorrelated investments such as private equity real estate and options writing

Here are my notes from the two interview, with time stamp. Let me know your takeaway.

Listen to the podcast Karsten Jeske: Cracking the Code on Retirement Spending Rates here on Player.FM.

• 2:30: “We cannot diversify our career as much as our portfolio.”
• 3:40: There are people taking a slower approach to FIRE but Karsten also have friends that like their normal lives but now are reaching out to find out more about this FIRE movement
• 6:20: There is some truth that 4% Safe Withdrawal Rate is too optimistic
• 8:10: At the same time, the withdrawal rate study factors in some seriously poor sequence such as 1929 and 1960s. If you reduce your withdrawal slightly from 4% to 3.2%, things will turn out okay.
• 9:20: If you have a longer spending period, your initial withdrawal rate needs to be lower. It is just amortization math. But the surprising thing is how little lower you need to move it. It is not like instead of a 30-year retirement, you have a 60-year retirement, you would need to move your initial withdrawal rate from 4% to 2%. It will be around 3-3.3%.
• 11:20: Using Shiller CAPE or Earnings yield and use market valuation to time the initial withdrawal rate to use. There is a strong correlation that those lowest safe initial withdrawal in history are also periods where market valuations are high
• 15:15: What if markets stayed overvalued for a prolonged period of time? By withdrawing based on a CAPE earnings yield percentage, if the markets remain overvalued, your portfolio value goes up, the absolute amount also goes up, which means that you could spend more money. It is more flexible compared to a static 4% safe withdrawal rate.
• 17:10: Is there a concern over low bond yields? Bond yields have been low before in the 1960s (and this is part of the safe withdrawal rate study)
• 19:30: Why Karsten does not like the Required Minimum Distribution approach. The main reason is that it is very rigid and not a very scientific approach. Nothing in life is as linear. In contrast, the Boglehead’s Variable Percentage Withdrawal (VPW) is a good tweak.
• 23:30: How to tackle a sequence of return risk for people with long retirements. If you have a longer period, the period of vulnerability to sequence risk also increases. Typically you can wait 10-15 years in a 30-year retirement to know your portfolio is able to survive well. For a 60-year retirement, you have to wait until 45 years later to know you are out of the woods. Some solutions
  • Just be flexible. Jobs and side gigs.
  • Have enough diversification in asset type at the start of your retirement so that it diversifies the volatility at the start of your retirement e.g. short-term cash, bonds. Sequence risk is selling volatile assets at the worst possible time and if you have enough uncorrelated assets that you can sell and get cash flow instead of selling the volatile assets, then it helps.
  • Micheal Kitces’ Bond-tent or Rising Equity Glidepath. Don’t use Target Date Fund. The glide path is so that your equity allocation is at the lowest during the lowest point in the bear market and then you pick it up.
• 28:00: It may be tough for clients at 80 years old to remain in high equity allocation. Karsten explains that you might want to use the rising equity glide path or take your equity allocation up only if you face a bear market or a negative sequence at the start of your retirement. If not, don’t rely on it so much, just have a normal allocation. Don’t do these blindly.
• 31:45: Why holding a basket of dividend stocks do not work. When you go high yield, you are being concentrated and you lose traditional high-quality safer bonds. Your dividends don’t hold up forever. Just focus on total return.
• 35:50: What kind of assets does Karsten recommend as passive assets for retirement. Private equity multifamily real estate. Sell very short-dated S&P 500 put (not passive). His majority would be passive unit trust.
• 39:00: Tackling US Health Plan and social security
• 44:00: Having an active network in retirement.

Listen to How The Creator Of The 4 Percent Rule Applied It For His Clients And His Own Retirement with Bill Bengen here on Player. FM.

• 7:30: Why Bill Bengen choose to be a Fee-Only adviser when it was not fashionable to do it (the 1990s)
• 19:00: Why did Bengen start researching on the 4% withdrawal rule. No one could answer him the question of how much to save for retirement, how much to spend in retirement.
• 22:43: How did he get close to the magical 4% number
• 25:00: People criticizing his 4% rate was too low in a 7% a year balance fund return world. Now people are criticizing his 4% is too high.
• 27:30: Bengen emphasizes that people need to be aware that the 4% withdrawal rate is a worst-case scenario and you cannot just rely on the worst-case. Given what he knows now, instead of the 4%, he would recommend a 5.25 – 5.50% withdrawal rate today in a low-inflation environment.
• 29:50: When Bengen introduced small-cap stocks, he realizes the safe withdrawal rate is close to 4.50%
• 33:30: How Bengen implements 4% with clients. It was ideal for him because they have a massive bull market during that period.
• 36:10: He wishes that financial planning software can benchmark a client’s current withdrawal rate against some historically poor sequences and warn clients before this.
• 37:40: Opinions on Monte-Carlo vs 4% withdrawal rate
• 42:00: Bengen explains how he implemented different withdrawal rates for clients. Start at 4.2%. For some with inheritance, he may start at 5.25%
• 45:00: Did September 11 affect things? (answer no. The 1960s and 70 sequence was worst)
• 49:00: What are the reasons for him to retire?
• 51:00: Bengen got his clients successfully out of the GFC. But he was unsuccessful in getting clients back in.
• 62:40: How Bengen looks at the 4% rule today and how tactically he will shift his portfolio. Bengen believes that we should look at the relative inflation and market valuation at the time you retire to judge what is a safe initial withdrawal rate for yourself. At this moment we believe is closer to 4.75 to 5%.

Do Like Me on Facebook. I share some tidbits that is not on the blog post there often. You can also choose to subscribe to my content via email below.

I break down my resources according to these topics:

1. Building Your Wealth Foundation – If you know and apply these simple financial concepts, your long term wealth should be pretty well managed. Find out what they are
2. Active Investing – For the active stock investors. My deeper thoughts from my stock investing experience
3. Learning about REITs – My Free “Course” on REIT Investing for Beginners and Seasoned Investors
4. Dividend Stock Tracker – Track all the common 4-10% yielding dividend stocks in SG
5. Free Stock Portfolio Tracking Google Sheets that many love
6. Retirement Planning, Financial Independence and Spending down money – My deep dive into how much you need to achieve these, and the different ways you can be financially free
7. Providend – Where I work doing research. Fee-Only Advisory. No Commissions. Financial Independence Advisers and Retirement Specialists. No charge for the first meeting to understand how it works

The endowment of universities is an area that I took an interest in the past because they have very specific requirements that are similar to what many look for in their wealth. (You can read could we model our retirement spending like endowment funds?)

University endowments sought to address two conflicting goals:

1. Achieve a particular level of income so as to fulfill a certain proportion of a university’s budget. The income requirement cannot be too volatile. If the university do not have this proportion of income, their operations would be affected.
2. Preserve the purchasing power of the endowment. The endowment needs to cater for future budgetary needds. Income requirements will go up over time due to inflation. The endowment would need to grow in value so as to preserve the purchasing power. This means the endowment need to grow at a particular rate of return.

You may realize this is the problems faced by many in financial independence. They need their portfolio to produce income yet at the same time they need to ensure the portfolio have enough to preserve future purchasing power.

What complicates things is that

1. The endowment may not know for a given year, how much in grants and gifts they will receive
2. In particular years, grants from the government might be cut. This puts operational constrains on the university and may mean the endowment may need to take on a higher proportion of the university operational cost. If they are not careful, this might kill the endowment’s future purchasing power.

This is the trade-off between today and tomorrow.

Investing the endowment’s fund to achieve a particular rate of return is very critical. This is the same for your money set aside for financial independence as well.

David Swensen, the famed Yale endowment fund manager who pioneered much of the forward-thinking endowment management ideas wrote the book Pioneering Portfolio Management: An Unconventional Approach to Institutional Investment.

Near the end of the book, Mr. Swensen shared with us the missteps of the New York University (NYU) endowment in the past. I thought it is too good not to share.

For context, the following were NYU endowment’s trustees:

1. Larry Tisch, chairman of NYU
2. Alan Greenberg, ace trader of Bear Stearns
3. Thomas Labrecque, president of Chase Manhattan
4. Maurice Greenberg, boss of AIG

They had the help of

1. Martin Lipton
2. Larry Silverstein, a Manhattan real-estate mogul
3. Joseph Steinberg, investor at Leucadia National
4. Henry Kaufman, who earned the nickname “Dr Doom”
5. Michael Steinhardt, Steinhardt Partners and recent years WidsomTree Investements

The Story of NYU’s Huge Bond Allocation

In the late 1970s and early 1980s, motivated by concerns regarding the fragility of the university’s finances and the riskiness of the stock market, NYU allocated an average of 66% to bonds, 30% to stocks, and 4% to other assets.

NYU differed materially from her sisters institutions by holding roughly double the average proportion of bonds and roughly half the average proportion of stocks.

Between 1981 and 1982, at the bottom of the equity market, NYU dropped its already low equity allocation from 33% to 7% of the portfolio, increasing the already high bond commitment form 62% to 90% of assets.

Bonds continued to maintain a share in excess of 90% of assets through 1985, according to public reports on asset allocation, while stocks languished at single-digit levels, falling as low as 3% of the endowment.

Even though after 1985 annual reports ceased to provide information on portfolio allocations, it appears that NYU persisted with its unusual portfolio structure throughout the late 1980s and early 1990s.

After a 9-year disclosure hiatus, in 1995 the university reported holding 86% of assets in bonds and 9% of assets in stocks, indicating a continuing commitment to bonds.

Only in 1997 did NYU begin to make a modest move away from fixed income to higher expected return assets.

Unfortunately, the bond-dominated portfolio left NYU on the sidelines during one of the greatest bull markets in history. From 1978 to 1998, stock returns exceeded bond returns in 16 of 20 years, with stocks enjoying a 6% per annum advantage over bonds.

Only in the aftermath of the 1987 crash did the fixed income strategy appear sensible, causing NYU board chairman Larry Tisch to receive a standing ovation at an NYU investment committee meeting.

Market activity supported only a brief huzzah as the S&P 500 ended the 1987 calendar year 5.2% above the level recorded at the beginning of the year.

Even when viewed from the perspective of a time frame as shot as the twelve calendar months that included one of the all-time great stock market debacles, NYU’s strategy failed to make sense.

As the bull market continued apace, Tisxh turned away questions regarding the lack of equity exposure by responding that “the train has left the station.”

Meanwhile, the opportunity costs for the NYU endowment mounted. From 1982 to 1998, an endowment wealth index for colleges and universities increased nearly 8-fold, while NYU’s endowment grew 4.6 times.

Had the institution’s results simply mirrored college and unversity medians, in 1998 NYU’s endowment would have been nearly a billion dollars large than the actual level of $1.3 billion.

Beginning in the late 1990s, NYU began to reduce its overallocation to domestic fixe income, moving assets to domestic and foreign equities and absolute return strategies.

Yet the legacy of the misguided bond bet endures, as NYU’s 2005 portfolio shows scant exposure to the important asset classes of private equity and real assets (Kyith: Swensen really likes these things.)

By failing to understand the relationship between the permanet nature of endowment funds and equity investments, NYU’s endowment sustained long lasting, if not permanent damage.

Some Personal Reflections

The burden of managing other people’s money

If you mismanage your own wealth, you suffer. If you mismanage your family’s wealth, your family suffers with you.

If you mismanage an endowment, you might destroy the legacy of an entire university. You may have jeopardized the kids’ generation down that could have benefited from the endowment.

Investing money for people you care about comes with a lot of responsibilities.

You may be able to take some concentration, illiquidity, credit, duration risk with your own money, but if you fxxk up, others are still OK.

I dunno about others but when you work in a wealth management firm like Providend, where your inputs may affect the lives of families and generations down, you really feel the weight of responsibility to not fxxk things up.

I start to have immense respect for these people managing money for others (well for those who really cared enough). NYU probably have an investment mandate that guides their allocation.

Many aim to be concentrated in the high return areas but the truth is that forecasting the forward high return areas can be tough

I wonder what led them to this kind of allocation.

1. Was it being too risk-averse after the turbulent 1970s? I don’t think so. If it is, they would have their own better inflation hedges such as equity, commodities, or gold. They moved away from these investment hedges.
2. Were they making a bet on bonds due to the ultra-high interest rates? Could very well be. Bonds have traditionally been a safe haven and have lower volatility compared to many other financial assets. It is a bonus when interest rates have fallen and the value of the bonds NYU held would have gone up a lot. It begs the question: If it ain’t broken, do you fix it?

Further research seem to show that Tisch harbored an irrational and all-weather fear that stocks were “too” expensive. Leonard Stern, a real-estate developer and long time trustee, question the bond policy.

Many investors try to suss out how to avoid certain areas of risks and uncertainties and get into areas where the returns are the highest.

In their brain, they would like to find the holy grail of investing in the sector, country or the stocks with relatively high returns yet avoid the world’s problems.

When they find that, they will dump their money in.

NYU probably found that holy grail in bonds due to the almost 20 years fall in interest rates (from 1980s to end 1990s).

But in a way they incur a huge opportunity cost because the 1980 to end 1990 was an even more massive secular bull market for stocks.

This is synomyous with perhaps our concentration on REITs, in Singapore or in the NASDAQ.

Diversification does two jobs:

1. It reduces the risk of concentrated blow-ups
2. It allows you to capture the market returns (read this)

NYU suffered from #2 in that they earn a good return but they missed out capturing an even better returns.

Many have question why not just invest in the S&P 500 and the answer is, are you OK with a decade of 0-2% a year returns for 10 years? Because that was the level of returns when everyone was rating the United States as an underperform (2000 to 2010).

The chart above shows a monthly chart of the iShares MSCI Emerging Markets ETF divide by the SPDR S&P 500 ETF Trust.

It shows the relative performance of the emerging markets versus the United States. We can see a tale of emerging market outperformance and then underperformance.

Is this a turning point for emerging markets or would it continue lower? In the small box, we see that even the frontier markets are showing strength.

What could cause a turn? I have no idea. This might not be a turn at all.

The question is… if you are concentrated in S&P 500, would this be your NYU bond moment?

What is the right way to make investment decisions as a group?

Lastly, what gets me curious was the decision making at NYU and what lessons we can carry with us in investment management.

I realize that:

1. You need to have an investment philosophy that you stick to, that you can clearly communicate. If you do not have something like that, you will be easily mistaken as market-timers or that people will be very confused by your investment decisions.
2. Yet financial paradigms may sometimes shift with is very difficult to detect when you live through it. Most things stay the same and do not change but paradigms do shift. How do you evaluate when things shift and when you should take action?

The need to be coherent yet be able to change when we need to is another tradeoff that is challenging to navigate.

I am not sure what were the conversations in NYU, but I think that it is the kind of conversations that may plague many of us. If we were in their position, we may change our allocation so often that it is as detrimental to our portfolio.

I think the right setup is a good decision making process that is independent of the investments we make.

It should be like a computer or checklist style that brings us through areas where we need to look more into, and when the evidence is strong enough, we look at the spectrum of risks, figure out whether we can live with the risks, make the decision, and pivot accordingly.

Everyone should come to the table and be radical truthseekers, no political correctness. The objective is to ensure we make the investment decisions with the greatest clarity we can.

If we fxxk it up after that then there is really nothing much we could do better. We figure out the next best decision with the new information that comes to light.

Experiences can Haunt You

Some people say that having experience in the markets can be invaluable. But it could haunt you as well.

Tisch and perhaps some of the managers and trustees were probably trained that valuation comes into play in finance. That is my training as well.

There is a price to pay for something and you should not overpay.

That vigilance not to overpay ultimately costed them.

If you are someone fresh in the markets, such as the investors today, you would have less reservations about potential dangers if you don’t know what is the danger you are suppose to guard against.

You may be able to benefit from that.

But at certain point, that lack of respect to value will come back and bite you.

Do Like Me on Facebook. I share some tidbits that is not on the blog post there often. You can also choose to subscribe to my content via email below.

I break down my resources according to these topics:

1. Building Your Wealth Foundation – If you know and apply these simple financial concepts, your long term wealth should be pretty well managed. Find out what they are
2. Active Investing – For the active stock investors. My deeper thoughts from my stock investing experience
3. Learning about REITs – My Free “Course” on REIT Investing for Beginners and Seasoned Investors
4. Dividend Stock Tracker – Track all the common 4-10% yielding dividend stocks in SG
5. Free Stock Portfolio Tracking Google Sheets that many love
6. Retirement Planning, Financial Independence and Spending down money – My deep dive into how much you need to achieve these, and the different ways you can be financially free
7. Providend – Where I work doing research. Fee-Only Advisory. No Commissions. Financial Independence Advisers and Retirement Specialists. No charge for the first meeting to understand how it works