My contrarian thought of the day? I feel that the retirement planning industry downplays the role of luck. Life is not a as certain as the smooth exponential curves that they show you. Perhaps the statistically optimal bet is to jump a bit early and hope for the best, while having a backup plan for the worst. You might just win an extra 10 years of freedom.

If you tinker with portfolio survival calculators like FireCalc and cFIREsim that model hundreds of possible paths, you may notice that the “failure” paths usually happen when a bear market occurs soon after you retire. If you keep spending when a portfolio is down, it may never recover.

Even if you have the same portfolio size, same withdrawals, and the same average returns, having the bad years occur upfront can lead to failure while having the bad years at the end can lead to success. This is known as sequence of returns risk.

Retiring in 2000 with a 4% withdrawal rate: Warning! 🚨🚨🚨 In 2021, most people happily accept that the stock market just goes up and up. However, every so often there will be a “lost decade”. If you retired in 2000 with a portfolio invested in the S&P 500 and used a 4% withdrawal rate (increasing each year by 3% for inflation), here’s how that would have looked like (yellow line):

Retiring in 2010 with a 4% withdrawal rate: More money than you started with. 💰💰💰 If you have solid returns upfront, then you gained a decade of priceless freedom! For retirees of the “Class of 2011”, consider that their portfolio is likely larger today in 2021 even after a decade of withdrawals.

Retiring in 2021? Crystal ball is cloudy. If you are in the retirement “Class of 2021”, many predictions call for another lost decade. Yet, even if the next 10 years have poor returns, better times may be right around the corner. From this article by Davis Advisors:

Though frustrating, stretches of disappointing results for the market are not unprecedented. History shows however, that these difficult stretches have been followed by periods of recovery. Why? Because lower prices increase future returns. – Christopher Davis

This article was written in 2012, and it turns out that Davis was right. As of Q2 2021, the trailing 10-year annual return of the S&P 500 is over 12% annualized. Here is a chart showing the subsequent 10-year performance after each past “lost decade of stock returns”.

Surviving the first 10 years of retirement. The lesson here is to avoid taking out big withdrawals during a stock market slump drop during the first 10 years, so that it can benefit from the rebound of the next 10 years. At the same time, you don’t want give up the chance of 10 extra years of freedom. Therefore, perhaps the best bet is to retire when you have a reached your chosen savings target (for example, 25 times annual expenses), but also maintain a detailed backup plan during the first 10 years. Here are some things you might include in that plan:

• Plan ahead for way that you can temporarily cut back on spending if you need to. Big to small. For example, plan to move to a lower-cost city, country, or housing option.
• Identify non-essential assets that you will sell if you need to. Vacation property, etc.
• Maintain employment opportunities in your current career field. Go back to part-time, freelance, consulting, etc.
• Have alternative employment plans in a different career field to create supplemental income.

(By “plan”, I mean written out on a piece of paper. This improves the clarity of your thinking.)

The most powerful way to counter “sequence of returns risk” is variable withdrawals – a fancy term for the brilliant idea of not taking out as much money from your portfolio when it is getting beaten down. But the first 10 years is the most important, and the first 10 years is probably the easiest to go back to the workforce in a limited capacity.

Bottom line. Deciding when to stop working can be a difficult, personality-driven decision, but one option is to retiring with 95-98% odds of success with a practical backup plan, rather than waiting several more years and reaching 99.5% odds of success. Accept that luck matters (and also that you might have to go back to work). However, you also might gain extra priceless years of freedom. Life is never 100% certain anyway.

Vanguard Research has published a new whitepaper titled Fuel for the FIRE: Updating the 4% rule for early retirees, which discusses its assumptions and how different factors can hurt or improve your odds of success. Many of these topics have been discussed at length elsewhere, but as always I appreciate the power of concise definitions and simple charts to help with understanding.

Here is a nice, concise definition for FIRE:

FIRE stands for “Financial Independence Retire Early.” FIRE investors save as much of their income as possible during their working years, hoping to attain financial independence at a young age and maintain it through the rest of their life—aka retirement.

Here is a nice, concise history of the 4% Rule:

Bengen (1994) calculated the maximum percentage that retirees could withdraw annually from their portfolio without running out of money over 30 years. Advisors refer to this percentage as the safe withdrawal rate. Bengen summarized his findings as follows: “Assuming a minimum requirement of 30 years of portfolio longevity, a first-year withdrawal rate of 4 percent, followed by inflation-adjusted withdrawals in subsequent years, should be safe.” And the 4% rule was born.

Here are the potential issues with the assumptions embedded within the 4% rule:

• The use of historical returns as a guide for future returns
• A retirement horizon of 30 years
• Returns equal to those of market indexes, without accounting for fees
• A portfolio invested only in domestic assets (“home bias”)
• A fixed percentage withdrawal in real terms (“dollar plus inflation”)

Here are suggested adjustments. Additional, helpful details are in the paper.

Don’t assume historical averages will hold for the future. Vanguard calculates their own forward-looking estimates based on factors like stock P/E ratios, current bond interest rates, and recent inflation statistics. They are a lot lower than historical averages, as seen in the graphic above (at the top of this post).

Understand that your retirement horizon may be much longer than 30 years. The longer a portfolio has to last, the more likely it can fail.

Minimize costs. Advisor fees, mutual fund and ETF fees, taxes, and other fees will cut directly into your net income. 1% in investment fees makes a big impact.

Invest in a diversified portfolio. Vanguard believes that adding some international assets will improve your chances of success. Right now, international stocks have lower valuations (P/E and related) as compared to US stocks.

Use a dynamic spending strategy. As you can see below, this is one of the most powerful ways to improve your odds of success. If you can spend less during a bear market (while also getting to spend more in a bull market), your portfolio’s chances of survival improve dramatically. Either your budget has enough “padding” such that cutting back won’t hurt much, or it hurts but you are willing to endure that temporary pain, or you maintain the option to work a little to earn some additional income if needed.

Vanguard doesn’t give any hard numbers when it comes to replacing the 4% number, but the lower expected future returns, longer time horizon, and fee impact all point to a lower number. However, being flexible with your portfolio withdrawals can raise the number.

I enjoy thinking about these sorts of variables and ways to optimize, but the fact is that nobody knows the future “safe” withdrawal rate, even within a percentage point. You have to let go of the idea of 100% certainty. Planning for flexibility (identifying areas to cut back temporarily, maintaining backup work options) and having belief in your ability to adapt is critical for pulling off FIRE at any reasonable withdrawal rate (say 3% to 4%). FIRE is about balancing the fear of running out of money with the fear of running out of time.

Are stocks too overpriced? Is inflation coming to crush bonds? The media is not incentivized to tell you what is often the best advice: do absolutely nothing. If you still want to take action, consider rebalancing your portfolio. If you’ve stayed invested throughout the last several years, your portfolio may have shifted as in the scenario above:

For example, imagine you selected an asset allocation of 50% stocks and 50% bonds. If 4 years go by during which stocks return an average of 8% a year and bonds 2%, you’ll find that your new asset mix is more like 56% stocks and 44% bonds.

Here are some quick tips about rebalancing your portfolio back towards your target risk level, taken from Vanguard article #1 and Vanguard article #2.

Here are three possible rebalancing strategies:

• Time: Rebalance your portfolio on a predetermined schedule such as quarterly, semiannually, or annually (not daily or weekly).
• Threshold: Rebalance your portfolio only when its asset allocation has drifted from its target by a predetermined percentage.
• Time and threshold: Blend both strategies to further balance your risk.

Here are three practical tips from Vanguard to rebalance with minimal tax drag:

• Focus on tax-advantaged accounts. Selling investments from a taxable account that’s gained value will most likely mean you’ll owe taxes on the realized gains. To avoid this, you could rebalance within your tax-advantaged accounts only.
• Rebalance with portfolio cash flows. Direct cash inflows such as dividends and interest into your portfolio’s underweighted asset classes. And when withdrawing from your portfolio, start with your overweighted asset classes. (If you’re age 72 or over, take your required minimum distribution (RMD) from your retirement account(s) while you’re rebalancing your portfolio. You can then reinvest your RMDs in one of your taxable accounts that has an underweighted asset class.)
• Be mindful of costs. To minimize transaction costs and taxes, you could opt to partially rebalance your portfolio to its target asset allocation. Focusing primarily on shares with a higher cost basis (in taxable accounts) or on asset classes that are extremely overweighted or underweighted will limit both taxes and transaction costs associated with rebalancing.

These tips are very closely related to my own simple rebalancing system. Here’s what my process looks like these days:

• Only peek once a quarter. I update my Google portfolio spreadsheet and log into Personal Capital once a quarter. Otherwise, try not to track daily movements in my portfolio or the stock market in general. Consuming more information is not always better, as you start to confuse noise vs. signal.
• Rebalance first with available cash. In my Solo 401k and taxable brokerage accounts, this includes bond interest, dividends, and capital gains distributions. During the accumulation stage, this included regular savings from job income.
• If the stock/bond ratio is still off by more than 5%, then rebalance more using tax-advantaged accounts. I have multiple asset classes, but for triggering rebalancing, I focus on the overall stocks/bonds ratio during my quarterly check-up. My equities are all “risk on” (including Small Cap Value, Emerging Markets, and REITs) and my bonds are all “risk off” (US Treasuries, TIPS, and FDIC/NCUA-insured CDs only). I can use my 401k balance (including brokerage window), IRAs, and Solo 401k brokerage plan to make adjustments with no capital gains.
• If absolutely required in a rare case, make taxable sale using specific ID of tax lots. I select the “Specific ID” method at Vanguard to identify the tax lots when selling. I can thus choose to realize a bigger gain when my tax rates are low, and a lesser gain when my tax rates are high.

Rebalancing should be a relatively minor adjustment, but selling 5% can be enough to feel like you took some positive action. (I try to avoid large, sudden changes for any reason, even though I do feel the fear at times.) If stocks go down, you can be happy you sold some stocks while they were “up”. If stocks keep going up, you’ll still be mostly invested and participating in those gains.

There are now trillions of dollars held by Target Date Funds (TDFs) inside employer-sponsored retirement plans like 401k’s and 403b’s, but you still don’t see much coverage on them in the financial media. Perhaps they are too boring to grab clicks or too unprofitable to market to individuals. Morningstar just released their 2021 Target-Date fund report (email required), and this year it seems even more focused on the employer institutional side and less on the actual employees that use it. However, Christine Benz (also of Morningstar) makes up for this with her article In Praise of Target-Date Funds.

Oftentimes, target-date critics are selling some type of investment advice themselves; they may not admit it, but they view target-date funds as competition.

My second thought when I see target-date funds coming in for criticism is to wonder: Are you seeing what I’m seeing? Because from where I sit, target-date funds have been nothing short of the biggest positive development for investors since the index fund.

Here is a summary of the benefits of Target Date funds:

• TDFs take advantage of the behavioral inertia that encourages inaction during times of crisis. There was relatively little TDF selling activity during the March 2020 market drop. In fact, the automatic rebalancing may have improved returns compared to self-directed investors.
• TDFs provide reasonable investment advice for a very low cost, and investors actually follow it. You get an age-appropriate asset mix which gradually gets more conservative over time, and the default is that people follow the advice. Many people would otherwise not be able to afford or seek out similar quality advice, and many people who can afford it don’t follow it.
• TDFs will automatically improve over time, thanks to the trend toward lower costs over time and the accessibility of new asset classes as technology and costs also decrease.

Here are some broad takeaways from the Morningstar industry report:

• The COVID-19 pandemic lowered overall retirement savings contributions by an estimated 60% when you compare 2020 net contributions vs. 2019 net contributions. This unfortunate result was due to a combination of company’s suspending or lowering employer contributions and workers lowering their salary deferrals.
• Assets continue to flow from higher-cost TDFs to lower-cost TDFs. For example, Fidelity Freedom Index funds have gained about $50 billion in assets over the last five years, while the more expensive, actively-managed Fidelity Freedom funds have lost $35 billion during those same five years.
• Competition is good. The BlackRock LifePath Index series collected the most net new money among target-date series. 2021 is the first year since 2008 that Vanguard Target Retirement hasn’t won that title. There is now a lot of competition in the low-cost, well-diversified, index-based TDF arena.

Curious what’s inside your Target Date fund? Here is the average glide path across 53 different TDF series. (M* didn’t update this chart for 2021 again, so this is taken from 2019 report.) On average, most TDFs have an asset allocation close to 90% equity and 10% bonds in the early years, with the equity percentage dropping (and bond percentage rising) as time goes on. At the year of retirement, the average asset allocation is roughly 45% equity and 55% bonds.

One important option to remember is that you don’t have to choose the TDF corresponding to the date that you turn 65. If you wish, you can pick a different year to somewhat adjust your risk level.

Gold or Silver-rated Target Date Funds. A detailed explanation and full rankings are in the report. Here are the gold/silver-rated funds for 2021:

• Blackrock LifePath Index
• Blackrock LifePath Dynamic
• PIMCO RealPath Blend
• JPMorgan SmartRetirement Blend
• JPMorgan SmartRetirement
• T. Rowe Price Retirement
• MassMutual Select Retirement
• Fidelity Freedom Index
• Fidelity Freedom
• State Street Target Retirement
• Vanguard Target Retirement
• American Funds Target Date

Bottom line. Target Date funds (TDFs) are probably under-appreciated for the benefits that they provide. For the most part, workers don’t get to choose which TDF series they can invest in, so there is little point worrying about slight differences in glide paths, recent performance, or Morningstar ratings. As long as you have one from a reputable firm with reasonable costs, you are receiving the major benefits of TDFs listed above. People who “satsifice” by settling for “good enough” tend to be happier in life than “maximizers”, so perhaps that extends here as well.

(If your fund is one of the bottom-dwellers, you may want to send this report to the HR department. Employee activism are part of the reason that these options are getting better over time.)