The Financial Independent

Risk is everywhere, but it goes hand in hand with reward. When approaching early retirement, the question becomes: how much risk do you tolerate? Oh, but the question might manifest in different ways: What’s a “safe” withdrawal rate?^[1] Should you have a mortgage (or any other kind of debt)? My stance is, don’t fuck it up— if you’ve gotten this far, the last thing you want is to lose it taking on some unnecessary risk, but conversely, if you want to succeed, then you cannot avoid playing a high-stakes game of Risk (…The Game of Global Domination).

Just like cholesterol, there’s good risk and bad risk. Playing it safe by stashing all your money in a savings account might keep your heart rate steady, but it won’t give you any significant returns. In fact, with inflation slowly chipping away at it, you might end up feeling quite deflated. On the other hand, diving headfirst into the stock market is like riding a roller coaster; it has ups and downs, and you might end up losing your lunch. And yet, a broad market equity ETF is the cornerstone of most retirement planning because it all balances out for the better over the long term.

So, what’s the right mix? Well, that’s a personal decision, my friend; it depends on where you are in the journey. From money markets and fixed income to real estate and options, there’s a whole buffet of options to choose from. Also, yes, crypto is an option, which I want to specifically call out (as I swear I’m not a hater), but you should consider these to be very high risk & reward; the epitome of “go big or go home” investments. For my own positions today, I’m sitting at approximately 10% money markets, 30% bond funds, and 60% large-cap equities. I would prefer to hold less cash, but money market rates have been very juicy. But generally, starting out, you have an excess of time for investments to pay off but limited capital, and so the “mix” might very well be just aggressive high risk & reward assets (equities, usually). Then, as you acquire more capital, your risk tolerance ought to fall, and that’s when you start buying into lower-risk assets.

Withdrawals— how much can you safely take out without sending your retirement plans tumbling down like a house of cards? Think of it as a dance between your risk tolerance and market volatility; if you’re not a fan of surprises and prefer a smooth waltz, then a lower-risk portfolio is your song. But you can’t let yourself go so low that you fall over! On the other hand, if you can handle a bit of tango with the stock market, then a higher-risk strategy might be your ticket to a higher withdrawal rate.

Imagine you stuffed 100% of your savings in a bond fund and then proceeded to retire. If the fund is generating 4 or 5% in total yield, your ability to withdraw 4% or more is practically off the table. You need to leave enough of the yield invested or you’ll start to lose out to inflation. Also, considering periods of high inflation, this bond fund might’ve actually lost money in real terms, in which case you wouldn’t even want to withdraw anything at all. Given that, it should come as no surprise that nearing retirement, the share of high-risk assets shouldn’t fall to zero; in fact, a typical recommendation might be somewhere on the order of 30-50% equities even in retirement. If you can tolerate a higher amount of risk, your empire of assets is better positioned to weather inflation and a have a higher withdrawal. Win-win.

But there’s an uninvited guest that keeps crashing this retirement party— inflation. It’s like a sneaky tax that silently munches on your money, and when you’re not looking, it takes the best bite out of your sandwich. Scary, right? Sure, it doesn’t show up on any tax return or the receipt at any store, but it’s there in the background. That’s why you can’t rely solely on low-risk investments that offer meager returns. Real risk-free interest rates have had prolonged periods of negative yield, and they’ve been below the safe withdrawal rate of 3.5-4% for more than the last 40 years^[2]. One of the reasons I’m not a crypto hater is its immunity to government debasement; it’s just a damn shame it’s still too volatile for my tastes. Like the ocean beating on a rock, you have to withstand inflation, or it’ll be worn away, and you don’t want to go back to work because of it. Remember: don’t fuck it up.

Switching gears to talk mortgages and other low-interest loans (say student debt). To keep or not to keep? That is the question. Leverage is the greatest thing since sliced bread, or so I’m told. You get to borrow money at a low fixed rate and invest in higher-yielding assets. You get to fill two plates at the investment buffet and get an extra dessert. A sweet deal! But in retirement, you’re also forced to withdraw more, rain or shine. And let’s not forget about the insurance you’re forced to buy— an additional expense of say $2500 per year that you have to pay. The downside of this cheap leverage is risk; there’s more risk to manage with a mortgage. You could end up being forced to lock in losses during bad market conditions. “No thanks” I say!

When it comes to mortgages, my immediate thought is “there ain’t no such thing as a free lunch.” From that perspective, if borrowing money to buy assets was such a good idea, why then would the bank lend you money? Why wouldn’t they take that money that they would give to you and stick it in the market and make a higher return? The banks just originate the mortgages and then sell them, you might say, but that’s still not really an explanation because the buyers of those assets down the line had the same choice. No one is going to willingly lose money… at least not for long! Unless it’s Dumb Money^[3], which probably applies to you, and it certainly applies to me. Clearly, then, having a mortgage must not be an unambiguous “win”. Personally, while I had mortgages when I was climbing the wealth ladder, as I approached the early retirement phase, I decided to liberate myself from debtor’s prison.

Risk is the spice of life, and when it comes to retirement, you need to know how much you can handle. Low-risk investments may offer stability, but they may not provide sufficient returns, and maintaining a high yield and beating inflation is going to require a strong constitution as you ride the stock market waves. Retirement is like a game of chance, where winning means sipping margaritas on a tropical beach, and losing… well, let’s not go there. May the odds be ever in your favor!

Questions / Comments, feel free to reach out to TheFinancialIndependent@gmail.com. Cheers!