NYT - They All Retired Before They Hit 40. Then This Happened

The New York Times outlines the impact of the COVID-19 market crash on FIRE plans. Most FIRE plans made assumptions about strong, consistent market returns each & every year.  Nearly none of the FIRE strategies model scenarios where the market falls 30% and does not recover for a significant period of time.  Due to this many FIRE "retirements" are now in the flusher as well as suffering from travel restrictions to low cost areas to live (“geographic arbitrage).

As stated earlier - "The primary failure of FIRE is that it does not plan for low, medium, and high scenarios in regards to market returns and inflation."

NYT - They All Retired Before They Hit 40. Then This Happened
https://www.nytimes.com/2020/04/02/style/fire-movement-stock-market-coronavirus.html

Pouring Ice on FIRE

Over the past couple years there has been endless promotion of FIRE (Financial Independence, Retiring Early).  Many of the advocates outline how saving hard while minimizing expenses will allow you to retire early - often while you are only in your 30s. YouTube videos and media provide all the basic math showing stock market investments over a decade followed by a 4% withdrawal rate.

There are many positive concepts promoted by the FIRE movement including notions of minimizing debt, not buying new cars, investing in 401Ks and being frugal.  Some of these are generic ideas which make common sense for every generation.  Many of these concepts are covered in my "So You Want To Be a Millionaire" article from 2008 -- well before the FIRE movement appeared.

The primary short-coming of FIRE is that it does not consider all the possible events and complex (and likely) future scenarios.  In other words it is a simple "answer" for a "complex" problem.

Most FIRE promotional material do not account for the following:

• Medical Insurance costs when no longer covered by your employer.
• Medical Costs for serious illness (even when you have insurance it can be expensive)
• Losing a partner (divorce or death)
• Having Children (cost over $300,000 to raise each)
• Marriage (many FIRE proposals assume you will forever be single)
• Location issues (not being happy about where you moved for a low-cost lifestyle)
• Social Security - not getting significant payments due to not working 35 years

There has been a slew of recent articles that covered some of the FIRE drawbacks (and benefits) including the question of what to do after "retiring". A few articles are provided below:

• These people left their jobs behind to retire early — then life got in the way. Here’s how they coped with FIRE plans gone wrong
• I followed the path to FIRE — and learned that early retirement is the wrong goal
• 5 Myths About FIRE And Early Retirement That Just Won't Die
• 5 Things To Take From The FIRE Movement (Even If You Don’t Want To Retire Early)

The real problem with FIRE is that it does not take into account all the possible future scenarios.  What happens if inflation greatly increases? (Most millennials have never experienced this). What is the consumer index on many core consumer  items goes up greatly?  What happens if the stock market greatly under-performs? 

Most FIRE articles assume that the stock market will continue to perform well over a decade period before you start withdrawing money.  What happens if the market sinks for a decade?  The primary failure of FIRE is that it does not plan for low, medium, and high scenarios in regards to market returns and inflation.  Most FIRE planning scenarios are too simplistic; at minimum you should create a spreadsheet with assumptions about market returns, savings rate, inflation, and your expenses.  This spreadsheet should be easily alterable so that you can plan a low, medium, and high scenario for review.  Plan across all possible scenarios.

Most FIRE scenarios assume a fixed 4% withdrawal rate.  Withdrawal rates are a complex problem without a single fixed answer.  Individuals must take a look at withdrawals in more detail.  One good source of information is - The Ultimate Guide to Safe Withdrawal Rates – Part 19: Equity Glidepaths in Retirement

One other item to note is that many FIRE plans promote saving with 401Ks and IRAs.  Using 401Ks is important to get an employer match (effectively free money). The one detail that FIRE articles fail to usually mention is that while 401Ks / IRAs are tax-protected -- there are significant penalties for early withdrawal. Usually you will not be able to withdraw this money (without penalties) until long after you retired early.

While I agree with many of the investing and savings concepts driving the FIRE movement, there is a need to pour some ICE on FIRE due to the lack of effective scenario planning and the failure to account for common life events.

Even the AARP is wondering "How much longer will Social Security be around?"

While the media continues to spew headlines proclaiming the death of pension plans   ('It's really over': Corporate pensions head for extinction as nature of retirement plans changes)- an event for most corporations which occurred over two decades ago; there is minimal mainstream press over the risk of depending on Social Security in retirement and what planning actions you should take.

There have been numerous articles outlining how the system will run through its reserve assets by 2035 and will need to reduce payments if nothing is done (AARP: How much longer will Social Security be around?) and multiple politicians running for office in 2020 have proposed plans for "saving" social security.  The bottom line is there has been no action in Washington D.C. for two decades.  Either there must be a increase in the portion of salary taxed and/or for an increase in the ceiling on the amount of salary that is taxed.

This lack of political action, of course, has left the Social Security system in a unfortunate position where it will not be able to fulfill its obligations starting in 2035 (according to the 2019 Trustee Report). "OASI would be able to pay 77% of promised benefits when funds are depleted in 2034" according to USA Today What happens when Social Security goes broke?

The action needed in your retirement planning

The bottom line is that with no mechanism to rescue Social Security in place you should be expecting payment cuts of 23% in whatever payments you expect out of Social Security out in 2035 Your retirement planning should include this expectation plus the assumption of no cost of living increases.

Any retirement plan evaluating cash flow in your later years should have this assumption in place as one of the scenarios to be evaluated.

Retirement Calculators

I have finally reached the point in life where I am looking for retirement calculators.  Maybe this is just wishful thinking because there is someway to go before I am eligible for social security.

Along the way I have been searching for online retirement calculators and articles.  I have created a spreadsheet for savings, investments, and spending by year -- which at some point when its perfected I will post.

In the meantime I found a good article which references several good on-line retirement calculators.

5 Excellent Retirement Calculators (And All Are Free)

https://www.forbes.com/sites/robertberger/2015/07/12/5-excellent-retirement-calculators-and-all-are-free/#7631ca374d1c

401K: Focus on Fees

Subtransfer agent fees, early redemption fees, custodial fees, wrap fees, investment adviser fees, 12b-1 fees, brokerage commissions, administrative fees, revenue sharing fees and fees for services… The list is so convoluted and endless, the mutual fund firms can’t even create diagrams depicting the fees that can be readily understood. If the industry itself can not even determine how they are fleecing the plan participants then how are the corporate sponsors and employees ever expected to figure it out.

Fortunately the Department of Labor is stepping up to the table with demands that the fees are properly disclosed on the ERISA-required form that every plan must file annually with the federal government. The changes are expected to be put in place in January 2009.

Hopefully these changes will help end the 401K plan practice of finding every possible angle to stick it to investors. A recent HingeFire post (see What is the cost to beat the market?) outlined how mutual funds have found new inventive ways to pick the pockets of mutual fund investors. Fees can make a significant difference in the amount of funds available for an employees’ retirement and it is critical that 401K plans are more transparent with all the expenses charged to plan participants.

Bankrate asks “Why's Your 401(k) Plan Heading South?” -- the answer is Fees.

Lifecycle that makes sense

Many savvy financial experts are hesitant to recommend lifecycle or target-date funds because many are just a pyramid of fees; burdening the investor with the expenses of both the underlying funds and additional fees for the management of the life-cycle fund. These funds come across to many as just another way for fund families to increase their revenue. Coupled with the reality that very few of these funds outperform their associated indexes, most investors would be better off managing their own diversification.

The crux of the problem is the expenses; automatic lifecycle as a concept works if the fees can be reduced. Fortunately there are a number of ETFs now offered that provide expenses that are typical less then half of most life cycle funds in the market. Target date funds are popular conceptual with investors simply because you can “set & forget”; the advent of life-cycle ETFs are likely to enhance their broad acceptance with the probable added benefit of driving many large mutual fund families to reduce their fees for these vehicles.

TD Ameritrade and XShares have launched five new target-date ETFs; TDAX Independence 2010 ETF (TDD), TDAX Independence 2020 ETF (TDH), TDAX Independence 2030 ETF (TDN) and TDAX Independence 2040 ETF (TDV) and TDAX In-Target ETF (TDX). These target-date ETFs have expense ratios of 0.65%, compared with about 1.3% for the average comparable mutual fund, Other ETF underwriters plan to offer other lifecycle choices shortly, many of these will have even lower expense ratios.

The recent round of pension reform, in which QDIAs were defined by the U.S. Department of Labor, will place lifecycle offerings as the default investments in numerous 401K plans. Many of these retirement plans will likely start considering the ETF lifecycle products as employees clamor for lower fees.

New ETFs Target Retirement Market
http://finance.yahoo.com/focus-retirement/article/103739/New-ETFs-Target-Retirement-Market?mod=retirement-401k

What is a QDIA? and why should I care?

QDIA stands for ‘qualified default investment alternative”. The recent determination of what investments qualify as QDIAs opens the door for automatic enrollment of many Americans into their corporate 401K plans. Nearly 20% of workers do not enroll in their corporate plans, many times missing out on company matching and the ability to accumulate funds for retirement.

Under the Pension Protection Act of 2006, employers can now automatically enroll their employees in the company’s 401(k) plan. However firms have been waiting on the ruling by the U.S. Department of Labor regarding what meets the requirement to be QDIAs before moving forward.

Employers can now direct the funds of automatically enrolled employees to balanced mutual funds, lifecycle / target-date funds, and managed accounts. Stable value funds and guaranteed insurance contracts (GICs) no longer meet the criteria to serve as QDIAs in 401K plans. Most financial planners view this change in a positive light; balanced and lifecycle funds are far more appropriate for 401K retirement plans then fixed rate investments focused on capital preservation.

Qualified Approval
http://finance.yahoo.com/focus-retirement/article/103820/Qualified-Approval?mod=retirement-401k

For Golden Years: Stick with Proper Portfolio Diversification

In the current environment where the gains in foreign markets have outsized the U.S. indexes over the past few years, there are an increasing number of articles focusing on the benefits of investing overseas. Urged on by many international funds, the financial media has been hyping American investors to greatly increase their exposure to foreign markets, sometimes to the point of recklessness.

It is important that investors adhere to standard diversification strategies to ensure long term success. Greatly increasing your exposure to foreign markets now simply because they have had a good run is not prudent; remember past performance in no guarantee of future performance. Investors should keep in mind that international markets, especially emerging markets, are extremely volatile. They are just as likely to go down 50% per year as up 50% per year. The trend of the falling dollar which has ignited international gains can reverse at any given moment, backing up like a bowling ball to mow down your overseas investment returns.

Keep in mind that your retirement is funded in U.S, dollars; this usually implies that your exposure to dollars should significantly exceed the percentage capitalization that the domestic markets represent. Merely matching your domestic portfolio allocation to the 50% capitalization represented by U.S. equity markets is not sufficient. Especially in view that many of the foreign markets representing the bulk of the world capitalization lack the regulative oversight and adequate disclosure of the American stock markets.

Increasing your exposure to international investments now is really a form of market timing, something most financial advisors urge you to avoid. It makes more sense to stick to a long-term properly diversified portfolio that aligns with your age and risk tolerance.

One example of an article pushing investors to greatly increase their foreign exposure is this recent gem from Forbes:

For Golden Years, Invest Abroad
http://finance.yahoo.com/focus-retirement/article/103799/For-Golden-Years,-Invest-Abroad?mod=retirement-IRA