Compound And Chill

We'll start with a success story from the Wall Street Journal about a 60 year old Costco employee who has accumulated $1 million in his 401k. He says he could probably retire but doesn't want to yet. I'd say he could probably make it work if he was desperate to retire but it would not be stress free unless his wife has at least half as much in her 401k. 

The way I read the article, he just contributed every pay period (still does), left it alone and it compounded. It doesn't sound like he did anything brilliant to get to this outcome and more importantly, it doesn't sound like he did anything stupid and it compounded into a lot of money. 

There's no mention of how he invested, presumably just index funds but it's just a 401k and most 401k plans' fund choices are far from optimal for various reasons but that's ok, it got the job done, he has far more money than he ever expected just by getting out of the way and letting it compound. 

An investment portfolio doesn't have to be optimal, it just needs to have some valid and reasonable basis to believe it can get the job done. I am not a fan of any product that includes AGG like bond exposure or bonds with duration (VBAIX and target date funds), they are far from optimal but they are valid and can get the job done. 

Here's an interesting study I put together that I think speaks to compounding with suboptimal allocations combined with a slightly higher withdrawal rate and beginning retirement at an unfortunate time.

I went with replicating the Cambria Trinity ETF (TRTY) because I attribute "XXX and Chill" to Meb Faber tweeting about TRTY. The study starts January 3, 2000, starts with $1 million and assumes a 5% withdrawal rate (1.25% every calendar quarter). 

Each portfolio has its pros and cons. The TRTY replication has obviously had a much smoother ride but with Portfolio 1, the investor is today almost $250,000 ahead of the TRTY replication. The starting date is about as bad as it could have been. The stock market cut in half twice in eight years but despite even taking 5% out, each portfolio has a lot more than when they started. If these people retired at a normalish age in 2000, then 26 and half years in to their retirement, they probably don't have another 26 and half years in front of them. In terms of dollars and cents, this is a successful retirement outcome.

Each portfolio clearly had drawbacks, repeated for emphasis, but the compounding worked. The drawbacks didn't invalidate the allocations and the results got the job done. 

Just compound and chill. 

And because I think it's related, an anecdote about a bridge strategy that a client is using as part of their early years retirement plan involving an inherited IRA. The law changed a few years ago requiring inherited IRAs to be emptied out in ten years (does not apply to spouses). If the inherited IRA is even sort of large, it makes sense to spread the withdrawals out over at least a few years to probably pay less in taxes. 

Taking out $300,000 all at once for example would probably kick many of us into a higher bracket versus spreading that $300,000 over five or six years. When the client was 64, he's 67 now, he started taking out a monthly distribution that annualized out to 19%. He's at the same distribution amount after three years and one month and his distribution now annualize out to 33% of his remaining inherited IRA balance. 

There's of course a sequence of return issue looking forward. We're attempting to manage the risk, getting a few months in front of his distributions but if the market does something hideous then his balance might not last three more years, if the market does something heroically great, then maybe he gets 4-5 more years out of the account. 

When we talk about bridging to a milestone like Social Security with an account that has to deplete (inherited IRA), the roughly six years we're working with in this example is a successful outcome. The client already takes Social Security so it is simply an example but his story is a template for how this can work. 

If this could be you, trying to plan what you believe is the best time to take Social Security, an inherited IRA that is bigger than an emergency fund gives you some optionality that maybe you didn't have. 

I'll pivot to my Social Security numbers to explore the optionality. My age 62 amount is $2725/mo. If I could sustain $3000-$3500 monthly distributions for three years from my inherited IRA (I don't actually have an inherited IRA) with that amount being sufficient for my needs, in three years my SS payout would have gone up to $3456/mo by waiting. 

Taking it at 62 still might be the answer you come up with but having the optionality is pretty handy, I always want more optionality if possible.

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