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Are you over complicating your finances in retirement? Or are you maybe making things too simple? That's the theme on
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today's Ask Me Anything episode, including some interesting new ideas I learned during my research about optimal
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portfolio rebalancing strategies. Stay tuned. Welcome to Personal Finance for long-term investors, where we believe
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Benjamin Franklin's advice that an investment in knowledge pays the best interest both in finances and in your
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life. Every episode teaches you personal finance and long-term investing in simple terms. Now, here's your host,
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Jesse Kramer. Welcome to Personal Finance for Long-Term Investors, episode 138. I'm Jesse Kramer. I'm a financial
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planner working with retirees and busy professionals thinking about retirement across the USA. You can learn more at
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planwithjesse.com. Yes, that's a new web page for those avid listeners. Planwithjesse.com.
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Today is our 16th AMA ask me anything episode. Before we dive in though, this week's super soft t-shirt winner is
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Growing the Valley podcast, who left a five-star rating and review on Apple Podcast. So, hey, Growing the Valley,
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thank you for the kind words. Please drop me an email to [email protected]
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so I can get that supersoft t-shirt sent out to you. Now, on with the ask me anything episode. As a reminder, these
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are real questions from listeners just like you. So, please don't hesitate to
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email me a question to the email address jessebestinterest.blog. Again, Jesse bestinterest.blog. I read
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every single email that you guys send. Now, a few questions I've gotten over
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recent months reminded me of the the Einstein quote. Everything should be as simple as possible, but no simpler.
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That's the theme of today's episode. I truly think financial planning and
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investing and retirement planning is usually often over complicated especially in the DIYer world and the
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online forums where I I'll see arguments erupt about 3/100ths of a percent as a
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fee or whether small cap value is a mandatory requirement in your portfolio or not. I've seen groups of people kind
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of plant themselves on topics like social security where they say, "Hey, if
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you don't claim as early as possible, you're a moron." And they are opposed by
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people who plant themselves on the other side who say, "If you don't delay social
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security until you're 70, well then you're a moron." So anyway, my point is
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that a lot of people have strong opinions, strongly held, and sometimes there is complexity involved. But I do
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think something I see more often than not is over complexity. So yes, you know, retirement has its complexities,
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but we can simplify it. at least we can simplify it to a certain point because you know maybe there is 10 or 20% of the
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ideas that I hear where I feel like those ideas might be too simple or too easy. So anyway, the last thing I'll say
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in this preamble is I realize that yeah, there's some subjectivity to this idea
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that I'm talking about today. And and what I'm kind of saying is there's a
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line in between too complex and too simple. And I am subjectively drawing that line here today. Fair enough. I
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won't deny that fact. So, if you think I've drawn the line in the wrong place,
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feel free to call me out by sending an email to jessebinest.blog. I'd love to
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read your email. And we're going to dive into question one right now from Wes.
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Wes says, "Jesse, I appreciate the podcast and the blog content that goes beyond personal finance 101. Speaking of
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complex things, I have a question about generating investment losses to offset appreciated assets or the income from a
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Roth conversion. My adviser has been talking about a long short strategy that I'm researching. However, I was thinking
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I could either short a stock I think will go up, risky, or simply buy a leveraged ETF, less risky, that is the
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inverse of the S&P 500. It seems like a simple strategy, but I don't see much
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content out there about this. So, I'm guessing I'm missing some pitfalls. Can
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you give me some input? I Yeah, thanks for the question. Very interesting question. Now, normally I would kind of
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dive into all the details behind your question first. I'm going to do it slightly out of order listeners in this
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question, but don't worry, you will get an understanding of exactly what Wes is
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asking here, but I'm I'm going to paint a little picture first. Now, let's say
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you've invested money in the past and you've got $10,000 in capital gains,
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which you haven't realized yet. But when you do realize it, we'll be subject to a
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we'll say a 15% capital gains tax. So, you'd owe $1,500 in tax. But then, let's
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say you pursue a strategy, maybe similar to a strategy that Wes is outlining here, that creates $10,000 in capital
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losses. those losses offset the entire gain, eliminates the tax, and you're thinking to yourself like, "Nice, you
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just eliminated $1,500 in tax." However, we kind of glossed over the fact that
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you just generated $10,000 in losses. So, the $10,000 in losses totally wipe out the $10,000 in gains, and you no
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longer actually profited from your investment. The losses offset, wipe out the gains. So, the question is, would
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you rather have $10,000 in gains and and pay $1,500 in taxes or have no gains whatsoever? I would take the first
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scenario every day. You know, why lose $10,000 to save $1,500? Now, what I've
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just painted there is a very, very simple scenario. And most of the strategies that professionals are going
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to use are certainly more nuanced and yes, more complex than what I've just outlined. Now, what they hope to do is
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create some losses and some gains. The losses are going to be realized, but the gains will be unrealized. In other
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words, the assets that are sitting at a loss, the professionals will sell those assets so that you, the investor,
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actually have losses that appear on your tax return. But the gains, they say, we're not going to sell those assets.
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We're going to hold on to them because the whole point here is that we want to
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we want to wipe taxes away. We don't want to create more taxes for you. So, we are not going to realize the gains,
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at least not yet. So your realized losses can be used to lower this year's tax bill, of course, which is nice.
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Those new unrealized gains, we kick them down the road to a future tax year. We don't have to pay taxes on the
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unrealized gains, at least not yet. So the question becomes, will we ever have to pay taxes on the unrealized gains?
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And and that's why I think in some way whenever we're talking about these kind
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of capital gains, capital loss strategies, if the problem involves kicking the gains down the road to a
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future year, that's fine. But the truth is, you can't really ever outrun that
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tax problem except by dying. Yes, by dying. When you die, your taxable estate goes to your heirs at a what's called a
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stepped up cost basis. And it totally wipes out the capital gains and it totally wipes out what would have been
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your tax bill. And that brings about a little side note, brings about a funny little pattern in financial planning
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circles where we have to balance two competing ideas. that the first idea is that everyone will die someday and we
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must treat death as a reality, as an eventuality. But the second idea is that we need to be a little cautious about
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treating death as a win and treating living as a loss. And this scenario is one example. You know, sweet, you die
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with unrealized capital gains and your heirs get a big win. It's true, but you're still dead and you didn't get to
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spend that money of yours while you were alive. or another one. You claimed social security at 62 and that ended up
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being super smart for you because you died at 71 and age 71 is well before the break even age for delaying social
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security. So, it's a good thing you claimed early and got yours. Well, who are we talking to here? The dead
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71year-olds. I mean, did they really win the game? Another one. Oh, man. Jesse, you're you're wasting $2,000 a year for
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30 years on term life insurance. What a waste. Well, are you saying I failed because I'm surviving? So epicat the
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point here is that death is a a reality and eventuality for all of us eventually
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and I genuinely think there does come a time when for example we ought to prudently say should we realize you know
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capital gains for this ill sick 87year-old or do we discuss the idea of their death because for that person if
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they're going to die soon does it make sense to realize capital gains right now
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yeah unfortunately at some point that conversation does become a reality but I'll get emails from a 55-year-old who
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thinks they're going to kick the can down the road on their highly appreciated tech stocks until they die
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30 years out, 40 years out in the future. So anyway, a funny little aside there. Let's go back to the main program
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here about this capital gains long short strategy, that kind of thing. So short of dying like we talked about though,
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what these sort of loss strategies attempt to do again is create some losses this year while not actually
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losing you money on net. Now for example, you know, Wes talks about a long short strategy in his question.
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these long short strategies. What exactly is going on here? Well, often what these strategies do is they use
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leverage, right? They use some form of borrowed money to give you extra investment exposure. It's a weird
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concept. Let me see if I can explain it. So, let's say you have $100 to invest,
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but on top of that, you borrow another $100 and that's the leverage. And the
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leverage comes with a cost to it, right? Borrowing money, taking a loan, that has
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a cost. And so, we'll put a pin in that cost for now, but you had a hundred of
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your own dollars and you borrowed a hundred more. So, you now have $200 to invest. and you choose to invest 150 of
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that into the S&P 500. If you want to get more technical, you're probably
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building a direct index of the S&P 500 by owning all 500 companies. But either
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way, you have $100 invested in the S&P and that's long, right? In investment
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world, when you're betting for something, that's considered long. When you're betting against something that's
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considered a short, like the big short. So anyway, this is a long short strategy. $150 is invested long in the
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S&P and then you take the remaining $50 you have and you short the S&P 500. Yes,
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in some way you are betting against yourself, but on net though you have $150 long and you have $50 short. So
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your net exposure is $100 long. In other words, you have the same investment exposure as if you had only invested
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your own $100 in the S&P 500. Right? Even though you you have that borrowed money, you're actually not taking any
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extra investment risk with it. You're not doing anything super risky, but you
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know that in most years, at least some part of your portfolio between the 150 long and the $50 short, at least one of
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those two parts is going to be at a loss. Or if you went the direct indexing route, you know that some of your
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individual holdings, some of those individual companies are definitely going to lose money on an annual basis.
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So, let's say some of your shorts lose money, you sell them. Those losses can
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then be used to offset other gains from your portfolio. They can be used to offset the taxes from Roth conversions,
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which would be an income tax or other forms of income tax. The point is that you can use your losses to offset taxes.
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And your adviser, Wes, would likely say, "Hey, and you didn't actually lose any
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money because your longs are up. The longs have these unrealized gains that more than make up for the shorts losing
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money." That's a totally factual statement. The question is, and I'll go
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into this in more detail, the question is, would you have been better off just being 100% long in the first place and
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not dealing with any of the losses in the first place? I'd wager, at least for
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a lot of people, the answer there is yes. So, in my experience, the best strategies for using any sort of kind of
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capital losses to offset gains, it occurs when the losses are incidental, not when the losses are purposeful. And
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not all of us in our investing lifetime are going to have those incidental losses in our lives, let alone on a on
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an annual basis. And that's totally okay. In other words, what I'm saying
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here is for some people, your portfolio will do nothing but go up. Or at least it'll go up so much that by the time it
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goes down, you're still up. You're not below where you started because your
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portfolio has grown so much since the start. So if you find yourself in this situation, that's not a bad thing. Your
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portfolio is up. So sometimes you might get some incidental losses and you can use those incidental losses to offset
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capital gains to offset some income taxes. That's great. But one of the big questions I have is should we let the
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tax tail which might be a 15% tax tail wag the investing dog which is going to be 100% of the underlying money right
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the investments themselves. Now direct indexing has all the same issues. You know this strategy what I should say a
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long short direct indexing strategy has all the same issues as all direct indexing strategies which we discussed
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on episode 121. You know those issues are higher costs some tax pitfalls especially when it comes to the wash
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sale rule tracking error against the index diminishing benefits over time asset minimums. Only relatively wealthy
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people can even begin to participate in these strategies. And then it only applies to taxable accounts here. Right?
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None of this applies to retirement accounts cuz those are all qualified in the first place. There aren't gains,
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capital gains. There aren't capital losses inside of a retirement account. But the diminishing benefit over time is
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a really big one, Wes, that I want to focus on. A lot of these strategies require forever maintenance because if
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you recall, you're not really making the capital gains totally disappear. When
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your direct index, if one side of your long short portfolio is kicking off losses, the other side is creating
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unrealized gains. And so to liquidate this direct index long short portfolio, you would have to realize all those
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gains and that flies in the face of what you're trying to accomplish in the first
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place. Who would do that? So what ends up happening is you're going to have to
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maintain this this strategy for a long time. But the costs of a direct index portfolio or the costs of a long short
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portfolio where there's some some leverage, those costs will still be there for a long time. So if you're
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choosing to pursue one of these strategies, I think it's important to look at what your tax savings might be,
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you know, this year, next year, and other high tax years, totally important to look at that. And it's important to
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see how much in losses your portfolio is going to generate because as long as markets generally go up over time, the
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fact is you will have fewer and fewer losses as time goes on. We call that loss decay or tax alpha decay. And then
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you're going to need to measure against that how much indirect index fees you'll
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expect to pay not just this year, not just next year, but for decades. And it probably does feel amazing. It is
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amazing that an investor who pursues the strategy might get 3% or 4% in tax alpha
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or in extra performance that comes from saving so much money on taxes, but eventually that tax alpha will drop to
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zero and the fund is no longer creating any sort of meaningful losses for you to
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use. And even if it was, you might not be in a tax situation anymore to use those losses, but you're still paying
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half a percent, 3/4 of a percent, 1% per year. And so the tax alpha that you got
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when you first started the strategy is slowly getting eaten away by the much higher than normal fees that you're
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paying. And the people who use the strategy, quote unquote, the best the best candidates for this strategy, I
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should say, are not, you know, the late60s retirees. They're people in their 40s and 50s. They're the higher
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earners in the best years of their careers. They're getting paid maybe an equity compensation from a publicly
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traded company. These are the people who might have to hold that direct index long short strategy for 40 or 50 more
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years less they want to realize all the capital gains that they avoided in the first place. But holding the strategy
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for 30 or 40 or 50 years as I just identified has its own big problems. So, in summary, I have some serious
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reservations about this strategy, and I think for the vast majority of people out there, including many of the
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wealthier people who might be listening right now, I'd be cautious here. As Einstein said, this is not as simple as
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possible. Thank you for the question. Uh, Wes, here's a quick ad and then we'll get back to the show. I love
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getting your questions and some of you ask me questions about the wealth management firm I work for in Rochester,
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New York. Others ask about the best interest blog and this podcast, Personal Finance for Long-Term Investors, which
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operate without advertising, without pushy sales, and with no pay walls. How can the blog and podcast stay afloat
00:15:10
without me dumping my own money into it? Well, to answer both those questions, I
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want to point you to episode 78 of Personal Finance for Long-Term Investors. I intentionally recorded
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episode 78 to shine light on those topics and inform you how you are actually helping and can continue
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helping these projects carry forward. So, if you've ever been curious about the business of my blog and podcast, or
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if you're curious about my day job in wealth management, please check out episode 78 and let me know what you
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think. And now on to question two from Cliff. As I get closer to my retirement, I wonder how long my retirement savings
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will last. My wife has some of her IRA with a trusted broker who is suggesting a 5% withdrawal rate. She asked how long
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it will last and he said likely forever because it should return 8% on average and we would only be taking 5%. Do you
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agree with this, Cliff? Thanks for the question. And I believe the explanation that this broker suggested to your wife
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is on the too simple side of things. It is too simple. After all, if we use the broker's logic, if it's returning 8% on
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average, why can't your wife withdraw 7.9% per year? I think the same logic ought to apply, right? 7.9 is less than
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8 and that should probably last forever, too. So, there's a problem there. Let me
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try to add a little bit of nuance to what the broker said. I think what the broker should have said is history would
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suggest that your portfolio will return 8% per year on average and therefore most of the time you could easily
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withdraw 5% per year, maybe even a little more and be totally fine. However, this simple framework overlooks
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a really important fact, which is that the earliest years of your retirement matter the most by far. If the early
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years have very bad investment returns for you, it creates this chain reaction that affects the rest of your retirement
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timeline. We call this the sequence of returns risk. And in order to mitigate that risk, we recommend planning your
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withdrawal rate in the four to 5% range at least to start and then we can revisit that withdrawal rate over time.
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Now, that's obviously a longer, more complex statement than what the broker said, but if the broker had said
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something like that, I think it would have been much closer to the truth. If you look at how the 4% rule was
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originally created, what you see is that in more than 50% of historical scenarios, we actually could have
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withdrawn more than 6% per year. We could have used a 6% rule adjusted up for inflation every year and been
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totally safe. In fact, in some scenarios, you could have withdrawn more than 8% per year and been totally safe.
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But in the worst scenario, in the back testing, you could only withdraw 3.9% per year to avoid depleting your
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portfolio. And again, that's with all the 4% rule, Trinity study assumptions
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of a 50/50 portfolio and etc., etc. We won't get into all those details on this
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episode. The point is that we draw the line at 4% because in one of the 100 back tests, 3.9% was the place where it
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failed. So that's why we draw the line at 4%. And I think the question is, should you let that one worst case
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scenario define your retirement? And and one of the big problems is just that there's so much luck of the draw, right?
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someone who retired in the early 1980s and if you're not, you know, a student
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of market history, a big bare market and kind of the stagflationy7s which were really bad that really ended
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in in about 1982. Starting in 1982 was what some people consider and and kind of if you look at the numbers might be
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the best bull market of all time. 1982 through 1999 stopped by the uh internet bubble. And you could also point to
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maybe like March of 2009 through today as being another one of the greatest bull markets of all time. Anyway, if you
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retired in the early 1980s, you could have lived your entire 30-year retirement withdrawing more than 8% per
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year adjusted each year for inflation, right? They could have retired and and think about that. The 4% rule means you
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have to save 25x your portfolio. Well, this particular retiree who retired in the early 80s, they could spend more
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than 8% per year. They could have retired with only 12 times their annual spending saved in their portfolio. They
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don't need 25x. They only needed 12x. But someone in the same circumstance as
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retiring in the mid60s, they, as I mentioned before, that was the the worst case scenario. They could have only
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withdrawn 3.9% per year and would have needed the full 25 times their annual spending to retire. And that's a massive
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difference in how much you need to save to retire. And it's solely due to, in
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this case, the good or bad luck of timing. So, here's my personal recommendation or personal solution for
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how to think about this problem. I think you can use the true 4% rule as a starting point, but only a starting
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point because that 4% rule creates a conservative bookend that kind of limits one side of what your retirement might
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look like. If you want an easy, but admittedly still flawed, rule of thumb to be a little more optimistic, it's
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that a 5% withdrawal rate has been safe in most historical scenarios. that a 6% withdrawal rate has been safe for about
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half of historical scenarios. And obviously your specifics matter a lot here. And I think if you're willing to
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be flexible, specifically by decreasing your spending during poor market periods, then you're probably going to
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avoid many of the bad outcomes that come from higher withdrawal rates. When you hear about the 4% rule, the 5% rule, the
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6% rule, when you hear people like me describing them to you on a podcast, that particular retiree in the
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simulation, so to speak, never adjusted their spending once, right? There are people, and there were investment
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markets where the market was down 30%, their portfolio was down, you know, whatever, if they're if they're
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halfinvested in stocks, their portfolio might have been down 15 or 20%. Maybe they lived through the.com bubble. Maybe
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they lived through the great financial crisis. Their stock side of their portfolio was down 50%. And they never
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once adjusted their spending. Now, that's probably not realistic, right? Most of you, most of us are going to
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adjust your spending. So, that's why I say if you're willing to be flexible,
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specifically by decreasing your spending during poor market periods, you'll surely avoid many of the adverse
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outcomes that come from higher withdrawal rates. And then ultimately, if you want precision, which many people
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do, then your unique retirement attributes and really what I think about here is your unique kind of spending
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profile over your retirement has to be used to hone in on a better answer for you. So again, because the 4% rule is
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kind of based on some really rigid inputs that went in to create it, we need to add some flexibility to those
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inputs. So what I think we should do there is you should say, what exactly does safely spend mean to you? How will
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your spending change from year to year throughout your retirement? How is your portfolio allocated among different
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assets? Because 4% rule is just 50% stocks, 50% bonds. How long will your retirement last? The 4% rule is based on
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a 30-year retirement. Maybe your retirement is going to be different. What does inflation look like during
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your retirement period? I realize that's impossible to know, but inflationary
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assumptions are extremely important for any kind of projection, retirement projection, especially over multiple
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decades. And then of course, what will investment returns look like during your retirement? Again, impossible to know in
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advance. But what is very uh easy to find out and what I think we all need to find out is basically if I spin the
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dial, if I dial up or dial down inflation, if I dial up or dial down investment returns, how does that affect
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my results? And that's where some analytical retirement tools uh can do a lot of heavy lifting. So, what I've
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described here certainly isn't easier or simpler than what Cliff's wife's broker
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said. It's much more nuanced than what Cliff's wife's broker said. But I think
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it's important that we understand that not everything can be simplified all the
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way down to hey so easy that a third grader can do it. So thank you Cliff. Good question. I appreciate you writing
00:22:30
in. And now Q3 is from Lucy. Lucy says we're both 60 years old and looking to
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retire soon. My husband has been sending me some articles that really push for both of us to claim social security as
00:22:40
early as possible due to future social security liquidity concerns. Can you play devil's advocate against his idea?
00:22:47
Lucy, I would love to be the person. I'd love to be the man who argues against
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your husband. That's definitely a role that I want. You know what? Just call me
00:22:54
up anytime you want. If you want to prove him wrong, I'm sure he's going to
00:22:57
understand and uh he'll just play along nicely. Hey, a strange guy on the internet with a podcast is telling me
00:23:03
how I'm wrong. No, I'm kidding, Lucy. I'm happy happy to help. And I hope I I
00:23:08
add enough nuance here to, you know, maybe just expose your husband to some interesting ideas that he hadn't thought
00:23:13
about before. Let's first discuss the liquidity or viability of social security itself and then we'll talk
00:23:19
about the good, better, and best social security claiming strategies. So yeah, will social security still be there when
00:23:24
you need it to be? Many of you might have seen or heard that the social security trust fund could be depleted
00:23:30
sometime in the mid 2030s. And to many people that sounds like the system is about to break apart and and probably
00:23:37
will stop paying benefits. But that is not the truth. And that's far far far
00:23:41
from what the projections actually say. So when the trust fund reserves are depleted again 2033, 2034, 2035, social
00:23:48
security will still be there. What's going to happen though is that incoming
00:23:52
payroll taxes are going to fund most of the benefits. And and that's actually
00:23:56
what's going on today. It's just that most of us don't realize it. Every
00:23:58
working person, right, pays social security taxes every year. And those taxes currently support something like
00:24:05
80% of all the social security outflows. The trust fund, which is going to run out eventually, the trust fund covers
00:24:11
the remaining 20%. So, if the trust fund went away today, the current social security taxes that we are all paying
00:24:18
would make retirees about 80% whole. Now, that's not a good outcome. Obviously, we don't want that. We
00:24:24
shouldn't accept that. We want to make everybody 100% whole. But what I just
00:24:28
described being 80% whole is far different than saying that your social security benefit is going to zero. If
00:24:34
you'd rather have a story that deals with numbers, think of this. 70 million
00:24:38
Americans collect Social Security benefits today. And looking at the population distribution by age, those
00:24:44
numbers are pretty unlikely to change over the next 10 years. So again, 70 million people will be collecting social
00:24:49
security roughly by the mid 2030s. All of them are voters, right? They're over
00:24:53
the age of 18. And if you tell 70 million people that their income is going to get cut either by $2,000 a
00:25:00
month if the system just totally disappears or by even $400 a month, which would be if the benefit cut gets
00:25:06
cut down to the 80% number, those 70 million people are not going to like that outcome. And so where there's a
00:25:11
will, there's a way. And I would bet that the retired electorate has a will to not let Social Security benefits get
00:25:17
cut. Now, according to projections from the Social Security Administration, closing the gap could be achieved with a
00:25:24
bunch of different policy changes. Increasing payroll taxes, which wouldn't be fun. Raising or eliminating the
00:25:30
taxable wage cap, that's an interesting one. You might know that only the first
00:25:33
$180,000 of someone's earned income is subject to social security tax. You know, Warren Buffett, who you know, I'm
00:25:40
a fanboy of, he loved to call out the the BS on this fact because he paid the same amount of social security tax each
00:25:46
year, which was about $10,000 on the 180,000. So, you know, Warren Buffett is paying $10,000 a year in social security
00:25:53
taxes, and so was his secretary, right? Every dollar that Warren Buffett earned over $180,000 in a year is not subject
00:26:00
to social security tax. So, if they raise that cap, it's an additional tax basically on the highest income earners
00:26:07
for sure. But yeah, it would help close that gap. Other policy changes, they could gradually adjust benefits. I think
00:26:12
this is possible and likely. They could increase the retirement age modestly. I think that is also quite possible and
00:26:18
likely. And I think there's a unique take that I haven't really heard mentioned very often. They could
00:26:22
actually lower the retirement age below 62, but then pair that with a relatively
00:26:27
severe throttling of the benefits themselves. You know, right now you might know that collecting at age 62
00:26:33
gives you 70% of your full retirement benefit. Or in other words, you take a 30% haircut for life if you choose to
00:26:40
collect uh social security at age 62. Well, what if they allowed you to collect at age 60 with a 50% haircut for
00:26:46
life or whatever the numbers have to be? Cuz again, I putting myself in the shoes
00:26:50
of an actuary. I we need to do something that lessens the overall stress to the social security system. And there is a
00:26:56
way to say, "Yeah, we'll let you collect early, but we'll give you such a big
00:27:00
haircut that actually it ends up being better for the system overall." And none
00:27:04
of those changes require dismantling the system. So Lucy, I think it's fair to
00:27:07
share those ideas with your husband. It's very unlikely that Social Security
00:27:10
will be going away. And now that brings us to the optimal time to collect. Let's
00:27:14
start with something obvious and simple, but pretty important. If you knew exactly when you and your spouse were
00:27:19
going to die, then you could precisely pick your best, most ideal social security claiming dates. And of course,
00:27:24
you don't know that. But I think it's important to make the most educated
00:27:28
guess that we can because when it comes to an optimal strategy, what we have to do here is say, well, the probability
00:27:34
suggests that we are going to die at ages A and B and therefore we should claim our social security in this way.
00:27:40
Social Security uses this concept called full retirement age, FRA, full retirement age, to determine how much
00:27:46
your eligible benefit you will get to collect. Your personal full retirement age depends on the year you were born.
00:27:51
For most of well I shouldn't say for most for all of today's retirees it's
00:27:55
either 67 or 66 or maybe 66 in a certain number of months as I just alluded to you can start collecting at age 62 or
00:28:03
before your full retirement age but there's a price to pay and your benefits
00:28:06
will be permanently reduced but then if you wait to collect until after your full retirement age then your benefits
00:28:12
will be permanently increased. Now if there's just one person involved so there's not a spouse involved just yet.
00:28:17
If there's just one person involved and all you have to think about is your own
00:28:20
benefit, then the pure logic and the pure math is pretty straightforward. It basically says if you die before age 77,
00:28:27
then collecting as early as possible would have been best. But again, we have to go back to earlier where it's like,
00:28:32
well, if you die early, is that really a win? I know, I know. But pure math and logic says if you die before age 77, you
00:28:38
will have wished you started collecting social security at age 62. If you die between ages like 78 and 80, early 80s,
00:28:45
then all the scenarios, all the ages are roughly equal. And then really if you die after age 80, especially it becomes
00:28:52
really clear if you die like after age 82, then having waited until age 70 to start collecting will have been best in
00:29:00
hindsight, right? I think this makes sense because your benefit goes up if you wait to collect till 70 and
00:29:05
therefore the longer you live after age 70, the more likely that is to have turned out to been a smart decision. But
00:29:11
there is much more to consider here. And I think to get to the real meat of the answer, you know, what are some
00:29:15
applicable strategies, thought processes, if then scenarios that can guide you and your family in social
00:29:20
security decisions? The poker player Annie Duke, she'd like to say that two things determine the outcomes in your
00:29:26
life. Thing one is the quality of your decisions and thing two is luck. So, put another way, there are some things in
00:29:32
your control and some things out of your control. And so, whatever decision you make regarding social security, you have
00:29:38
to accept that luck might strike and your decision won't have been the optimum one. And it's not because you
00:29:42
made a bad decision. It's just because of luck. Even though bad luck might screw you over, you still want to make a
00:29:47
a high quality decision if you can. You want to try to get this right. So, let me start with this. Social Security is
00:29:52
pretty close to a one-way decision that you cannot undo. But the exception to that is that once you start collecting
00:29:57
social security, you do technically have up to 12 months to change your mind. And
00:30:02
if you do change your mind, then you have to repay any of the benefits that you'd received so far. They call that a
00:30:07
withdrawal. And you get one of those withdrawals in your lifetime. A little known fact, you can undo your decision
00:30:12
to start claiming Social Security. But once you delay Social Security, right, you can never go back in time and
00:30:17
reclaim your missed benefits. You can't be 67 years old having never claimed and
00:30:22
say actually I want to retroactively go back to 63 and and start collecting. So ideally that's why you want to get this
00:30:28
decision right. You know in a perfect world you you get it right the first time. So let's think about you and your
00:30:33
spouse. Spousal benefits and survivor benefits two different things. Spousal benefits and survivor benefits. Many
00:30:39
rabbit holes in social security planning. And spousal and survivor benefits are two of those rabbit holes.
00:30:44
And I I mean rabbit holes because there are many paths and they go pretty deep and it's easy to get lost. The upshot
00:30:50
for basic social security planning is that your decision to collect social security not only affects you, but it
00:30:57
could affect your current spouse. It could affect your expouse andor it could affect your future spouse or your future
00:31:04
widow. So basically, it doesn't matter who you're married to now, who you were
00:31:08
married to in the past, or who you might be married to in the future. your decision to collect social security is
00:31:14
likely going to affect them. So let's say Bob has a primary insurance amount
00:31:18
of $3,200 a month. Again, that primary insurance amount that represents what Bob would have collected if he collects
00:31:23
at his full retirement age. So if he collects early, it's going to be less than 3200 a month. If he collects late,
00:31:28
it's going to be more than 3200 a month. But we'll say Bob's primary insurance
00:31:32
amount is 3200 a month. Bob's married to Sharon. Her PIA is 1,200 a month. And
00:31:38
let's say to make this simple, they both opt to start collecting at full retirement age. And thus, they're
00:31:42
collecting exactly 100% of the PIA numbers we just described. 3200 for Bob, 1,200 for Sharon. Well, right off the
00:31:50
bat, Sharon will be collecting something called a spousal benefit. Now, why? It's
00:31:54
because Sharon's benefit 1,200 is less than half of Bob's. Bob's 3200. Half of
00:32:00
3200 is 1,600. So, Sharon's 1,200 is less than half of Bob's. So, she is
00:32:06
eligible for 50% of Bob's PIA or $1,600 a month. So, she's going to collect her
00:32:12
own $1,200 benefit and then she's going to get an additional $400 a month at no
00:32:17
sort of penalty to Bob at all. There's no penalties involved. No one is losing
00:32:21
any benefits here. It's just that as a spouse, you are eligible for 50% of your
00:32:26
spouse's PIA. And yes, Sharon is collecting this while she's alive and and while Bob is alive. This is the
00:32:32
spousal benefit and the ages that Sharon and Bob choose to collect social security. Again, if they had chosen to
00:32:37
collect early, if they had chosen to collect late, those decisions do affect what the spousal benefit looks like. So,
00:32:43
it's important to know that. Now, what if Bob dies? Well, notably, if Bob dies,
00:32:48
Sharon is going to step up into Bob's full benefit, receiving the full $3,200
00:32:53
a month that that Bob was receiving. Sharon's own benefit would would drop away. However, if Bob had started
00:32:59
collecting early at age 62, his benefit would have only been about $2,300 a month. And after Bob died, Sharon would
00:33:06
step into that $2,300 per month benefit. And if Bob had started collecting, say at age 70, his benefit actually would
00:33:12
have been about $4,000 a month. And Sharon would have stepped into that $4,000 a month benefit when Bob died. So
00:33:19
the point is that Bob's decision to collect at 67 and collect $3,200 a month. It didn't only affect his benefit
00:33:26
while he lived. It also had these side effects on Sharon's benefits both while
00:33:30
they were alive and after Bob died. So the point is again that spouses need careful consideration when deciding when
00:33:37
to claim social security. They need to consider various scenarios for which spouse dies first and at which ages. So
00:33:44
some rules of thumb for you when it comes to these spousal and survivor benefits. Again, it's a spousal benefit
00:33:49
when they're both alive and Sharon was collecting half of Bob's benefit. It
00:33:53
becomes a survivor benefit once Bob died and then Sharon steps into Bob's full
00:33:57
benefit. So some rules of thumb here that apply in a lot of cases, maybe not every case, but apply in a lot of cases
00:34:03
is that the lesser earning spouse, so in this case, Sharon, the lesser earning spouse can often start collecting social
00:34:09
security as early as possible, but that the higher earning spouse should delay social security as long as possible to
00:34:16
age 70 because again, their decision to do so has a 100% chance of affecting their own benefit, but then also has a
00:34:24
roughly 50% chance of affecting their spouse's eventual benefit. with, you know, the Sharon and Bob scenario being
00:34:30
a perfect example. If Bob had waited till 70, his own benefit would have been higher while he was alive and also
00:34:36
Sharon's benefit would have been higher after Bob died. Now, I think it's okay
00:34:40
too to dig into the probabilities of who dies first. You know, to think of health, illness, family history, that
00:34:45
kind of thing. The most common questions that you can ask yourself surrounding your kind of a married couple's decision
00:34:51
to collect social security revolve around your personal health and and family history. You should ask, does
00:34:56
anything there in your personal or family history point to either an early or a late death? If you're healthy and
00:35:02
all your relatives live to 100, it's reasonable to assume that you might have
00:35:06
a similar fate. If you're chronically ill and your relatives have all passed
00:35:09
away early, again, you could reasonably assume that you might have a similar fate. Certainly not a doctor here, but
00:35:14
the idea is that they say genetics load the gun and environment pull the trigger. The idea is, you know, yeah,
00:35:19
you aren't condemned to your family history. You do have dials to control. Don't forget that. But it's worth
00:35:24
understanding what either your family history or your personal health history looks like. Next, I would ask yourself,
00:35:30
do you really need to take Social Security early? Like truly, do you have a financial need to take it early?
00:35:35
Because if that extra income is going to bridge the gap between cat food and a normal human diet, well, maybe you have
00:35:42
to take it early. But if you don't need it, why are you taking it early? Delaying Social Security acts as
00:35:47
longevity insurance. In fact, the full name of the Social Security program for retirees has longevity insurance right
00:35:54
there in the name. So, protecting against the risk that you're going to live to 90 or 95 or beyond, that's
00:36:00
pretty important. And the longer you wait, the higher your benefit will be and the better your long-term outcomes
00:36:05
will be. Now, going back to Lucy's original question, she mentioned that they're retiring soon. But what if
00:36:09
someone wanted to keep on working? Are there any interactions between your normal work income and social security
00:36:14
income? The short answer here is yes. there's a negative interaction if you are younger than your full retirement
00:36:20
age, but there's no negative interaction if you are at your full retirement age
00:36:25
or older. So, for that reason, it very rarely ever makes sense for someone to claim social security early if they are
00:36:31
also still working. But it can make sense for someone to claim social security at full retirement age even if
00:36:36
they are still working. You know, I think the next idea is I think using social security as a possible sequence
00:36:42
risk buffer can be a great idea. Again, the idea is that you might start retirement without having claimed social
00:36:47
security. Your plan is to live off your portfolio, but if the markets perform poorly and all of a sudden you realize
00:36:53
that you're subject or you're exposed to some sequence risk because of that poor
00:36:56
performance. What do you want to do in that situation? Well, in a perfect world, you would give your portfolio
00:37:01
time to recover. You would lessen your withdrawals in order to leave more money in your portfolio to recover. How do you
00:37:08
lessen your withdrawals? Of course, you can cut out spending. You can be flexible like we mentioned a few minutes
00:37:12
ago. You can also turn on social security and boom, right there you say, "Oh, we have an extra $3,000 a month
00:37:19
coming in. That's $3,000 a month that doesn't have to come out of my portfolio." And that really does kind of
00:37:24
dampen or buffer your risk against a a sequence of return risk. And last, I'd
00:37:28
consider some uh taxability concerns. So, generally, claiming Social Security will reduce your ability to do smart tax
00:37:34
planning, and it's certainly not the end of the world, but it is a secondary cost
00:37:38
worth considering. In a perfect world, you would leave your options open to do smart tax planning. And the more income
00:37:44
coming in, usually the fewer opportunities you have, and social security does count as income. So, in
00:37:49
short, there aren't many situations where I'd recommend a married couple
00:37:52
both collect early as possible. Lucy, there might be one exception for being really open-minded is that if both
00:37:58
spouses have a really poor health history and a poor family health history, suggesting that both of them
00:38:02
are likely to pass away before break even age, I could see both of them claiming early. But either way, many,
00:38:08
many different considerations when it comes to social security claiming. Most of those considerations suggest that at
00:38:13
least one of the two spouses delay their claiming to 60 or 67. Here's a quick ad
00:38:18
and then we'll get back to the show. I send a free weekly email to thousands of
00:38:22
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00:39:04
retirement, and you can sign up for free at bestinterest.blog. And last question for today from Nicole
00:39:10
Jesse, could you please do an AMA question about rebalancing your portfolio? I feel like different experts
00:39:15
talk about doing it quarterly, doing it twice a year, doing it once a year. A lot of people talk about doing it based
00:39:20
on the calendar in that way, but then other people talk about drift. For example, if your 60/40 portfolio drifts
00:39:26
more than 5%, say to 65% stocks or to 55% stocks, then you rebalance it. How do you rebalance, Jesse, and why? Well,
00:39:34
this is an awesome question, Nicole, and and selfishly, I admit, I think it's
00:39:37
awesome because it gives me a chance to really to flesh out some of my personal thoughts on something I've always had a
00:39:43
a feeling for in the back of my mind. I've never really gotten it out on paper. And truthfully, I've never dug
00:39:48
into any sort of like alternative view or what researchers have to say. So all of a sudden now through answering this
00:39:54
question, I feel like I've really kind of solidified my own opinion on it. So
00:39:58
it's just a win-win. So listeners, if you're not familiar with rebalancing,
00:40:02
Nicole described it pretty well in her question. So thank you, Nicole. The idea is that an investor might decide, okay,
00:40:07
my portfolio should be 60% stocks and 40% bonds. Okay, that's great. But as the value of that investor's stocks and
00:40:14
bonds change over time, their original 60/40 allocation is going to change, too. And the act of rebalancing is that
00:40:20
investor deciding to bring the portfolio back to 60/40. So the question is when should that happen? But first I think a
00:40:27
good place to start this answer is why do we need to rebalance in the first place? Well, it's pretty simple. We do
00:40:32
need to rebalance to ensure that our portfolio has the proper amount of risk and so that our portfolio meets the
00:40:38
needs of our financial plan. We do not need to rebalance because that's the way
00:40:42
to improve our long-term returns. So I'll say that again. We do not and should not assume that rebalancing will
00:40:48
lead to better long-term returns. It might, but it might not. Increasing your returns is not one of the reasons to
00:40:54
rebalance. So, the reason, as I said a minute ago, is to make sure that your portfolio is still doing what you need
00:41:00
it to do. It still has the right amount of risk in it. It still has the right amount of potential growth in it to meet
00:41:05
your long-term needs. It's all about meeting your long-term financial plan. Or another thing is, you know, I've
00:41:10
talked about it here before. I usually look at everyone's portfolio through some sort of asset liability matching
00:41:15
lens and we want to make sure that everyone's portfolio has the right amount of assets to meet their
00:41:19
short-term needs, their midterm needs, their long-term needs. So sometimes we need to rebalance to ensure we're doing
00:41:24
that. And so what happens if you don't rebalance? Well, not rebalancing a portfolio will cause it to drift from
00:41:30
its original target allocation, perhaps resulting in these unintended concentrations in your top performing
00:41:35
assets, often stocks, which brings increased vulnerability to market downturns. And so while the lack of
00:41:41
rebalancing may allow for higher returns during bull markets, it can lead to bigger losses during bare markets. So
00:41:47
with that preamble, let's now answer the question, how often should you be rebalancing? So first and foremost, you
00:41:53
can and should consider using your just your normal portfolio activities to more
00:41:57
easily rebalance. Meaning every single portfolio has some dividends coming in or some interest, some new contributions
00:42:04
going into your accounts or some withdrawals coming out of your accounts, right? money is already moving in and
00:42:08
out of your accounts and in and out of your portfolio. So, you can and probably should use that money as part of your
00:42:14
rebalancing strategy anyway. If you're contributing $1,000 a month into a taxable brokerage account and that
00:42:20
account currently has too many stocks in it, well, maybe you decide to have all 1,000 of your new 1,000 per month going
00:42:26
only into bonds for a few months. You can rebalance that way. You don't need
00:42:30
to sell your stocks to rebalance. Instead, you just use the new deposits. Similarly, you could choose to turn off
00:42:35
dividend reinvestment for a while and use all those portfolio income sources to only go into one specific asset to
00:42:42
achieve some rebalancing over time. But often times doing something like that isn't actually enough. You need to take
00:42:48
some action above and beyond that to achieve rebalancing. And as Nicole mentioned in her question, the two most
00:42:53
popular styles of rebalancing are timebased, once a quarter, twice a year, once a year, something like that. And
00:42:59
then driftbased or threshold-based. You rebalance when your assets get 5% out of
00:43:03
whack or 10% out of whack or you rebalance when a particular allocation is 25% different when it started than
00:43:09
than when it started. You know, if you have a 5% allocation to small cap value and that 5% goes down to 3%. Well,
00:43:15
that's a 40% change. So anyway, you can have some thresholds set there. Now,
00:43:20
strictly speaking and you know, kind of in theory, a drift or threshold strategy
00:43:24
makes a lot more sense because you're rebalancing based on the characteristics
00:43:28
of the portfolio itself. the portfolio and its risk are out of whack. That's a
00:43:32
great reason to rebalance. A calendar-based strategy, on the other hand, might dictate rebalancing when
00:43:38
it's really not needed. Like, okay, it's October again. Well, what does October
00:43:42
have anything to do with your portfolio? It's arbitrary, is my point. But the
00:43:46
problem, and this problem exists with any rebalancing strategy, is to consider the costs of doing so. There aren't that
00:43:52
many trading costs these days, which is a good thing. But you still ought to be aware of trading costs. They do exist.
00:43:58
Some of the mutual funds you own might have a trading cost associated with them. Taxes are another cost at least
00:44:03
inside of a taxable account. And then your time is another cost, even though sure that's a bit subjective. Some of
00:44:08
you uh it might be really easy for you to rebalance cuz your simple portfolio and you're pretty good at the math. And
00:44:14
for others of you, it might be a real chore to rebalance. But the point is, the more you rebalance, the more costs
00:44:18
you might be incurring. So, if your threshold rebalancing strategy has you making trades every single month, is
00:44:24
that really better than a a calendarbased strategy that recommends you do it once a year? So, that's what a
00:44:29
Vanguard research team wanted to look into. And they published a paper in 2022, I'll link it here in the show
00:44:34
notes, that attempted to answer those kind of questions. They tested all sorts of various rebalancing strategies for
00:44:39
different portfolios. And they concluded that for just about any portfolio allocation, the optimal rebalancing
00:44:44
strategy is either once per year or once per year only if your target allocation
00:44:51
is more than 1% out of whack. And those two conclusions, they're basically the
00:44:55
same thing in my opinion. So anyway, the whole point is it's once a year. The
00:44:58
optimal portfolio rebalancing strategy is once a year. They looked at other time periods, too. They found that daily
00:45:03
rebalancing is the worst thing you could possibly do, but the next worst thing is
00:45:08
never rebalancing at all. And then if we're going from worst to best, then comes weekly, monthly, bimonthly, and
00:45:14
quarterly. So the point there is that doing rebalancing too often, especially if it has some legitimate trading costs
00:45:19
to it is more detrimental. And just rebalancing once a year, was their optimal solution. So how do we actually
00:45:26
execute that? Well, I think we still want our routine portfolio activities, again, the dividends and the interest,
00:45:31
the deposits and the withdrawals. We still want those routine activities to take rebalancing into account. If our
00:45:37
portfolio is drifting, there's nothing wrong with using those activities to bring the allocation back in line. And I
00:45:43
guess the reason why I say that is because those activities are happening anyway. There's no additional cost to
00:45:47
them because they're happening anyway. You're playing with house money is the
00:45:50
way to think about it. So, you might as well rebalance if you're playing with
00:45:53
house money. But beyond those routine activities, we want to set a once-yearly reminder to rebalance. And candidly, I
00:46:00
think that once yearly reminder can serve as a time when you revisit your entire financial plan if you want to,
00:46:05
ensuring that the conclusions you reached 12 months ago are still valid today. You can revisit your allocation
00:46:10
itself to ensure it's still the right allocation for what your financial plan
00:46:13
needs. And then, of course, you can execute whatever trades are required to bring your portfolio back into line. I
00:46:19
think that's a pretty simple solution, possibly much simpler than some of the
00:46:23
rebalancing advice you see online, but it's certainly not sitting back and doing nothing. So Nicole, thank you for
00:46:28
the question and listeners, thank you for the awesome questions today. I hope this convinced you that financial
00:46:33
planning can be pretty simple, but at the same time, there comes a point where we have to say, "Ah, we can't be simpler
00:46:38
than that." Thank you as always for sending in your awesome ask me anything
00:46:41
questions. You can send future questions to [email protected]. I look forward to reading your emails
00:46:47
and thank you once again for listening to Personal Finance for Long-Term Investors. Thanks for tuning in to this
00:46:52
episode of Personal Finance for Long-Term Investors. If you have a question for Jesse to answer on a future
00:46:58
episode, send him an email over at his blog, The Bestin Interest. His email address is [email protected].
00:47:06
Again, that's jessevestinterest.blog. Did you enjoy the show? Subscribe, rate,
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and review the podcast wherever you listen. This helps others find the show and invest in knowledge themselves. And
00:47:19
we really appreciate it. We'll catch you on the next episode of Personal Finance
00:47:23
for Long-Term Investors. Personal Finance for Long-Term Investors is a personal podcast meant for education and
00:47:29
entertainment. It should not be taken as financial advice and it's not prescriptive of your financial
00:47:34
situation.