Here are some things I think I am thinking about this weekend.

1) Your 12 Good Years.

I came across this very good article by an advisor named Dan Haylett in which he discusses how to optimize your retirement years for enjoyment. He writes about what he calls “your 12 good years”:

“In your 60s and early 70s, if you’re reasonably healthy, you’re still you. You can travel. You can be spontaneous. You can handle long days. You can manage your own life without help. You have the energy to start new projects, learn new skills, and take on challenges.

You’re not invincible (you’re not 30), but you’re still fundamentally capable.

By your mid 70s and into your 80s, things shift. Not dramatically. Not all at once. But gradually, consistently, undeniably.

You might still travel, but not as far or as often. You might still be active, but you need more recovery time. You might still be independent, but you start needing help with things that used to be trivial, like changing a lightbulb, carrying heavy shopping, and navigating airports.

The things you do become smaller. More local. More cautious. Not because you’ve lost your spirit, but because your body has started setting the terms.“

That really nails it. And then he concludes:

“So what do you do with this information?

You front-load your retirement.

Not your spending, necessarily. But Your experiences. Your energy. Your ambition.

The first 10-12 years of retirement should be the richest, fullest, most intentional years of your life. Not the most cautious. Not the most careful. The most alive.“

Bingo. Really well said. Like Dan, I see this all the time. It’s a hard issue to deal with in large part because those early years of retirement are fraught with financial uncertainty. You are making this huge transition from having had an income and saving for the last 40+ years to suddenly grappling with a small income and the potential that your portfolio might start to dwindle. It’s even harder if you’re trying to delay Social Security to 70 and you’re bridging that gap between 65-70. Those early years in retirement are the most psychologically difficult. And the trap is thinking it gets harder when it typically doesn’t. Most people do retirement planning worried they’ll run out of money so they think they need to be excessively frugal in the early years of retirement. And while that could be a concern in some cases it’s often not because life gets, paradoxically, more certain as you get much older. Not only are you running out of time (which makes your financial planning simpler), but you just start doing less because you become more physically and mentally limited in what you want to do. So you end up spending less and better managing your liabilities because time imposes it on you.

The lesson is, don’t miss out on those 12 good years because you’re being overly cautious about your finances due to uncertainty! Or better yet, find an investment strategy that is specifically designed to give you an understanding of time within your financial plan, wink, wink.

Anyhow, go give Dan’s piece a read. It’s very good and I hope it encourages you to plan properly for those early retirement years.

2) Why Rich People Act Poor.

Ramit Sethi asks a great question on Twitter:

“Why do you think wealthy people find it so difficult to describe themselves as wealthy?”

He’s referring to the way a lot of millionaires talk about themselves as though they’re middle class or upper middle class when they’re objectively upper class.

In my experience it’s that weird range of having about a $2MM-$10MM net worth. You’re objectively upper class, but you might not feel like it because you probably think upper class means flying private jets and eating caviar all day. In the USA a $2-3MM net worth puts you in the top 10% of net worth. So why do these people often feel like they’re middle class or upper middle instead of upper class? In my experience working with people like this it’s two things:

  1. These people didn’t obtain an upper class net worth by spending money! They’ve typically been frugal. They worked hard, earned a good income and saved a lot. They might not spend exactly like a middle class person, but they aren’t far from it. So they spend 40 years saving methodically and being frugal and then one day they suddenly realize they’re actually really rich. But the kicker is they still don’t spend money like they’re really rich so they still think of themselves as middle or upper middle class because they actually spend money like those people.
  2. Their net worth isn’t fully liquid. Most people’s net worth at this stage is mostly in their house and equities. They’ve amassed a high net worth by saving and then reallocating that savings to real estate and stocks, which have done fantastically for the last 40 years. And while the equities might technically be liquid financial assets, they’re still long duration instruments that most people don’t want to fund spending from. So there’s an element of golden handcuffs in having a net worth that is mostly tied up in stocks and real estate because even though you can theoeretically tap that liquidity you don’t really want to because it’s always been there earning you those higher returns.

This all obviously ties into Thing #1 because it can be incredibly hard for the people in Thing #2 to get comfortable with the idea that they should try to benefit from what’s described in Thing #1.

3) More on the Defined Duration Frontier.

My friend Jesse Cramer had a great question on LinkedIn about the new Defined Duration Frontier tool:

“I’m playing around with it as I write this, Cullen. Kudos to you and your team for putting it together. Can I offer one idea? More verbiage to explain exactly what’s going on / what the plot is showing.“

I’ve said this a lot in recent years, but I am growing even more conviction about it – asset-liability matching strategies are how most good financial planning will be done in the future and it’s crazy to me that they’re not more popular now. There are small groups of advisors using some version of them, but for the most part they’re just sloppy bucketing strategies. And the Defined Duration Frontier is designed to show how an ALM strategy might be allocated to optimize for temporal optionality. That’s the main goal of this tool. I added a short explainer:

“How This Tool Works: This tool presents the time horizon over which different assets expose your portfolio to sequence of returns risk (portfolio drawdowns when you might need liquidity). We quantify the “Defined Duration” (the expected time horizon over which an asset has potential sequence risk) and the Portfolio Builder maps out your weighted defined duration and sequence risk score. A sequence score of 1 reflects low risk and a sequence score of 3+ reflects higher risk. To reduce sequence risk in an asset-liability matching strategy you will want to optimize for liquidity optionality which is reflected in the corresponding table.”

The problem with old school Modern Portfolio Theory and the “efficient frontier” is that it shows a theoretically efficient asset allocation. So, if it’s 60/40 stocks/bonds then you might hold a well balanced portfolio, but you really have no idea whether that portfolio is helping you fund your spending needs over different time horizons. More importantly, you have no idea how that portfolio helps you mitigate sequence of returns risk across time. And that’s the thing that paralyzes people considering Things #1 and Things #2 – they’re perpetually worried not only about having enough, but whether they have enough at the right time.

Now this is where ALM strategies are super powerful. In the DDF tool the default setting is almost exactly a 60/40 stock/bond allocation. The difference is, it’s disaggregated across its different time horizons to mitigate sequence risk. And if you’re matching those assets to specific financial goals the portfolio actually communicates sequence risk AND purpose because you can see a more tangible goal aligned with each asset you own. It’s incredibly powerful and this goes way beyond simplified bucketing strategies because you can customize the buckets in a much more granular manner.

I find it interesting when people critique bucketing strategies because they typically claim the strategy is “mental accounting” and suffers from a rebalancing problem. Well, any strategy with a withdrawal rate requires a rebalancing solution and bucketing strategies actually do this more efficiently because, when they’re done correctly, they should optimize funding from shorter duration instruments. That’s the whole point after all. By diversifying across time horizons you reduce sequence risk which enhances your ability to consistently fund from shorter-term buckets. You only fund from a long duration bucket when you absolutely must. This not only enhances returns potentially by pushing the duration of the portfolio longer on average, but it provides behavioral alpha in the portfolio by assigning specific assets for funding needs where you’re typically allowing longer duration assets to remain at work for longer. So the “mental accounting” isn’t just some phony psychological tool. It’s very specifically part of the design where you behave better because you actually know what the role of each asset in your portfolio is. That said, I am not a big fan of simplified bucketing strategies because they don’t actually solve these problems very well, but there’s a rational middle ground between having an overly complex institutional style ALM portfolio and building a low cost indexing style portfolio that enhances overly simplified 3 bucket style investing.

Well, that’s all I’ve got for now. I hope you’re having a great weekend and as always, stay discipined out there.