Tuesday, May 30, 2017

I Got Hacked!!

Several years ago in another state, our home was broken into while we were on vacation. We filed an insurance claim and within a few weeks, most everything was back to normal. For the rest of the time we lived there though, I always got a pit in my stomach coming home.

Last week, our digital house was broken into. Somehow, someone got my login info for my investment accounts and made some unauthorized trades. Having gone through both experiences, I can tell you that neither is fun. But being the victim of a digital crime sure beats being a victim in the physical world.

This would always be a big deal, but it was a bigger deal than just having our retirement accounts hacked since we also use our brokerage account as our primary checking account. Even though they don't accept or disburse cash or have any locations near us, this works just as good as having a local bank or credit union. We rarely use cash for anything and if we need to get any, our ATM fees are reimbursed so I never care what the charge is to use a random gas station ATM.

What Happened


One day I was in a series of all-day meetings and took the chance to check my phone during a quick break. I saw that I had a series of notifications, including two missed calls, a voicemail, and a notification that some stock orders had been executed in my IRA.

I normally would brush off the other alerts (I hate voicemail), but the stock trade didn't seem right. We have some automatic investments set up, but it wasn't the right time of the month for that to be happening. My wife has joint access to all of our accounts but doesn't usually do any transactions outside of our checking account. And lastly, what the heck is USAK and why did my phone say that I was the proud new owner of 15,000 shares?!?

I quickly excused myself from the meeting and did some more research. The voicemail was from my brokerage firm letting my know that they had noticed some suspicious activity on my accounts. As a result, they proactively had frozen my account from any more online transactions. Their fraud team was already all over it before I even let them know that this was, in fact, fraud.

The suspicious activity involved selling off my S&P 500 ETF, and immediately using the proceeds to buy shares of a somewhat thinly traded stock. My first thought was that this was a part of a "pump and dump" scheme. So far, though, I haven't seen any activity that looks like dumping. In fact, whoever placed the order got the shares for under $6.30 and they are up >6% since then. Even though that's better than my ETF over the same period, I'm glad things are back to normal.

I've been primarily invested in ETFs for a while now, but this experience has gotten me to think about going back to traditional Index Mutual Funds. Since they only can be bought or sold once a day, it wouldn't be possible for someone to do intra-day trading like this.

What If You Get Hacked


The first thing to do if you find yourself in this situation is to know your brokerage firm's fraud policy. Most big firms will have a policy that essentially boils down to you not being responsible for fraud. Just don't do something stupid like give a crazy ex-girlfriend your password since that could imply authorization.

Fidelity has a Customer Protection Guarantee, Schwab has a Security Guarantee, and Vanguard has an Online Fraud Pledge. Each of these pages gives some tips on how to avoid this from happening. I follow most of these steps, but no one is completely immune. If you're with one of these firms, relax. Call them as soon as you can to get it resolved, but don't freak out either.

When I called in, they made me answer some additional security questions before changing my username and password. Because there could be a virus on my computer, they wouldn't allow online transactions until I told them all my computers had been professionally scrubbed.

I trust myself more than Geek Squad's competence and they were okay with me doing my own virus scans. As it turns out, something nasty was discovered during a virus scan on one of our seldom used laptops but all our machines are now squeaky clean.


The Aftermath


Because of this fraud, I had to spend about an hour on the phone and get new account numbers. They automatically set up the new accounts like the old ones, but we had to reestablish payments for our mortgage. I also had to reconfigure the new accounts in Mint and Personal Capital. We got a new checkbook over-nighted to us and I changed my direct deposit. The only remaining inconvenience is that we still don't have a new debit card. I primarily use a credit card (that I pay in full every month) so this is fine.

In hindsight, this could have been MUCH worse. I've known people that have had this happen to in the past so I knew not to worry. I was surprised at how quickly it was resolved and how little was needed to prove that it was fraud. I hope you don't ever have to go through this. But if you do, it isn't as bad as you might think.

Tuesday, May 23, 2017

A Big Risk to Early Retirement - Inflation Risk

Lest you read my last post and think that I completely ignore the very real inflation risk in retirement, allow me to walk you through my thought process of how I account for it.

I already mentioned that when I project out our portfolio growth I’m assuming a non-inflation adjusted rate of return of 8%. If inflation were to average 2%, then my real return would actually be just 6%. I could just assume a lower rate of return, but I prefer to make some more granular assumptions about inflation.

It All Starts with Budgeting


Each year, I pull our full years' expenses by category and make some minor adjustments to come up with a representative retirement budget.

First, I eliminate principal and interest payments on our house. Our mortgage will be paid off well in advance of retirement, so this won’t be needed. Next, I reduce our income taxes to account for lower income in retirement. I also reduce our charitable giving amount to account for us not having an income to tithe from, but not to zero since we will still want to be generous in retirement. Lastly, I eliminate any retirement account contributions since I won’t be eligible to contribute.

Not all of our expenses will be lower in retirement. I adjust our healthcare and travel expenses by assuming they will each be double current levels. Everything else stays the same. After all of these adjustments, I’m left with a budget that is roughly half of our household expenses. That sounds really low, but the majority of our current expenses are paying down the house, income taxes, and charitable giving so it is not unrealistic. In some categories like groceries, it may even be high given that we currently cover food for a family of six and will someday be empty nesters.

Inflation Assumptions


With this representative budget, I then apply inflation assumptions. The key difference here is that I use different inflation assumptions for different categories. Historical inflation has been 3-4% and I assume for most categories an inflation rate of 3%. The average for my lifespan hasn't exceeded 3%, but it's a real risk that it could be much higher. For me, medical expenses are the big wildcard. Not only do I assume they will be double my current level of spending, I also assume an inflation rate of 7% on medical expenses. If I were budgeting to be paying for higher education costs in retirement (I’m not), I would use a 7% inflation assumption for those costs as well.

Using this representative budget and specific inflation rates, I then inflate our expenses by the number of years between now and retirement to get an inflation adjusted retirement budget. Each year of retirement, I assume that expenses will continue to increase at the rates outlined above.

Inflation Impact on Retirement Income


One very interesting thing to consider is how inflation can eat away at your portfolio. For simple numbers, let’s assume you retire and have $1M worth of investments to live off of. It's an oversimplification, but let's also assume a steady 8% return, 3.5% inflation, and first-year expenses of $60,000. Since $60,000 is 6% of $1,000,000 and you’re earning 8%, then you can live off the earnings forever, right? Wrong.

You see, what happens is that even though you are consistently earning 8%, the growth of your earnings is lower than that because you aren't reinvesting all of those earnings. Because your expenses are growing at 3.5%, and your income isn’t growing as quickly, your expenses will actually be greater than your income after just 15 years. After that, you begin whittling away your principal until year 33 when you run out of money entirely.

In this way, inflation is one of the biggest risks to early retirement. Everyone is impacted by inflation. The longer your retirement, the more time inflation has to grow and exceed your investment income.

Below I've outlined what hypothetical portfolio values would be with the assumptions outlined earlier.


How to protect against inflation?


There are a few things I am doing to protect our retirement dreams from inflation. The first is to have an initial withdrawal rate much lower than 6%. In your working years, you want to have as big a gap as possible between income and expenses. In retirement, you want to have a gap between expected investment income and expenses. Whether you plan to spend most of your money in your lifetime or leave an inheritance, inflation can derail either of those plans.

The primary other strategy is to remain invested in stocks. Over time, stocks are the only asset class that has consistently outperformed inflation. While earnings growth may not exceed inflation, left untouched a diversified stock portfolio would not lose purchasing power over time.

There are many ways to account for inflation in retirement planning, but this simple method works for me for now. It is absolutely something you don't want to ignore, but I don't lose sleep over it either. What are your inflation assumptions?

Saturday, May 20, 2017

Assumptions for Early Retirement

I recently was talking to a friend who disagreed with my retirement planning assumption that our investments would average an 8% return. I had felt that my assumption was conservative given that I am close to 100% invested in equities. He felt that 4-5% was a better long-term assumption. Dave Ramsey assumes 12%. Who is right?

At the end the day, who really knows? We're doing our best to save and invest a good chunk of our income and staying invested in the asset class with the best track record and best potential growth. But the conversation did get me thinking so I did some additional research.

Over at Moneychimp.com, there is a great resource that shows annual returns on the S&P 500 going back to 1871. You can look at any date range and see returns adjusted for inflation. This is great data for us because the majority of our portfolio is in index funds that track the S&P500. Their biggest takeaway is that:
"Over the very long run, the stock market has had an inflation-adjusted annualized return rate of between six and seven percent."

When I assume 8% return, I'm assuming that to be before inflation. Is that what my friend meant? I don't think so, but I'll have to follow up. My impression was that he was just particularly pessimistic.

I was curious though, so I did some digging into the data set and found some things worth sharing (all numbers not adjusted for inflation).

S&P 500 Historical Returns



  • The best 1-year return for the S&P 500 was 56.8% (1933)

  • The worst 1-year return was -44.2% (1931)

  • Average annual returns from 1871-2016 were 10.7%

As you would expect, the longer you invest the more likely that you wouldn't have lost any money.

  • The best 5-year annual return was 29.8% (1924-1928)

  • The worse 5-year annual return was -6.9% (1928-1932)

  • The average 5-year return was 10.7%/yr

It took going out to a 10-year time frame before there were no periods where you would have lost money. Investing in the worst 9-year period of 2000-2008, you would have averaged -1.7% per year.

  • The best 10-year annual return was 21.6% (1949-1958)

  • The worst 10-year annual return was 0.6% (1999-2008)

  • The average 10-year return has been 10.8%/yr

Our Retirement Plan Assumptions


The length of time I'm really interested in is even longer than 10 years. My goal is to have my working years last around 25 years and then to be retired for 40+ years. I'm about 10 years in with another 15 to go.

  • The average 25-year period has been an 11.1% return

  • The best 25-year period was 18.2% (1975-1999)

  • The worst 25-year period was 5.8% (1872-1896) 

We first started saving for retirement in 2006 and average market returns from 2007-2016 have been 8.8%. Our returns have been slightly higher than this, but aren't as clean to track since we have been continuously investing new money for the past 11 years.

All this to say, we're assuming 8% returns over the next 15 years and based on what we've seen so far and what has happened long before we started investing, we remain comfortable with that assumption.

I should have even more years in retirement than in my career, but my plan assumes a low withdrawal rate, under 4%. In retirement, we won't be relying on sustained market returns to provide for our lifestyle but will remain invested primarily in equities similar to the strategy outlined in Simple Wealth, Inevitable Wealth.

I'm currently reading Nassim Taleb's book Antifragile and he makes the very valid point that until the worst of anything happened, it wasn't actually the worst. Said another way, just because a mountain is the tallest you've seen doesn't mean it's the tallest in the world. I know that future returns could be worse (or better) than we've ever seen before, but planning on an early retirement allows me to have sufficient margin in my plan to compensate for unexpected downturns.

See below for some more info on different investment horizons high, low, and average annual returns for a specific number of years.

What rate of return do you use for your retirement planning assumptions?

Monday, May 1, 2017

April 2017 Net Worth Update

For those who are just joining, each month I publicly update our household net worth. April was a good month for us, but nothing out of the ordinary. With this months’ increase of $6,744 to $657,793, we are still on pace to reach our goal of $700,000 by the end of the year.

NET WORTH DETAILS

CASH

Our cash went up a bit this month and continues to get closer to our goal of ~$40-50k. We had a couple items this month that slowed us down like a week of travel, rental car, etc. This next month we'll also be fencing in part of the backyard and starting some other backyard projects. Household projects slow down our cash build up, but these allow us to enjoy our yard in a way we never have.

INVESTMENTS

The S&P 500 returned 0.9% this month, and most of our investments track that index. 15% of my income continues to go to my 401k, but we haven't done anything else special.

We finally received and paid all of the hospital bills for our newborn this month as well. We paid from our HSA which I include in the investments category because I do plan on eventually having it invested and growing. As long as the balance is lower than our deductible though, I'll keep it in cash.

Our total out of pocket was ~$3,500 for the baby. That was literally the cheapest we could go and still give birth at a hospital. My wife has always preferred natural childbirth, and is super tough. This is our fourth child to be born naturally and she’s never had any anesthesia/epidural. Avoiding pain meds during childbirth significantly reduces the hospital bill. Saving money isn’t the reason she avoids them, but it is a nice side benefit. One money saving tip we do use at the hospital though, it to bring our own Tylenol. Have you seen how much hospitals charge for OTC meds?

This month I had an experience that helped highlight a benefit of regularly tracking my net worth. One of our investments accounts is an old 401k we haven’t added to it in several years. I was feeling that it wasn’t moving much even though it is all invested in equities. Since I track the monthly balances for all our accounts as part of this process, it was nice to be able to quickly go in and show that it actually has gone up quite a bit. It just didn’t feel like it since the balance has been hovering around $15,000 for so long. That account has actually gone from $14k to $19k just in the past year or so.

CARS

Nothing too exciting in the car department. As expected, they continue to depreciate slowly, but really are close to their end of life value so long as they continue to be in good mechanical condition.

Late in the month I was driving back from the airport and noticed what smelled like engine coolant coming from my wife's Expedition. Shortly before I got home the hood briefly started smoking but thankfully didn't overheat. Much to my chagrin, I knew I didn’t have time to fix this myself, so had to bite the bullet and let a mechanic do it. Thankfully they were able to get it done all in the same day, and $500 later the leaky hoses and parts have been replaced.

I am certainly an advocate for DIY, but there are some instances where it just makes sense to pay a professional. Reasons to hire a professional either are for time or expertise. If the reason is expertise, I’ve found that I can often learn to do most things myself (thank you YouTube!). If I need something done with a tight deadline, I am not always able to do it myself. This was one of those times. It is worth pointing out that we tend to have at least one $500 repair per year on my wife's Expedition. Her truck has 140,000 miles on it. Contrast that to my Corolla, which has never been in the shop (beyond routine maintenance) and has over 200,000 miles. If Toyota made a big enough vehicle, we'd probably have two. (No, the Sequoia is not big enough).

HOUSE

We continue to pay extra towards our mortgage, but less than we plan to pay once we reach our cash goal. We really haven’t seen many houses go up for sale in our area, but feel the estimate is conservative. Our next-door neighbor will be selling his house and downsizing as he becomes an empty nester this summer. His house is a bit smaller than ours and I’m not sure about the interior condition, but it will be interesting to see what it sells for and what the new owners do to the place.

All-in all, I'm pleased to report we're on track to reach out net worth goals.