Investments are risky. Your future “interest gathered” is uncertain and you’re subject to a variety of risks including things like inflation. Don’t fall into the trap of assuming that your investments will return you, say, 7% each year forever and that the amount of dollars sufficient to live on now will still be sufficient in ten years.
Time and money are fungible to a certain extent. By retiring early you’re buying time with money (which you are not going to earn). Make sure the exchange rate is good and that you won’t spend most of your newly acquired time trying to compensate for lack of money.
Humans, being what they are, don’t do well in the absence of external pressure. To put it crudely, a life of leisure makes a man soft, dumb, and lazy. There are, of course, exceptions, but when people don’t have to do much, they usually do not do much.
Yeah, but not that risky. If you start with a sum in the “low hundreds of thousands” like Metus describes, and are frugal, you could easily live for a decade without having to earn any positive return whatsoever. And on the scale of decades, a diversified portfolio of stock-based index funds, hedged with other asset classes, is very unlikely to do worse than inflation.
If you start with a sum in the “low hundreds of thousands” like Metus describes, and are frugal, you could easily live for a decade without having to earn any positive return whatsoever.
That is true, of course. On the other hand after that decade you’ll be without money, without a job, and probably having issues integrating back into working for a living.
And on the scale of decades, a diversified portfolio of stock-based index funds, hedged with other asset classes, is very unlikely to do worse than inflation.
I disagree. The problem is that you’re looking specifically at the US stock market and there is the issue of survivorship bias.
On the scale of decades, what tended to happen to diversified portfolios of European stocks during the XX century? Or do you know when did the main Japanese stock index, the Nikkei 225 reach its top? It was in 1989 and all downhill since then.
On the other hand after that decade you’ll be without money, without a job
Yes, true. It would probably not be a good idea to attempt to retire with only one decade’s worth of funds and plan never to work again. On the other hand, you could see how things go for the first 5 years and then go back to work if needed.
The problem is that you’re looking specifically at the US stock market
So would you expect a US + international market cap-weighted index fund like Vanguard’s Total World Stock Index Fund (bonus: available as an ETF) to have more variance or do worse than the US stock market by itself? That would surprise me.
Or were you just saying you think the US was exceptional during the 20th century, and investors should not expect similar returns (either by diversifying across nations, or reliably picking a winning nation) in the 21st? Hmm, now I am curious what stock market returns looked like for the whole world in the 20th C.
there is the issue of survivorship bias
Unfortunately I wasn’t able to determine whether that particular chart took into account survivorship bias, but I did find this blog post written by the author of the book the chart was taken from, suggesting that he’s at least familiar with the issue.
Or were you just saying you think the US was exceptional during the 20th century, and investors should not expect similar returns
Yes, that is what I am saying.
whether that particular chart took into account survivorship bias
I meant survivorship bias in the country sense. What’s the return of a German stock portfolio over the last century? It is zero—the portfolio went to zero in WW2 and without additional money invested it stays at zero.
On the one hand, this is an important issue and shouldn’t be ignored if you’re planning for your retirement.
On the other hand… Let’s think about a scenario where you’ve worked hard and saved hard until (say) the age of 40, and then 10 years later there’s a national catastrophe on the level of losing a major war which wipes out all your savings. You are, indeed, going to be in trouble. But so is someone who’s been working for pay all that time: they’ve lost all their savings too, and probably their job. Either position’s going to be pretty terrible.
But if your retirement portfolio is internationally diversified (and it should be!) then you aren’t just vulnerable to war and revolution in your home country, you are vulnerable to war and revolution in any of the countries where you are invested. Survivorship bias is definitely relevant.
Sure. But now I remark that there are lots of countries and such total wipeouts are really quite rare. So, e.g., if your portfolio is something like equally divided among 10 major countries, and each of them has a total wipeout once per 30 years (of course these are both really crude approximations), then what happens is that once per 30 years you lose 10% of your investments, which is kinda like losing 0.3% per year, which is about what most index funds charge in management fees. (Of course it’s worse really because it’s “lumpier”.)
So, again, it’s an important issue but I remain to be convinced that it’s that important an issue.
if your portfolio is something like equally divided among 10 major countries, and each of them has a total wipeout once per 30 years
Why don’t you look at reality instead of going for abstract approximations? You are assuming that a “major country” being wiped out by a war would not affect other countries. Really? The 2008 crisis didn’t even come close to being a wipeout and how correlated were the stock markets of the major countries during the crisis? Or, if you want to go back to WW2, which stock markets remained unscathed while Germany was wiped out?
I am concerned that our argument takes the form: “I think this effect is bigger than you think it is!” “Oh, but I think it’s smaller than you think it is!” repeated a few times. For all we know, we agree about the actual effect but have wrong ideas about one another’s estimates of how big it is. Can we perhaps find some actual concrete proposition that we disagree on? (Or, as may well happen, find that there isn’t one.)
Here’s a candidate. It’s a more detailed and, where possible, quantitative statement of my own opinion. It’s a conjunction so there should be plenty to disagree with :-). I don’t believe anything I’ve said in this discussion has been incompatible with any of these points.
(1) Survivor bias at the country level is an important issue and you shouldn’t ignore it in estimating the prospects of an investment portfolio. (2) The possibility that your own country gets wiped out economically is real; it has probability on the order of 0.5% or so per year (let’s say 0.25% to 1.0%), it affects people who are still working at least half as badly as early retirees (I suspect nearer to parity than that), and while it’s worth trying to be prepared for it I don’t see it as a major factor in deciding whether to retire early. (3) The possibility that another country you’re heavily invested in gets wiped out is also real; if your international investments are reasonably diversified (or small, though that has its own problems) then the impact is on the order of 0.3% loss per year. More precisely, I’ll say 0.2% to 1.0%. (4) The possibility that another country with impact on one you’re heavily invested in gets wiped out is also real; there are more ways for it to happen but the impact is smaller per instance. However, it’s somewhat “priced in” already even for someone who’s ignored the issue, because such impacts already affect whatever indices they’ve looked at. Let’s say that the size of this effect beyond what a naive prospective early retiree is already expecting is in the range 0% to 0.5% depending, e.g., on where they are. (5) The net effect of all this is that if you’re considering retiring early, you should deduct 1% or so from your estimate of annual investment growth if you haven’t previously contemplated this sort of risk, and when comparing the risks of early retirement with those of continuing to work you should not forget the risk of your own country getting wiped out economically by war, hyperinflation, etc.
Why don’t you look at reality instead of going for abstract approximations?
Because doing the necessary research would take maybe 10x as long (quite possibly 100x as long) and I have higher-priority uses for that much time.
You are assuming that a “major country” being wiped out by a war would not affect other countries. [...]
No. I am assuming that what we’re interested in here is the differential impact of this sort of disaster on an early-retired person’s savings, compared with its impact on a still-working person’s job, job prospects, and savings. (Because the relevant question is whether retiring early and living on savings is a worse decision than it might otherwise look like, because of this danger.)
The more countries affected by a disaster, the more likely it is that there’s a big effect on the country in which you live, and hence the more likely that it hits still-working people hard too.
And yes, countries’ outcomes are correlated. Also, there are considerably more than 10 countries of substantial size in the world. Using a low figure there serves as a partial correction for the correlation, as well as for the fact that most people don’t have a portfolio balanced equally across all the world’s countries.
The historical performance of an index like the S&P or Nikkei has the cross-country effects of disasters elsewhere already factored in. Such effects will be underestimated by someone looking at historical index performance only if the indices they look at are, for some reason, less affected by cross-country effects than others relevant to them. That certainly might be true (e.g., European countries’ stock markets may be more correlated with one another than any of them is with the US, in which case looking at the DJIA or the S&P 500 would underestimate the risk of being hit by another country’s disaster if you’re in the US but hold substantial investments in Europe) but this feels like a second-order effect to me.
I think my original point was just that the effect (survivorship bias at the country level) exists and most people happily ignore it. Looks like we agree about that.
My follow-up point was that this effect—survivorship bias at the country level—belongs to the class of things which makes your estimates of future returns suspect. However we’ve moved on to another issue—how to account for the possibility of a major disaster (war, revolution, hyperinflation, etc.) while planning your life and what does this possibility and its consequences look like.
I think I’d like to stress the the consequences will be complicated and widespread, not reducible to lopping a percentage point off your expected returns. I also think that estimates have to be country-specific. The probabilities of the US going down are noticeably less than the probabilities of, say, Russia, going down. However a Russian implosion will be more contained (in the sense of affecting other countries) while if the US implodes it might well take the entire North America and Western Europe down with it.
One additional point is that you’re not only interested in the expected return on your portfolio. You are also interested in the expected variance. The probability of disaster does not only reduce your expected return, but it also pushes up, considerably, your expected variance as well as makes your expected probability distribution asymmetric (more asymmetric, really).
By the way, I do not agree that “the historical performance of an index like the S&P or Nikkei has the cross-country effects of disasters elsewhere already factored in.” The reason is that the interdependency of countries is not a constant. It grew a LOT during the XX century, especially its last few decades. For example, S&P is much more correlated with Nikkei now than it was in the 60s. Chinese economic numbers whipsaw Brazil (which exports huge amounts of iron ore to China) and significantly affect the US stock market. Or, remember what happened to the US stock markets when it turned out that Greece is bankrupt?
The world is much more interrelated now than it used to be. Historical performance does not reflect the current reality.
Let’s think about a scenario where you’ve worked hard and saved hard until (say) the age of 40, and then 10 years later there’s a national catastrophe on the level of losing a major war
These are different issues.
This subthread is basically about estimating future returns from diversified stock portfolios and whether S&P returns for the last few decades provide a good baseline for that.
You are talking about the stability of life and about whether saving money is useful if there’s a chance your country will be smashed into little bits.
By the way, a much more likely scenario for a Western country is not losing a major war but having a hyperinflation episode. In this case the guy with the savings loses all, while the guy with a job is much better off.
You raised the issue of survivorship bias at the country level and gave the example of a country wiped out by a major war. So I explained why, if you’re adjusting the expectations of a retiree to account for what that sort of event could do to their investments, you also need to adjust the expectations of a non-retiree, who will also be hit hard by it.
Hyperinflation is indeed a good example of something that could hurt the retiree a lot worse than someone still working, but it seems to me that it depends a lot on (1) what form the retiree’s savings take and (2) what causes and consequences the hyperinflation has. For instance, if investments in the stock market lose a lot of their (real) value in a hyperinflationary episode, I’d expect that to be accompanied by a lot of job losses—so the worst case for a retiree with a lot of stock-market investments is also bad for someone still working.
On the other hand, you could see how things go for the first 5 years and then go back to work if needed.
Will you be allowed back into the labor force? Many employers, especially in the IT industry, will almost certainly turn you away if you have an unexplained hole in your resume that’s 5 years wide. Basically the only reason that can cover a 5-year gap is education of some kind (usually something like graduate education). If you say, “Oh, I just retired for 5 years, but now I’m looking for a job again,” that’s not going to help your chances of landing a job.
This might not be as much of a problem in IT as you might worry, especially if you have personal projects or open source contributions to show for it. It’s difficult enough finding skilled developers that if your skill is in demand, a good recruiter will still go to bat for you. I’d say it harms your chances, but it won’t kill a career.
Three comments.
Investments are risky. Your future “interest gathered” is uncertain and you’re subject to a variety of risks including things like inflation. Don’t fall into the trap of assuming that your investments will return you, say, 7% each year forever and that the amount of dollars sufficient to live on now will still be sufficient in ten years.
Time and money are fungible to a certain extent. By retiring early you’re buying time with money (which you are not going to earn). Make sure the exchange rate is good and that you won’t spend most of your newly acquired time trying to compensate for lack of money.
Humans, being what they are, don’t do well in the absence of external pressure. To put it crudely, a life of leisure makes a man soft, dumb, and lazy. There are, of course, exceptions, but when people don’t have to do much, they usually do not do much.
Yeah, but not that risky. If you start with a sum in the “low hundreds of thousands” like Metus describes, and are frugal, you could easily live for a decade without having to earn any positive return whatsoever. And on the scale of decades, a diversified portfolio of stock-based index funds, hedged with other asset classes, is very unlikely to do worse than inflation.
See this chart.
That is true, of course. On the other hand after that decade you’ll be without money, without a job, and probably having issues integrating back into working for a living.
I disagree. The problem is that you’re looking specifically at the US stock market and there is the issue of survivorship bias.
On the scale of decades, what tended to happen to diversified portfolios of European stocks during the XX century? Or do you know when did the main Japanese stock index, the Nikkei 225 reach its top? It was in 1989 and all downhill since then.
Yes, true. It would probably not be a good idea to attempt to retire with only one decade’s worth of funds and plan never to work again. On the other hand, you could see how things go for the first 5 years and then go back to work if needed.
So would you expect a US + international market cap-weighted index fund like Vanguard’s Total World Stock Index Fund (bonus: available as an ETF) to have more variance or do worse than the US stock market by itself? That would surprise me.
Or were you just saying you think the US was exceptional during the 20th century, and investors should not expect similar returns (either by diversifying across nations, or reliably picking a winning nation) in the 21st? Hmm, now I am curious what stock market returns looked like for the whole world in the 20th C.
Unfortunately I wasn’t able to determine whether that particular chart took into account survivorship bias, but I did find this blog post written by the author of the book the chart was taken from, suggesting that he’s at least familiar with the issue.
Yes, that is what I am saying.
I meant survivorship bias in the country sense. What’s the return of a German stock portfolio over the last century? It is zero—the portfolio went to zero in WW2 and without additional money invested it stays at zero.
On the one hand, this is an important issue and shouldn’t be ignored if you’re planning for your retirement.
On the other hand… Let’s think about a scenario where you’ve worked hard and saved hard until (say) the age of 40, and then 10 years later there’s a national catastrophe on the level of losing a major war which wipes out all your savings. You are, indeed, going to be in trouble. But so is someone who’s been working for pay all that time: they’ve lost all their savings too, and probably their job. Either position’s going to be pretty terrible.
But if your retirement portfolio is internationally diversified (and it should be!) then you aren’t just vulnerable to war and revolution in your home country, you are vulnerable to war and revolution in any of the countries where you are invested. Survivorship bias is definitely relevant.
Sure. But now I remark that there are lots of countries and such total wipeouts are really quite rare. So, e.g., if your portfolio is something like equally divided among 10 major countries, and each of them has a total wipeout once per 30 years (of course these are both really crude approximations), then what happens is that once per 30 years you lose 10% of your investments, which is kinda like losing 0.3% per year, which is about what most index funds charge in management fees. (Of course it’s worse really because it’s “lumpier”.)
So, again, it’s an important issue but I remain to be convinced that it’s that important an issue.
Why don’t you look at reality instead of going for abstract approximations? You are assuming that a “major country” being wiped out by a war would not affect other countries. Really? The 2008 crisis didn’t even come close to being a wipeout and how correlated were the stock markets of the major countries during the crisis? Or, if you want to go back to WW2, which stock markets remained unscathed while Germany was wiped out?
I am concerned that our argument takes the form: “I think this effect is bigger than you think it is!” “Oh, but I think it’s smaller than you think it is!” repeated a few times. For all we know, we agree about the actual effect but have wrong ideas about one another’s estimates of how big it is. Can we perhaps find some actual concrete proposition that we disagree on? (Or, as may well happen, find that there isn’t one.)
Here’s a candidate. It’s a more detailed and, where possible, quantitative statement of my own opinion. It’s a conjunction so there should be plenty to disagree with :-). I don’t believe anything I’ve said in this discussion has been incompatible with any of these points.
(1) Survivor bias at the country level is an important issue and you shouldn’t ignore it in estimating the prospects of an investment portfolio. (2) The possibility that your own country gets wiped out economically is real; it has probability on the order of 0.5% or so per year (let’s say 0.25% to 1.0%), it affects people who are still working at least half as badly as early retirees (I suspect nearer to parity than that), and while it’s worth trying to be prepared for it I don’t see it as a major factor in deciding whether to retire early. (3) The possibility that another country you’re heavily invested in gets wiped out is also real; if your international investments are reasonably diversified (or small, though that has its own problems) then the impact is on the order of 0.3% loss per year. More precisely, I’ll say 0.2% to 1.0%. (4) The possibility that another country with impact on one you’re heavily invested in gets wiped out is also real; there are more ways for it to happen but the impact is smaller per instance. However, it’s somewhat “priced in” already even for someone who’s ignored the issue, because such impacts already affect whatever indices they’ve looked at. Let’s say that the size of this effect beyond what a naive prospective early retiree is already expecting is in the range 0% to 0.5% depending, e.g., on where they are. (5) The net effect of all this is that if you’re considering retiring early, you should deduct 1% or so from your estimate of annual investment growth if you haven’t previously contemplated this sort of risk, and when comparing the risks of early retirement with those of continuing to work you should not forget the risk of your own country getting wiped out economically by war, hyperinflation, etc.
Because doing the necessary research would take maybe 10x as long (quite possibly 100x as long) and I have higher-priority uses for that much time.
No. I am assuming that what we’re interested in here is the differential impact of this sort of disaster on an early-retired person’s savings, compared with its impact on a still-working person’s job, job prospects, and savings. (Because the relevant question is whether retiring early and living on savings is a worse decision than it might otherwise look like, because of this danger.)
The more countries affected by a disaster, the more likely it is that there’s a big effect on the country in which you live, and hence the more likely that it hits still-working people hard too.
And yes, countries’ outcomes are correlated. Also, there are considerably more than 10 countries of substantial size in the world. Using a low figure there serves as a partial correction for the correlation, as well as for the fact that most people don’t have a portfolio balanced equally across all the world’s countries.
The historical performance of an index like the S&P or Nikkei has the cross-country effects of disasters elsewhere already factored in. Such effects will be underestimated by someone looking at historical index performance only if the indices they look at are, for some reason, less affected by cross-country effects than others relevant to them. That certainly might be true (e.g., European countries’ stock markets may be more correlated with one another than any of them is with the US, in which case looking at the DJIA or the S&P 500 would underestimate the risk of being hit by another country’s disaster if you’re in the US but hold substantial investments in Europe) but this feels like a second-order effect to me.
I think my original point was just that the effect (survivorship bias at the country level) exists and most people happily ignore it. Looks like we agree about that.
My follow-up point was that this effect—survivorship bias at the country level—belongs to the class of things which makes your estimates of future returns suspect. However we’ve moved on to another issue—how to account for the possibility of a major disaster (war, revolution, hyperinflation, etc.) while planning your life and what does this possibility and its consequences look like.
I think I’d like to stress the the consequences will be complicated and widespread, not reducible to lopping a percentage point off your expected returns. I also think that estimates have to be country-specific. The probabilities of the US going down are noticeably less than the probabilities of, say, Russia, going down. However a Russian implosion will be more contained (in the sense of affecting other countries) while if the US implodes it might well take the entire North America and Western Europe down with it.
One additional point is that you’re not only interested in the expected return on your portfolio. You are also interested in the expected variance. The probability of disaster does not only reduce your expected return, but it also pushes up, considerably, your expected variance as well as makes your expected probability distribution asymmetric (more asymmetric, really).
By the way, I do not agree that “the historical performance of an index like the S&P or Nikkei has the cross-country effects of disasters elsewhere already factored in.” The reason is that the interdependency of countries is not a constant. It grew a LOT during the XX century, especially its last few decades. For example, S&P is much more correlated with Nikkei now than it was in the 60s. Chinese economic numbers whipsaw Brazil (which exports huge amounts of iron ore to China) and significantly affect the US stock market. Or, remember what happened to the US stock markets when it turned out that Greece is bankrupt?
The world is much more interrelated now than it used to be. Historical performance does not reflect the current reality.
These are different issues.
This subthread is basically about estimating future returns from diversified stock portfolios and whether S&P returns for the last few decades provide a good baseline for that.
You are talking about the stability of life and about whether saving money is useful if there’s a chance your country will be smashed into little bits.
By the way, a much more likely scenario for a Western country is not losing a major war but having a hyperinflation episode. In this case the guy with the savings loses all, while the guy with a job is much better off.
You raised the issue of survivorship bias at the country level and gave the example of a country wiped out by a major war. So I explained why, if you’re adjusting the expectations of a retiree to account for what that sort of event could do to their investments, you also need to adjust the expectations of a non-retiree, who will also be hit hard by it.
Hyperinflation is indeed a good example of something that could hurt the retiree a lot worse than someone still working, but it seems to me that it depends a lot on (1) what form the retiree’s savings take and (2) what causes and consequences the hyperinflation has. For instance, if investments in the stock market lose a lot of their (real) value in a hyperinflationary episode, I’d expect that to be accompanied by a lot of job losses—so the worst case for a retiree with a lot of stock-market investments is also bad for someone still working.
Hmm, interesting points. I had not seriously taken into account survivorship bias in this national sense before. I will have to think more about that.
Eric Weinstein argues strongly against returns being 20century level, and says they are now vector fields, not scalars. I concur (not that I matter)
Will you be allowed back into the labor force? Many employers, especially in the IT industry, will almost certainly turn you away if you have an unexplained hole in your resume that’s 5 years wide. Basically the only reason that can cover a 5-year gap is education of some kind (usually something like graduate education). If you say, “Oh, I just retired for 5 years, but now I’m looking for a job again,” that’s not going to help your chances of landing a job.
This might not be as much of a problem in IT as you might worry, especially if you have personal projects or open source contributions to show for it. It’s difficult enough finding skilled developers that if your skill is in demand, a good recruiter will still go to bat for you. I’d say it harms your chances, but it won’t kill a career.