What To Do When The Paycheck Stops With Fritz Gilbert Part 2 | Ep 209

Speaker 1:
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Jonathan:
And what we're going to be doing today is actually pulling back the curtain, taking a look at the numbers. Fritz spent the last five years going into his retirement planing for this moment. And it'll be kind of cool to actually see what he thought he was going to do, to what he actually did, especially in light of what's going on in the world with the coronavirus. How things are kind of mapping out, is he happy with his decision? Would he do anything differently? This is going to be a lot of fun. And we're going to break this topic wide open right after this.

Jonathan:
All right, Brad, I mean, there's a lot here. I mean, you've had this paycheck that's been coming in. You might have switched employers. But the one thing you could count on was that there's a paycheck that's going to land. And especially for traditional retirees. It's not an exaggeration to think that you have earned your last dollar, right? So now, you are drawing down on the money you accumulated to this point. And so I think this is going to be a really important conversation.

Brad:
Yeah, I agree. And it's funny, because a lot of this is mental, right? And this is what we talked about in the first episode with Fritz, about just how difficult it is to plan for your retirement generally, putting the money aside. Just how do I navigate, as a human being, my new life, which is what it is.

Brad:
And not to mention, then getting into the money and thinking about this is an entirely different scenario mentally, which is, "I've been earning a paycheck for my entire adult life. And now the paycheck has stopped. And what do I do? Even though I've planned." Right?

Brad:
Hopefully, everyone listening to this podcast is planning in some way in terms of money for their retirement. But it is so difficult when that paycheck stops. So really excited to dive into it with Frit. And Fritz, welcome back to Choose FI.

Fritz Gilbert:
Yeah. Thanks guys. Two weeks in a row. Retirement's getting even great. It's great. Thanks for having me back.

Jonathan:
Yeah. Once you retire, you become a celebrity in our eyes, "Oh look! He did it." No. I think one of the things is really identifying that you're having a successful retirement. You're having a retirement that even in really uncertain times, you're really glad that you prepared the way you did, and took the steps that you did.

Jonathan:
And I think now's a chance for us to look at it through the lens of economic uncertainty and see are you happy that you did it the way you did? So I think let's start with what to do when the paycheck stops. How did you go about creating a new paycheck? Let's talk about the bucket strategy here.

Fritz Gilbert:
Yeah, big topic. There's a lot of different ways to skin the cat, and maybe peel the apple is a better analogy.

Jonathan:
Yeah. No animals were hurt in the making of this podcast.

Fritz Gilbert:
No. If you think about that mental aspect, as Brad said, of going from accumulation to withdrawal, that's huge. And I really did a lot of thinking about this, again, two years ahead of retirement, maybe three. I started thinking about what am I going to do? I started reading.

Fritz Gilbert:
And I settled on the bucket strategy. People bicker and might debate. There's a lot of different ways to do this. That's fine. What I like about the bucket strategy, quick summary what it is. I think most people know.

Fritz Gilbert:
You got three buckets. You can do more, but I use three. The first bucket is cash, liquid, after tax, one to three years. I tend to go with three. I'm a more conservative investor. Bucket two is kind of that five to seven year, from year three to year seven. So it's about a four to five year window of things like bonds.

Fritz Gilbert:
The whole point of this is you want to have enough in buckets one and two that you can minimize your sequence and return risks. So when you're in a situation like we are now with huge volatility, you're not going into the stock market and selling your stocks every month, and kind of doing reverse dollar cost averaging, which can really kill you, because you got to sell more shares as the price does down. So you want to build a buffer. And bucket three is all that longterm equity stuff, right?

Fritz Gilbert:
So the concept is pretty well known. But when you really, and you guys love the tactical minutia. And this is one of those tactical minutia elements. How do you actually go about recreating that paycheck once you understand the concept? And I came up with a system that I'm really happy with. So let me run through that.

Fritz Gilbert:
Basically, we're talking bucket one, right? That's where you're living at. And how do you recreate that paycheck? So what we did is we set up a capital 1360, standalone account. Let me back up and give you some logic.

Fritz Gilbert:
You could budget, right? The key is you can't exceed your safe withdrawal rate. We all know that, right? You got to be below your 4% or 3.25 if you believe Big ERN's incredible numbers, right? So we're targeting three to three and a quarter percent safe withdrawal rate. So how do you know if you're spending that much?

Fritz Gilbert:
Well, you can sit and do a spreadsheet, and do budgeting every month. I'm not going to do that. I hate tracking that level of detail. What did I do when we were working? I saved everything off the top. And we just knew whatever was left, we could spend, right? We'd save aggressively. And we didn't worry about budgeting. We knew we could spend what was left. How can we recreate that in retirement? To keep ourselves on a budget without setting up a budget, right?

Fritz Gilbert:
So what I did is I did the math. What's our safe withdrawal rate? It's X. Let's use $50000 a year to make the math easy. You got $50000 a year you're going to spend. So I would take $50000 on January 1st. And by the way, you want to have this in place before you retire. You want to have a fully funded bucket one before you retire. Heaven forbid you retire in February 2020, and then you hit the volatility we've seen since, right?

Fritz Gilbert:
So you want to have a full funded bucket one. We moved $50000, to use an example, into this Capital One account. And every month, we'd just transfer the monthly allocation. So what would that be? $4000? We have a $4000 paycheck that transfers every month automatically from Capital One into our checking account. We don't use the Capital One account for anything else.

Fritz Gilbert:
What's beautiful about that is December 31st rolls around, you look at your beginning balance in the Capital One, you look at your ending balance, and you add any income, right? You get a little income from the blog or writing a book, these things that just happen to pop up. I track those. I just let those flow into the checking.

Fritz Gilbert:
You add the income with these automated transfers, you know what you spend in a year. It's simple. It takes me 15 minutes a year, and I'm done. It takes no effort. And it just works. And then I'm talking a long time here. So feel free if you want to jump in.

Fritz Gilbert:
But let me say one more thing. How do you refill bucket one? The other thing that's beautiful about this, you can look at any given point in the year into your Capital One, you can see how much you've spent, how much you've withdrawn.

Fritz Gilbert:
And what we did, thankfully, in our two years of retirement thus far, about every two or three months, I would just keeping refilling bucket one. I'd sell stocks, because stocks were hot. So if stocks were still doing well, I would just automatically ... Let's say we're doing $4000 a month. We're three months in. I've spent 12000. Hey! The market's doing well. I just went and sell $12000 of stocks, and move it into a separate account, which I keep in Vanguard, money market fund so that I don't contaminate my spending math, right?

Fritz Gilbert:
So we continually refill bucket one. And then at the end of the year, we just take the Vanguard money, move it over to Capital One, and do it all over again. And it works great.

Jonathan:
Yeah. I wanted to clarify. You said cash one to three years of liquid spending. So out of $50000 a year spend, one to three years is a pretty big range, right? And you have $50000 to $150000 in cash. It sounded to me like you were saying your Capital One contained a projected one year of spending. Was that accurate, or where the fluidity? Where the range coming into place there?

Fritz Gilbert:
Yeah, good question. And I think the other thing you could raise is, "Hey! Is there an opportunity cost for holding that much cash?" Right? And I think there would be bigger arguments against that. "Hey! You're holding too much cash."

Fritz Gilbert:
My answer to the first piece, and then I'll get into yours. There is an opportunity cost. But insurance isn't cheap, right? And you've got to buy car insurance. You don't think about it. You're driving your car, you know you're insured. Coronavirus hits, and the market drops 30%. Hey! It didn't bother me in the least. I knew that I didn't have to touch anything. So to me the opportunity cost is worth the better sleeping at night.

Fritz Gilbert:
To answer your question, we do keep a total of three years in cash, or maybe short term bonds, in all fairness. But I typically keep one to two years in the Capital One, and I keep the balance in my Vanguard account, just because we're moving stuff in and out. We'll talk about what's happening with the coronavirus.

Fritz Gilbert:
We've actually been buying stocks. Well, I had a little bit extra cash sitting in my Vanguard money market fund. Technically, that's kind of part of bucket one. So I had it split between the two different pots. One was just to track the spending, kind of keep it at a year, a year and a half's worth level. And then the other just kind of moves around based on what we're buying and selling, and potentially income, things like that. And that sits in the Vanguard. Between the two of the, we keep about three years.

Brad:
Fritz, I'm curious about this bucket one. I like how you have this set up. So let's just make the math even simpler. We'll say 48000, right? It's 48000-

Fritz Gilbert:
Yeah. Thank you.

Brad:
You backed yourself into a corner there.

Fritz Gilbert:
Money nerd we got. I was doing that in my head going, "That doesn't quite work. But hey!"

Brad:
So on January 1st, you put 48K into this Capital One account in your case. And you have this automatic transfer of 4000. So every single month on the first, 4000 goes into your checking. So really, the Capital One account is less useful to track your spending, because you know by definition it's just 4000 coming out of that.

Brad:
So I guess what I'm curious about more is actually the checking account. So now 4000 is coming in on January 1st. Now, as we know, life is lumpy, right? If you have your mortgage paid off, you might have to pay your taxes on May the 1st, and that might be a couple of thousand dollars.

Brad:
So clearly your monthly expenses aren't exactly $4000, right? Because again, life is lumpy for all sorts of things that you have to pay for. So I would assume that you would actually track your spending through your checking account by virtue of what's leftover. So is that right? Am I conceptualizing this accurately?

Fritz Gilbert:
Good questions. That raised two areas that I think are worth talking about. Life is lumpy, right? So what we did, and this is a critical element of it, we tracked ... I'm not big on tracking spending. I don't do the budgeting thing. Oh! Shame on me, right? Chose a fight. And I don't do budgeting, right?

Brad:
I don't do budgeting either, my friend.

Fritz Gilbert:
I retired early. You don't have to, right? There are other ways to do that. What we did do in preparation for retirement, we tracked every penny we spent. We tried to do a year. I made it 11 months and finally gave up. But we did 11 months. Tracked every single penny.

Jonathan:
Sounds Christmas was welcomed.

Fritz Gilbert:
Yeah.

Jonathan:
How many relatives do we have?

Fritz Gilbert:
So we knew how many lumpy expenses we had, and we calculated that into the 48000. So if you think about it, the 48000 divided by 4, 4000 a month, realistically, we knew our monthly spending, let's use your example, is maybe 3000 a month. And then we've got lumps that we need.

Fritz Gilbert:
So the way we balanced that, and right now is a good example with coronavirus. We're not traveling. We're not eating out. We're not spending any money, right? So as our checking account kind of grows and grows and grows, well, I just transfer back to Capital One, or let's say I get a little extra income. I'm tracking it on a spreadsheet. We move it back into either Vanguard or Capital One, depending on what I'm trying to do with it.

Fritz Gilbert:
So I think you can get to the spending by looking at the transfers, the net transfers, because I will move money back of we're underspending, and then adding in the income. It seems to work for us. So that's the first part of the answer.

Fritz Gilbert:
The second part, and this is really important, people don't think about this. What about an emergency reserve? How do you handle the air conditioner that blows up in August and it's a $5000 fix? How do you manage the rood repair? How does that fit into this?

Fritz Gilbert:
And what we did do to address that, again, you want to stay within your safe withdraw rate, right? There was a great article. I read a book. It was one of the Wall Street Journal books on retirement planing. And I read a lot as I was putting this together.

Fritz Gilbert:
And you can actually do a pretty good estimate of those, I call them, unexpected expected, right? You got to expect the unexpected. So we looked at the roof of our cabin, okay. 15 year lifespan costs X. So let's just say it's $15000 to make the math easy. It's $15000 that last 15 years. You can amortize that as 1000 bucks a year.

Fritz Gilbert:
You're going to have to buy a car, right? How often do you got to buy a car? Do the math. Okay. Every five years. And you're going to spend 2000 for it. You're going to have 10000 residual left. Do the math. It's 10000 over five years. That's $2000 a year.

Fritz Gilbert:
If you add all of those types of things up, in our case, it came up to about $1000 a month of expected unexpected. So what we did is we would actually reduce that 4000 down to 3000 that we're transferring, and we'd take 1000 of unexpected expected, and we'd set up a reserve. That's one thing nice with Capital One. You can set up bucketed accounts within your ... You can do sub-accounts.

Jonathan:
He's got a bucket inside his bucket. It's raining buckets. That's really nice.

Fritz Gilbert:
Now what we do, so we'll do that 48000 at the beginning of the year. 12000 of it will go in the emergency reserves. 36000 of it creates the automatic paycheck. And if any of these unexpected expected pop up, we just pull it out of that emergency reserve. And over time, that'll build up, and we can replace our car. We can replace the roof. And we'll have money sitting aside of it, without going over our safe withdraw rate. So it adds a little it of nuance to it. But I think it works.

Brad:
Yeah, Fritz. That really does make perfect sense. I like how you tracked this. And you did mention in there the coronavirus, right? This is a massive thing that's going on the world. And you're well less than two years into your retirement obviously. Certainly within the sequence of return risk area.

Brad:
And I'm curious how you're thinking about that. You also mentioned that you had extra money left over, right? And are you buying into this dip, or drop in the market? Talk us through how you're really thinking about, "Wow! The world is changing. And I'm recently retired. What do I do now?"

Fritz Gilbert:
Yeah. Sequence of return risk, right? Talk about a risk being realized. Good question. I think, first, I get criticized sometimes by readers. If you just jump and talk about the financial aspect without being empathetic to the people that are really suffering, right? People are losing their jobs. People are dying. I mean, a shout out to those folks. We appreciate the pain you're going through.

Fritz Gilbert:
But on the financial aspect of it, let me start with this. As you're setting up this bucket strategy, you've also got to think about your initial asset allocation, right? You guys are 100% VTSAX. Let's go, right? We get that.

Fritz Gilbert:
In my case, being a more traditional retiree, we went with a little bit of a modification. If you think about [inaudible 00:15:22], he's got this reverse life path mentality, where to minimize sequence return risk, you ought to pull your equity exposure down early in retirement, and maybe grow it later.

Fritz Gilbert:
So we got to about a 50% equity allocation when I retired, about 40% bond, about 10% cash. If you actually do the math on the buckets, you can actually do it. I've got a spreadsheet where it actually breaks it out.

Fritz Gilbert:
If you look at three years in bucket one, five years in bucket two, and the rest in bucket three and you're using a 3% safe withdrawal rate, it says your asset allocation should be roughly 10% cash, 15% bonds, and 75% equity. That fills the buckets.

Fritz Gilbert:
To me, kind of the ceiling to implement the bucket strategy says you want to have about a 75% equity exposure max. So that's my ceiling. And my floor, which I choose to kind of enter retirement at was about 50%. I knew we had enough. We're at a 3% withdrawal rate. So I wasn't chasing the big returns.

Fritz Gilbert:
All that to say we're starting out with 50% equity. Every year, end of the year, I go through a year end process. And I tend to do annual rebalancing in conjunction with refilling the bucket. Kind of formally checking all the math. I do these mini-refills through the year.

Fritz Gilbert:
So once a year, formal rebalancing. There you go. There's a picture up here on the board of what we started with. 48%. Pretty good guess, on stocks. This is an article I wrote right before I retired on what we're starting with. We had 48% stocks, 40% bonds, and then 10% cash with a little bit of alternative equities, where you're golden, some stuff like that, hedging type stuff.

Fritz Gilbert:
So what we've done in this down market is ... Long term, you got to have returns to keep up with inflation. 50% is a pretty conservative equity. I can go up to 75%, right? So I'm kind of waiting to buy. I had a lot of dry powder, intentionally. I wanted to minimize sequence of return risk. The market was hot. My view it was overvalued. We knew there was going to be return coming.

Fritz Gilbert:
So I came up with this aggressive rebalancing strategy, I call it. It's not market timing in my view, because as the market goes down, think about it, your equity allocation is going to naturally drop. So if you were consistently rebalancing your portfolio, which I don't think you need to do in a normal environment. But in an aggressive down market, like big onset. This is the biggest drop we've ever had, right?

Fritz Gilbert:
If you just ran your numbers from the top, let's say in February to the bottom of the end of March, your asset allocation would've shifted potentially dramatically, right? Five, 10 points.

Fritz Gilbert:
So what we came up with, in '08, I blew all the dry powder early. Things are going down. We've been hot for a long time. We threw everything in. And then it kept going and kept going and kept going. I was like, "Oh! I wish I would've kept some dry powder." Right? It's a tough thing. How do you catch a falling knife.

Fritz Gilbert:
So what I came up was a strategy where for every 5% decline in the market, we would transfer 1-2% of our net worth. We'd sell cash, maybe bonds, right? I only had so much cash. We tended to do more of selling bonds, because they were still doing well. So we sold the bonds and we bought stocks.

Fritz Gilbert:
What I would do, on the day that I bought that, and I actually have a chart, we can put in the notes, that shows every point that I bought at. Once I made a buy, I would actually put it in my calculator, what the SMP was that day. I'd multiple it times .95, and I'd take a screenshot of that calculator so I'd know the day I bought it by the date on the calendar, the picture. I'd know the price I bought it, and I'd know my next price point. And I'd just forget about it.

Fritz Gilbert:
Keep an eye on the market. A couple of days later, big down day in the market. I'd pull up that little picture. Oh! It's getting close to my strike point. Okay. Do I want to do 1%? And the further down it went, the more I increased the percent of my net worth. So my last buy was on March 26th, 28th, whatever the absolute bottom was. I bought 2% of my net worth. And so far, it's been the lowest point.

Fritz Gilbert:
So I'm not trying to market time. I'm just trying to build a structure that allows me to rebalance the portfolio. And I know I've got room to grow that equity up to maybe 75% before I'm going to start getting nervous. So that's the approach we came up with.

Jonathan:
Let's go through this. I went ahead and pulled up your slide on the screen here, pulled from your article that you wrote. And I'm trying to just make sense of it, just for the audience so if they're watching this on the YouTube channel, they'll be able to see it right along with this. But if they're listening, just, I think, probably there's enough numbers embedded in what you just said that it's worth just slowing down in the slope again.

Jonathan:
So the idea being you have a lot of dry powder. So you have up to three years sitting in cash. And then on top of that, you have close to 50% of your net worth is in bonds. So bonds are cash. It's like 50% of your net worth. Was that accurate?

Fritz Gilbert:
Yep. Good summary.

Jonathan:
Okay. So we're not talking about your equities. You're not moving your equities. You're not touching your equities in a volatile environment like this. So instead, you're looking at your cash, and you're looking at your bonds, and you're saying, "As I see my equities plunge, I want to be approaching this from a place of confidence. And I want to create some rules for myself ahead of time on how I would get back in."

Jonathan:
So with this slide on the screen, the peak was some time in February. It went down to the very bottom right around March 20th, I believe. As of right now, from the perspective of late April 2020, the bottom was March twenty something. So talk me through how you were watching the market one time, and how you made decisions to purchase, and where those purchases came from. Did they come from stocks? Did they come from cash? Come from bonds? What did you do?

Fritz Gilbert:
Yeah. And then you get into the complexity of Roth versus before tax, 401K, and tax location optimization. We could really go into a lot of things if we want to touch on that later.

Jonathan:
Oh! And we will.

Fritz Gilbert:
I shouldn't have opened that can of worms. So basically, you're right. The general premise was I was under-weighted equities intentionally to have a conservative start to minimize sequence of return risk, and I didn't want it to get any lower, right?

Fritz Gilbert:
So as the equities went down, if you did the math, I would've fallen before my minimum asset allocation into equities. So we had a little bit of extra cash beyond the three years. So I kind of did that first. And then I started moving the bonds, because the bonds were doing well, and I think JL Collins did a post. I love JL. I know you guys like him too, Jim Collins. And he was doing the same thing. He was selling bonds, buying equities. So I started moving that.

Fritz Gilbert:
Basically, what's nice about this, you take that screenshot on the day that you do the transaction. And then you don't have to worry about it. You just kind of watch the market. I don't sit here and stare at screens all day. I live life. I'm retired. It's not about taking care of the money, right? This is a very, very minor part of my life.

Fritz Gilbert:
But when you hear the market's down, or I kind of glance at it through the day, whatever, on a big down day, or after a couple of big down days, I just look at where that last price point was. And if we're getting close to hitting another one, I start paying attention. And then I'll execute the trade. Obviously I'm doing mutual funds, to answer your question.

Fritz Gilbert:
So everything's in mutual funds. So trades on the closing value, which kind of makes it difficult, because you got to guess, right? You're not quite at the closing value when you execute the trade. I typically execute it maybe 30 minutes before the end of the day.

Fritz Gilbert:
And then once I do it, I take a picture of it, and I wait until we get there again. And what's nice now that it has kind of come back up, I don't worry about it. I know where my lowest. I could pull my phone right now and show you on my phone that picture I took. And I can actually tell you the date. We were joking about it. It was March 23rd. And VTSAX hit $54.49, right? Down from a high of 79.69 on December 31st. It might might not have been the high, but the year-end value.

Fritz Gilbert:
So VTSAX, it had dropped, what is it? $30, right? $35, 40%. Is that right? You guys probably know better than I do. 50, 60, 70. I'm sorry. $25. So if you look at year to day, this is through April 24th, VTSAX is down about 13.5%. Of you looked at this portfolio of 50% bonds and cash, 50% VTSAX, with this rebalancing strategy, it's down 5.8%. So it's only down ... It's down less than a half of what VTSAX is.

Jonathan:
And so now, as you play this out, I'm looking at the sheet again. And for context here, and I'm not 100% sure when this was last updated. It looks like I was around the ... Yeah. 24th of April.

Fritz Gilbert:
Yesterday.

Jonathan:
Yesterday. So the SMP 500 was sitting at basically 2800 for all intents and purposes. I mean, does this just mean you're just sitting back now until ... Based on these kind of rules, this thing that you set up, are you just relaxing until it goes below 2200? Or what's the-

Fritz Gilbert:
Exactly. It'd be my last buy, which is 2200 minus 5% reduction. That's about 100 bucks. So like 2100. If it gets down close to 2100, I'll start paying attention, and I'll move another tranche.

Fritz Gilbert:
So if this thing ... I mean, we're in so much volatility right now. It's nice to not be panicked about it. What's really weird about this guys, I actually start getting excited when the market's tanking. I'm like, "oh, good! I'm going to get close to another tranche. I'm going to be able to pull the trigger and buy some more." Which is great, because it gives you something to be excited about during a horrendous bear market, and it takes away a lot of that anxiety, because you're thinking longterm.

Fritz Gilbert:
Now, in fairness, what I need to do is I need to add the opposite side of this. And I will. Basically, as I mentioned earlier, when equities are well, I was selling equities as we were spending money. So I was constantly selling equities every three or four months. Obviously that stopped right now, and we're just drawing down bucket one.

Fritz Gilbert:
So if you really wanted to draw this out on both sides, I would have similar rules on the upside, when it goes up 5% above the high. I would sell 1%. Again, it's just that it's a more strict rebalancing approach than just kind of waiting till the end of the year, which is what I've historically done.

Brad:
Fritz, I like how you have these rules built into it. And I'm curious, did you consider doing something like actually setting limit orders where you it would happen automatically so you didn't have to consider it. So if it dropped that 5%, on the day that you made your last purchase, you just calculated your 5% down.

Brad:
And then since you have so much cash, I assume, let's just say hypothetically you could do it at Vanguard. I guess you couldn't do that with a mutual fund, but you could it-

Fritz Gilbert:
That's the problem.

Brad:
With an ETF, right? Which is substantially similar.

Fritz Gilbert:
The problem is my entire portfolio was built kind of back when mutual funds were the only game in town. So everything I've got is built around mutual funds. I do use stop-loss, I do use GTCs. I have some fund money in TD Ameritrade that I play around. I trade options. I do all kinds of stupid stuff.

Fritz Gilbert:
And that is small enough that it doesn't matter. And I do all those kind of stop-loss and resting orders there. I haven't found an effective way to do it with these for three reasons. One is it doesn't necessarily hit there, right? It's the closing price for a mutual fund. So that would be a problem. And I don't think you can set up trigger orders on Vanguard. I haven't checked into it, because I just didn't think it was available.

Fritz Gilbert:
And the third one is it's not always clear to me until I kind of ... Once I place one trade, I kind of forget about it for while. And then I'll look at it when we're getting close. But obviously I've got Roth, I've got before tax, and I've got after tax. So where I actually place those trades might change a little bit from trade to trade. And I'd just like to keep the flexibility so I can kind of look at what I'm doing with my overall balancing.

Jonathan:
All right everyone. As promised, we are going to have Fritz break down his tax allocation. So we've talked about asset allocation. With tax allocation, what we're looking at is how does he take advantage of before tax vehicles like your 401K, after tax vehicles like Roth IRA, taxable accounts. What's the intersection, and how does that intersection work with regards to his bucket strategy, with regards to how he pays himself. And we'll get right to that, right after this.

Jonathan:
So let's talk about tax allocation and your strategy. And we posed the same question to Big ERN just a couple of episodes back on making portfolio adjustments. And he basically said he was surprised and shocked by how it really just depended on the person's individual situation.

Jonathan:
But since we're looking at your situation, then we can really zone in on this. And this is ... Yes. So you're 50% cash and bonds, and you're close to 50% equities, and there are some other smaller alternative investments mixed in there as well. But where are you holding those? Are you keeping those in your 401K? In your Roth IRA? In taxable accounts? Where are you storing your wealth? And how does that change or affect your strategy?

Fritz Gilbert:
Yeah, good question. And I think this gets down to when you're starting to fine tune optimization. I think if you get 20% of it right, you get 80% of the value. This is probably getting into that minutia, when you really get into tax optimized location. It hasn't been a focus of mine. But I'm very aware of it.

Fritz Gilbert:
And the problem I've got, and I think a lot of baby boomers have, all through my career, all we basically had was a 401K with before tax. The Roth didn't come about until well into my career. By then I had already had this compounding thing building up in the before tax.

Fritz Gilbert:
And when these things first came out, man, everybody was, "You got to put money in the before tax. You get a tax break. Your taxable income goes down." And that was all well and good. The problem is-

Jonathan:
You get taxed later. But later is here.

Fritz Gilbert:
Exactly. And now, later is here. And I've got a sizeable amount of money sitting in before tax. And it's not tax optimized, right? I mean, ideally, let's just go high level. And Big ERN could argue this. I'm looking forward to the article he's going to put together, because obviously he's really good at figuring the numbers.

Fritz Gilbert:
I kind of use this rule thumb that I came across. And I've got an article in there, in my ... I actually put together a draw down strategy. And it's part of what Jonathan's been showing. And in that article, I go through the tax optimization structure. So real high level. After tax, right? What do you need in there? That's your liquid fund, because you have to be able to get to it. So you can't have it in a before tax or Roth, where you don't want to pull it out.

Fritz Gilbert:
So after tax is best for your short term liquidity stuff. And it's not bad for stocks, because the capital gains are taxed at a lower tax rate, right? Capital gains tax rate. Okay. So that's after tax. The Roth, again, you put the money in after tax, all the growth, all the earnings are tax free. So what do you want to put in there? You want to put the big hitters in there. You want to put the VTSAX, goes in the Roth, typically.

Fritz Gilbert:
The before tax, all the things that you put in there, that you got the tax break on back when you made the contribution, the entire basis is taxable, and the entire income is taxable. Even worse, it's taxable at your marginal tax rate, right? So it's a really high tax. So what do you want to put in there? Stuff that would normally get taxed at that rate anyway. Bonds, right? Excluding municipal bonds. Obviously you put the after tax, because it's tax free.

Fritz Gilbert:
But the taxable both revenue, which counts as income anyway, that's the type of stuff you want to put into your before tax account. Now obviously, I've been investing in this thing for 20 years. I've been throwing money into the VTSAX or equivalent. So it's got all kinds of junk in there. It's not optimized.

Fritz Gilbert:
The way I address that is I'm also doing roll overs every year, because I've got too much money in my before tax. I don't want to get crushed when the required minimum distributions come out when I hit age 72. So between now and age 72, every year, about October, I put together a spreadsheet on all my estimated income, I look at my tax bracket, and I say, "Okay. How much room have I got between my estimated income and the top of the top bracket?"

Fritz Gilbert:
And I take that much money, because it's a table transaction, obviously. It counts as income. I take that much money, and I move it from my before tax 401K into my Roth. As I'm doing that annual rollover, that's when I try to play around with improving my tax efficiency by what asset classes I buy in the transaction, if that makes sense.

Jonathan:
Yeah. And I wanted to actually clarify that, because we really haven't spent a lot of time talking about required minimum distribution, just because they don't really affect you until you reach 72, which is a long way for me. So it's like a selfish thing.

Jonathan:
But to point out to people, you referenced marginal tax brackets here. So for you and your wife, you're married filing joined, the end of the 22% marginal tax bracket is around $78000. Is that close, Brad?

Brad:
Yeah, Jonathan. You were almost spot on there. I looked this up real quick, and for married filing joined, it looks like the 2019 federal tax bracket. So it looks like for married filing joined that the 12% marginal bracket goes all the way up to $70950. Now, keep in mind that's taxable income.

Brad:
So you have the standard deduction to add to it. So for 2019, I think that was 24400. So you're actually over $100000 in gross income you can have and still be at that 12% marginal bracket.

Jonathan:
So that's actually pretty interesting. So you have a fair amount of room there in the 12%, which is a pretty ... That's a pretty favorable marginal tax bracket. But when you start talking about required minimum distributions, I haven't done any significant calculations.

Jonathan:
But if you have $1 million, or $1 million plus in your 401K, and now suddenly that's subject to a calculation that says what's your life expectancy, and you have to draw all this down before you pass away, it's going to force you to take a lot of money. And that money is going to be taxed at your marginal tax rate, which is going to force you into 24% or beyond very, very quickly. You could be forced to take upwards of $50000 in a year, which from a tax optimization's perspective, you're not going to be super excited about that tax bill.

Jonathan:
So that's kind of why in this wiggle room you have ... You're retiring significantly before the age of 72. If you have room, you don't want to just let these years pass you by. You want to optimize as best as you can. Is that accurate?

Fritz Gilbert:
That's exactly it. The other thing you got to think about, the real question is what's the tax rate going to be when you have to pay for that withdrawal? Is it lower now or is it lower in the future?

Fritz Gilbert:
So there's two things in play. One is what happens to the tax rates? And the other is what's your income going to be, right? So you start throwing in social security, which could be taxable. It kicks in at 65, 70. Guess what? That's pretty close to the same age as RMDs.

Fritz Gilbert:
And in my view, who knows, I think tax rates probably have more room to go up than down from where we are today. Look at this stimulus money we're pumping out right now to try to help people out. At some point, that's going to cause ... SOmebody's got to pay for that at some point.

Fritz Gilbert:
You look at all the social security obligations, Medicaid, all the government spending and obligations, typically is going to come out of tax revenue in one way or another. So you've got to look at future tax rates, and you've got to look at your current income, and compare those two when you're making the decision. For us, it's kind of a no brainer. I'm taking as much as I can every year, up to the top of the tax bracket that I'm targeting, and I'm moving it over as a rollover.

Jonathan:
And a rollover, you're putting it into a rollover into a Roth IRA. So you're saying government, you can tax me. That forces that taxable event in the current tax year. But in exchange for that, you get into a vehicle where it can grow tax free from there?

Fritz Gilbert:
Exactly. And as part of that, to go back to our question of what do you buy, and where do you but it, that's typically where you want to put your stocks, is in your Roth. So part of what I've been doing, and to Big ERN's comment, money is fungible, right? So it doesn't really matter how you do it.

Fritz Gilbert:
I did some rollovers last year. I sold bonds, because my before tax had a lot of bonds. I brought them into the Roth. I set it in a short term bond fund. So it was sitting there. It's liquid. It's basically, it's protected, because it's short duration. So as I was buying to go back to this buying every 5% decline in the market, I was doing most of that in my Roth, moving money from kind of this holding place I had had from when I did the rollover, and buying that into the VTSAX or the mutual fund equivalent as part of the strategy focusing that on the Roth, because that's the last place I'm going to touch money, hopefully.

Fritz Gilbert:
So that should be bucket three. That should be stocks anyway. And that's where they're best suited from a tax optimization's standpoint. Complicated stuff. But hopefully people follow that.

Jonathan:
So Fritz, you and ERN have a story, kind of back and forth. I know you have slightly different strategies on how you go about this.

Fritz Gilbert:
I love that guy, though.

Brad:
He's awesome.

Fritz Gilbert:
That guy is a genius. He's so much smarter than I am.

Jonathan:
Well, you're in good company. But having said that, ERN makes the point that the data would probably steer you towards ... He basically says that bucket strategy is just another form of market timing, and that if you're goal, and ERN, you'll tell me if I'm misrepresenting your position, but if your goal is to prevent sequence of return risk, this doesn't cut it, because in the case that you've just described, you're setting aside three years of cash.

Jonathan:
But a sequence of return risk issue really isn't ... It isn't describing a V-shaped recovery, where you go down and you come back rather quickly. It's a long, protracted recession, depression event, where you have five years. And that first five years, post retirement really kind of defines the success rate for many, many retirees.

Jonathan:
So in a situation like yours where you're parking three years of cash, what if at the end of year three, we're still dealing with this? There's this delay, it's still hanging out at the bottom, how do you think this bucket strategy holds up to the idea of sequence of return risk for a long, protracted recession?

Fritz Gilbert:
Yeah. And I respect Big ERN a lot. I have a lot of respect for his work. And I think even on the podcast last week when he was talking about he's basically building for a great depression type of scenario. He wants to be able to survive that. And anything worse than that, okay, he'd be in trouble. But he could survive up to that.

Fritz Gilbert:
I would argue this. If we get into that, he's going to be selling stocks too, right? The different is, I think, not to put words in his mouth, he would have less of an allocation dedicated to bonds and cash. And he would be more heavily weighed into equities, because he said, "Look, the longterm growth of equities mitigates the risk of a protracted bear market."

Fritz Gilbert:
My feeling, I guess, is we've got the three years in cash, and then theoretically another five years of bonds. We could eight years without selling stocks. Somewhere in that eight year period, you're going to have enough of a rebound, hopefully, to do some refilling. But worst case, you go eight full years without selling a stock.

Fritz Gilbert:
If we've gone eight years with the stocks below their high, I don't think any strategy is going to work, right? So I think the big different between me and Big ERN, I probably give up the upside of having a high allocation to stocks. I think we're all going to be in trouble if we going to do a 10 year protracted bear market, whether you're just selling stocks as you go to kind of fund your retirement, or whether you're kind of building the strategy of keeping it more and more liquid as you get closer to needing it.

Fritz Gilbert:
To me, it comes down to personal preference. What fits your risk profile? What are you most comfortable with? And it might be one of these questions where I'm not 100% optimized. But I'm 98% optimized. And the 2% that I'm giving by an opportunity cost is worth it to me because I'm confident in the system. It's working really well thus far, and I don't worry about it. I sleep well at night.

Fritz Gilbert:
Guys, I don't even think about money in retirement. I've got my paycheck coming in. I can spend what we got. If the market goes crazy like it is right now, yeah, I'll pay attention, I look at it. Aside from that, I go a month. I check my net worth once a year. I don't care about that stuff. It's there. I know I'm within my safe withdrawal rate. And I know I got a cash cushion. To me, that's worth giving up a little bit opportunity cost.

Brad:
Yeah. I like that. Certainly sleep well at night, with eight years worth of liquidity. Plus it sounds like you're safe withdrawal rate, it's not like you're at 4.5%. You're on the conservative side, down in the below three. Like you said, you can plan for all of these events.

Brad:
And obviously, if something worse than the great depression happens, would it really have been in your best interest to have planned for that anyway? Right? That would be the craziest of black swan events. That doesn't make sense to me. So it sounds as if, in your case, certainly from a sleeping well perspective, you're well covered.

Fritz Gilbert:
I'm comfortable. I like it. And I've had a lot of readers. My audience is obviously primarily baby boomers. Many are kind of at the same demographic as I am, recently retired. And been a lot of exchange with the coronavirus.

Fritz Gilbert:
And pretty much universally, everyone that's implemented this strategy has sent me emails, the ones that have sent me emails, are universally, "Man, I'm so glad I put this in place. I've got no concerns. Life if good. I'm not worried about money in the retirement." There's a lot to be said for that peace of mind.

Jonathan:
All right. Well, this concludes part two of our what to do when the paycheck stops series, keys to a successful retirement with Fritz Gilbert from the Retirement Manifesto. Fritz, someone's listening to this, they want to pick up a copy of your book, they want to check out your website, what's the best way for someone to connect with you?

Fritz Gilbert:
Yeah. I appreciate the chance to do a little plug, theretirementmanifesto.com. You can buy the book right off my website. I've got a page there. You can look me up on Twitter, Facebook, Instagram, all under either The Retirement Manifesto, or Retirement Manifesto. So look me up. I'd love to chat with everybody.

Jonathan:
I want to reiterate a huge thanks to Fritz for coming on the show and sharing so generously the content that he's put together. I hope this helps you as you start to practice and formulate what your own plan might look like, to have a successful retirement at any age.

Jonathan:
For those of you that retirement, this is way, way off in the future. Right now you're focused on financial resilience and financial independence, go to our website, choosefi.com/start. We've created a landing page there to help maximize the value that here at Choose FI we feel that we can provide. Take us up on this. Get started. Take action. Everything else gets easier when you do that.

Jonathan:
All right, my friends. We'll see you next time as we continue to go down the road less traveled.

Speaker 1:
You've been listening to Choose FI Radio Podcast, where we help middle class America build wealth, one life hack at a time.