In episode 72 of the NewRetirement Podcast, Steve Chen is joined by guest David Chen. David is the brother of a good friend of Steve’s from high school and a member of our community. They discuss David’s story, some of the biggest lessons and insights from his journey around investing, and his plan for generating income for life. Plus what he learned about estate planning through dealing with his dad’s passing.
Transcript of Podcast with David Chen
Steve Chen: Welcome to the NewRetirement Podcast. Today we’re going to be talking with David Chen, the brother of a good friend of mine from high school and a member of our community. Through a combination of good habits and some good fortune, David retired three years ago at the age of 53. So we’re going to be talking about David’s story, some of the big lessons he’s learned along the way and insights from his journey.
He’s got some interesting ideas and strategies he’s pursuing around generating income in retirement, which we’re going to talk through. Also, he’s learned some lessons in dealing with his own father’s estate as his father passed away, and he wants to share that as well. So a lot of really good real-world lessons for us here.
For what it’s worth, until we got reacquainted recently, my strongest memory of Dave was getting driven around in the back of like Golf GTI in high school, where he was blasting Oingo Boingo music and just driving his brother Joe, who’s my good friend, and myself around. So it’s kind of interesting hearing how his life has turned out and kind of catching up after all these years. So with all that, Dave, welcome to our show. Thanks for taking the time.
David Chen: Well, thank you. Happy to be here.
Steve: Dave, I’d love to first hear from you, your own story about your career and some of the big… We were talking, catch up earlier, sharing some of the inflection points that let you achieve financial independence in a way that wasn’t standard. I mean, I think some of your good habits contributed to it, but it’s an interesting story and obviously has informed your perspective on saving and shifting to retirement.
David: Sure. Well, first I’d like to start with, a lot of times when you hear from people, it’s from the perspective of they got a large inheritance or something happened to which people automatically tune out and they think that this couldn’t happen to them. So that’s part of the reason I wanted to come on and talk through my experience, is because I think what I experienced is what everyone else can experience at the same time.
So my career is, I’ve always been in IT. I’ve got 32 years in IT. I started at IBM in ’89, and from IBM, I moved to HP. I had 16 years at IBM. I moved over to HP for seven years. And from HP, I then moved to another company called CSC, Computer Sciences Corporation, which ended up merging with HP a couple years later and became the company DXC. And I ended up retiring from them.
But all of these companies that I just rattled off, they’re all the largest four, five largest IT companies within the services industry. And I considered myself lucky to be able to work among almost all of them.
Steve: I remember when we were talking, you shared that there was a moment in time, I think in 2013, where there was a transition happening with one of the companies and you made some big decisions, and that kind of informed your trajectory a little bit.
David: Right, right. So in 2013, I was let go by HP. At that time, I had four kids, and they were young, they were all in sports. Essentially a vulnerable time in our lives, and it was shocking and scary. But as Steve Jobs had said, he had a quote, “Looking back on your life, you could only connect the dots.” And he’s actually right because one of the lessons I had learned is, that event singularly helped me achieve early retirement and financially independence seven years later at 2020, at age 53, like you said. That never would’ve happened had I not left HP. So, a couple things happened from that event in which I don’t think is intuitively obvious to people, I don’t hear a lot of people talking about it.
Being let go, it made me aware that 401(k)s that large companies had, most of us are used to having a 401(k), and we think that’s the path to retirement. Well, what I’ve come to see is that 401(k)s can also be in handcuff. The reason why is because while 401(k)s I think are appropriate in most cases, they bring about average returns. And as a trade-off of that, you don’t have a large selection to choose from, and I think that that’s nice and safe.
But in 2013, by being let go from HP, I had both an HP 401(k) and my previous IBM 401(k), which I left at IBM. So at that time, conventional wisdom was to roll them over into an IRA, especially if you’re not close to 55 because of the rule of 55 where your 401(k)s, you are able to tap them early. I wasn’t there. So the conventional wisdom is to roll them into an IRA, and I did that. When you roll them into an IRA, you’re not able to transfer the assets in kind. What that means is, whatever they’re in, like a large index or a mid-cap index, you can’t transfer those assets one for one. You have to liquefy into cash and move that into your IRA. And then within your IRA, then you pick the new assets that you want to invest in.
David: Well, at that time, I was like pretty much everyone else. I had my 401(k) choices. I had no idea what to invest in. I was researching and learning. So what I did was, since it was in cash, at that time, Apple was coming out with their iPhone 4, new operating system, and iPad upgrades, and all that stuff. I was a big Apple fan at that time, and I saw the fact that all the Apple stores were always busy. So I just put all of my retirement a hundred percent into Apple. That was just before it split 7-for-1 two, three months before. So then it split and then it split again. And Apple, as we all know the story, just climbed like crazy. So that flexibility that the IRAs gave me at the time, that I would not have recognized had I stayed in HP because I was locked into my 401(k)s, allowed me to achieve financial independence. So that’s one lesson learned.
By the way, I’m not sure what people can do about that. What I advise people is once you know… And by the way, why we want to have more financial discussions, I think as a society, most people don’t like to talk about their money investments and things like that. But if you don’t share information, hopefully there’s somebody listening to this and say, “Wow, I didn’t realize that. Maybe I should be investing in an IRA or looking to see if my 401(k) can do in-service distributions,” which means while you’re working, you can remove your funds from your 401(k) into an IRA. That gives you that added investment flexibility, right? If you don’t know to ask or to even look for that, then you won’t be able to take advantage of these types of opportunities. So that’s one lesson learned.
The second lesson learned is a very subtle connected dots linkage that I made. Because 401(k)s by the very nature are very diverse and safe, they get average returns. What occurred to me was the philosophy around working, which is when you’re in general investments, I’ll say that, it’s not just 401(k)s, but when you’re in general index investments, in which most people make that decision because it’s very safe for all the right reasons, but because it gives you average returns. What I don’t think most people think about is that if a priority of yours is to retire early, then the average returns hurt you because the average returns are geared around a 30- to 35-year work span. It has to be, right? Because if it wasn’t, then you would hear everybody touting saying, “I invested in this one ETF, and because of this, I shaved 12 years off my working.” That doesn’t happen.
So you can tell that the four to 8% percentage rate is geared towards 30, 35 years. It just has to be math wise as well. So I don’t think very many people put that linkage together. So that’s another lessons learned, is if you want to retire early, you have to do a combination of things, which one of them I did by finding Apple. But, I don’t want to give the people the impression that’s the only way to do it. You do need to know how to swing for the fences in order to raise your average return, but that’s only part of the equation. Then the other part is, you have to have a large savings rate, which means you have to live below your means. Those two in combination will help you retire early. But that’s stuff that everybody hears from all of the other fire podcasts.
Steve: Yeah, I mean, I want to make a couple of quick comments here. So I agree that those are the levers, right? You probably know Mr. Money Mustache. I remember I laughed when I first heard his name, but he is Mr. High Savings Rate. And yes, a high savings rate, I’ve heard this from other experts, it’s the single biggest factor for-
David: Key to success.
Steve: What you did, you took a ton of risk. I mean, I think that we also want to be clear that in your situation, you made a good decision, also in hindsight, maybe it’s a little bit fortuitous that you made this bet on a company that literally is driving the indexes across the board. I mean, Apple’s the single biggest component of SB. It’s like whatever. It’s a huge part of the economic success of this country. But there’s never a risk-free return. If you’re getting higher returns, you do have higher risk.
David: That’s right.
Steve: I mean, you do have some risk, and something we’re going to talk about later, by having the concentration of one stock. I’ve talked to people, they’ve owned a lot of Tesla and it’s really worked out for them, but we don’t know. I mean, some of these valuations are really high on a relative basis for some of these equities. So you do have material risks. So eventually, what they say is you need to take a lot of risk to get rich, but if you want to stay rich, diversify.
Steve: Actually, I’m curious, did you diversify after you achieved a certain level of wealth?
David: I did. In fact, I diversified in two ways. The first is while I was investing. I said, “I shouldn’t be a hundred percent at Apple.” Everybody through common sense would know that you should diversify. So I tried doing that. I went into Alibaba, I went into GoPro. Those were doing their IPOs. Same thing. I’m not just swinging for defenses in a dumb way. I’m selectively picking companies, that at that time in 2013, you could see GoPro was on a tear and so was Alibaba, right? But both of them, the problem with them and why it’s so hard to swing for defenses is that most companies end up petering out there. There’s some trade off. It’s very difficult, as we all know, to pick a good company. So I ended up liquidating and going back into Apple because I couldn’t find another company that seemed to be having a better trajectory but also allowed me to have some semblance of sleep.
David: I’ll give you example. Had I picked Tesla, Tesla grew more than Apple, but there is no way I would’ve been able to sleep during the five, six years that Apple and Tesla were both not growing very well. I mean, they only appreciated over the past three years. I mean, there was six years of almost no growth that I had to live through and wonder if I made the right call. So it definitely wasn’t easy.
Now, your point on diversification, what I wanted to do with the lessons learned is, you’re absolutely right, but I think in terms of the different phases. Because the accumulation phase is one thing, and that’s the point issue that I think you were also trying to make which is, you need to both save as well as you need to do certain things and take higher risk if you want to raise your rate of return. That is a sacrifice you need to make if the priority is to retire early.
David: And that’s the linkage I wanted to make to people, is because so many times, when I talk with people and they all talk to me and say, “How did you do it?” and you start talking about some of the risk factors because you have to talk about risk, they go, “No, no, I can’t do that.” They want to be safe. Well, there’s no free lunch here. So that’s the linkage, is if you want to take years off of your 14 years, you have to do something. Well, one of these things, and that’s tied into the safe nature of the 401(k)s and things like that.
Okay, now, what do you do after you have a large portfolio? Yes, I did take a look at diversification, but at the same time, diversification, you hear the same thing. Now, diversification by itself is not easy. It sounds easy. It sounds like it would be an easy process, but I’ll give you an example around Warren Buffet. Warren Buffet let his Apple sides of his portfolio grow to 47%, and most people would say he’s nuts. But now, he and I, we have the same problem, even though I’m not trying to equate myself to Warren Buffet. We have the same problem, which is, once you have a good investment, how do you diversify safely? That is the other key point that you and I have talked about, which is, how do you not diversify or diversify for the sake of diversifying that you are then diversifying either out of ignorance or not going into worse companies? So I think Warren Buffet has the same problem.
If he’s going to try to take his 47% of portfolio and make it safe, where would he go into that is safer at this point? Now in hindsight, now that we all know the company that Apple has become, where would you put it? That won’t have the same capital utilization, the same growth, the same moat around it, and the same management team. They’re hitting on all cylinders. So what would you pick? And I’ll segue that into a problem that most people struggle with, which is, what assets do you pick? So I started off in looking at diversifying, picking Total Stock Index. VTI, I’m a big Vanguard fan because of low expenses. So I started off with a core holding of VTI total stock, and then branching into international whatever. I’ve kind of flipped that around, and the reason why is because I’ve kind of seen the total index also brings in all of these other companies that have a worse profile. Yes, it’s diversified, but you’re also diluting your potential gains for not a whole lot more safety.
So what I decided to do was I kind of switched my thinking. Instead of doing my core holding, let’s say 40% into VTI, I’ll do my 40% into something like SCHD, the Schwab Index, which kind of is a little bit of a unicorn now in which it gives you the same capital gains, but it also gives you a higher dividend. And it seems to be a good subset of companies where you still get the diversification. But what’s happening is this, what I’ve decided to do is I’ve switched from going Total Stock Index to the core holding should be between SCHD and something like VYM, which is write the high dividend yield for Vanguard VIG, high growth quality dividend, growth for Vanguard. So you’ll see a method behind my matters. What I’m doing is I’m creating a core around good quality, dividend bearing stocks because I’m a believer that by focusing on dividends, people will disagree, but by focusing on good quality dividend companies, you’re actually getting the best of the best. The companies tend to be very good.
Then what I’m doing is, with that core, I’m then putting in 10% around the core, 10% into international, 10% into total stock, 10% into value stocks, the VUG Index, 10% into Wellington or Wellesley, things like that to shore up the core with what I think… Oh, and REITs. So I’m going into VNQ, the total REITs, because the core dividends don’t have REITs. So I’m shoring up the core with what I think it’s missing, but the core is now made up of a dividend-based methodology versus a blind total stock index.
Steve: Okay. So I’m going to play this back for you a bit. Okay. So you’re working, you’re saving, and I think one of the things you mentioned is you’ve always lived on 70% of your income. So you’ve been able to save at a 30% rate, which is high, which is great. So that let you build up a pool of savings, largely in qualified accounts like a 401(k)s. You get laid off, you take a step back, and you’re like, “Okay, I want to take more risk.” You make a good decision and put a bunch of it into Apple. Study that, diversify a little bit, but you’re still banking individual stocks. It’s just still risky. Keep riding on Apple, get to this point where you’ve built a very big portfolio.
And at this point, we’re going to talk about this in a minute, you start figuring out how you can turn that asset pool, de-risk it a little bit by diversifying, and then you’re also doing some stuff around turning on income based on these assets, which we’re going to talk about in a second. But, how much of your overall portfolio is still Apple? Is it like half or something? Is that what you’re saying? I mean, you don’t have to answer.
David: Yeah, no, no.
Steve: I’m just curious how much you’ve diverse, because I am a believer. I mean, the thing about individual stocks is, and Apple is obviously an exception versus the whole market, if you buy the whole market, you’re buying the ingenuity, if you’re buying in the US. If every person working hard and hopefully they’re running in a fiduciary way and you’re capturing their returns, it’s not going to get the same absolute return as the best performing individual stock we’ve seen in recent history or maybe ever. But you’re also not going to get necessarily the same volatility. One thing I want to talk about later is also like Kodak. We both grew up in Rochester. We saw this company that was impossible, incredible company, and then it imploded and went to zero, which-
David: Quickly too.
Steve: Yeah. So even though we’re like, “Oh, Apple’s indestructible,” you don’t know. I mean, we don’t really know, and if you have a huge concentration risk, I mean, they could come back and bite you.
David: Yeah. So yes, but that also points to something else. It doesn’t come without pain. I’m going to talk about the pain at the end, don’t let me forget.
David: It is I think an important lesson also for people to see. It’s one of lessons learned. So once my portfolio got up to 10 and a half mil, how I diversified was, once it hit certain points, like 150 and 172, I had determined I was going to take from the top, sell high, buy low. And that sounds way easier than it really is.
David: But I decided I was going to take off the top and, like you said, diversify in order to save what we have. Because at that point, gains aren’t as important compared to the risks you take if something happens. When I say gains, I’m really talking about opportunity costs. So a year and a half ago, I diversified into fixed index annuities to solve a couple problems, and what they do for me is, if I diversify, I want to build up what’s called my 4-3-2-1 plan. That’s an easy way of remembering. If you think about it, four, three, two, one adds up to 10. So the four is my what’s called set and forget.
David: By the way, I’m a big subscriber of the bucket strategy, and we’ll talk about the reasons why later on. But, the three is my dividend bucket, and the two is my fixed index annuity bucket, and then the one, I’ll call liquid, not quite cash, but they’re liquid enough in which they’re safe for an emergency fund and to use to address sequence return risk. So that’s an easy way of knowing my four buckets of four, three, two, one. The reason in building the FIA buckets is this: Most people would go through the traditional thinking of I’m going to build a bond layer.
Okay, I’ve got the stocks that gave me the accumulation layer, or I mean the capital gains layer, so now how do you temper that? And they would go into bonds. But as you and I saw over the past two years, bonds for different variables, they’re still subject to volatility. Unless you’re going to pick individual bonds in which when you hold them, you’ll get your money back and then you live off of the interest that it’s giving you, any other type of diverse bond vehicle that you go into, BND, you can still take a capital loss. So you’re not assured that you’re going to get your money back and it’s not as volatile. It doesn’t move as much, but you can still take a loss. And if you need your money, now that I’m retired and I’m tapping my portfolio for income, when you need money in an extended downturn, your bonds have the same sequence risk.
David: So what the FIAs, the fixed index annuities, do for me is it keeps my principal safe. It still gives me income. It lets me defer as well. That’s a third thing, because we’re about to talk about, let’s say Roth conversions because that was a big driver behind my retiring early. In order to do Roth conversions, if you pick any other type of annuity to fix the problem, you could pick an immediate annuity, but then an immediate annuity, you are fixing your tax position, if you will. So if most of your money is in pre-tax, like mine is, and most people’s are, if you buy a immediate annuity, that income will always be taxable income, a portion of it. So one of the lessons learned in early retirement is, taxable income is the death of you, because it handcuffs you.
Steve: Yeah, yeah.
David: A lot of people don’t understand and realize that until they’re doing the financial calculations later on, but taxable income really hurts you, and so you want to do a lot of things in early retirement. If you’re retiring later on, then sometimes there’s nothing you can do about it. But in early retirement, you want to be able to address the tax issue. So fixed annuity-
Steve: It lets you basically generate income that doesn’t count as it’s not taxable income. You’re moving around the taxable income till later, so you can do Roth conversions in a window. Is that what’s happening?
David: Exactly right. As well as the entire annuity as a vehicle can be converted to a Roth. You can’t do that with an immediate annuity or other annuity type. Your fixed annuity or fixed index annuity… And just to be clear, fixed index annuity is what I did, but you could always convert to a fixed annuity. The only difference is that you are picking the interest rate, right? In a fixed annuity, you’re locking into interest rate. Fixed index annuity, you’re indexing it to some index that’s closely aligned to the market. So I hope to get a little bit more gain, but you’ll never get less than zero. So I’m taking a little bit of risk there of zeros, but I’m taking far less risk than if it was an average.
Steve: Right, right. So why do you call it four, three, two, one in terms of the bucket strategy? Are those duration periods or just kind of the segments, the names you picked for the buckets that you used?
David: Yeah. No, no. Actually, the reason is even simpler than that, Steve. Four, three, two, one is the size of the buckets. So I’ve got four mils in a set and forget. And by the way, how you get a large set and forget bucket is, you raise your dividend yield in your dividend bucket. I have 85 assets. A lot of people would say that’s unwieldy, but the reason why is because I’m trying to raise my… My overall dividend yield is 10.6%. So out of my $3 million dividend bucket, I’m cranking out 320 versus normally if I put it in safe, three or 4% dividend yield vehicles, I’d have to allocate a much bigger portion of my 10 mil.
Steve: Okay, got it. Can we talk a little bit about what you’re trying to do with Roth conversion? So you’re like, “Okay, I can achieve, I’ve got a big enough asset pool, but it’s largely unqualified,” then you’re kind of looking forward, you’re like, “I need to fund my life,” and I know you talked about, “I want to dial in something for my estate, I want to dial in my income.” And I think another interesting point you made is, you want to be able to enjoy your income. You want to be able to spend it, which I do see. I start seeing you on social media like, “Hey, you’re living your life, it’s great.” You’re not worried about it.
Steve: And then you want to be tax efficient as you’re repositioning your assets. One of other quick comment is, for a lot of our users, they like to go into retirement with their assets diversified across taxable. They’ve already been taxed, brokerage accounts, tax deferred to 401(k) and IRA, they’re qualified money, and then some tax deferred. Very often it’s not very much, but then they’re trying to get in that tax-exempt vehicle, the Roth at the end. But I’d love to hear your story about how you are moving between these buckets and what your strategy is.
David: Right, right. So on the Roth conversions, part of why I wanted to retire early is because when you figure out your tax strategies, you find out very quickly that the earlier you retire, the more years you have to be able to spread out your Roth conversions. As well as in my case, I wanted to take advantage of the years until 2025 of low tax rates, because of tax rates going up in 2025 or in 2026. And that’s a tax risk, by the way, that everybody should acknowledge and know about and plan for.
So as they’re going through their calculations, the more I can spread out over the years until I have to do enough Roth conversions, until I’m 63 because of IRMAA, which is the Medicare calculation, the bulk of my conversions is timed to end at 63. So then I can do my remainder Roth conversions at 200K a year from 63 to 70. And the rationale there is, the 200K keeps me under IRMAA, so I don’t have any IRMAA impact and it stops at 70 so that I’m not stacking my Roth conversions on top of Social Security because I’m going to take Social Security at 70 and then my wife at 72. She’ll take her Social Security at 67, her full retirement age, she’s two years older than me. So that when she’s 72 and I’m 70 and I claim, she’ll be able to get her spousal support.
Steve: Okay, got it.
David: But you can see from a tax planning perspective, I’m trying to avoid stacking my Roth convergence in top of that Social Security payment I just told you about.
Steve: Essentially you’ve been doing Roth conversions since you retired, right?
Steve: Or you’re starting now from call it 53, 54, you’re going to run them for 16 years until you’re 70.
David: That’s right. The reason why I say it became obvious to me to retire early, that’s another lessons learned that I think is valuable for people to hear, because as we know, people are always subject to the one more year thinking mentality, which keeps them on, and it’s a scary thing for them to know when do I leave to be able to start doing these Roth conversions?
You don’t want to do Roth conversions while you’re working because you’re just stacking your tax rate. You’re locking in essentially your tax rate on top of the income that you have already. So in a lot of cases that doesn’t make sense. So the way I figured it out was, when I was working, when you figure out the tax advantages and what you’re saving and you calculate that into your income and what you gain by working and staying working and what that additional money will do, like I said before, on risk, eventually the gains don’t mean anything, right?
David: The gains mean less to you than the risk. In this case, the gains and working the extra income as well as the loss of healthy time because you become acutely aware when you retire, your money stays in the background, but you know what really comes forefront? Your healthy years, how you can do things, go out on a boat.
You can do what we just did, go to Iceland and Arctic Circle and do the polar plunge. You can’t do that if you’re not healthy. That becomes ultimately the most valuable thing. Well, now you realize that your healthy years are diminishing. So once you factor all that in, it became easy to say, “I’ll retire early at 53, in my prime earning years.”
Steve: Yeah, right.
David: And the rationale was, the amount that I would save in Roth conversions by converting early and letting it grow early in my Roth account was worth more than what it was working. I’ll give you an example of how people over analyze this.
People always look at tax rate and they say, “Oh, that’s why I’m not converting now. It’s because I don’t want to pay the big lump.” Well, if you think about what happened to me, my Apple stock, just to use Apple as an example, but you can stretch it out over two, three years, and it still works. My Apple stock, I transferred it in kind, did a Roth conversion, so I paid in my after tax bucket the taxes like you’re supposed to. And by the way, the after tax came from my pre-tax account because I’m under what’s called 72(t) distributions. We can talk about that. That’s a way of early retiring of tapping your portfolio early before 69 and a half. So when I converted, I paid taxes on that Roth conversion, that Roth conversion came out of my taxable, bucket went down.
David: Essentially, my net income in that year went down and my Roth balance stayed the same. But because it stayed in Apple, think about what happened. Apple just went up 47, 48%. At the beginning of this year, it was 125, I converted at 125 and a half, 126. Now it’s at 189.
David: Well, all that happened is, my taxable went down but my ROTH went up in the same year. I haven’t paid any taxes if you think about it that way. And all those gains will now be tax-free going on from here on out. So now most people will say, “Yeah, but my investments aren’t like Apple.” Okay, but you’re getting eight, 10%, right? So if you are in the 24% bracket, let’s say, which means 370,000, you can convert, if you convert, don’t worry about the taxes because if you’re making 10%, you’ll make it up in three years.
Steve: Right, right.
David: And then the rest of the years, growth is all gravy, and then you don’t have to worry about Social Security tax, IRMAA, widow’s tax, and estate tax.
Steve: Yeah. But you have to have the ability to pay the taxes if you’re converting up to that level. So if you convert 370,000 bucks and you’re 24% tax bracket, you’re walking off like 90, 100,000 dollars of taxes.
David: That’s right. So that was part of the calculation when I retired early. Because I’m under 69 and a half, what I had to do was a calculation that limited essentially the amount of Roth conversions I could do in my early years up to 69 and a half, which is why I call my 60, 61, and 62 years my big bang years. The reason why the Roth conversions are limited is because, like you said, I have to pay the tax. The tax comes out of my pre-tax, which then I can only take out so much under a 72(t), four or 5%. So I had to calculate all that up from a bottoms up perspective to be able to figure out essentially how much can I pay in taxes into year, which then told me how much can I convert. So I didn’t do it from the perspective of how much can I convert, it was how much can I take out in my 72(t).
Steve: Okay, got it. But you’re paying for the taxes from the convert… I mean, all the money’s coming out of qualified, including the dollars you’re going to pay in taxes, are coming out of that pool, sums going into Roth. And then how about paying for your life? How about just the day-to-day? Is that from the annuity stuff?
David: Yeah, so that is total in the 72(t). And for paying for my life, I mean that goes to the lessons learned you and I were talking about, about living below your means. In the beginning we talked about how we lived on 40 thou a year. And to most people, I get challenged all the time, “How did you guys do that with four kids?” We never had new cars. We never had any new furniture. We didn’t have TVs. I mean, we made all the sacrifices you would have to in order to do that. And part of how I did that was I boosted my savings. I mean, I did Roths in 2000 before anybody else I knew even knew what Roths were. And how I afforded my Roth is, I maxed out my 401(k). When you max out your 401(k) and your HSA, you save enough because you’re contributing pre-tax, you save enough in taxes to pay for your IRA contribution.
Steve: Okay, got it.
David: See, a lot of people don’t think about it that way. So that allowed me to contribute to both, and very little hurt on my part.
But now do you feel like your lifestyle has changed a lot? You sound like you were disciplined, a high savings rate, controlled your expenses. And I guess your kids are older now. So now you have a much bigger asset pool, you’re dialing in your income. Do you feel like you’re really enjoying your life a lot more?
Absolutely. So life and retirement, when you don’t have a schedule to live by, you get to focus on all the things you always wanted to do to fulfill yourself. And at this stage, all my kids are out of college. My second-oldest son is getting married next year. So you see them being successful. It’s a fun time of life to be in, which is another reason for retiring early between this time and when grandkids will come. That’s the only time that we have to focus on ourselves and enjoy our lives.
Steve: Right. You’re like a young single couple except you have money.
David: Exactly. Well, that’s another thing, I mean, to talk about the benefits of retirement. As a married couple, you get to focus on yourselves again. Because a lot of times, I know many of your listeners are in the same situation, you’re working so hard and you’re trying to achieve your retirement goals that you and your wife, you end up talking at each other and not with each other. And that’s all right. That’s how all very couples are for generations and for all eternity. But very few couples get the chance that we do, which is retire early, now have a reset period where we get to just concentrate on ourselves and live the type of lives that we want. It’s pretty cool.
Steve: That’s pretty nice. I know. I see your adventure, so it’s cool to hear about what your adventure.
David: So that’s a great segue into my dad because like you said about enjoying life, not everything’s all hunky-dory, right?
Steve: Yeah, yeah, for sure. I remember you were posting some stuff about your dad’s patents and stuff like that, and then when we chatted a bit, you shared a story that I think he was an engineer at Kodak, he had a strong career there, but he also had a huge amount of risk. He had I think a lot of company stock and health care and benefits and stuff like that, or pension. But yeah, would love to hear what you learned from that and then how that’s affected your own thinking.
David: It’s affected me in a big way, and this was another large reason for me trying to spread the word, if you will, because it was a key symptom of what I call financial arrogance that I see around in the early retirement, end of retirement community. In your own forum, when I post and contribute to, I can see it there, and I’ll talk about that in a second. So my dad passed away in November, and until then, we never talked finances or anything. We had the very typical father-son relationship. In fact, I’m lucky to say over the past 12 years, our relationship really blossomed, especially since I retired because I got a chance to spend time with him.
I was in charge of taking care of his estate, and it became apparent that he incurred a lot of debt. And his last 10, 12 years, he was hounded by debt collectors and things like that. And I share that because I didn’t realize how much of a burden that is, and worry and strain the past 12 years has been on him completely. He hid that completely. He was a proud father and he hid that from us. Well, here’s the reason why it was eyeopening for me. My dad worked for Kodak. He had a great retirement.
He had a perfect retirement. He happily retired from Kodak. Kodak issued a 2102 retirement phases where he got lifetime health care for leaving. But then what happened is, you and I both know, in Rochester, Eastman Kodak in one year, they declared bankruptcy. They demolished the retirement plan. They got rid of the health care benefits that they had committed to. Their stock plummeted, and my dad was a loyal employee. He worked there all his life. So I’d say not all, but a good chunk of his savings was in Kodak stock.
David: He lost everything. Now, in hindsight, you and I, we could say, “Oh, he should have known better,” but I guess the important point for all of us is, how many of us make our retirement plans and our models? We all have models on how we’re allocating assets, just like you were talking about with me, and where do you invest in and all that stuff. We make decisions and we say, “Oh, I’ll invest in the Total Stock Market Index, and the Total Stock Index will always be there.” We don’t know. Now, I agreed that the risk is low.
But what happens is, my dad also thought Kodak will always be there, and if you grew up in Rochester, New York, you were kind of blinded to that fact. You thought Kodak would always be there and providing for everyone, and their stock would always be high.
Steve: 130-year-old company, right? I mean, it’s like-
David: Exactly, exactly. So what happened is, after my dad, and not just with my dad, I’ve talked to other people, and out of privacy, I won’t name them or anything, but I would say there’s five, six other people that I’ve talked with, that I’ve consulted with because they know I early retired. They wanted to see what’s happening and how to arrange their portfolio. They’re in the same shape.
By the way, it occurred to me that those are only the people that’ll talk to me and reveal things. So, how many people in America are either eking by or barely making it or taking on a risk that they don’t even know? A lot of people, when we talk about financial arrogance, I say that because people don’t recognize the risk that they’re taking on in managing their own portfolio themselves and to quantify that risk or to give an example, because most people won’t acknowledge it.
You and I both know all of us lived through this. There was a time when all companies had pensions, and that was the way it was. Then they slowly transferred that risk over by saying, “Hey, you can manage yourself in 401(k)s. You have all the flexibility in the world. Isn’t that great?” And IRAs and things like that, and then cash balance, pensions came out, and you could manage that. Well, intuitively, when I talk about that for the masses, I’m not talking individual people and their level of knowledge, you can acknowledge how scary that is. I don’t think people realize how much risk got transferred from companies to people.
And oh, by the way, I also make this supposition. If managing your portfolio was easy, I’ll give you 4%, I’ll do an annuity at 4%, and I’ll invest the rest and collect a difference. If it was that simple, there is a reason why in my mind, when I look at companies, why GM made GMAC and why Apple is making their own financing companies. You know why? Finance is easy.
David: It’s easy being the middleman and skimming off of transactions and making money off of interest, the delta and interest.
Steve: No risk.
David: That’s easy. What’s hard is pensions. There’s a reason why companies are going that way. But pensions, why are companies getting rid of all their pensions? They can’t afford it because it is not easy to manage your own portfolio when you have fixed withdrawal rates due to risk. That’s why I’ve kind of turned around on fixed index annuities, fixed annuities or income annuities, depending on your level of knowledge, because if you don’t know anything, like a member of my family, then do an immediate annuity where you don’t have to think about it.
Here’s the reason why I talk about financial arrogance. If I put a post in your forum on, “I’m thinking about putting part of my portfolio into an annuity, an immediate annuity,” you know how many people would jump on my throat saying, “That’s the worst thing ever, and you should manage…” The reason why is they think they can manage it themselves, and they don’t realize the risk to your retirement 20 years down the road to your portfolio.
Now, that’s a good segue into risk. I’ve acknowledged now that I don’t have income coming into my portfolio, and I’m living on that. It’s not just the risk of mismanagement or picking the wrong stocks. It’s the risk of myself. If you manage yourself, you are always doing what you and I are talking about, moving funds around, picking a better fund, a better return, or doing something. You could very easily make the wrong decision. There’s a risk of dementia. Somebody I know in my neighborhood got dementia and drain their entire account.
David: It’s very sad. What do you do? The people left behind are in trouble. And then somebody else gets hacked. Every time I get a text from somebody, I wonder whether I’m being hacked, and it very well could happen. I could leave my cell phone someplace and somebody pick it up. And just doesn’t have to be now, it could be 10 years from now, 20, when I’m not of sound mind and not quick, and I leave my cell phone someplace and they hack into my accounts.
Steve: How are you hedging that risk? Do you have an advisor? Or what are you doing now?
David: Yeah. So I do have an advisor, Gaby Mechem from NIM Financials, and then there’s Byron Hardlem, CPA. So, just to give a shout-out. But, essentially you have to surround yourself with a good team, and they’ve given me advice and counsel on not only… I’ll give you an example, to fix index annuity. One reason how I hedge on sequence returns in an extended downturn is they provide lifetime income, but I didn’t want that. As soon as I say lifetime income, you should be thinking, in your head, “That’s good and bad because there’s a rider fee,” and you pay that rider fee even in a downturn, so you are losing money. Well, guess what? She was able to find income riders through carriers that don’t charge a fee.
The reason why I like that, even though then you would be saying, “Yeah, but they’re charging their expenses, they’re recouping at some other place,” you’re absolutely right, but as long as they’re not charging it in a discreet fee. Then if I’m in a fixed index annuity and I go down to zero, guess what? They don’t pay a fee. I mean, there’s no fees taken out. So the only time fees get taken out is if I’m in a growth scenario, and I gladly trade a little bit of upside for no downside and no fee. So that’s how using those types of vehicles have I addressed sequence risk and principal protection and longevity. There’s other risk factors, inflation, all that other stuff that we can talk through at a later time.
Steve: Yeah. Yeah. Well, I think just to recap this part, a couple thoughts. So I totally agree with you. Just to go back a bit, when we moved from DB plans to DC plans, so from pension plans to 401(k)s, we basically shifted all this risk to individuals and we went to every individual’s country and said, “You’re in charge of your own retirement, and now you have to be as smart as a CFO who has managing the pension before and manage your own investments.”
Steve: And that’s like a crazy idea. The progression has been basically early vintages, so like I’m a person who got a 401(k) and no pension. The initial defaults were terrible, the fees were high, performance was terrible. Remember looking at it, it didn’t go anywhere for a long time. Now and later vintages like, okay, fees are lower, defaults are better. So people are defaulted into more risk, which is good. But yeah, just to go back from where we were, it’s like people were making no returns. Now if they take more risks, they’re taking at least the market returns. You got control of your situation, took even more risk and got higher returns. Good.
David: Then you de-risk.
Steve: Yeah, and then you eventually de-risk, which is a good move. By doing these annuities. By the way, also, I’ll link in too, we did an interview with Glen Nakamoto who was another community member. He was researching, getting annuities, you couldn’t get anyone to talk to him about it. He is like, “I want this income layer. I wanted social security,” and he wanted some guaranteed annuities to kind of add up to a certain amount of guaranteed income to make sure his core must-have spending was addressed. But he had a hard time finding people who would talk to him about it, but he ultimately did it because he felt like the math was right. And we can link to it. You can see all of his thinking.
But, what you’re doing is interesting. You’re buying term annuities to get income for certain amount of time, and then you’re also investing at the same time to recoup your principles so that you can recycle this in almost 10-year windows. But the interesting thing is, by having the annuity, you feel comfortable spending it all. You’re kind of like, “Well, over a long duration I’m confident in the market, so I’m happy to spend my money.” Because I think another thing that happens is, a lot of people, they go to retire… Well, first they’re not sure they can retire, and so they do one more year and they keep working forever. And then they go to retire and they don’t want to touch their money because it’s like their nest egg, and so they can’t spend it. And then time goes by and then they’re 80 years old and they’re like, “Now I’m too old. I can’t actually enjoy myself.” So they miss that window, like actually using the money when it has the highest utility.
David: You’re absolutely right. That decumulation stage is psychologically one of the hardest things about this phase in life. It’s a good point you make. There’s two, right? One is, when do you stop working? That is a very difficult psychological step, and sometimes it’s made for you, that decision, but a lot of the times you have to decide yourself. But then the other is, after a lifetime of saving behavior, how do you flip that so that you can enjoy retirement? That’s another aspect of annuities in which why I’m a proponent of them now, and I’ll talk about them through an example that I had a year ago when I was traveling with my wife through Europe.
When I checked into the Prague Marriott, their concierge said that they were renovating, so they didn’t have it available, but they had three restaurants there at the hotel. They said, “We will give you a $200 credit every night for the three nights that you’re here and you can spend it at any of these three restaurants.” We said, “Hey, great. That makes up for it. We’re very happy.” So every night we spent at a different restaurant and we spent the $200, and as you can guess, the spending of the $200 was, what prime rib should we have and what type of wine should we enjoy, and should we have this appetizer? Maybe we’ll take two appetizers because we like both of them.
So then it kind of occurred to me, and it’s kind of funny because I’m remembering a conversation where I said, “Hey, this is a great example of finance example.” My wife says, “Will you turn it off?” But I digress. So on the $200, if you had told me that my portfolio just returned $200 that day, go ahead and spend it. What would’ve been my normal human reaction that everybody else would’ve done? Yeah, I’ll spend the $200, but I don’t know if market risk were in it. Last year we were in a downturn, right? There was fear in the market and whatever. So instead of spending 200, I might spend 150, I’ll hedge a little bit, I’ll spend 150. And instead of getting the best cut of meat, maybe I’ll get the lesser cut of meat, whatever. That’s how I get to the 150 and things like that.
That’s what all of us are talking about when we talk about lower your cost, your standard of living, things like that in order to make trade-offs, right? Because we’re used to in a saving methodology where you save money at the expense of something else so that you can enjoy something later on, that’s a saving mentality, the scarcity mentality. Well, now all of a sudden when you’re decumulating, you have to spend it all. That’s hard because of that behavior I just talked about with that scarcity, you think you need to make a trade-off. Well, if you are getting an annuity, think about the $200 that the hotel gave you. That’s exactly like an annuity. The money comes in and you spend it. That’s the natural human behavior because you know it’s out of your control, that you’ll get it again next month. And there’s something psychological. It’s the same $200.
Steve: Right. Yep.
David: One is under you, one is under annuity. And I’m telling you, it makes a big huge difference in how you enjoy your retirement. So that’s one lessons learned. The second lessons learned is, you stop budgeting. Now, I wouldn’t say that for everyone, if you know what I’m saying. You don’t have to do this and all. But I’ve talked to a couple other retirees. I was astounded that they did the same thing because I thought I was the only one. Here’s what happened. I was the type of guy he is. I’m sure most of your listeners are too. I tracked every penny. All the way back to 1989, in Quicken and spreadsheets and stuff like that, I tracked everything. That was my behavior simply because of the scarcity mentality. If I knew I was saving in one area, I could allocate it to another area, and that’s how you track things.
Once I got to retirement, it started with the first year, I start tracking everything naturally. It was natural to me. And it didn’t take long. Two months in, in which I said, “Wait a minute, if I’m doing a fixed withdrawal on my 72(t), why am I tracking everything in retirement?” Because also, it helps that you don’t have savings buckets, retirement buckets. You don’t have work buckets, closed buckets. All you really have is a spend bucket on food, gas, and fun, right? I mean, it’s very simple. So I said, “Why don’t I just set up guardrails in which out of the total amount, I carved out half of it, which was still higher than my 40,000 that I used to write?” And I said, “Why don’t I set up guardrails?” So as I pass that in my spending, I’ll start to kind of look and go, “What am I spending it on? Maybe I should cut back or whatever.” But if I don’t hit the guardrails, then I’m fine.
So I stopped budgeting, literally. It’s been three years now. I couldn’t tell you what I spend money on because I don’t care. I don’t look, we just spend money. And once you know it, the saving mentality is still very hard to break. We still nickel-and-dime, but the difference is, we nickel-and-dime on what doesn’t matter to us. You don’t want to be my insurance rep, right?
David: I will beat you up on the cost of car insurance and umbrella insurance, things like that, because I can. I don’t nickel-and-dime on the fun stuff or food or going out to eat, travel. We just spend. And once you know it, I’ve never even gone past the first guardrail I set up for myself. It just naturally. I’m waiting to do it. I may get more first class tickets and whatever someplace just to do it. But we don’t do it. And I suspect most of your listeners… I don’t say this like, “Oh, look at me because I have a big portfolio.” I’m saying this so that people have a level of comfort, knowing that in retirement you can make it. Because if you’re early retiree, you didn’t get here by just willy-nilly, doing whatever and not tracking your spending. You got here through a series of behaviors, and this is how you can make it fun now, but you’ll still be who you are.
Steve: Right. It’s awesome to hear this. I’m going to ask you one more question, and then I think we should wrap it up. I feel like we’re going to post this and our audience might come back and say, “All right, let’s have Dave explain exactly what he’s doing,” because I think that there’s a lot of nuance to what you’re doing in your strategies, which are pretty interesting.
One thing that I know is that there’s basically two classes of people in the world in terms of outcomes. There’s people that go to retire and then they run out of money.
And there’s people that have money and they retire, and they tend to, at the end of their life, have even more money. And I’m curious, for you, there’s a book Die With Zero, which I have yet to read, but it’s been recommended by multiple people, but are you trying to dial in a specific outcome? Or how do you think that own trajectory and your estate is going to end up given the planning that you’ve done?
David: Yeah, I think because I am a natural believer in the market. It’s a good question because it speaks to the nature of who you are from an investing mentality, right? Because if you’re not a believer in your market, you’re going to invest in your checking accounts and CDs and stuff like that and whatever, then you probably will run out of money. But I’m a natural believer in the market, so these big indexes that I’m trying to get into so I don’t spend as much time managing my portfolio, I believe vastly outpaces my natural spending behavior.
I’ll give you another strategy that this financial team I was talking about, I didn’t do it all by myself. It’s a good strategy that I think. I’ll just kind of lay it out to you this way. There is a way you can use pre-tax dollars if you have your own company to buy them out of a solo 401(k) vehicle. So you can use pre-tax dollars to buy life insurance. The solution goes like this: If you could insure for a certain amount so that you knew what you were giving each kid, because I have kids, if you don’t have kids, it’s a different solution, but if you have kids, what would I give your kids? Because for a lot of people who are trying to manage your money, you’re trying to think about what is the residual value, which is why you’re adjusting your rate of return and your spend rate so that you kind of know what you’re going to leave behind. But that’s tricky. So you’re taking all those calculations on in the forefront.
Well, you can do that through insurance, and I would venture to say that you do your next generations this favor by giving them too much money. We had decided on a certain insurance level that you take the insurance payouts to each of the kids, and the insurance proceeds were paid pre-tax. So you’re saving money that way and you are allocating, it’s a defined benefit now what you’re giving your kids. Well, now that you’ve figured that out and that came out of your pre-tax funds, guess what? You just took that entire variable level and your entire portfolio, you can spend, or you can also give the charity. And oh, by the way, how we’re addressing that just for people to give it a little nuance later on in light. One reason why I’m putting everything into Roths is so that later on I can do a CRT, have the income from the CRT, which is a charitable remainder trust.
That’s where I think a lot of people get it wrong. They dictate where they want their funds to go on their debts, what charities. Well, that’s the wrong thing to do because the tax benefit comes to your heirs under charitable remainder trust. You get to take that tax benefit upfront. By the way, that can offset a Roth conversion and you get lifetime income and you are giving to charity at the same time. So all of those are strategies that you can do on how to spend the money yet still have money to live on and you’re living safely. Because now you get to spend it all without worry, you’ve already provided for everyone. So how’s that in a nutshell for kind of figuring things out?
Steve: That’s awesome.
David: I think I’m too risky-
Steve: Yeah, no, I appreciate it. That’s super good. I mean, one of the things we’re going to do and then we’ll wrap it up is, we are working on, just like we built the Roth Conversion Explorer, we’re going to build a withdrawal retirement income explorer that lets you pull different levers, try to move things around. You’re introducing a lot of ideas here that are interesting, like targeting your estate through insurance, doing the CRT to kind of capture the tax write off and income, but still give to a charity. It’s super interesting.
So David, thanks for being on our show. To our audience, thanks for listening. Our goal at NewRetirement is to help anyone do better with their money and their time. Check out our community. Dave is part of it. I’m part of it. It’s on Facebook. You can come to our site, try our platform for building your own financial plan. You can do a lot of nifty, getting organized, seeing what’s possible, seeing how to be tax efficient, getting better sense, confidence and control. All feedback is welcome. And then any reviews on iTunes or anything are super welcome as well. We want to spread the word about this podcast. Okay. So with that, thank you and have a great day, Dave. Thanks for being on the podcast.
David: Thanks for having me on.