By Dr. James M. Dahle, WCI Founder
You have often heard the phrase around here, “If you've won the game, stop playing,” perhaps most famously from WCICON22 keynote speaker Dr. William Bernstein. It obviously makes sense on an intuitive level, but when you try to break it down to the nuts and bolts level, nobody has ever really defined it. Today, we're going to talk about what “stop playing the game” really means.
Dial Back the Asset Allocation
The main thing that people mean when they use the phrase “stop playing the game” is to stop taking the same amount of investing risk that you did when you accumulated that nest egg. Maybe you won the game as a result of a long-term savings and investing plan. Maybe you had a windfall from the sale of a business or an inheritance. No matter how you won it, the idea is that if you needed a 75/25 portfolio before to meet your goals and now only need a 40/60 portfolio to do so, you should have a 40/60 portfolio (even if you can tolerate the volatility and risk of a 75/25 portfolio). It can be a funny thing, though. When you design your portfolio you should consider your
- Willingness, and
to take on risk. However, after you hit your number, your need to take risk goes down, while, conversely, your ability to take risk often goes up! Consider Warren Buffett for instance. The man doesn't need bonds because even if his equities lost 99% of their value, he would still have 1,000X as much money as he would ever need to support his lifestyle. He has a massive ability to take risk.
But if you just barely hit 25X or 33X (or whatever feels like “enough” to you) of your annual spending and you want to stop working, your ability to take investment risk has significantly declined along with your need and probably your willingness to do so. It makes an awful lot of sense for you to have a less aggressive asset allocation.
How to Adjust Your Asset Allocation
Naturally, just like when you rebalance your asset allocation, you want to make a permanent adjustment without incurring a lot of costs. You want to avoid fees as much as possible, and you want to minimize the tax hit. Ideally, you can make this sort of a change inside your retirement accounts, where there are no tax costs and, usually, minimal transaction fees. But if you find yourself having to sell appreciated assets in a taxable account, be smart about how you do it.
- Be sure you're not reinvesting dividend or capital gain distributions.
- Look for losses you can tax-loss harvest to offset those gains.
- Use any old capital losses you may have stored up.
- Be sure you're only paying at Long Term Capital Gains rates by only selling investments you've held for at least one year.
- Sell the highest basis shares first—to minimize how much of the money raised to reinvest in safer investments is subject to taxes at all.
- Consider your life expectancy and the value of a step up in basis to your heirs.
Now, what will you invest the proceeds into? The first option is to just buy more of the safe assets you already have in your portfolio. The safe assets in my portfolio are nominal bonds via the TSP G Fund and the Vanguard Intermediate Tax-Free Bond Fund (VWITX) and Treasury Inflation Protected Securities (TIPS) via the Vanguard Inflation Protected Securities Fund or the Schwab TIPS ETF. If I were going to decrease the aggressiveness of my asset allocation, those are probably the first assets for which I would reach.
However, there are lots of other options out there. You could simply put money into cash, with zero risk of nominal principal loss. If your fixed income isn't particularly safe, maybe you cut back on how much is in junk bonds, corporate bonds, or long-term treasuries.
Another option is to put money into insurance products—not because you think the investment return is going to be awesome, but because you are willing to give up investment return in exchange for some guarantees. You figure, “I'll let the insurance company take the risk of a market downturn or of me living a long time.”
Perhaps the most straightforward of these products is a Single Premium Immediate Annuity (SPIA). When you buy a SPIA, you are essentially buying a pension from an insurance company. You give them a lump sum of money, and the company guarantees you a fixed sum every month for as long as you live. It is hard to find one of these that adjusts with inflation, but at least on a nominal basis, you have passed a lot of your risk on to the insurance company. There are some riders on other fixed annuities, variable annuities, and cash value life insurance that can perform similar functions, albeit usually with significantly higher commissions and complexities. Just delaying Social Security until age 70 is one form of moving money into insurance products, but a SPIA is probably the best deal like this available out there.
There is a bit of a market timing question here, too. While, emotionally, you may want to reduce risk in the midst of a nasty bear market, you are going to be better off most of the time if you do so well into a bull market. Good news! Unless winning the game was a result of the sale of a business, a winning lottery ticket, or an inheritance, it probably occurred well into a bull market, anyway. So, right when you win the game is likely a great time to pull the trigger and get into a less aggressive portfolio.
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Liability Matching Portfolio
The concept of a “Liability Matching Portfolio” (LMP) has also been proposed by Bernstein, and similar concepts have been discussed by academics Zvi Bodie and Moshe Milevsky. The idea here is that you match your portfolio to your liabilities, i.e. you match what you invest in to your future expenses. It makes sense, since the purpose of your investment portfolio is to meet your needs and goals—not to beat the market, maximize returns, or impress your friends. If your “liability” (i.e. need) is to guarantee $100,000 in inflation-adjusted income to spend each year for the next 30 years, one easy way to do that is with a 30-year TIPS ladder. You buy a $100,000, one-year TIPS to cover your spending next year. You buy a $100,000 two-year TIPS to cover your spending the year after that. You buy a three-year TIPS for the following year and so on until you buy a 30-year TIPS. And then each year, you buy a new 30-year TIPS if you want to extend this time period. The return on this TIPS ladder isn't going to impress anyone at a cocktail party, but it is HIGHLY likely to meet your goals. Other safe investments (SPIAs, bonds, cash, etc.) can be used in a similar manner.
Perhaps you simply want to use a LMP for your needs and keep the rest of the portfolio (that will provide for your wants, extras, giving, and legacy) invested more aggressively. Perfectly fine. But you've stopped playing the game with money that you need during your life.
Cut Back on the Leverage
Here's another interesting way to stop playing the game. You will meet countless financial gurus, bloggers, podcasters, and other yahoos on the internet and social media who advocate that you keep your debt—especially low-interest rate debt—because you can earn more on your investments than the interest rate on your debt. Well, guess what? You've won the game. You don't NEED to earn any more on your investments, much less arbitrage the value of your microwave loan, car loan, student loan, or mortgage to meet your goals. So, why do it? Why not just pay off those debts and eliminate leverage risk from your life? You see real estate investors do this all the time, and if they use a regular old mortgage, the investment tends to do it automatically. As they pay off the mortgage with the operating income from the property, it becomes less and less leveraged (and usually their cash flow gets better and better) as time goes on and the loan is eventually paid off.
One of the first things Katie and I did as we approached “enough” was to pay off the mortgage on our home, which was our last debt. Mathematically speaking, dragging that 2.75% mortgage around for a few more years and investing the lump sums we used to pay off the mortgage would have resulted in us having more money. But guess what? We don't need more money. Why would we risk the roof over the heads of our children just to get a little more? Didn't make any sense to us, so we paid it off.
In my opinion, one of the funniest things about the “pay off debt or invest” debates you see is that there are very few people who only do one of those things. Most people either really do both or they really do neither in any significant way.
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Another big risk people have in their lives is a decrease in the value of their business. If you have won the game, perhaps you should do what you can to reduce that risk, too. You can sell the business and eliminate that risk completely. But there are less extreme options. You can have the business buy more insurance or increase its cash reserves. You can pay off any loans the business may have, or at least get rid of any personal guarantees you may have on the loans of your business (including real estate businesses you own). You can also sell part of the business, whether a minority share where you maintain control or a majority share where you lose control (you get the money or the control, your choice.) The proceeds from that sale are no longer subject to business risk.
In the medical world, this might mean bringing on a partner and selling that partner part of the business as a cash buy-in or a sweat equity buy-in. Either way, you're moving money and risk out of the business and into your personal portfolio.
One of the best parts about winning the game and becoming financially independent is that you no longer have to do things you don't want to do. Don't want to do clinics on Wednesdays? Tell your administrator you're out. Don't want to work nights or take call? You can tell the administrator “no” or offer to pay your partners to do your share. You can skip useless meetings and quit playing silly games at work. Most importantly, you can work less. Chances are, you would love to work less even if you love your work and want to keep doing it. When I survey doctors anonymously, about 35% tell me they would quit working completely, and 55% say they would cut back on how much they work if they had the money. Well, you have the money. So, cut back a bit if you want.
If you own a business, you can now hire out the duties and tasks you don't enjoy doing. Yes, we know you CAN do them and you might even be the best person to do them, but you've already won the game, so you should quit playing. You can drop product lines you don't like, you can drop less profitable customers, you can get rid of the people who create hassle in your life, and you can get out of partnerships that you were in just for the money. For a doc, maybe you can fire patients that you hate seeing on your schedule, or you can quit doing procedures you don't like or that increase the risk of a malpractice suit. You can limit your practice just to the patients and medical conditions you most enjoy caring for.
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The Emotional Aspect
Chances are that if you win the game much earlier in life than the traditional retirement age, you will have to deal with some unique emotions and existential dilemmas. Consider this recent post from a Boglehead:
“I have $7,000,000 in Vanguard Index, 80% in Total Stock Market and 20% of that in Vanguard Total International Stock Index. I have another $4,000,000 in paid off real estate, for a total of $11M. I am 54 years old, and my company is thriving. I am burned out beyond belief, but I am so young to walk away from such a lucrative business. I have read plenty on this forum about ‘winning the game.' I can walk away now, but will I lose my identity in the process? I'd love to hear comments from you on walking away and never looking back. I haven't commented in a long time, but I'd love to hear from the ‘winners.'”
There is clearly more to not playing the game than cold hard logic and finances. Not only do people enjoy their work for non-financial reasons, but many of us turn our investing focus away from our own needs and toward those of our heirs and favorite charities as we become wealthier. There are always more generations to “win the game for.” I don't have a lot of wisdom to share here, despite spending a lot of time thinking about it for years. Just know that you will probably spend some time and effort struggling against leaving the game right when perhaps one would think you should, whether that game is working/earning/saving or simply investing aggressively.
“Stop playing the game” means different things to different people. But once you've won the game, it is time to start considering what it means to you.
What do you think? Have you won “the game?” What did you do afterward? Did you stop playing? In what way? If you have not won the game, what do you plan to do once you have? Comment below!