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January 21, 2020
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Steve: Welcome to The NewRetirement Podcast. Today we’re going to be talking with Larry Swedroe, the director of research for Buckingham Strategic Wealth about his new book and what he’s learned helping people plan for their future over his 20 plus year career in financial services and wealth management. So with that brief read in, Larry, welcome to our show. It’s great to have you join us.
Larry: My pleasure to be with you, Steven.
Steve: So before we get started, if you could give us a quick overview of your background for our listeners, I think that would be really helpful.
Larry: Sure. Just from an educational background, I have a bachelor in business administration from City College business school, Baruch college, went to NYU for a master’s in finance. And so to have a dual master’s as well in international trade theory. I’ve spent most of my now 47 year career advising some of the largest multinational corporations on managing risks as a consultant for city co-op managing risks for some of them, including CBS, which was my first job as manager of international finance. And later for Prudential Home Mortgage, which was the largest mortgage company in the country.
Larry: I ran foreign exchange trading rooms in an offshore funding bank for Citicorp. I ran a large part of Citicorp West coast investment banking operations and was vice chairman of Prudential Home Mortgage responsible, all of our interest rate credit risk management as well. So really I spent my whole career helping companies to that point manage all types of financial risks. And then when Prudential Home Mortgage was sold, I joined Buckingham Strategic Wealth, which was a wealth management firm. They were great financial planners but they didn’t have backgrounds in risk management and so there was a great fit. So I decided to join them and for the last 25 years I’ve been helping individuals and institutional investors think about how to manage financial risks and then also integrate well thought out financial plan into an overall estate tax and risk management plan.
Steve: Awesome. That’s a pretty long and illustrious career. I also want to note, you’ve authored 16 books on investing and over 3000 articles and posts about these topics and I think that you’ve also had a couple peer reviewed articles as well. So you’ve been a pretty prolific writer. Any highlights there about with your book writing that you want to cover, your writing that you want to cover?
Larry: Well this is actually the, You’re Complete Guide to a Successful and Secure Retirement is actually the 17th. I’m particularly proud of this because I was able to recruit what I consider an all star team to help me write it, Wade Pfau who wrote the introduction to the book is certainly considered one of the retirement experts in the US. I had an expert on planning a life in retirement who I got to meet where we were both appearing at a Washington university conference and he helped me write the first chapter, intentionally put there to plan a life in retirement. It doesn’t matter if you’re financially successful, but you end up committing suicide because you didn’t plan a meaningful life in retirement. So that’s why we put that chapter there. And I had a whole slew of other experts covering the 20 or so chapters in the book to help make it, I think the most complete guide out there.
Larry: I wrote the book because there are lots of other good books on retirement planning, but they tend to focus on one aspect of retirement such as investing or social security strategies or withdrawal strategies or the estate planning. But there was no good book that covered the full spectrum and I thought I could add a lot by putting a lot of information into one easy place and create lots of lists or checklists that people could use to make sure they are addressing all the important points that I think are needed to lead a successful life in retirement.
Steve: Yeah, no, I think the book does a good job of that. I was reading through it in the past several days here and it is great that you pulled together all these experts and the reason we got connected is that Paul Merriman, just noted, I don’t know if it was Twitter or some social channel I saw that, and he just said, “Look, instead of answering everyone’s questions these days, I’m going to just tell people to read your book.” So I was like, all right, with that, let’s take a look at what’s going on here. So with … One of the things you open with is kind of like why people should plan, right? And some of the big challenges they face. You described it as the four horsemen of the retirement apocalypse. Can you elaborate on that a little bit?
Larry: Yeah. The typical main point, lots of institutional investors use this model of a typical 60/40 portfolio, 60% stocks and 40% bonds. And that is, had a great track record for the typical investor, we can use as a proxy the S&P 500 for the equities, and a intermediate treasury bond or say a five year treasury bond, high quality for the bond side. And over the life of the data series we have had that since about 1920s, that portfolio is delivered in an incredible about 8% a year return, but in the last 35 years or so, it’s done even spectacularly better earning about 10% a year. So many people projecting the past believing it’s a predictor of the future are counting on those kinds of returns to enable them to lead a good life in retirement, meet their financial needs.
Larry: Unfortunately, you have to look at how returns are earned to be able to project the past into the future, and we have had some tailwinds that are almost certainly not going to be repeated. Interest rates have collapsed that added a tailwind to bonds performance and equity valuations, meaning price earnings ratios as one metric have gone way up and trees don’t grow to skies, as they say, and so PE ratios can’t keep expanding. Today, for example, while bonds historically have returned in the five to 6% range, today an intermediate treasury, the yield is in the area of call it one and a half to one and three quarters. So you’re going to have much lower returns from that 40% of your portfolio and equity valuations are now much higher than they were. And that means equity returns are expected to be much lower.
Larry: Most financial economists today project US equity returns using the S&P 500 as a proxy in a six to maybe 7% range. And if you have bonds even at two, a 60/40 is going to give you about half of what it has earned in the last 35 years. That’s a shock to people systems, they need to plan work a lot longer, save more or lower their goals, or they’re likely to see their plans blow up and otherwise they’ll be alive without enough money to meet their needs. But that’s just two of the four horsemen in the apocalypse there, Steven.
Steve: Right. So to summarize, you’re saying, okay, these high valuations, equity valuations and kind of lower bond returns are going to instead of returning the 10% nominal return right over the past several past few decades, we should be looking at 5% on a 60/40?
Larry: Yeah, and maybe even that’s a bit aggressive unless you’re investing globally where valuations are much lower because those markets both developed international and emerging markets have underperformed for the last decade. So they have valuations, are much lower and that means they have higher expected but not of course guaranteed returns. So 5% for, I would say a globally diversified portfolio, maybe a bit less for a US centric, which is sadly what most investors in the US do. They have an asset of home country bias out of our allocation in terms of the global market capitalization, and yet the typical US investor holds 80 to 90% US assets.
Steve: By the way, one argument I’ve heard against them, I agree with that, with the home country bias and the risks that happens there. But one thing someone pointed out to me was, well, a lot of these US companies have massive international exposure, so therefore I’m getting international exposure because they’re selling to international audiences. Do you buy that argument or not?
Larry: To some degree, that’s true of large companies and the world is becoming more integrated. And if you can get the company itself 50% in the US and 50% internationally, well probably Mercedes Benz does also, only it trades as a German stock. And it turns out the German stocks maybe trading at a 12 PE and US stocks at an 18 PE and they have similar global diversification of where they’re selling. US stocks have just been on a run and therefore are more highly valued. But the other point I want to make is smaller companies are very much different. So you could think about it as small restaurant train in Germany or Japan or Brazil or Argentina or wherever, Korea, is going to look a lot different than a US restaurant chain.
Larry: And so you have that example where GMN, BMW might look more similar. So you really, when you diversify internationally, you really want to focus more on the smallest stocks and emerging markets to get broader diversity picture.
Steve: That’s awesome. That color’s awesome. I want to dive in this a little bit because I’m curious on your opinion. I know we can’t be in the business of predicting the future, but with, I’ll give you my perspective. Okay. We’ve been printing money, the world is a washing capital, that capital is looking for a place to go. It’s been going into financial assets including the equity markets and in bonds and it’s driving yields down. If we “Revert to the mean,” what do you think that might look like? I think everyone’s, so many people expect a recession because we’ve been kind of expanding for so long. And I think they are looking at these valuations saying, “Oh, well I think it’s going to come back down.” But where … How does that unfold when there’s tons of money on the table?
Larry: Yeah, sure. I’m happy to try to answer that, but I’ll give you a little lewd to that as a warning if you will. There are no good economic forecasts just as there are no good stock forecasts. That’s why Warren Buffet tells people to ignore all forecasts because … And there forecast tell you more about them and their egos than they do about where the market or economies are heading. He had said, he hasn’t listened to or read in economic forecast or a market forecast in the last 25 years or so, so that’s my advice. Just ignore them. Have a well thought out plan that takes the right amount of risk to allow you to achieve your goals.
Larry: With that said, first of all, the fact is the US has not been printing massive amount of money and the money supply itself has not been growing that rapidly. That would cause inflation to be a serious problem, so that fact or that narrative is just incorrect. However, what we have seen of course, is much low interest rates and even negative interest rates in a good part of the world. There’s actually very good research on this of what that leads investors to do and individual investors, especially those who focus and use what I call a cash flow approach to investing. So they spend their dividends and interest, which in my opinion is a very big era. You should not be doing that. You should be using what I call a total return approach to investing, because when interest rates get very low, they can’t meet their spending requirements and they then go and find higher yielding, riskier investments such as dividend paying stocks, real estate, MLPs, instead of safe bank CDs or treasuries.
Larry: And that works until it doesn’t, like the man who jumped off the empire state building and as he passed the 50th floor he said, so far so good. And then 2008 happens and those supposedly safe investments you were in crash, they dropped 25, 30, 50, 60%. So what happens is this, and we can say this with a high degree of certainty based on the historical evidence, when interest rates get very low, investors chase risk taking more risks than they should. And that drives up valuations and prices of things like dividend paying stocks, real estate, utilities, other stock. And then when interest rates start to recover, eventually they tend to do that. And we have demand and economic growth pushing rates up.
Larry: Then that money reverses, leaves those assets and goes back to what people … Oh good, now I can get my four or five, 6% on my CDs or say bonds. I don’t need to take the risk. And then you get under-performance of those assets there. So, and of course you could have a recession or a global crisis caused by some geopolitical risks and you could get those riskier assets crashing as well. So my advice is one, ignore them, never invest in them, don’t follow a cashflow strategy. I’ve written some papers on that as well.
Steve: Your perspective is awesome. So what do you think, I mean, it’s interesting watching what’s happening with the rates though because we’re going into, I mean we are in a negative rate world now at least. I think the majority of EU bonds return a negative nominal rate, is that correct?
Larry: We’re either right there or we’re very close to it. US yields are still flat or even slightly negative in real terms, depends on where you think inflation might be. So in very low environment and now historically the real rate of interest has been a bit under the real growth of the economy. You have a little bit of a liquidity premium there. You add inflation on, we’re just in an environment where people are one, I will add this though, and it’s why it’s so hard to predict. Everyone is fully aware and that was the fifth horsemen of the apocalypse I mentioned in my book. The risk that’s social security is not, it’s not that it’s bankrupt. It will still be able to pay out about 75% of its obligations in about 13 years or so when if we do nothing, it will not be able to payout its obligations. But people are afraid of that and so maybe they’re saving more.
Larry: You get countries like China, which don’t have social safety nets. Those people have incredibly high savings rates and in Europe as well, their aging population, they are worried with their birth dearth that their benefits won’t be there as well. So you get very high savings rates and that is suppressing interest rates because you have a big demand for safe assets. So we could see longterm even, possibly lower than what we’ve seen historically, real interest rates. So don’t wait for interest rates to be jumping up, that’s been a real problem. So many investors have made the mistake of staying very short with their bonds, earning almost nothing on their money for most of the last 10 years because they were afraid rates go up. My advice is always stick right in about that middle of the yield curve, that balances between risks of interest rates going down or interest rates running up for inflation, you’re right in the middle there.
Steve: That’s great. And by the way yeah, I used nominal, I should have said real when I was talking about the EU bonds, but yeah.
Larry: The EU nominal bonds yields are below zero, so after real yields are way below zero.
Steve: Right. It’s pretty interesting. And so I think one thing you’re bringing up is, just to round out your four and five horsemen. So it’s high equities, low bond yields, longevity, right? That’s a huge driver.
Larry: Yeah, we are living a lot longer and you have to prepare for that. The average second to die life expectancy today of a normal 65 year old couple is almost to age 90 which means half the time one of you are likely to be alive. So everyone really needs to think about at least the 30 year horizon at age 65 and I think a lot of people are just not prepared and thinking about it in that way.
Steve: Yeah. No, exactly. Especially when in the US, many people approaching retirement have saved one to $200,000 and they have to real about how they’re going to live, what’s the quality of life going to be? How long should they work, how are they going to draw those assets or can they … And how much risk to take. I would also say that I think demographics is this … I mean, longevity is part of this whole demographic discussion, but what you’re seeing in Europe and Japan and Russia where they’re the, you called earlier the birth dearth, right? And we’re not having enough children to repopulate and maintain these social programs. And that’s also dropping real estate prices because there’s not people that live in these houses. I think that’s a huge factor that people aren’t necessarily counting on when they look at these forecasts or they think about the future.
Larry: And also means lower economic growth because you get economic growth from population increases. You get it from productivity increases and you get it from whether the labor force increases in its participation or decreasing. Well if you have declining population growth as we have too much of Europe and big time negative in Japan and Russia, then that’s going to be a drag on overall economic activity, not necessarily per capita economic activity, but the DNP will be much slower growth and so people are scared what that means and so they want to save a lot more and that’s holding interest rates down all over the world, at least for now.
Steve: All right, so we’ve got the super, there’s lots of risks in front of us.
Larry: And we got one more.
Steve: One more, looking at longterm care, which is also driven by longevity, right? We’re all going to live. I was reading your book-
Larry: Odds of needing longterm care go up dramatically, by the time you’re in your seventies or certainly eighties the odds that you will need longterm care are incredibly high. A high percentage of the people will need some period of longterm care and most people are not building that need into their plans. And then as I mentioned, there is a fifth, which is the risk that social security may only be able to pay out 75% so if you want to be conservative, you should at least be considering that possibility.
Steve: All right, I’m going to try to recap this because this is actually helpful for me as I think about a kind of our overall ecosystem, but it really feels like … So longevity and demographics are the huge drivers here. And as those two forces get people to be a little bit more concerned, they start to save more money, that’s driving down interest rates causing these low bond yields and high equity valuations. And people have been kind of modeling based on these prevailing returns of the past several decades. But that will potentially unwind because then you’re right, that PE ratios can’t keep going up forever.
Steve: And then there are costs for living and then longterm care, are going to likely go up. I mean, they’re going to go up and they also face the risk of, hey, with demographics, social security and Medicare, will there be enough taxpayers out there to support these programs and if people are staying alive for super long time, they’re going to be claiming those benefits. And how’s that map all going to work out? But it … I think the way you position these big drivers is correct and super interesting.
Larry: Let me add just one other point since we’re on this issue of demographics, there is some good news here. While we’re, of course we’re living longer. That’s good news, if you’re in good health and have the financial resources to enjoy a good life. But the other part here that’s important is there’s been a huge change in the nature of work we do in the last 50 years. 50 years ago, many if not a majority of jobs in the US required hard physical labor. Today, most jobs are sitting at a desk or you’re actually in your home now. The amount of heavy manufacturing work that requires backbreaking labor has come way down. So that is enabling people to stay in the workforce a lot longer, which is a good thing of course.
Larry: And today the average age of retirement in Japan, partly because they recognize they’re living longer and they’re concerned about lack of children, is now over 70 and I think that’s what you’re likely to see in the US. I’m 68 this month, I’m still working, many of my friends, even in their early seventies. We just had one of my partners who was a financial advisor, finally retire at 80 because he’s able to work, his mind is perfect and he loved what he did, helping people live the best lives they could. And so I think that’s a positive on the side. So you get much higher labor participation rates as people stay in the workforce. And then they spend of course more money as well. And so you could see an offset to the economy from that and of course give them a better chance of achieving their financial goals, so it’s not a one sided story here totally.
Steve: Totally. Yeah, and I think that staying in work and then the evolution of work is going to be one of the biggest changes we’re going to see in the next 10 or 20 years that people will find their own work, they will work longer and maybe part-time, especially as we get more productive. I mean, another risk to our kind of way our society is that as we automate more, we need more of certain kinds of like knowledge workers and a lot less of highly automated repeatable things that computers can do or robots can do. And that’s a big adjustment that we’re going to have to make as well.
Steve: But yeah, and so I think one last point, and I don’t want to make this too depressing, but one of the stats you also called out was that the highest suicide rate in the US is men over 70, that was kind of a shocker to read. I didn’t think that … I didn’t know that was the case. And I think you attributed that to the people losing kind of the sense of purpose and social isolation. Anything else that you think causes that?
Larry: Yeah, so that’s why we put the first chapter of the book is to plan a life in retirement. I had a good friend or has become a good friend, author Alan Spector, who wrote a wonderful book, Your Retirement Quest, and he focuses on what the research shows is that so many people when they retire, what they lose are the two things that are the most important determinants of whether you’re happy in life. They are number one, the depth and breadth of your social relations and secondarily what I call a reason to get up in the morning. Something that is mentally stimulating and emotionally fulfilling, so you feel a sense of accomplishment as well. Once you have enough money to put food on the table, clothing, that kind of thing, you’re not worried about that. Literally those are the only two things that matter. More money does not make you a happier is what the research shows.
Larry: In the US the average level of income where you’re no more happy is actually only on average about $75,000. Now, might be 150 in New York and 50 in Hope Hawkinson, but it tells you, you don’t have to be a multimillionaire to be happy, but you need depth and breadth of social relationships, those three o’clock in the morning friends, someone you can call at three in the morning when you have an emergency and they won’t hesitate to pick up the phone and come and help you. And work with so many of us get our social connections at work as well as our sense of fulfillment and accomplishment that when we retire, if we don’t have purpose in our life, like we’re going to go to education classes or be a candy striper and meet people at the hospital. I had two uncles who did tax returns for people who couldn’t afford to do it.
Larry: Learning a new language, whatever it is that makes you happy and fulfilled keeps you connected. If you don’t plan for that, well then you’ve got a serious problem. And if you’re a man, your wife, who may have been a stay at home homemaker and now all of a sudden your home, it’s the old syndrome. I’ve married you for better or worse, but not for lunch. And now all of a sudden this person’s around and they’ve got their own life and the highest divorce rate is actually now the whole lot of what you could call silver divorces, people who are now we’re tied from work and now all of a sudden they’re all their time is together because they haven’t planned a meaningful life. So this is why we wrote that first chapter, to give people a way to develop a plan that they can try out before they actually retire. We give them checklists, et cetera. And again, I would recommend Alan’s wonderful book, Your Retirement Quest.
Steve: Awesome. Yeah, that’s a great segue into kind of how people should use this book. And just to frame it up, so for many of our users, they’re kind of 50 plus, they’re approaching retirement and they’re getting really serious about it. And we also have younger users as well. They’re saving money, so many of them have hundreds of thousands of dollars up to a couple million bucks in there. But they know that they need to be thoughtful about how they use this money. So with that kind of framing, we talked a little bit about like having a vision for your future, what do you think the most important, I don’t want to go through all parts of your book, right?
Steve: Because you do cover a lot of stuff. Discovery process, the asset allocation part of it. Having an investment policy statement and managing your portfolio. Kind of like rebalancing it, how to use Monte Carlo, how to just define how you invest active versus passive. And then also how do you avoid huge risks and many other things. Right? What do you think are the most important parts of the book or is it really organized in the priority order that you would take, you would kind of go to people and then go through this stuff?
Larry: Well, the way we organize the book was first as we discussed to put planning a life in retirement. Unfortunately most people don’t do that and we think it’s critical, and the research on divorce and suicide rates certainly supports that. And then we talk about a discovery process, giving people list of questions they need to answer both themselves and if they’re married, a spouse, to determine what is important to them, what are their values, what values do they want to pass onto their children? If you were to ask the kinds of questions, like if you were to die, learn you were going to die tomorrow, what would you regret not having done? And then building the ability to do those things into your plan. That kind of thing is really important. So you want to discover what’s important to you in terms of expenses and values and experiences. And then you want to develop your life plan around that.
Larry: And then we turn to the investment section because that’s where most people focus and many people even have a wealth advisor to help them do that. But the rest of the book is really where I think is best to spend our time because it’s an area most people simply fail to discuss. And one of the biggest ones is the estate plan and even having discussions with family members, their children, about their assets, money is such a taboo subject in the US that we find most people we talked to their children don’t know what the documents say. They don’t know where the assets are, they don’t know who someones banker, insurance agent, wealth advisor might be, and they have no idea what purpose the parents wanted to have for their money, why they’re giving some children may be more than others. And so we provide sections in the book on what needs to be developed with an estate plan and also very importantly, how to prepare you for the money that they will or will not inherit.
Steve: Yeah, totally important. I talked recently with Cameron Huddleston, she wrote up book, Mom and Dad, We Need to Talk, that dove into this mainly from her experience around her mom’s medical needs and going through Alzheimer’s and dementia where she knew she needed to be in control. And like what happens if you don’t act … If you’re not ready for this and you don’t have the right powers of attorney in place, medical directors and stuff like that. It gets to be really complicated and you know, friction fall and expensive to do this after the fact. If you’re not ready to kind of like do this hand off. And I think the big, one of the big things that comes out is you need to plan for not having control of your life at some point. And what does that hand off look like? And you’re going to have to trust somebody else, it’s often your children, right? Or maybe a sibling to kind of have some level of control in your life. How do you see your, the people that you guys advise dealing with this?
Larry: Yeah, so we encourage them, first of all, to take what I call an open kimono approach. They should sit down with the family, discuss what the financial assets are, what your plan to do with the money, who will inherit what. And if you have a preference, which some people logically do, you have one child who may be needs more support than others either for medical or other reasons. That’s okay. And as long as you’re explaining it to your children, you likely won’t have why dad leave, mom and dad leave more to my sister than me. Well if you have that conversation, you can avoid it. That problem.
Larry: The second thing is, as we discussed, people don’t even know where documents are. So if someone dies in a plane crash or a sudden heart attack and hey, we don’t even know where the bank accounts are. When my father-in-law died, we had to chase down 13 banks where he had accounts because his family has lucky enough to survive the Holocaust in the concentration camps. He was afraid even of the banks, having money there and it took us a long time to track every one of these down. So it’s absolutely critical that your children or your spouses or your trustees know who your advisors are, who has the documents, who’s in charge. If and the last chapter of our book may be the most important is on elder abuse.
Larry: The longer you live, the more likely you are going to experience cognitive decline at some point. And you must have a plan because those who experience cognitive decline become a highly susceptible to criminals with either hacking attacks or other abuses. And often it’s even with family members. In fact, it is the most common robbery if you will, of assets comes from family members. So you have to have a plan that deals with, I’ll just say one other story. My wife and I in our documents, which every year we have a meeting with our children. We review again where all these documents are. They know exactly what we are worth, who’s going to get what, et cetera, but we have in our documents also that I have the right and same for my wife, that if either of us thinks the other is cognitively impaired, or beginning that, we have the right to demand a medical checkup and if they cannot pass a cognitive test, they are to be removed from all financial powers of attorney, credit cards taken away.
Larry: No bank accounts, no brokerage accounts and the other spouse and/or trustees could be your wealth advisor, could be another trustee or a trusted family member is given the authority. That’s absolutely critical. Everyone who’s listening should have that in their documents.
Steve: Yeah. That’s interesting to, it’s great to hear how you’re dealing with this potential scenario in the future. It almost feels like people need a small, like a mini government, like a system of checks and balances where it’s not, you’re not just handing all the power to one person or another, but there’s actually the families involved and also third party advisors, which I think is a great idea.
Larry: We’ve seen so many cases that are parents of, one child had a drug problem, another, his business was failing and then they’d go in and raid the accounts of somebody who can’t protect themselves anymore, let alone the cyber criminals and subject to getting your credit cards and bank information stolen. Or the phone calls we have all probably had saying, you owe a certain amount of money and if you don’t pay this, we’re coming get you or whatever.
Steve: Yeah, no, it’s true. It’s ridiculous what’s out there. I think a lot of it is there is this kind of social engineering, right? That’s how a lot of hacking happens. People just make phone calls either to companies or to people and say, “Hey, I’m this and this and you know I’m stuck in Mexico. I need you to wire money right now.” And stuff like that.
Larry: I say this just as a side point realistically, that people who have found the most susceptible are single elderly women. They end to be prey because the criminals know they’re the easiest to go after. So that’s, you’re more likely to be targeted. So you really have to make sure that you have these protections in place or everything you and your spouse worked for could disappear literally overnight.
Steve: Wow. Well, it’s great to get your perspective on that and a good heads up for our listeners. So before we move on, I want to, I think one of the big things that we’ve seen from our users is, they’re building plans. They want to get to a high degree of confidence about their plan, right? That their money will last as long as they needed to. They want to know when they can retire and be confident that it’s the right time. We have a lot of people thinking about that, like should I retire this year or should I work another couple of years? How do you think people should go about assessing that risk and also managing it over time?
Larry: Well, for anyone who was working with a wealth advisor because they think they can benefit for all of this holistic planning, helping you decide when to take social security and many people get that wrong, whether you should buy annuities or not and if so, what kind? Having your estate documents, having the right types of insurance and you’re buying longterm healthcare or not. All of these issues have to be considered in the plan and then what we do, and this is what I recommend because I don’t know any other way to do it appropriately, otherwise your sort of pulling a number out of thin air, just guessing. We run what’s called a Monte Carlo simulation, which takes the current best estimates of stock returns and bond returns. So might be, for example, we think say six or 7% for stocks and 2% for bonds and then looks at the historical volatility, because as we know, you’re almost certainly not going to get that seven through. It just means there’s a 50% chance you’ll get more than seven in stocks and a 50% chance you’ll get less.
Larry: Similarly, with the bonds, maybe you get lucky and it’s a great period and you get 10 or 11, maybe it’s a really bad period, like 2000 to 2009 when stocks lost money. So when you run a money call low and you can then say, well, if I take three, four, 5% looking at various withdrawal rates and different equity to bond allocations, what your odds of running out of money are. And some cases we’ve helped people and showed them that, hey, they don’t need to take as much stock risk as they have. You can sleep a lot better. Some cases we’ve told them, hey, you need, you can actually spend more than you’re currently doing and still have good odds of success. In some cases we’ve had to tell people you should give less to charity than you’re currently doing. We know you think that’s important, but having food on the table is more important and you’re taking too much risk.
Larry: So the only way you could play around with these various scenarios, in Monte Carlo we use runs 3000 different possible economics scenarios. And that gives us a way to think about the odds of success. And we like to think that if you have flexibility, meaning you can cut spending, if that left tail or black swan risk shows up, then you can take a bit more risk. Maybe an 85% odds of success are good enough. But if you’re that widower who is renting an apartment and takes Uber wherever she goes, there’s not much she can cut. Well you probably should be at 99%, so you have to evaluate each individual situation and understand how much is a failure you are able to take and have ready and written in place so you’re not panicking, what I call a plan B.
Larry: If we get in 08 or 09 or 73 for 2000 to 2002 where markets just crash 56% then you can put in place these actions like moving to a lower cost living areas, downsizing your home, working longer if you were still in the workforce, then you can have low odds of success if you’re prepared to take those stops. Otherwise, you should take less risk of failure.
Larry: One last thing, Steven, if you don’t have those tools and don’t work with an advisor, at age 65 I would say today, while we used to use a 4% Safe Harbor rule of thumb, so if you got a million dollar portfolio, you could withdraw 4% or 40,000 the first year raising from inflation. Maybe you get 30,000 from social security, so you’re getting 70,000 total. If that is enough for you, great, you’re in good shape, but because bond yields are lower and equity values are higher, we think today a more prudent for that 65 year old is if really want to be conservative, I’d make it 3% for, if you don’t need to be quite that conservative, three and a half.
Steve: Yeah. We’ve heard that from some of our other podcast guests as well that they’re kind of between three to 4%, three and a half percent, sounds about right for the “Safe withdrawal rate.”
Larry: And by the way, of course, as you age and you rerun the numbers there is no point in say a 90 year old taking 3% when 10% might be okay. All right? So you need to keep running these every couple of years as you age and your portfolio actually delivers performance. It’s not that put it, and set it and forget it. You should run it regularly.
Steve: Right. Yeah, no, it’s one of the big things that we’re going to actually, it’s not in, but it’s on the roadmap for our planning platform is to fold in Monte Carlo. Why do you run 3000 versus a thousand passes through Monte Carlo?
Larry: Well, there’s a balance. Obviously, at some point you get diminishing returns. The program we used happened to have chose 3000, if it chose 2,900 or 5,000 that would have been okay. Somewhere in that range is a good enough picture of what the world looks like.
Steve: Right. And what do you see your clients shooting for, like 90%, 95% certainty that the plan is going to hold, are chances of success or is it lower?
Larry: Like I was explaining, it really depends on the person who … And considering their options. Most of our clients have, what I would call substantial net worth. They’re not ultra high net worth. They’re in the call it million to two million range of kind of be the medium for our clients. Of course, we have some who have a lot more or a hundred million or more, and we have many in a three to a hundred thousand to a million and even 150,000 to a million. So the more money you have, likely the more options you have to cut spending. Someone who’s spending, for example, if that $10 million portfolio and we’re spending 400,000 a year, probably could easily cut it to 300 or 250 if they needed to and they’d likely even be willing to do that without suffering a big degradation in their lifestyle.
Larry: But someone who’s spending maybe 80,000 a year and doesn’t have much room because they don’t travel two or three trips around the world, they don’t eat in fancy restaurants. They may be have very limited room and someone who’s spending 40 or 50 may have almost none. So it’s a spectrum. Most of our clients, I would say will have some room to shoot for that 85-ish kind of odds is best. The people who are closer to the margin of call it, I do not want to have to spend less than X, then you’re up in the mid to high nineties.
Steve: Right. Well I think another thing you can do is you could, you can split it, right? You can have a minimum level of spending that you must have for your kind of shelter, food, stuff like that, healthcare. And then you can have a desired level of spending that’s, where you’re taking more risk for that higher bandit income and do it that way.
Larry: Yeah. So I think this much simpler and more prudent way is you have a plan A, which is what you want to spend and keep your spending to a level that gives you at least say that 85, 80%, 85% odds of success, whatever you’re willing to live with as a failure possibility. And then you have a written plan B that says if the risk shows up, here’s the three, four or five steps I’m going to take. So when 08 happened, our clients were ready. They knew all right, we’re going to have to cut our spending. We’re going to give up our annual trip to Europe and make it every other year. We’re not going to buy a car every three years. We’ll make it every five or 10, whatever. They had their plan and they weren’t panicking to say, “Oh, what are we going to do now?” It was well thought out. Not in the midst of a panic when emotion ruled.
Steve: Right. That’s a great way to look at it. They have some nice high class problems. Not everybody has that, those options, but …
Larry: Most people of our clients, typically have some options. You don’t have to eat out and spend $80 at a restaurant. You can go to a local neighborhood place, maybe bring your own bottle of wine and get just as good as company and just as good conversation and probably 80 or 90% of the quality of the food. Still have a good evening. So you have some ability instead of eating that meal out, once a week you go once a month.
Steve: Yep. No, I totally agree. I think a lot of people, if for everybody across the spectrum, expenses are a huge part of this and really understanding what’s driving those expenses and being efficient about it is a big part of this. All right, so let’s keep going. I want to kind of, you … One of the things in your book is kind of like the nine planning errors to avoid. Can you give us a kind of a quick overview of what those are and how people can mitigate them?
Larry: Sue. One of the most important ones is something we call sequence risk. Because when you’re in the accumulation phase, the order of returns doesn’t matter too much. Although actually it’s better if you get your great returns later because you have more assets, right? But when you’re in the withdrawal phase, it matters greatly what happens in the first few years because if the market, say you retire and it’s 2000 market drops 20% next year, another 20, 25%, you’re now withdrawing assets. And then when the market began to recover in 03 you can’t recover and therefore plans can blow up. And that’s why even though stocks provided a 7% real return from the 1920s through our current period, the safe withdrawal rate was only a 4% real return, so that’s the problem. You will have to become more conservative as you approach retirement itself. And that’s why you need to use that safe harbor rule.
Larry: Another big one is a lot of people overestimate their ability to continue to work. It could be that your health condition deteriorates, you could have cognitive decline, your industry and your knowledge bases, technologically now obsolete, so that’s a problem. You got to be careful not to overestimate that ability. Another one is to become too conservative. 65 year old couple we said should be planning or at least 30 years, so you’ve got to make sure that money lasts 30 years. When I was growing up, someone who was 65 probably if they let live five or 10 years, that would have been a lot. I hardly knew anyone over 75 when I was growing up. So you can’t get too conservative, you don’t want to have equity allocations too low. Another big one I’ll mention is taking withdrawals from the wrong location and we have a whole chapter on withdrawal strategies. You want to make sure you’re withdrawing your assets in the right location. Typically, once you take your RMD or required minimum-
Larry: Distributions from your IRA, you want to then take as much as you need from your taxable account. And if you have a Roth account, that should always be last. So you want to look at that. And the last thing I’ll mention, although we wouldn’t have covered all nine is the risk of inflation. We all have a recency bias and inflation has not been a problem for the last 20 years or so, but it was a huge problem in the 60s, 70s, and early 80s and it could just as easily come back. And so you want to be very careful not to underestimate that risk.
Steve: Okay. That’s awesome. Yeah, I appreciate the summary of all this stuff, especially about getting too conservative. I think a lot of people, they need to think, oh, I could be … There 65 and if you, there’s a decent chance that want to either you or your spouse will still be alive in your 90s. You’ve got to think about a 30 year timeframe and that’s a very long time.
Larry: Yeah. And that conflicts with a natural want. We get older, we tend to become more nervous about markets and for good reasons, maybe we’re not working anymore so we can’t replace losses. So there’ll be a tendency to want to get too conservative and you have to be very careful not to, drop your equity allocation so low that you are not likely to generate enough return to meet your goal. And that’s again where Monte Carlo can help.
Steve: Yeah. I think one of the big takeaways too is, I mean, while we do software for planning and we fully support doing DIY, do it yourself, we know there’s a lot of people that are, do it with mes or do it for mes, types. And I think that the advisor has a huge role in just coaching people, educating them and understanding these things, but also coaching them through these different parts, these different kinds of risks as their life changes and they look forward like things to look out for like this. Hey, you really can’t. You may want to throw it all in fixed income right now at 60 but that’s not a good idea and here’s why.
Larry: One thought here and I have a section of book on, should you use a financial advisor? You get a common cold, you got a headache, you can go online and do some research and treat yourself and you’re likely to be okay. In this book we show all of the complex issues that are integrated and relate to each other. There is almost nobody I know out there except financial planners themselves who has the knowledge to make good decisions. It’s not that people aren’t intelligent enough, but they don’t have the breadth of knowledge. This is not a common cold problem, you need someone at least to look over an entire plan to make sure it integrates estate planning, taxes, insurance of all kinds and investment to make sure all of the parts fit together and allow you to achieve your purpose and your goal. Very few people have the training to get it all right.
Larry: So at the very least you should have someone help you develop a plan and then on occasion may be every year or every other year, do a thorough review as things change. And if you think you have the skillsets to manage it in between, maybe you rely on them on an hourly basis, fine. Other people obviously feel that they can benefit from an advisor who was there full-time watching everything and integrating all of these things for them.
Steve: That’s a great perspective. So before I wrap up here, just would love to kind of get your own take for your own plan, how do you … Do you have a plan to dial back the work level at some point? Or how do you see your own future unfolding?
Larry: Yeah, well originally my plan was to retire when I sold the company. I had enough assets 25 years ago. I didn’t need to work anymore. I was going to, I thought I’d go try and teach. I had guest lectured at Stanford and other places and really enjoyed teaching, so I was going to go look for that kind of job to work part-time and then having been an investment banker type, most of my career I had had little time to be around my children and I wanted to while they were still young, have more time to spend with them but then I found, a friends of mine had started this investment advisory firm and they were great planners but they didn’t have the risks, skills and experience that I had, so we thought, both of us thought it would be a great fit and we basically started this company and took it from, we had seven million of assets when I joined and today it has cumulative over 50 billion of assets.
Larry: We either advise or administer over with offices in 35 cities and I’m the director of research. My job is based to read the literature, write it up so people can understand these dense academic papers that are filled with complex math formulas and allow someone to then interpret what is the research look at, what did it find and what are the implications. And so my job today is purely an educator teacher, training other advisers in our community and meeting with their clients to help them with discussions. And I love what I do, I work at a home. I don’t travel very much anymore, so I’m getting to do what I love to do. So I’ll be 68, I thought I would have been basically retired 25 years ago. I could see myself doing this, at least in fact, I’ve committed for at least another three years and then maybe start to cut back a bit. But I don’t see anywhere in the near future where I wouldn’t be working, say at least half-time.
Steve: Nice. Well, the data backs you up but the most knowledge workers, if they can retire within two and a half years or they do retire within two and a half years, they’re back consulting, starting a new company or doing nonprofit work and yeah, I totally get it. I mean it’s super engaging where if you love what you do and you find it super engaging, are there better alternatives? I mean you can travel all the time, but you might get to, I mean, then you’re basically a full-time traveler and that’s your job, so.
Larry: Yeah. My wife and I take two big trips every year around the world with a leading travel company called Pow. We just came back from two weeks in Japan and earlier this year we were in Germany for two weeks. We plan out ahead and so the next one is the Dalmatian coast in Australia and New Zealand and then Israel and Jordan. So we get plenty of travel. We also travel to see our grandkids, but I get great joy out of helping people. It’s my way of giving back. I love the research, the intellectual challenge of it as well. So that gives me the two purposes, my social connections and the depth of breadth with them. I get to work with my friends and got to meet so many nice people over the years. I’ve become good friends with many of our clients and I have the emotional and intellectual stimulation. So why retire? When it becomes work I’ll retire.
Steve: Right. Well what’s so interesting is you’re, so you’re 68, if you keep going, three years you will be 71, right? But if you stay healthy and active and you’re kind of cranking along, even then if you might live for another 23 years, you’re kind of like, all right, well gee, do I want to stop now?
Larry: One little story, on our board of directors for a mutual fund complex we run through another … One of us subsidiaries is a felon named Harry Markowitz, who is famous for his work on modern portfolio theory. He is the father of modern portfolio theory and he’s in his 90s and he’s on our board.
Steve: Right. Well, it’ll be interesting to see how the world looks over the next 10 or 20 years if we keep cranking on, health span and keeping people going and healthier for longer and people take good care of themselves. I mean, I agree with you. I look around now and in my family and friends its like, oh, I know more and more people that are 90 to a hundred which 30 years ago or 40 years ago that was super unlikely. So people are definitely living longer. So knock on wood, hopefully that continues.
Steve: All right, well look, this has been super good. Before we wrap up, any kind of key influencers or communities or resources that you think would be useful, I mean obviously we’ll give a shout out to your book, right? Your Complete Guide to a Successful and Secure Retirement and we’ll have a link to that on the show notes as well. But, and Buckingham, right? As well as you’re firm, but any other resources that you would recommend?
Larry: Yeah, first of all, I write blogs regularly for three websites so you can follow along with them. I write for the Evidence Based Investor, which I’d highly recommend just your average investor. You don’t need any high level investment skills to read the stuff that’s there. On the other extreme is a website called Alpha Architect. I write regularly for them as well. For anyone who is what I would call the geeky, really interested in the math and the science behind the investing, that is by far the best website out there, so that’s Alpha Architect. And the third that’s kind of in the middle of that is a website called advisorperspective.com and I would recommend you check their articles out as well. Between the three of them, I probably have about 12 to 13 pieces or so every month out there covering a wide variety of topics, not just investing, but financial planning and other issues.
Steve: That’s a lot. I write for Forbes and I’m lucky to get one or two out a month, but that’s good. All right, well good. Any questions for me?
Larry: No, thanks very much Steven. It’s been a real pleasure, I would be happy to come back anytime to discuss other issues. We didn’t get the things like social security and HSAs and some of the other stuff or just general investment questions or planning questions in general.
Steve: Yeah, no, I think we could, sometimes we have guests back on and we’ll do group discussions as well. So I could see that. I loved the fact that we kind of covered some of the high level economic theory and then also dove down into some of the nuts and bolts of planning. Larry, thanks for being on our show. Thanks Davorin Robison for being our sound engineer. Anyone listening, thanks for listening. Hopefully you found this useful. Our goal at NewRetirement is to help anyone plan and manage their retirement so they can make the most of their money and time. And just as a quick note here, we are trying to, we don’t cover everything that is covered in Larry’s book, but we cover some of it and we learn a ton from these podcasts as well and we’re trying to at least bring tools that people can use like books.
Steve: I mean software is a way to kind of build your own plan and kind of get control but also support other people in ecosystem like advisors that play a huge role. But if you made it this far, definitely check out Larry’s book and we’ll have the link on our website. And again, it’s Your Complete Guide to a Successful and Secure Retirement. Their website, we’ll put links up to the resources that Larry mentioned and to our site, newretirement.com. You can also follow us on Twitter @newretirement. And finally, we are trying to build the audience for this podcast. So if you could leave us a review on iTunes or Stitcher or anywhere we’d appreciate it. We read them and try to improve our show based on all the feedback.
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