How to Navigate The Changing Retirement Landscape with David Blanchett

Updated : Sep 02, 2019 in Articles

How to Navigate The Changing Retirement Landscape with David Blanchett


Casey: David, welcome to the podcast. David: Thanks for having me. Casey: Really excited to have you. We have been utilizing your research here
in our office and in my practice for years. I have talked about your research on our television
show. I’ve illustrated it to clients and on radio. We’ve talked about it on the podcast. I’ve written about in different books. I’m such a big fan of the way that you authentically
and impartially are able to do this research and share it with the world. Many times a lot of the research says that
people are receiving are coming from people that want to sell them something. You don’t have anything to sell them. You’re just doing it because you’re truly
interested in it. So interested in it that you’ve done some
of the most extensive education you possibly could for your very self in getting to where
you’re at, whether it’s CFP, CFA, getting your PhD as well. I know that you’re a PhD. You’ve got a PhD in financial planning. I read in your 40 under 40 that you were always
interested in the field of financial planning, wanted to be a financial advisor from a young
age. Is that true? David: That is. It’s an interesting goal in life to be in
the financial planning field. I don’t know what it was. When I was in high school I got a subscription
to Fortune. I had a mini mutual fund. I convinced two of my friends and three of
my parents’ friends to give me money and I invested it. At a young age I always liked the profession. I actually passed the CFP exam when I was
21 years old. I always loved the idea of helping folks make
better choices. I think that my parents were both teachers. They didn’t get the best financial advice. Seeing the power of financial planning really
motivated me to embrace the profession. Casey: Were you ever actually in the field
of offering people financial advice as a profession, or have you always been in this research field? Is that really where you wanted to be? David: I make the joke that I’ve been climbing
the Ivory Tower now for about 20 years. My very first job actually was I sold insurance
for Northwestern Mutual in college for three years. I would cold call. I would do all this kind of stuff. After that I actually did financial planning
for individuals for a number of years. That was enjoyable but I always was asking
questions about “Does this make sense? Is this the right thing to do?” I started doing more and more research. The more research I’ve done the more I wanted
to kind of build what I would say are solutions for other planners or other retirees at scale
versus the individual advice. Casey: Do you ever miss sitting down one on
one with those consultations and actually helping people one on one? Or are you able to do things on such a bigger
scale now that that’s more fulfilling? David: I still get some of that informally. Unfortunately, people that I know know that
I’m kind of good at financial planning so I get the opportunity to help them for free. I do get a lot of great discussions with academics,
with individuals that work at a variety of financial planning firms. I guess I’m engaged in a different way. I still get some of the taste of helping individuals
make better choices, but at the same time what are truly best practices for helping
someone accomplish their goal? I like living in both worlds. I really do, at the end of the day, like the
at-scale perspective of building tools that lots of folks can use versus helping someone
individually. That’s obviously where things actually matter. I hope that a lot of the stuff that I’m doing
makes sense for individuals and planners. I think that it does. I get that refresh all the time with interactions
with other academics, planners et cetera. Casey: I’m just one of probably tens of thousands
of advisors that follow your research and share it with their clients, share it with
the world. I know I’ve probably shared your research
with thousands of people over the years. There’s one piece of research that I want
to dig into a little bit further because it’s one that seems to come up in almost every
single meeting that I’ve ever had with a prospective client as we’re building their retirement
plan. There’s a lot of concern about inflation. People are concerned about what inflation’s
going to do over time. They question, “Should we be using 1%? 5%?” Inflation rates in the past have been double
digits. They feel that there’s a bit of this money
that’s been printed off at these printing presses that reserve banks around the world
and they go, “What’s that going to look like and what’s that going to do with my purchasing
power over time?” I often go back to a study that you did on
retirement spending. That was titled Estimating the True Cost of
Retirement. Can you tell us a little bit about that research
and how it came about? David: Sure. I always like to make the point that retirement
is the most expensive purchase you’re ever going to make. As much as your fancy new iPhone, your nice
new car, your fancy home costs, retirement is over a million dollars. It really makes sense to think about the assumptions
that we use to figure out the cost of retirement. With that research I actually used a data
set called the health and retirement study that tracks individuals throughout retirement,
so over time. One of the really unique things that came
out of that was this idea that retirees actually don’t tend to increase their spending every
year with inflation. They tend to spend a little bit less of inflation
every year, especially households that a lot of their spending is discretionary items. I think what happens there is a variety of
things. Effectively, as you grow older on average
you care less about things. You’re less likely to travel. You don’t spend that much on clothing et cetera. You actually tend to spend about 1% less of
inflation on average as you age. If you think inflation is going to be 3% a
year, the average retiree spends about 2% more per year, which is 1% less than inflation,
throughout retirement. There’s obviously exceptions to the rule. Health is a big issue we can talk about, but
most people actually don’t increase their spending every year by inflation. Casey: I can attest to that because we’ve
been working with clients since the late ‘90s. I’ve got families that we’ve worked with for
the last 20 years that are spending less today than they did 20 years ago. That’s really counterintuitive. If you just say, “It’s a 3% inflation rate,”
they should be spending well more than 60% more today than they spent 20 years ago. It just doesn’t seem to be the way things
work out. However, you always want to play defense against
these things that you can’t control. I take a look at your research and I say,
“Okay, it looks like maybe we should factor in really a 1% inflation rate.” Or, “Maybe we need to analyze each one of
the individual expenses that you’re going to have and put different inflation rates
on each one of those things and maybe reduce one of those things over time.” How do you think financial planners and pre-retirees
should go about incorporating inflation planning into their overall plan? Should they use a flat inflation rate? Should they analyze things individually? David: Here’s a few things. First off, whenever I’ve done a webinar with
individuals where I can do polling questions I’ll often ask, “What should we assume
your spending in changes in retirement? It will grow faster than inflation, it grows
with inflation or less than inflation.” Most people want to say, “It grows faster
than inflation.” Healthcare costs are a really big deal. You’ve really got to ramp things up. To me this is a hold-off on that thought. Let’s actually think about it a bit differently. We still actually use inflation as the base
estimate for the change in spending in retirement for some of our models. There’s a few different reasons for that. To me, what this does or should do is give
you alternative perspective. You can assume inflation is the primary scenario. You should say, “Hey, wait a minute. We know that a lot of people that retire don’t
actually increase their spending with inflation. Let’s do another scenario that’s probably
more representative of what’s likely to happen.” Assume that you spend 1% less in today’s dollars
every year in retirement. What does that mean for what you have to save
for retirement? To me this is more about scenario planning
versus kind of a single hard and fast rule. Casey: Okay. If we’re going through these different scenarios
obviously, as you said, healthcare is going to come up a lot. When you mentioned that healthcare expenses
are one of the biggest concerns… I’ve heard it’s the number one concern of
retirees, the number two concern of retirees. What effect does the increase in annual cost
of healthcare have on overall spending for the average retiree? David: For most people healthcare is actually
not that big of a deal. Let me explain for… Casey: Yeah, you’ve just got a bunch of
people to this guy, “I’m not going to listen to this guy anymore.” David: Hold on. For the average 65-year-old household they
devote about 10% of total spending to healthcare costs. The average 85-year-old household it’s only
about 20% to healthcare. The thing about healthcare that is scary is
a few things. One, you’ve got Medicare premiums increasing
rapidly. You’ve got general health expenses increasing
considerably. To me, the scary thing with healthcare is
what I would call a health shock. It’s “I need to go to the nursing home
and it costs $100,000 a year or three or four years.” Most people though don’t experience those. Healthcare for most people is a risk that
won’t be realized. It’s not something that you can really easily
plan for because, again, most folks don’t have significant health expenses but those
that do it can be overwhelming. I think that healthcare isn’t a normal kind
of risk in that I know not everyone’s going to have health shock, but those that do it’s
really big deal. There’s not really a good way to solve the
problem. People say, “Long term care insurance.” Of course long term care insurance, but it’s
becoming incredibly expensive. A lot of folks can’t get it. There’s not really an easy way to hedge out
the risk of having that healthcare shock at some point in retirement. Casey: It might not be easy to necessarily
figure it out, but as we’re putting together our strategy you said healthcare shocks are
the problem. That’s not necessarily the rising cost of
healthcare itself because you’ve got good coverage for that. If we make sure we get good Medicare coverage,
get good supplement, get a good drug plan and incorporated a long term care strategy
now at least we can hedge against those healthcare shocks assuming we can afford the basic healthcare,
the long term care incorporated into the plan. A lot of people are just going to have to
take some risks. I guess that’s the thing about retirement
planning. It’s imperfect. Everyone wants to go into retirement saying,
“I’ve got all of my bases covered,” but it’s really impossible to absolutely know
you have everything figured out, right? David: Right. I’m a research guy. I run all these simulations. I’ll do a 5,000 run simulation and I’ll
feel really good about myself. You only get one chance at retirement. When it’s just your retirement lots of things
can happen. That’s why I don’t know that … Financial
plans are incredibly useful for clients but so many things can happen that really cause
them to break down or fail. Health is one example. There’s other things that can happen too. The best financial plan can go awry if you
retire three years early. There are so many uncertainties in life that
we have to think about, but it’s hard to plan for unless they happen. I need to be aware of what happens, so “If
I retire early what does this mean for my spending?” If you actually do retire early that could
be really bad. I think that a good plan you’ve acknowledged
the possibilities, but you can’t possibly plan for all of them. Casey: Jumping to that talk about potentially
retiring early. You had written and did a study titled The
Retirement Mirage that had to do with it. It said why investors should focus less on
timing and more on saving. You focused on a study in there. There was a study listed. The EBRI states that nearly half, 47%, of
current retirees were forced into early retirement. That’s a huge number. 47% of current retirees forced into early
retirement. You went on to say this may be the case, but
retirement plans are often wrong and a number of Americans retire earlier than they plan
to wreaking havoc on finances. Someone who expects to retire at 65 may be
more likely to actually retire at 63 and the impact can be severe. David: Yeah, it’s kind of depressing. What’s funny is a lot of people aren’t very
good savers. America as a whole are pretty terrible savers. People always say, “I’ll make it up at the
end. Maybe I’ll work a few years extra. I’ll save a bit more.” In reality, that’s not going to happen for
a lot of people. In reality, a lot of folks retire because
they have a health issue, because their spouse has a health issue, because they lose their
job. The implication is kind of dire. The only thing you can really do to protect
against that is to save more, unless you’re willing to live off less in retirement. A lot of financial planners talk about rate
of returns. “We’re going to account for different market
outcomes and scenarios.” From my perspective, a much more real outcome
that’s more likely, that’s more severe is “What if I retire a lot earlier than I expect?” You just need to be aware of the implications
if that actually does come to pass. Casey: The implications for savers I think
are very clear. You just need to save as much as you can because… That was something my dad always instilled
in me. He said, “You may lose everything tomorrow. You may lose your house tomorrow.” Everything can change in a moment and you
have to be prepared for that. Don’t think that you’re going to continue
to earn X amount for the rest of your life because anything can happen. For someone that’s getting close to retirement,
say they’re five years out from retirement. I sit down with families all the time. We just had a couple in here the other day. They’re now three years out from their planned
retirement date. They came in and started working with us three
years ago. When we first sat down I put together a plan
assuming they would retire the year they came in to visit with us. They said, “We’re not going to retire for
six years.” I said, “Yeah, but you don’t know that.” Is that what we should do when we look at
retirement plans is go ahead…? If we’re within, say, f5-10 years of retirement
let’s just assume an earlier date prior to that date that is maybe our goal date. How much earlier do we actually plan on that
occurring? Is it right here, right now what are we going
to do? Or is it two or three years less? David: There’s no one kind of easy answer. I think that one benefit that you have as
you approach retirement is you approach certainty. I’m 37 years old. I have so many unknowns ahead of me. I’ve got hopefully 30 years until retirement. I’m making assumptions today about how much
I have to save based upon that retirement date. As I move closer and closer to retirement
I’m going to have a better idea of where things stand. Even someone that is five years away from
retirement can still have that unfortunate shock where they could say, “Okay, I’m going
to retire in five years. Things are looking good.” In two years they get laid off and they can’t
return to work at all. One thing I found in that research is that
a good approximation is the average person retires a half a year early for every one
year past age 61. If you say you’re going to retire at 65
you’re going to retire- that’s four years past age 61- about two years earlier than
you expect to on average. Again, I really hope that people can make
it there but the EBRI statistics pretty clearly show that actually in the data that they looked
at about half of the people retire early. It’s true that some folks retire late but
that’s an anomaly. If I had to guess, a lot of the folks that
are retiring later it’s because they have to, not because they want to. Casey: Yeah. Actually that couple that I spoke about we
had originally planned for a six year retirement. Now what’s happened is he’s struggling with
some psychological issues. Stress. Also the work has changed. They’ve put him in a different position. He doesn’t like his new position and it kind
of feels like they’re pushing him out. He said, “I don’t know if I can physically
take it much longer.” Now we’re planning on retiring about a year
from now. That’s two years earlier than his planned
retirement date is where we’re actually ultimately going to land. That’s why I always encourage people to plan
for the worst case scenario. A lot of those worst case scenarios that you’ve
tested over time have had to do with really the longevity of retirement. The safety in income strategies. This is something that’s been talked about
in research extensively since the late ‘70s, early ‘80s when retirement really came to
be a thing. A lot of that talk has been about safe withdrawal
rates. How much can we safely withdraw from a retirement
portfolio and expect it to last a lifetime? I love your research in this world. You’ve also done a lot of this research in
conjunction with another one of our guests, Dr. Wade Pfau. We might actually think about these things
a little differently now that we’ve got the other half of the brain here. One of the things I want to go back to though
is when we talk about safe withdrawal rates. I wonder how your research on the true cost
of retirement… The research on how retirees are actually
spending once we factor in inflation and their decreases in spending over time, how did that
affect safe withdrawal rates, and assumptions that are used in planning, and the way retirement
planners are planning today? David: It definitely bumps that up. I think that the piece that you mentioned
earlier, the true cost of retirement. The goal of that was to question a lot of
these fundamental assumptions we use when you’re figuring out how much you have to
save for retirement or the inverse, the safe withdrawal rate. One example of a common assumption is that
you increase your spending every year by inflation. If you don’t increase your spending by inflation
it reduces the money you have to save for retirement. Thinking about things like safe withdrawal
rates, I think that there’s a lot of interesting research out there but I think a lot of it
is somewhat misguided for at least two reasons. One are the key assumptions about, for example,
returns. What do you assume the markets will earn in
the future? I think that most researchers use historical
long term averages. That’s incredibly problematic because while
bond yields have risen recently, we’re still really low by historical standards. The U.S. historical returns are better than
almost any country in the world for the last 115 years. I’d love for the good times to continue. I just don’t know that they are. The second thing is the metrics we use to
quantify an outcome. A common metric that’s used by advisers is
what’s called the probability of success. It’s a pretty good first approximation of
what is a good or bad event? You just run a bunch of scenarios and you
figure out what percent of the time does someone accomplish what they’re trying to do? I want $50,000 a year for 30 years. In this simulation how often do I achieve
that goal? The problem with that metric is it ignores
the magnitude of failure. It treats going broke in year two as the same
as going broke in year 30. I think that when you tack on things like
guaranteed income in the ability of retirees to make adjustments and everything else. I think that a lot of talk about safe withdrawal
rates are probably a bit conservative. You probably take out more money because you
can make an adjustment if you have to. You have this kind of base level of income. It’s a really, really complex problem. It would be a 100,000 word paper to even tackle
part of it. We take away at these pieces, but there’s
so much to think about that it’s really hard to put it all together in one great piece
of research. Casey: One part of this, what you’re saying
is that we’re focusing on how much we can safely withdraw when we put together these
retirement plans, run different simulations. We’re looking at historical returns of bonds
and stocks. Now with interest rates near all-time lows
we’ve got stock market valuations near all-time highs. We say, “Can we really expect those returns
over the next 30 years?” It might make sense to incorporate a different
type of strategy versus this static withdrawal rate, I think as you referred to it in your
papers, which is “Let’s start at 4%.We’ll adjust it for inflation every year.” Let’s assume that it’s more dynamic. There’s this dynamic withdrawal strategy,
a static withdrawal strategy. You could also incorporate a guaranteed withdrawal
strategy in there. Let’s talk about the difference between a
dynamic and a static withdrawal rate. What’s the difference there? David: Sure. A static is what we assume in research. Dynamic is what happens in real life. For better or for worse, we have a lot faster
computers today than we had, say, 20 or 30 years ago. A lot of financial plans and models assume
that you make decisions at retirement and then you follow those decisions with some
kind of basic adjustment for the duration of retirement. I take out $50,000 when I retire. That amount is increased by, say, inflation
every year for 30 years. That’s a static model. A dynamic model is what will actually happen
in real life. Where I take out a certain amount when I first
retire and then next year I come back and I ask the question, “How am I doing? Is this sustainable?” Then I make adjustments. I think that static models tell us a lot about
what is safe but they don’t reflect reality. I know that some people have expenses that
they can’t change. It’s a nondiscretionary expense. For most people you can make changes over
time. I think that over the last decade or so there’s
been what I would call better research exploring our savings levels based upon this idea that,
hey, people can make changes over time. How do you make those changes and how does
it affect that initial withdrawal decision? Casey: When you talk about dynamic we’re talking
about taking a look and revisiting the retirement plan every single year and saying, “Okay,
I did well last year so I can increase my withdrawal this year.” Or, “I didn’t do real well last year. Let me go ahead and reduce that withdrawal
rate for the next year.” Right? David: Yeah. I think fundamentally this is what a financial
planner should be doing. The danger of retirees if left to their own
devices is they’re going to take some amount of money out and then just keep doing that
for some period of time. A really important value of advice is telling
someone, “Hey, wait a minute. I know that you want this much money but this
is the implications of that.” I spend all this time doing research and modeling
and the goal of all this is just to form expectations. “Mr. or Mrs. Client, you can do whatever
you want but I’m here to let you know that this is probably a better path to take. If you don’t do what my recommendations suggest
this is where things could end up.” I think where the biggest disconnects are
is when someone doesn’t understand the implications of what they’re doing. I think that advisors help bridge that gap
and help them understand, “Hey, if you keep doing this, this is the implications of that.” Casey: I think this goes along the lines of
what we call our flexible withdrawal strategy. When we implement a plan we’re going to take
a look at it every year and try to figure out periodically where should we be taking
our withdrawals from, and separating things out into both paychecks and play checks. Making sure that those paychecks, those nondiscretionary
expenses, that income that we have to have every single year is going to be there forever. Then we accept some flexibility or a dynamic
approach with those discretionary expenses. Is that an approach that you’re advocating
here? David: Yeah. I think that in reality there’s all these
different types of buckets people use to think about spending. There’s needs, wants and wishes. There’s discretionary and nondiscretionary. Fundamentally retirees usually have some amount
that they want to have every year. I think you call it a paycheck. Then there’s some amount they can choose to
adjust over time. That’s the play check. I think that the problem with a lot of research
is it assumes that all spending is effectively the paycheck. That it’s not adjustable over time. Anyone that’s worked with people know that
that’s not usually the case. That we all have different levels of adjustments
we can make if we have to. The key is the ability to make those changes
has a huge impact on what that safe withdrawal amount or rate is when you first retire. Casey: One of the things that I push back
on in this realm sometimes when we talk about paychecks and play checks is I find when a
retiree, especially in those first 5 or 10 years they just stepped into retirement and
they want to go on vacation next year. Maybe the market has been real good. They shouldn’t take that distribution to say,
“Hey, I’m going. I have to. I’ve earned it. I’m going no matter what.” I think we have to exercise some caution as
well in saying, “Okay, these are our play checks.” I think a lot of those what we think of as
discretionary expenses while we’re working become nondiscretionary psychologically during
retirement. David: I would say, “Okay, you can take
the vacation, but here’s the thing. The markets have to behave themselves for
the next five years for you to keep doing that. You can do it, but just know that there’s
implications down the road of doing so.” I’d be hesitant to tell someone no based upon,
again, how their plan is just because maybe they can’t take that vacation five years from
now. There’s this idea of people over time have
health issues. Things happen that limit their ability to
be able to travel. You want someone to enjoy their retirement
within their means. If they want to accept the possibility that
“Hey, if the markets misbehave this is going to be it,” that’s good. If they say, “Hey, I’m doing this every
year,” that’s the problem. Casey: All right. Then we’re trying to figure out how long we
should project that they actually spend in retirement as part of this. That was a good part of your research over
time. I think you actually said at one point that
we’re looking at it the wrong way. We shouldn’t assume any period of time, even
20, 25 or 30 years. It should be something different. What do you think about that time period we
spend in retirement? How should we make those assumptions? It seems like we need to in some way. David: Yeah. You have to have a time horizon. I think one thing that is really critical
for probably all your clients to understand is that there is a growing divide in America
today based upon how long you live in retirement based upon income. For better or for worse, individuals that
have higher income levels are living a lot longer than the average American. I think that when you see statistics about
the life expectancy is 76 today that’s for a newborn. That’s not for someone who’s 65 years old
and is in the highest income decile. I think that retirement decisions are affected
by how long retirement lasts. I’m going to use the annuity word, but I think
that in reality income for life is a really vital thing to be aware of. I think it’s that uncertainty about retirement
that creates a lot of difficulty for retirees. You don’t know how long to plan for. Do I plan for 2 years or for 50 years? I think that what you want to do is make it
manageable but also realistic. I think that in reality it’s going to be an
excess of 30 years for a lot of people that are retiring today that are 65 years old just
because of the advances we’re seeing in healthcare and medicine, especially among wealthy Americans. Casey: You’re saying you don’t adhere to
“I hate annuities and you should too”? David: I do not. Here’s the thing. I don’t love generalizations. I understand that there’s a lot of really
crappy annuities out there. I could use even worse words to describe them. Here’s the thing, they’ve been around for
thousands of years. Much longer than these things we call mutual
funds. The reason is, is because people… I go to Las Vegas all the time for conferences. I love Las Vegas. I love to go gamble and play blackjack and
whatever the… Whoever I’m with, I don’t care. It’s just a good time. I’m a very rational person though. I know that every hand of blackjack I play
I lose about 2% whatever I’m gambling because the house has an edge. I still love playing blackjack. I’m guessing a lot of your listeners go
to Vegas, they go to casinos, they have a good time. You go because you enjoy it. An economist might say, “David, you’re irrational. You’re playing this game that you’re losing
money.” I don’t care. It’s the same thing with insurance. I have life insurance. Insurance is not a positive expected value
item. No one buys life insurance thinking, “Hey,
I’m going to beat the insurance company.” They’ve got these things called actuaries. Those guys are really freaking smart. An annuity is not an investment. It’s a risk transfer mechanism. I’m talking about annuities as income vehicles,
not necessarily the accumulation versions. I think the problem is that a lot of annuities
today are viewed through the investment lens versus the income lens. From the income lens they can make a lot of
sense. That being said, there are lots of really
crappy annuities but there are also some great ones too. I don’t think you should dismiss the value
of a product just because there are some bad apples. Casey: That being said, why do you think…? There’s probably 10 times as many bad mutual
funds out there as there are annuities. You know this being at Morningstar as long
as you have, how many annuities there are in comparison to how many mutual funds there
are. Why is it that annuities have gotten such
a bad name? You even said it yourself. You said, “I’m going to use that word, annuity.” David: You’ve got to warn people if you’re
going to use the word annuity. I don’t know. I think that part of it could just be that
a lot of the folks that sell annuities aren’t financial planners. They’re not fiduciaries. They don’t have your best interests at heart. There’s also the issue of transparency. I think that what we see… The worst annuities are the least transparent. You just can’t understand them. I’ll never forget, I was trying to understand
a relatively complex variable annuity. I called up the insurance company and I got
this answer. I read their prospectus. It’s like 110 pages of… It’s just a terrible experience. I called up the insurance company. I called up their customer service and I got
an answer. I was like, “That doesn’t seem right to
me.” Then I called them back the next day, a different
person and I got a different answer. If me, Mr. PhD, CFP, random designation guy
cannot figure out how these products work, how does the average person? If I am sold something I don’t understand
how do I understand its value? How do I know that it’s working for me? I think that it isn’t always that the products
are even bad. It’s that they’re so complex you don’t
understand what they’re actually doing for you. There’s all these reasons why I think that
they have a bad name. I’m hoping that there’s things that we can
do initially to clear that up. At the end of the day, knowing you have a
guaranteed source of income for as long as you’re alive, that’s pretty valuable. Casey: I think your advocation of annuities
hasn’t been in the realm of accumulation, long term growth. It hasn’t been in the area of creating a death
benefit or a long term care benefit or tax deferral. It’s been very much focused on guaranteed
income. David: Right. I think that annuities can work as accumulation
vehicles as well. To be fair, if you’re talking about a tax
advantage vehicle to grow money in, a 401(k), an IRA is a better place to start. If I am a wealthy individual who’s at a
very high tax rate, annuities can be a really solid way to think about growing wealth. I just think that for accumulation there’s
usually better vehicles at least as a starting place to grow wealth with. Casey: Especially if you have a higher risk
tolerance. If you have the ability to go through some
ups and downs then you’re probably going to make a better long term return with equities. However, if you’re going to panic when the
market’s down and you don’t have the risk tolerance for it, you might actually do better
making 4% to 5%, 4% to 6% in sometimes a fixed indexed annuity rather than taking on the
risk of the market. It’s all unique to the individual. I guess that right there makes me want to
jump down to a question that we had from one of our fans. I want to get back to this topic, but I’ve
got to interject this because I think it has to do with being along those lines of what’s
right for you might be different for somebody else. It’s difficult to make these general assumptions
or give general answers. Sam Robinson asks, “Does David think active
or passive investing is the way to go for a 39-year-old?” David: The answer to the question is yes. Casey: That’s kind of what I thought. David: Here’s the thing. There’s lots of research that says that passive
is better than active. Here’s what it really says. It says that fees matter. I actually did a paper, I don’t know, seven
years ago looking at Vanguard’s active mutual books. Here’s the thing. They have absolutely rocked. They have beaten… I had seven different tests of “Did they
outperform?” Almost all of them were positive. Here’s why. It was a relatively low cost that I would
call high quality active investment. I’m not anti-active. I’m anti high cost investments that aren’t
truly active. I think most active funds are closet passive. They’re replicating an index and they’re
charging high fees. I think that portfolios can definitely have
both. If I had to pick one I would just pick passive
because it’s easier. If you could identify high quality active
managers that are low cost, do that. I think it’s more complex in the taxable space. There’s tax implications. There’s no one right answer here. I think that the key is to understand what
you’re buying and why you’re buying. If active excites you and it gets you to save
more then do that. If you just want to buy something and never
look at it, active is probably not the right place to invest. I think, again, it depends upon the investor,
the account type, the goals et cetera. Casey: Good. That goes on to say everybody’s unique. It might take a diversified approach of both
active and passive depending on where you’re at and the type of market you’re in in any
given time. Back to this topic of annuities, you said
that annuities can make a good allocation for guaranteed income during retirement. You had some research on the appropriate allocation
of annuities, bonds, equities. How does somebody determine how much of their
assets should be allocated to an annuity as they step into retirement? David: This is kind of the theme of today’s
podcast. There’s no one right answer for everyone. Casey: That’s the difficult part about a
personal financial planning podcast. David: Especially for retirement. I think retirement is the one area… If you’re 30 years old, save 15%, buy some
life insurance, generalize. Retirement is really unique. It really boils down to all these irrevocable
decisions you make about how you fund things. To your earlier point about paychecks and
play checks, how much do you want to have as absolute certainty for life? What is the number that you need to feel comfortable
that if the markets go crazy that you’re good to go? That to me is a great starting place to answer
the question “How much should I annuitize?” We have much more complex models we use to
figure it out but, again, what do you need to feel comfortable as a retiree? Some people might say, “I want to annuitize
all of it,” and that could be totally fine. Someone might say, “David, I’ve got social
security. If I have to I can live off that.” That could be enough. It’s really a question for each person based
upon what you’ve got when you retire and what you want to accomplish. Casey: Let’s talk about what you want to accomplish
in that realm because you’re balancing some things there. I think there’s two main things that you’re
balancing. Let’s make sure I don’t miss anything here. As far as two primary things you’re balancing
the idea of “How much do I want to leave behind? What’s the legacy I want to leave behind?”
and “What degree of certainty do I want to have in my income?” David: Right. In reality you could say there’s a 10-dimensional
chart you could use to figure out what each person needs. Fundamentally what you’re buying with an annuity
is insurance over your life. Every insurance you lose money on average. The cost of that is the wealth you leave behind
to heirs. You can do things to reduce the loss to heirs. You can add a 10 year period certain payment
or a cash refund provision. What that does is it reduces the benefit. You can accomplish both though. If you want income for life and you want to
have money for your heirs, tack on some of these riders. I think that it’s okay. Annuities can be rational, for lack of a better
term, if it makes you comfortable in retirement. I don’t care. If the best portfolio in the world keeps you
up every night worried about retirement, what’s the point? Again, it’s how do you want to experience
your retirement? One thing that there’s lots of research on
is that people, retirees, are terrible at spending down their accumulated wealth. It’s very painful for a retiree to spend down
their nest egg. “Oh my God, I have to make this last for
as long as I’m going to live. I don’t know how long it’s going to last. What if something happens?” It’s so much easier to spend income. Even if it’s a “bad deal” to buy an annuity,
what you see is that it can really help someone better enjoy their retirement because it gives
them a paycheck that is automatic, that doesn’t require that kind of constant pain of spending
down their lifetime savings. Casey: It goes back to this concept of focusing
not on return on investment but your return on life. If that guaranteed income, that certainty
helps you really enjoy your life that much more, that’s what you created it for in the
first place. Maybe you give up a little flexibility, a
little growth, a little legacy but you get to really enjoy the here and now. That also leads us into some of your research
on the optimal equity allocation glide path. That means how much should we have in equities
when we step into retirement, and what should that look like over time? I think the traditional research has shown
us… Why don’t we just take the rule of 100? You’re 60 years old. We’re going to put 40% in equities and 60%
in fixed income. Over time we’re going to start to reduce that
equity allocation as you age. It seems like some of the research out there
is starting to show us the opposite, and maybe even that equities aren’t really needed. David: You have to have equities, I think. There’s been some research that talks about
the idea of a rising glide path, taking on more risk as you age. I think that’s just shenanigans. I think about my grandma. I’m not going to say, “Hey grandma, let’s
make your portfolio more aggressive as you age.” That doesn’t fly with me. I think that like everything else, it’s a
personalized choice. When I talk about risk today there’s obviously
all these different definitions of risk. One definition of risk that us investment
nerds talk about is standard deviation or the volatility of your portfolio. Here’s the thing. Right now there is risk that the portfolio
that’s in equities we could have another market crash. Here’s the other risk. If you have a very conservative portfolio
you’re going to earn less than inflation potentially. You’re going to have a shock if interest rates
rise. I think that for most people the smart place
to be is a diversified, boring portfolio. Let’s call it half stocks, half bonds and
retire that adjusts over time. If, for example, the markets behave nicely
and it goes up, you can maybe take on more risk because you want to maximize the bequest
or money you’re going to leave to your heirs. I don’t know that retirees should be that
aggressive. I think a lot of folks want to dig themselves
out of a hole if they’re behind with aggressive returns. I think safety really is more important for
retirees but *safety is not having no equities. You have to have some equities. If you don’t you’re not going to have that
portfolio last more than probably 20 or 30 years. You’ve got to take on some risks. Just be smart about it. Casey: Of course I think we have to mention
a disclaimer. That’s a generalization. There could be someone that’s spending $10,000
or $20,000 a year. They’ve got $5,000,000. They get a 4% fixed rate and they put it all
in a fixed account. Heck, in a CD at the bank paying 2%. They don’t need equities but it doesn’t mean
that that’s not an appropriate allocation. I think research shows us that pretty much
everyone should have some type of equity for the best statistical proven allocation, I
guess I want to say. David: Yeah. I think that to your point, there’s two different
drivers of the right equity allocation. There’s what I would call risk capacity and
risk preference. Capacity is the risk that you should take
given your funded status, given your years to retirement, given the risk of your total
of all these different definitions. It’s based upon you as an individual. The other piece is your risk preference. How do you feel about taking risk? If you’re someone who has the capacity to
take on whatever risk you want to you can do whatever you want. If you’re that person who’s overfunded,
what makes you the happiest? I think that where most people are though
is they’re kind of in the middle. Where they’re trying to figure out “What
is the right level of risk for me given my situation?” I think for them it’s taking just enough so
when the markets go south I don’t panic. I think that’s a place where advisors can
really, really help. You’ve seen a lot of investors left to their
own devices. They panicked back in 2008 and they realized
these losses. Staying invested and having someone to help
you do that I think really leads to a better long term outcome. Casey: We all like to use an acronym along
those lines which is CAN. Do you have the capacity for the risk, the
attitude for the risk, and the need for the risk in the first place? I think that’s something that everybody needs
to analyze. More people a day seem to be getting concerned
with equity valuation, especially those that were investing during 2008 or during the tech
bubble crash. They start to wonder, “Should I really be
holding this much in equities?” Now they look at interest rates potentially
rising in the future and they go, “Boy, should I really be holding onto bonds at this
period of time?” Now we’ve seen quite a bit of research by
different researchers, even professors saying that we should be looking at replacing our
bonds with annuities. Is that something you adhere to? What are your thoughts on that? David: Yeah. I’ve actually done some research that suggests
the same thing. I think the key there is the effective return
on an annuity, like an immediate annuity, is higher than a bond. The reason is this thing called mortality
credits. We don’t have enough time to go through the
math here completely. Long story short, when a bunch of folks get
together and pool their risk together, you earn a higher return if you survive because
you’re taking money from the losers. I wouldn’t recommend the extreme of that where
you replace all of your fixed income with annuities, but you’re going to earn a higher
rate of return buying an annuity than buying fixed income. If you’re someone who’s very, very conservative
a logical extension of that is you’re going to have more wealth in retirement if you annuitize
a good portion of it. I think that you need to think about, “How
am I going to invest?” If you’re going to invest in CDs you’re better
off buying an annuity with a good portion of your wealth. Casey: Some people are going to say, “Yeah,
but they’re too expensive and I don’t want to pay that much.” I want you to explain a quote I was able to
pull from you. You said, “Many few guaranteed income benefits
is expensive. However,” you said, “it is a relatively
inexpensive form of longevity insurance, especially from a behavioral finance perspective.” Are they expensive or inexpensive? Can you explain that? David: It’s kind of like the insurance that
they want to sell you at Best Buy. That’s really expensive insurance. When you buy that TV you don’t know… You always should say no to that. There’s not a good reason to say- Casey: Always say no. David: Right, because that’s not priced appropriately. Even if you look at things like immediate
annuities there’s big differences in pricing. If you go online you can get lots of quotes. There’s websites you can go to that give you
lots of quotes. If you get the best one it’s a pretty good
bargain. The behavioral comment just gets to the fact
that while, again, on average you’re not making money, it provides a peace of mind you cannot
achieve through a normal bond mutual fund. I have a grandfather. He is in his 90s. He gets a call every day from someone trying
to get him to buy something or just trying to scam him for a host of reasons. He’s still with it. He knows what’s going on. He’s not going to fall victim to that. At some point though he could. Here’s the thing. With an annuity you don’t have to worry about
that. Even myself, Mr. Investment Planner, at some
point I will annuitize a large portion of my wealth because I just don’t want to deal
with it. Someone might say, “David, you could earn
a higher return with an efficient portfolio.” I’ll still have some money invested but I
like the idea of a paycheck for life. You can do that artificially through a portfolio
but that’s not guaranteed. I want a guarantee. I want to know that no matter what happens
I’ve got money even if there is a cost. Casey: Let’s move on from this ‘A’ word
and move on to maybe another controversial subject as well. I really wanted to get your thoughts on this
because this is something you wrote about back in 2006. I want to see how your thoughts have changed,
if at all. It was in the Journal of Pension Benefits
titled Roth 401(k)s are Wrong for Most 401(k) Participants. Have your views changed as you’ve aged here,
or do you still think that everyone should be traditional 401(k) tax deductible and not
Roth 401(k)? David: I’ll tell you how they’ve changed. The math there isn’t all that complex. Unless your tax rate changes between now and
retirement it doesn’t matter if you do Roth or traditional, assuming you save the same
amount of money. What we see though is most people when they
retire have incomes that are lower than they were when they were working. There’s more benefits to taking the tax deduction
when you’re working. You get the child tax credit and other things. For most people, the vast majority, traditional
really is a better way to save for retirement. That being said, it makes sense to have some
of both. I do some of both because we don’t know what’s
going to happen in the future. I am predominantly traditional but I have
some Roth as well just because you can use it to manage marginal tax rates and do different
things. I still believe that, again, for most people
traditional makes the most sense. You want to have a little bit of both because
things change. Life happens. It’s good to hedge. Casey: I think in your research it said something
like tax rates have to increase 10% or something along those lines in order for it to make
sense. As you step into retirement they have to be
10% higher than when you made that contribution. That’s pretty significant but I think they
could be significantly more than that. I really don’t know. I think one of the things you pointed out
was somebody that’s 30 years out from retirement maybe it makes more sense for them, but as
you near retirement it makes it even more difficult to be making Roth contributions
versus traditional. I do both as well. I advocate all my advisors and everybody we
sit with… We’ve got to diversify our investments. We need to diversify our tax buckets at the
same time because we just can’t predict the future. It’s really a policy diversification or protection
or an in-policy insurance, if you will. David: If you’re someone who wants to save
gobs and gobs of money you should probably do it in Roth. There’s limits of what you can save in a 401(k)
plan. I think that there’s definitely reasons why
to do Roth. It probably won’t matter that much at the
end of the day. Again, for most people the deduction is going
to be worth more now than it’s going to be worth when they lose their jobs. Casey: Great. I’ve got just a couple of things really want
to make sure we get to before we run out of time. We’re going to jump around here towards the
end on some questions that I want to pull some really good answers out of you. A lot of them have to do with things that
I hear from people all the time. One of them has to do with renting and owning
and retirement. Should we own a home? Should we rent a home? Some people are just dead set and say, “You’ve
got to own a home. You can’t be throwing all that money away
on rent. You’re better off owning a home. You’ve got an asset there.” Others say, “No, I don’t want all the headache
and I don’t want to deal with utilities, maybe maintenance outside and things like that.” What are your thoughts? Should a retiree rent or own in retirement? David: First I would say whatever makes them
happy is probably a good- Casey: Return on life again. David: Return on life. Homes are terrible investments. Let’s not kid ourselves. They’re very expensive to maintain, to operate. They’re actually very risky as well. People think that homes are safe. They are not safe. Homes are unique and they’re both an investment
good and a consumption good. You derive a consumption from living there
and they can also increase in value. I think that if you’re going to be there for
a long time, say minimum of five years, you’re probably better off buying versus renting. The actual differences aren’t that significant. If it really matters to you to not mow your
yard and not to repair things renting is probably fine. The implicit cost of the decision varies over
time, but when you really account for all the costs of ownership it’s not nearly as
attractive as it seems. Casey: Right. I think it’s just having that hard asset for
some. Feeling like, “This is mine. You can’t take it away.” The value can still fluctuate quite dramatically. You could still have the asset, but the risk
that you mentioned there is in the value of that asset changing over time. Just as quickly as the stock market can shift
direction so can any area of the real estate market, farmland or homes and other assets. David: Right. If you’re willing to move the risk is significantly
less. If you live somewhere and rents increase dramatically
and you can move somewhere else, you’re in great shape. I think we’ll always be homeowners. My wife would not be okay renting, but that’s
my personal choice. It’s not a recommendation for everyone. Casey: One of my questions I have to ask,
because you’re one of the most well-educated individuals in the retirement research field. You find a lot of financial advisors don’t
have any designations behind their name. They don’t have maybe even a college degree
for that matter. Then you find the advisors at the other end
of the spectrum that have CFPs or CFAs or a variety of different designations. What are your thoughts on the state of advisory
education today? David: Some colleagues that I work with they
don’t have PhDs, they don’t have CFAs and they’re brilliant. They do an excellent job building strategies. There is a definite positive correlation between
designation, especially core designations in advisor ability. I think that other similar professions like
accountants and law there’s minimum standards. For better or for worse in this industry… If you take the Series 7 that doesn’t teach
you almost anything about being a financial planner. I think as an industry we need to focus more
on education because our clients rely on us for a lot of important decisions. Unfortunately the bar to work in this industry
I think is far too low. I’d love to see more mandated education
requirements as important in the future. Casey: If you are in the process of looking
for a new financial planner or financial advisor, you said there should be some type of minimum
education requirement. What do you think that minimum education requirement
should be if you’re searching for a new financial planner? David: In theory you want them to be a certified
financial planner. There’s other designations that work as well,
but that to me is the most accepted and most well-known. Just because you have designation though doesn’t
mean you actually know what you’re doing. There’s lots of designations that you can
get in like two hours today. I think that the key is… CFP it requires I think three years now of
experience, a college degree. I think that’s a pretty good early signal
that this person is serious about this industry and knows at least the basics of financial
planning. I say the basics because you can learn a lot
more than they teach you in the CFP. That just shows the commitment to, “Hey,
this person should know what they’re talking about.” Casey: Along those lines, and maybe we already
hit on it, but if you could change one thing in the world of financial advice, what would
it be? David: I think I just mentioned it. I think requiring a higher standard of care
as a fiduciary potentially and then education. I’m not all that concerned about how people
are paid, if it’s a commission or it’s a fee. I think there’s conflicts any way you slice
it. I just want this profession to be more knowledge
based and less sales based, and that requires education. I think that, again, a lot of folks will do
a great job without a mandate, but there’s a whole swath of folks that I think need to
get the education but just choose not to do so. Casey: I’m very passionate about that myself. You said the bar is set too low today. I’ve often said the bar is set disgustingly
low in this industry, especially when you compare it to what you see in the field of
medicine. You wouldn’t work with a doctor that didn’t
have formal education in order to operate on your knee or your heart. I’d argue your finances are just as important. We’ve got one last question from one of our
fans. Julia Wilder has a question that goes, “After
years of research, what are a few of the surprising facts that have been unexpected during the
past few years? Is the retirement landscape really changing
over these 20 years? If yes, what are a few of the most surprising
facts?” David: There’s a lot of potential questions
in there to answer. Casey: We can go with, “Over the last 20
years what’s changed and what’s been most surprising?” David: I don’t know if this is surprising
but what surprised me the most is changes in life expectancy for households based upon
income. It’s not that I don’t care about all Americans,
but most people have nothing saved for retirement. Those households that do, I think longevity
is going to become a significant issue in the next five or 10 years because they’re
living so much longer. Nothing has quite shocked me when I saw some
research a year or two ago about how it’s been changing over time. If you have to add on five years of retirement
expectation that is incredibly expensive. Just being aware of that I think is important
when thinking about “How much do I save? When can I retire?” All those different things. Casey: What about the financial advice landscape
as a whole? David: I think that it’s like this really,
really big ship. It’s hard to move but it’s been moving in
the right direction. I think that we had that fiduciary role that
got mixed in. It wasn’t perfect- nothing is- but it was
directionally correct. I’d like to see us get somewhere along those
lines but we’re moving there collectively anyway. I think that as an industry we’re doing more
and more knowledge based planning, more folks are getting designations. It’s just taking an awfully long time. Casey: Yeah. I hope we continue to move that way in the
future. My last question I’d like to ask as we wrap
up most of these conversations. I’ve asked this question to thousands of people
over the years. What does retirement mean to you? David: I’m 37 years old. Retirement to me is something I research but
I haven’t experienced yet. I think that when I look at my parents, my
wife’s parents, my grandparents, it’s a time to enjoy everything that you’ve worked hard
for for the last 30 or 40 years. It should be and could be the most enjoyable
part of your life, but you have to plan for it. That means more than just the financial aspect
of retirement. You and I talk a lot about the financial aspect
of things. I think figuring out what that next step means
and how you’re going to spend it is incredibly important. It’s worth thinking about for many, many years. Casey: Thanks so much for joining us here
on the podcast. I’ve been wanting to have this conversation
for a really long time. I had to be very selective about what questions
I was going to ask today because, oh boy, we probably could have talked for another
hour. I know you’ve got other things to do there
at Morningstar’s office so I’m going to let you go. Thank you so much for joining us. David: Thanks for having me.

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