Bogleheads® Conference 2023 - Wade Pfau Discusses Retirement Income Planning with Jim Dahle

00:00:00.000 | [ Applause ]

00:00:06.540 | All right.

00:00:07.480 | This next presentation we're going to do is another interview.

00:00:11.980 | But I have not -- I've decided not to ambush Wade with any questions.

00:00:18.420 | So I gave him my list of questions before we started.

00:00:21.020 | He had a week to think about it.

00:00:22.160 | I even said, "If you want to throw a few slides together

00:00:24.700 | to help answer some of these, you can."

00:00:26.360 | And so he has a few slides we'll use.

00:00:28.600 | Our clicker is not working perfectly.

00:00:30.500 | So we'll be doing the next slide thing.

00:00:32.560 | But it's going to work out okay.

00:00:34.700 | For those who don't know Wade, Wade has a PhD and a CFA.

00:00:38.840 | He is the founder of Retirement Researcher, which is an educational resource

00:00:43.740 | for individuals and financial advisors on topics related to retirement income planning.

00:00:48.780 | He's published a gazillion papers.

00:00:51.220 | He's published four books.

00:00:53.120 | And he's been all over all the journals

00:00:56.560 | and publications you would expect somebody of a stature to be in,

00:00:59.520 | like the Wall Street Journal, Time, Kiplinger's Money, et cetera.

00:01:03.100 | So very accomplished in his career so far.

00:01:05.200 | His focus has been on retirement, planning for retirement, helping retirees get

00:01:10.300 | through retirement, different types of withdrawals, and things like that.

00:01:13.900 | So what I like the most about Wade, though, is Wade is not afraid to take another look

00:01:20.340 | at something in an unconventional way and say, how can that be useful to retirees?

00:01:26.840 | And so we're going to talk about some of those topics today.

00:01:29.540 | But before we get into it, the first thing I want to talk

00:01:31.820 | about is something we run into all the time in medicine.

00:01:34.880 | I'm a practicing doc, and we have something called the Sunshine Act in medicine,

00:01:39.520 | where if somebody buys me lunch, like a drug rep buys me lunch, a $15 lunch,

00:01:44.800 | that goes in a database, a publicly searchable database.

00:01:48.340 | Medicine's very big on conflicts of interest.

00:01:50.960 | The financial services industry, not as much.

00:01:53.240 | But we're going to start talking about that.

00:01:56.980 | And anyone who wants to make a living today doing anything

00:02:00.320 | in financial services has conflicts of interest.

00:02:03.880 | And, Wade, can you talk a little bit about your conflicts of interest and then more generally

00:02:09.320 | about what you think an investor ought to do about conflicts when reading or listening

00:02:14.420 | to the words of somebody like you that has conflicts?

00:02:17.340 | You know, is disclosure enough, or should the presence of conflicts keep them from,

00:02:21.900 | you know, taking your advice and that sort of thing?

00:02:23.940 | Can you talk about your conflicts and how people ought to look at them?

00:02:27.080 | >> Yeah, yeah, absolutely.

00:02:27.980 | And thank you for having the session before lunch

00:02:30.420 | so that people couldn't get tomatoes from their salads to throw at me.

00:02:33.780 | Oh, it's not working yet.

00:02:36.220 | Can you hear okay?

00:02:37.780 | Okay. So, yeah, so let me -- oh, not quite loud enough.

00:02:42.460 | All right, so with conflicts, I think in the context of bogleheads looking

00:02:50.140 | at the forums, the big issue is insurance.

00:02:53.500 | So I want to talk about the insurance conflicts a little bit.

00:02:56.580 | First, as presented, it's a little bit of a chicken and an egg problem,

00:02:59.940 | but then gets specifically into the conflict issue itself.

00:03:03.500 | So I was a professor in Japan.

00:03:06.300 | I was teaching students mainly from emerging market countries.

00:03:10.020 | I was doing research on pension funds in emerging market countries.

00:03:13.780 | I wanted to move back to the United States.

00:03:16.220 | I realized emerging market pension fund research is not going to be

00:03:19.820 | of interest to U.S.-based employers.

00:03:22.260 | So I started looking for, like, what could I do?

00:03:24.700 | I studied -- that's when I studied for the CFA exam.

00:03:27.340 | That's when I came across the 4% rule.

00:03:29.500 | Now, as part of living in Japan, I had access to the -- it's now owned by Morningstar.

00:03:34.460 | It was a Dim Sum Stanton March global returns data set.

00:03:37.900 | And I was just curious, did the idea of the 4% rule in retirement income that was based

00:03:41.500 | on U.S. historical data, did that work in other countries?

00:03:45.420 | And so this article was published in 2010 when I was still just simply a professor in Japan

00:03:50.340 | with no connection to anything in the United States in terms of financial services.

00:03:55.420 | And the answer is, no, it's really an artifact of U.S. data.

00:03:58.580 | Now, Canada, too, and this is the original research

00:04:01.780 | where I gave the best possible asset allocation rather than looking

00:04:04.980 | at just, well, maybe a 50/50 portfolio.

00:04:07.420 | But generally, the 4% rule didn't work around the world.

00:04:10.340 | So then I started to read more about retirement income planning.

00:04:13.500 | I quickly realized that there's very conflicting viewpoints about this.

00:04:16.820 | So there's -- for a long time, I talked about this idea that there's two schools

00:04:19.980 | of thought, probability-based and safety-first.

00:04:22.860 | And there's just these huge disagreements.

00:04:24.540 | And you can see a lot of that at the boba heads.

00:04:26.780 | Questions like, is the 4% rule any good?

00:04:29.180 | Is there any role for annuities?

00:04:30.660 | All these kinds of questions where you can have people answer them

00:04:33.500 | in the exact opposite manner.

00:04:35.420 | And I just started exploring this more.

00:04:37.340 | I'm still living in Japan.

00:04:38.500 | I'm still not at this point -- well, by this point, I was maybe starting

00:04:41.620 | to actually look for a job in the U.S. But I'm still pretty much isolated

00:04:45.260 | from U.S. financial services.

00:04:47.220 | I wrote an article on this idea of the efficient frontier for retirement income,

00:04:51.100 | which really -- it doesn't say that annuities are a replacement for stocks.

00:04:54.660 | It's -- the conversation's always around bonds.

00:04:57.580 | And the idea of the efficient frontier for retirement income,

00:05:00.820 | instead of looking at stock bond allocations, you look at allocations

00:05:04.180 | of stocks in lifetime income annuities.

00:05:06.900 | And that's still pretty like chicken and egg here, pure research.

00:05:10.780 | Now, this is where the conflicts come in.

00:05:13.020 | As I move back to the United States, insurance companies want

00:05:16.540 | to promote this research.

00:05:18.220 | And so if you see an industry white paper out there that's --

00:05:23.060 | this paper is presented by insurance company A, I'm the author.

00:05:27.260 | Yes, I was probably paid something to do that.

00:05:28.900 | Now, there are exceptions because I do occasionally see my name being used

00:05:33.180 | in ways I didn't even know about.

00:05:34.820 | But probably, probably I was paid something to do that white paper.

00:05:39.180 | So that does create a conflict.

00:05:41.020 | Yes, you should be skeptical about it.

00:05:43.220 | Now, one aspect of this research that's different from a lot

00:05:47.580 | of research, it's possible to make up data.

00:05:50.900 | And that's less possible with this.

00:05:52.900 | Like, if you disagree with the conclusions of the paper,

00:05:56.100 | what I'm basically doing is math calculations.

00:05:58.740 | I'm explaining the methodology.

00:06:00.380 | I'm explaining all the assumptions.

00:06:03.220 | So the only possibilities are there's a mistake in the calculations,

00:06:06.660 | which I always worry about.

00:06:08.340 | I guess the conspiracy theorist would be there's intentional mistakes.

00:06:12.940 | There could also be unintentional mistakes.

00:06:15.060 | But I try very carefully to make sure that doesn't happen.

00:06:19.180 | And then the other possibility is just a disagreement about assumptions.

00:06:22.780 | And so I couldn't say to the average person on the street, well,

00:06:26.860 | it's okay because you can just recreate the analysis on your own.

00:06:30.140 | I think I can say that to the boogleheads community.

00:06:32.300 | There's a lot of members of boogleheads who are much more technically sound

00:06:35.140 | than I am.

00:06:35.540 | I'm pretty much self-taught at computer programming.

00:06:38.260 | That wasn't my specific background.

00:06:40.340 | And you have, like, the variable withdrawal percentage method

00:06:43.220 | at boogleheads.

00:06:43.820 | It goes really deep into the weeds.

00:06:45.900 | So there are boogleheads that could take my research, recreate it on their own,

00:06:51.260 | and if they find a problem with it, report that to the wider community.

00:06:55.020 | So that's generally how I would suggest dealing with the potential conflicts

00:06:57.980 | of interest because, yes, it exists.

00:07:00.660 | Now, I do turn down things.

00:07:03.260 | Whenever, multiple times in my life, I've turned down the opportunity

00:07:07.380 | to write white paper because I didn't think I could write something

00:07:09.660 | that the company would be able to use.

00:07:12.580 | But if it's something that aligns with this general concept that, yes,

00:07:15.940 | I really do believe annuities can work better than bonds

00:07:18.860 | in a retirement portfolio, then I feel comfortable doing that.

00:07:22.300 | And that's how I try to manage it.

00:07:25.780 | And that's where, with this research, I do think it's a little bit different

00:07:29.860 | because you can't just simply make up the data.

00:07:31.660 | There's the ability to look at the analysis,

00:07:36.260 | recreate it, and see if I've made a mistake.

00:07:39.060 | I have worked with Alan Roth on two occasions

00:07:42.820 | where he's had me a different set of assumptions.

00:07:45.340 | I've run it for him.

00:07:46.780 | He's written an article for it.

00:07:48.660 | I do try to use unbiased assumptions.

00:07:50.540 | But he wants to say, well, what if you're truly a booglehead

00:07:52.460 | where there's no investment fees or anything else like that?

00:07:55.340 | And then we get to conclusions.

00:07:57.740 | I think we have a little bit different interpretation of them.

00:08:00.540 | He tends to think that, okay,

00:08:01.860 | this completely overturned anything I'd done.

00:08:04.540 | I tend to think that, no, if you really stack the deck in favor

00:08:07.060 | of investments as much as possible, it kind of comes out more even.

00:08:10.900 | But nonetheless, that's kind of where we're at

00:08:13.620 | with how to think about the conflicts.

00:08:16.300 | >> Okay. Nothing about conflicts.

00:08:17.580 | Let's talk about retirement.

00:08:19.380 | Let's talk just broadly, decumulation and accumulation.

00:08:23.340 | After this session, the decumulators are going to be in here after lunch,

00:08:28.060 | and the accumulators are going to be in the next room.

00:08:30.100 | But can you explain broadly how the decumulation phase

00:08:33.660 | differs from the accumulation phase?

00:08:36.620 | >> Yes. So the accumulation phase,

00:08:38.660 | it of course could get a lot more complicated.

00:08:41.100 | But the idea is like, it's what modern portfolio theory is all about.

00:08:44.460 | You try to build a diversified portfolio

00:08:47.100 | that seeks the highest risk-adjusted return.

00:08:49.660 | And then based on your risk tolerance

00:08:51.940 | or your ability to stomach short-term market volatility,

00:08:54.700 | you're trying to find that right mix of stocks and bonds

00:08:57.300 | and other potential asset classes on the efficient frontier.

00:09:00.860 | Now, modern portfolio theory, that's an assets-only concept.

00:09:04.140 | It's just, how do you choose a portfolio seeking risk-adjusted return?

00:09:09.180 | And it's a single time period model.

00:09:11.380 | It can be used as an approximation

00:09:13.260 | of the household's investing problem pre-retirement.

00:09:16.780 | But post-retirement, what makes retirement different?

00:09:20.220 | You can't really treat it as an assets-only accumulation problem anymore.

00:09:24.380 | You have to treat it as an asset liability matching problem.

00:09:27.740 | I have to fund expenditures from my assets.

00:09:31.020 | That's going to change how things work.

00:09:33.380 | This is where the sequence of returns risk idea becomes more important.

00:09:37.420 | This is where then in the context of households,

00:09:40.740 | longevity becomes important.

00:09:42.700 | We don't know how long we're going to live.

00:09:44.660 | And so this is how I basically explain how retirement's different.

00:09:49.660 | Longevity risk becomes this overarching risk of retirement.

00:09:52.340 | Because we don't know how long we have to make the plan last for.

00:09:55.700 | In an investments-only world, you can't pool the longevity risk on your own.

00:10:01.900 | You have to assume some sort of long time horizon.

00:10:04.500 | That's the logic of the 4% rule.

00:10:07.300 | Originally, the idea was, if you had a 65-year-old couple,

00:10:09.740 | it's unlikely that either person would live past 95.

00:10:12.500 | That was meant to be a conservative planning age.

00:10:15.060 | Let's make sure the plan works for at least 30 years.

00:10:18.060 | That's how you can approach it in an investments-only world.

00:10:21.140 | Or you can bring actuarial risk pooling into that as well,

00:10:24.740 | where you have the ability to-- the aggregated pool.

00:10:29.100 | We don't know who's going to live the longest in that pool, who's not

00:10:32.580 | going to live very long in that pool.

00:10:33.740 | But we can start to use the idea that there's a distribution of longevity.

00:10:37.540 | And so we can plan to have a payout link closer to someone's life expectancy,

00:10:42.700 | rather than having to worry that they may live an extremely long time.

00:10:45.700 | But that longevity risk becomes an overarching risk of retirement.

00:10:48.420 | Because the longer somebody lives, the more expensive

00:10:51.300 | their retirement becomes.

00:10:52.740 | Every year of retirement is another year of expenditures

00:10:55.740 | that they need to fund.

00:10:56.800 | And then with a longer retirement, there's

00:10:58.540 | the other risks, the macroeconomic and market volatility,

00:11:02.140 | the sequence of returns, which Dana talked about very well yesterday.

00:11:06.100 | And I'm sure it may come up in other contexts.

00:11:08.300 | So I need to give the full story about it.

00:11:10.100 | But it's the idea that, if the market's down

00:11:12.540 | and you have to sell assets to fund an expenditure need,

00:11:16.100 | even if the market recovers, your portfolio

00:11:17.980 | doesn't get to enjoy the full recovery.

00:11:20.180 | So you're more exposed to market volatility

00:11:23.060 | when you're taking distributions from the portfolio.

00:11:25.860 | And you have to manage inflation.

00:11:28.060 | To the extent that our liability grows with inflation,

00:11:30.700 | we do have to be concerned about inflation.

00:11:32.740 | That's another difference from modern portfolio theory,

00:11:35.100 | where the risk-free asset is treated as a short-term treasury bill.

00:11:38.340 | That's not a risk-free asset when you're trying to fund a liability that

00:11:41.940 | may or may not--

00:11:43.180 | especially that may grow with inflation in retirement.

00:11:46.060 | And then you have personal spending shocks.

00:11:47.900 | So we've thought about, well, what's our budget for retirement?

00:11:50.700 | But then there's all these potential additional expenses

00:11:53.520 | that we haven't necessarily built into the budget--

00:11:56.300 | long-term care, major health bills, and so forth.

00:11:59.140 | And so we also have to think about, well,

00:12:00.860 | how are we going to manage reserves to not only meet our baseline spending

00:12:06.180 | needs, but also anticipate the possibility--

00:12:09.460 | and not the absolute certainty, but the possibility

00:12:12.780 | that we may have other large expenditures to face as well.

00:12:16.660 | Thank you for that broad overview of how

00:12:19.060 | investing and managing your money in retirement

00:12:22.580 | is different once you're living off the assets.

00:12:25.460 | You've talked before about retirement income styles.

00:12:29.460 | What are the various retirement income styles?

00:12:32.540 | Yeah, and this-- so this is really an evolution of--

00:12:36.060 | I don't know if you can see those are the colors I chose.

00:12:38.300 | But an evolution of the idea of there's these two schools of thought

00:12:41.940 | for retirement income.

00:12:43.540 | So let's take a tour of what these styles are.

00:12:46.380 | And then we can talk a little bit more about how we can think about them

00:12:50.100 | and what characteristics do they have.

00:12:52.380 | So in the upper right is total returns.

00:12:55.500 | Now, these styles do have other names.

00:12:57.100 | This is also called systematic withdrawals or SWIPS.

00:13:00.220 | This is the world of the 4% rule as a starting point.

00:13:03.180 | It's the idea of you build a diversified portfolio

00:13:06.140 | and take distributions from that portfolio in a systematic manner

00:13:09.820 | throughout retirement.

00:13:11.060 | And that's all you need to worry about is, well,

00:13:13.060 | let's just manage this portfolio and take distributions.

00:13:16.260 | So that's one of the core strategies, total returns,

00:13:19.380 | systematic withdrawals.

00:13:21.140 | The lower left will be the other core strategy.

00:13:24.100 | This I call income protection.

00:13:26.300 | It has other names as well.

00:13:27.540 | It can be called the flooring approach.

00:13:29.260 | It can be called essential versus discretionary.

00:13:32.220 | The idea with income protection is before you start investing,

00:13:35.940 | you want to make sure you have your basics covered.

00:13:38.060 | Now, that includes Social Security.

00:13:39.580 | That includes pensions.

00:13:41.100 | But if there's still a gap where you feel like you'd really

00:13:43.660 | like to have more reliable income to cover some basic expenditures,

00:13:48.020 | you might look to lifetime income annuities

00:13:50.100 | to provide that lifetime income protection to cover the basics.

00:13:54.100 | Then you can invest on top of that for more discretionary types of goals.

00:13:58.300 | So total return, income protection are going

00:14:01.060 | to be the two core strategies.

00:14:03.100 | And then we have two behavioral strategies.

00:14:05.380 | And I just call them that because their motivation was more behavioral.

00:14:09.340 | Starting in the upper left, this is time segmentation or also bucketing.

00:14:14.820 | Dana talked about it in a really effective manner yesterday.

00:14:18.340 | I think of asset dedication that she was talking about

00:14:21.220 | as the best real world implementation of theory behind time segmentation.

00:14:25.180 | Because if you ask 100 different people what time segmentation means,

00:14:28.740 | you will get 100 different answers.

00:14:30.780 | And a lot of those answers don't really have any true systematic

00:14:34.100 | underlying ability to test when do you extend the ladder and so forth.

00:14:39.420 | But the idea of time segmentation is we don't just invest for total returns.

00:14:44.220 | We invest differently based on the time horizon.

00:14:47.140 | Bonds are fixed income.

00:14:48.780 | So we use them to cover our fixed income expenses over the short term.

00:14:54.380 | Stocks are meant to provide growth.

00:14:56.540 | So we build this long term growth portfolio or growth bucket.

00:15:00.180 | And we allow those stocks to grow.

00:15:02.180 | And then we don't necessarily have to touch them for however many years

00:15:06.220 | with the idea that if there's a market downturn,

00:15:08.580 | the stocks will recover before we're forced to sell from the stock portfolio.

00:15:12.780 | So it's really a different way to frame the portfolio.

00:15:15.740 | If I have a 60/40 asset allocation stocks and bonds in a total return

00:15:20.220 | environment, I'm 60% stocks, 40% constant duration bond funds.

00:15:25.100 | In the time segmentation environment, maybe I'm 40% bonds

00:15:29.180 | because it took 40% of my assets to build a 10-year front end bond ladder.

00:15:33.660 | And then the rest of my money can just go in stocks at that point.

00:15:36.100 | And so the 60% stocks is what I'm using earmarked to cover expenses

00:15:40.500 | beyond that 10-year bond ladder that I created.

00:15:43.700 | And then finally, in the lower right, this is risk graph.

00:15:46.900 | And the idea here, this one will make a little more sense

00:15:49.540 | after talking about the factors that lead to these styles.

00:15:53.100 | But there's a sense of being comfortable with the market here,

00:15:56.220 | but also wanting some sort of guardrail behind that market risk

00:15:59.380 | that you're taking.

00:16:00.700 | And in terms of behavioral solutions, this

00:16:03.420 | would be the whole motivation behind a variable annuity

00:16:06.300 | with a lifetime income benefit.

00:16:08.580 | Behaviorally, you can still invest for upside,

00:16:10.980 | but you have a put option on the stock market.

00:16:12.980 | If the market goes down, there is a downside level

00:16:15.860 | of spending that that asset base will cover for your lifetime,

00:16:19.260 | no matter what happens in the financial markets.

00:16:21.420 | So I can still invest for upside.

00:16:23.540 | Now, I don't get the full upside because there's going to be fees,

00:16:26.140 | but I can still invest for upside and have a downside protection.

00:16:29.540 | And I think that's the most practical way

00:16:31.300 | to describe the philosophy behind risk graph,

00:16:33.460 | that it's seeking market growth, but in one sort of financial

00:16:37.660 | product, because that's where it's behavioral.

00:16:39.900 | You could do the same thing with stocks and SPIAs,

00:16:42.380 | but behaviorally, with one financial product,

00:16:45.180 | seeking upside growth, but still having some sort of floor

00:16:48.700 | downside spending protection at the same time.

00:16:51.500 | So let's pause right there.

00:16:52.740 | You'll see Rick Ferry walking around collecting questions.

00:16:56.260 | Depending on how loquacious Wade happens

00:16:58.700 | to be during this discussion, we'll

00:17:00.420 | see how many of those questions we get to at the end.

00:17:02.620 | But Rick will be collecting those.

00:17:04.460 | If it's like most sessions, we won't get to most of them.

00:17:07.500 | But Wade will be around for the rest of the conference

00:17:09.900 | to take those questions on a personal matter.

00:17:13.140 | You alluded to factors that--

00:17:15.060 | and really, what we're talking about is,

00:17:16.740 | how does someone decide which of these models they should use?

00:17:21.940 | So like I was saying before, most of the research I do

00:17:24.380 | is writing computer programs to simulate strategies,

00:17:27.140 | and then it's just calculations based on assumptions.

00:17:30.060 | This is different.

00:17:30.780 | I worked with a PhD in psychology

00:17:32.980 | to do this research, creating a questionnaire,

00:17:36.660 | looking for-- reading everything we could on retirement income,

00:17:40.220 | written for consumers, written for advisors,

00:17:42.860 | looking for trade-offs.

00:17:44.180 | Where do people have to make some sort of decision,

00:17:46.740 | writing questions around that, and then

00:17:49.380 | providing these questions to people

00:17:51.820 | who were willing to participate in answering?

00:17:54.480 | Initially, we had 900 questions.

00:17:55.980 | No one was asked to answer 900 questions.

00:17:58.300 | But we whittled it down to, at the end of the day,

00:18:00.580 | what I'm about to talk about is really 12 questions can tease

00:18:04.300 | that out.

00:18:05.460 | But at one point, we had nine different factors.

00:18:08.580 | And then we use exploratory factor analysis,

00:18:10.660 | which is a statistical technique that sort of clumps questions

00:18:13.500 | together to see what sort of questions

00:18:15.780 | seem to work together to provide some sort

00:18:17.940 | of distinct explanation about how

00:18:20.340 | people think about retirement.

00:18:22.140 | From that, we came down to two primary factors.

00:18:25.700 | And that's what I'll explain now.

00:18:27.820 | There's four secondary factors that I

00:18:29.820 | won't go through in detail.

00:18:31.540 | They help to further tell the story.

00:18:33.620 | And I think bogo heads, in general,

00:18:35.080 | may be more interested.

00:18:36.340 | But if you're just giving this to the average person,

00:18:38.580 | the two primary factors is really all you need.

00:18:41.340 | And again, these two primary factors

00:18:42.860 | came out of this sort of statistical work

00:18:45.460 | of seeing how do the answers to different questions

00:18:49.020 | relate to each other in a way that

00:18:51.180 | builds some sort of distinct factor for how people are

00:18:54.640 | thinking about retirement income.

00:18:56.740 | Now, the first of these is we call it probability-based

00:18:59.820 | versus safety-first.

00:19:00.820 | That's the old name of what I called schools

00:19:02.740 | of thought for retirement income.

00:19:04.460 | So it lives on.

00:19:05.980 | And there's no right answer to this.

00:19:07.700 | This is where it's your preferences.

00:19:09.580 | Financial markets are uncertain.

00:19:11.880 | How do you feel about this?

00:19:15.340 | There's no true correct answer here.

00:19:16.820 | If you're probability-based, you're

00:19:19.340 | comfortable relying on the idea that stocks

00:19:21.700 | will outperform bonds in a manner

00:19:23.260 | that you can rely upon in your retirement

00:19:26.100 | so that with a diversified portfolio,

00:19:28.560 | you can fund your expenditure needs in retirement.

00:19:31.300 | And fundamentally, you're OK with the idea of a 50% to 75%

00:19:35.740 | stock allocation in retirement because you

00:19:38.140 | feel like you can rely on that.

00:19:40.020 | Now, we did do a study recently with BlackRock,

00:19:42.820 | which I just mentioned the name only because they

00:19:44.860 | are a financial institution, not an insurance company.

00:19:47.580 | But one of the questions we asked them there was,

00:19:50.380 | what is your financial-- what is your forecast of the stock

00:19:53.500 | market over the next 10 years?

00:19:55.220 | It could be anywhere from less than 0%

00:19:57.460 | for the next 10 years per year, annualized, to more than 12%.

00:20:01.500 | Now, you might think probability-based

00:20:03.500 | is going to be more optimistic about the stock market.

00:20:06.620 | That's not the case.

00:20:07.660 | There's no relationship between what

00:20:09.640 | you think the stock market will do

00:20:11.660 | and whether you're probability-based or safety-first.

00:20:14.260 | If you're probability-based, you may

00:20:15.820 | believe the stock market's going to only average 2% a year.

00:20:18.980 | But you're still fundamentally comfortable

00:20:20.780 | relying on the market.

00:20:22.340 | If you're safety-first, you might

00:20:24.260 | think the stock market's going to average 12% a year.

00:20:26.620 | It doesn't make a difference.

00:20:28.180 | But when it comes to funding your core spending

00:20:30.580 | need in retirement, you're not really comfortable relying

00:20:34.160 | on the stock market for that.

00:20:35.740 | You'd rather have some sort of contractually protected income

00:20:39.380 | that, though it may not be truly 100% safe--

00:20:41.900 | that's got to be a caveat.

00:20:43.180 | There's nothing that's 100% safe--

00:20:45.340 | it at least has a high degree of safety

00:20:47.060 | relative to uncertain financial market outcomes.

00:20:50.720 | Now, that can mean holding individual bonds to maturity,

00:20:53.780 | or that can mean using risk pooling through insurance

00:20:56.900 | as an additional source of spending beyond bonds.

00:20:59.660 | That actually can be competitive with the stock market.

00:21:01.940 | And that's where either of these answers,

00:21:04.420 | they lead to viable strategies.

00:21:05.820 | So it's really what somebody's most comfortable with.

00:21:07.980 | Are you probability-based or safety-first?

00:21:10.620 | The other factor is optionality versus commitment.

00:21:14.860 | How much optionality do you want for your asset base?

00:21:18.660 | If you're optionality-oriented, you really value flexibility

00:21:23.020 | above all else.

00:21:24.300 | You want to be able to respond to new changes,

00:21:27.180 | take advantage of new opportunities,

00:21:29.340 | just be flexible with your assets,

00:21:31.740 | keep all the liquidity you can for your assets.

00:21:34.620 | You value that optionality.

00:21:37.100 | Other people might answer more with a commitment orientation.

00:21:40.740 | With a commitment orientation, you're

00:21:42.420 | saying that if you can find something that will solve

00:21:45.260 | for a lifetime need, you'd rather just lock it in

00:21:48.060 | and take it off your to-do list and not

00:21:49.820 | have to worry about that.

00:21:51.420 | There's also nuances here with, this

00:21:53.220 | will help me manage cognitive decline potentially.

00:21:55.980 | If I'm the person that manages the household finances,

00:21:58.800 | if I could commit to something that

00:22:00.300 | will protect other family members,

00:22:01.720 | if I'm no longer capable of making

00:22:03.140 | the financial decisions, this is the idea

00:22:05.540 | of a commitment orientation.

00:22:07.620 | So we've got these two factors.

00:22:10.060 | And this was the big aha moment for me.

00:22:11.860 | And the reason I had those displayed

00:22:13.980 | the way they were before is, what we do

00:22:16.180 | is make a matrix out of this.

00:22:17.700 | Probability based on the right, safety first on the left,

00:22:21.320 | optionality on top, commitment on the bottom.

00:22:24.740 | And again, this was the big aha for me.

00:22:26.620 | This explains these retirement strategies

00:22:29.340 | that we've been talking about for years.

00:22:31.580 | If your total returns, your probability-based,

00:22:34.860 | you're comfortable relying on the market

00:22:36.980 | and you're optionality-oriented, you

00:22:38.580 | want to maintain flexibility for your asset base.

00:22:41.180 | And that's fine.

00:22:42.960 | If you're income protection, you're safety first.

00:22:45.780 | You want contractual protections to cover your basics.

00:22:48.620 | And you have a commitment orientation.

00:22:50.340 | You're comfortable committing to something that

00:22:52.260 | will solve your lifetime need.

00:22:54.040 | Now, those are going to be the two core strategies,

00:22:56.220 | because there are correlations.

00:22:57.540 | People who are probability-based are also

00:22:59.700 | likely to be more optionality-oriented.

00:23:01.820 | People who are safety first also tend

00:23:03.580 | to be more commitment-oriented.

00:23:05.340 | But then you get the two kind of hybrid or behavioral strategies

00:23:08.020 | too.

00:23:08.780 | So time segmentation, you're safety first.

00:23:11.360 | You want contractual protections,

00:23:13.300 | but you also want optionality.

00:23:15.380 | I think that evolved in the financial services world

00:23:17.840 | as you get the contractual protections

00:23:19.500 | through your short-term buckets, you

00:23:21.460 | get the optionality through your long-term buckets.

00:23:24.260 | And then risk graph is you're probability-based.

00:23:27.140 | You're comfortable relying on the market.

00:23:28.900 | But you're also-- you like committing

00:23:30.460 | to something that can solve for the lifetime need.

00:23:33.780 | Now, with the secondary factors that I didn't explain,

00:23:36.300 | when you're in the bottom half, you

00:23:37.740 | tend to also be more worried about outliving your money.

00:23:39.980 | When you're in the top half, you're

00:23:41.420 | not as worried about outliving your money.

00:23:43.220 | So there's a sense that even though with risk graph,

00:23:45.460 | you're comfortable with the markets,

00:23:47.540 | you still want guardrails or some sort

00:23:49.340 | of backstop or protections.

00:23:50.780 | And you're comfortable committing to something

00:23:52.980 | that will help to solve for that problem.

00:23:56.700 | So the big issue that everybody worries about,

00:23:59.380 | sequence of returns risk.

00:24:01.020 | Even though your returns are OK on average

00:24:03.620 | throughout retirement, if the crummy returns come first,

00:24:06.780 | it can sink your retirement ship.

00:24:08.820 | What are the four broad ways to manage sequence of returns

00:24:11.340 | risk?

00:24:12.640 | Yes, so here's a comprehensive list

00:24:14.780 | of how to manage sequence risk.

00:24:16.700 | Now, there's going to be subcategories.

00:24:18.460 | But I think anything someone can name, I'm pretty sure,

00:24:21.460 | fits into one of these four.

00:24:23.460 | So sequence risk is really, it's kind of like,

00:24:25.420 | how do we manage volatility and then also

00:24:27.620 | longevity at the same time?

00:24:29.060 | How do we build a plan that's going

00:24:30.520 | to be sustainable in retirement?

00:24:32.500 | The four broad options, one, spend conservatively.

00:24:36.740 | That's the logic of the 4% rule.

00:24:39.020 | It's build an aggressive portfolio.

00:24:41.540 | But let's just figure out how low our spending

00:24:43.540 | has to go so that we don't have to worry

00:24:45.780 | about outliving our money.

00:24:47.320 | It's not the most satisfying way to approach retirement.

00:24:50.060 | It's also really a research simplification,

00:24:51.900 | because it assumes you don't have

00:24:53.660 | any sort of discretionary power to change your spending.

00:24:55.980 | You always just adjust it for inflation.

00:24:58.140 | But it's seeking to answer the question,

00:24:59.760 | how low does spending need to go to not run out of money?

00:25:03.340 | Now, sequence risk is triggered by selling assets at a loss.

00:25:07.860 | So the other approaches are all about,

00:25:09.900 | how can we better try to avoid selling assets at a loss?

00:25:13.660 | Spending flexibly is, if I can cut my spending when

00:25:18.420 | the markets are down however we define that--

00:25:21.280 | we can talk about that.

00:25:22.240 | And Dana talked about some of the methods

00:25:23.940 | yesterday as well with time segmentation

00:25:26.020 | that apply to spending flexibility strategies

00:25:28.860 | in the same manner.

00:25:30.020 | But when markets are somehow down,

00:25:32.180 | how can we adjust our spending downward

00:25:34.980 | to help avoid selling assets at the loss

00:25:37.360 | and to give our portfolio more opportunity to recover?

00:25:40.500 | So that's the core concept behind variable spending.

00:25:43.740 | Then the third category, reduce volatility.

00:25:46.380 | That doesn't mean simply using bonds in retirement,

00:25:48.700 | though now that the TIPS yield curve is at 2.4%,

00:25:53.260 | maybe that is high enough to just fund your retirement

00:25:55.920 | with a 30-year bond letter.

00:25:57.340 | But what we're talking about more with reduced volatility,

00:26:00.060 | it could be--

00:26:01.140 | well, this is a bucketing.

00:26:02.300 | The bucketing idea is you reduce volatility in the short run

00:26:04.800 | for at least volatility that you're

00:26:06.260 | exposed to in the short run.

00:26:08.260 | You could talk about annuities in this context.

00:26:10.220 | In the total return context, Michael Kitsies and I

00:26:13.140 | wrote about the idea of a rising equity glide path in retirement

00:26:15.820 | where you have the lowest stock allocation at retirement

00:26:18.540 | when you're the most vulnerable to a market downturn,

00:26:21.020 | and then you gradually increase without retirement.

00:26:23.380 | So different ideas around how you

00:26:24.960 | might reduce volatility at important moments

00:26:28.240 | in retirement.

00:26:29.700 | And then the fourth approach is buffer assets.

00:26:32.480 | So buffer assets are something outside your portfolio

00:26:36.540 | that you don't think of them as part of your portfolio,

00:26:39.640 | and they're not correlated with their portfolio, which

00:26:42.480 | more generally just means buffer assets shouldn't

00:26:44.680 | be able to lose value.

00:26:46.560 | And then you think of them as a temporary resource

00:26:48.760 | that you can spend from when you're-- again,

00:26:51.520 | back to this idea that when your portfolio is in trouble

00:26:53.900 | or when the markets are down, however defined,

00:26:57.100 | I can draw from the buffer asset as a temporary spending

00:27:00.020 | resource so that I don't have to suffer my portfolio at a loss,

00:27:04.260 | and that will allow my portfolio an opportunity to recover.

00:27:08.340 | And as a little teaser of what's coming up here.

00:27:10.300 | So I'm only comfortable identifying three things

00:27:13.020 | as buffer assets.

00:27:14.260 | The original buffer asset is cash.

00:27:17.580 | You have a big pile of cash.

00:27:19.500 | And you could think, well, is cash my short-term bucket?

00:27:22.360 | It could be cash as time segmentation if you've--

00:27:25.260 | it's really-- it's part of your spending strategy.

00:27:27.620 | But if you're thinking of cash more

00:27:29.080 | as I've got a pile of cash, I don't

00:27:30.580 | think of it as part of my portfolio,

00:27:32.340 | I'll use it as a temporary spending resource

00:27:34.140 | when I need to.

00:27:35.420 | That would be a cash reserve as a buffer asset.

00:27:38.560 | The other two buffer assets out there

00:27:40.180 | that then don't require as big of cash holding

00:27:42.140 | are, where the tomatoes can begin,

00:27:45.180 | the growing line of credit on a reverse mortgage home equity

00:27:47.940 | conversion mortgage.

00:27:49.480 | And that's something you can set up a requirement.

00:27:51.540 | And then going even further back in time,

00:27:53.620 | if you had this, a whole life insurance policy,

00:27:56.180 | the cash value of whole life insurance

00:27:58.220 | can play a similar role where you take proceeds

00:28:01.260 | as a loan from either the cash value or the reverse mortgage.

00:28:05.600 | And that becomes a temporary spending resource

00:28:08.300 | to get you through a market downturn.

00:28:10.180 | And we'll talk more about that.

00:28:11.900 | Oh, yes, we will.

00:28:15.060 | So that's the teaser.

00:28:15.900 | You know, it's interesting.

00:28:20.500 | The 4% rule came out in the '90s from a handful of studies

00:28:24.060 | and was revolutionary in this space.

00:28:27.820 | And yet, almost everybody in this space now agrees,

00:28:29.900 | that's a terrible way to fund your retirement.

00:28:33.100 | And that almost everybody should be

00:28:34.520 | using some sort of a variable withdrawal strategy.

00:28:38.180 | So why is that?

00:28:39.900 | And what's the 4% rule good for anyway?

00:28:43.620 | OK, so the 4% rule provided a really valuable contribution.

00:28:49.340 | It introduced the idea of sequence risk

00:28:51.620 | to the financial planning world.

00:28:53.660 | Because before the 4% rule, as I understand it,

00:28:56.140 | the article was published in 1994.

00:28:57.660 | So I wasn't around doing research at that time.

00:29:00.940 | But people were just using spreadsheets.

00:29:02.940 | And they were saying things like, well, the stock market

00:29:05.260 | should average 7% after inflation.

00:29:07.020 | I'll plug 7% in my spreadsheet.

00:29:09.220 | 7% is a safe withdrawal rate with 100% stock portfolio.

00:29:11.980 | Because every year I get 7% returns.

00:29:13.780 | I spend it.

00:29:14.380 | I'm never going to even tip it in my principal.

00:29:16.880 | I could even maybe spend 8% and slowly spend on my principal.

00:29:20.620 | Bill Bingen recognized that was ridiculous.

00:29:23.580 | And so he looked at the historical data

00:29:25.300 | to try to figure out, well, given that markets are

00:29:27.740 | volatile, even if the stock market averages 7%,

00:29:31.660 | that's approximately the S&P 500's real return compounded.

00:29:36.540 | What do you do about the market volatility?

00:29:38.380 | And so he explored that with US historical data

00:29:41.900 | and figured out if you retired in 1966 with a 50/50 portfolio,

00:29:46.860 | 4% was as much as you could have spent in the first year

00:29:49.980 | that if you then increased that for inflation growth,

00:29:52.660 | your money would have run out precisely 30 years later.

00:29:55.460 | And so that was his safe max.

00:29:56.940 | That was a maximum spending rate you

00:29:58.860 | could have safely used in the worst case 30 year

00:30:02.020 | period from US history.

00:30:04.740 | So that's a helpful guideline.

00:30:06.820 | But it's not really a real-world spending strategy

00:30:10.100 | because it has so many assumptions baked into it.

00:30:12.420 | It ignores taxes.

00:30:14.300 | It ignores the idea of investment fees,

00:30:16.020 | though I guess if you're VTI, you

00:30:17.740 | don't have to worry about that angle.

00:30:19.660 | But it's really a simplified investment strategy.

00:30:22.980 | S&P 500, intermediate-term government bonds,

00:30:26.540 | which might be a reason you could go higher than 4%

00:30:28.740 | with a more diversified portfolio,

00:30:31.740 | said it ignores taxes.

00:30:33.260 | What else?

00:30:33.820 | I mean, 30 years is a retirement horizon, 50% to 75% stocks.

00:30:38.820 | You're always rebalancing to the asset allocation

00:30:41.820 | that you've targeted.

00:30:43.420 | And well, there you go.

00:30:45.420 | That's the idea behind the 4% rule.

00:30:46.940 | And you never deviate from the idea

00:30:48.460 | that you just increase your spending for inflation.

00:30:50.660 | Now, I mentioned this idea that if you

00:30:53.260 | can be flexible with your spending,

00:30:55.740 | you can potentially start with something much higher than 4%.

00:30:58.900 | But 4% kind of worked itself into the zeitgeist

00:31:01.780 | is here is the basic rule of thumb

00:31:03.940 | about how much you can spend in retirement.

00:31:06.340 | There's a lot of information on that slide.

00:31:12.420 | Yeah, this has a lot of--

00:31:13.460 | How much time are we going to spend on this slide?

00:31:16.460 | So this is about the variable spending strategies.

00:31:21.380 | And so what we're looking at here is--

00:31:23.740 | and it all depends on capital market assumptions.

00:31:25.940 | This one was run at the beginning of the year

00:31:27.940 | when the TIPS yield was about 1.75%.

00:31:31.380 | If I reran this today, the 4% rule is going to work now.

00:31:34.900 | We've got real yields that are well--

00:31:37.860 | now, there is a--

00:31:40.460 | some Boglehead forum members have this idea

00:31:43.180 | that if the TIPS yield curve can support 4%,

00:31:46.220 | that's a guarantee that the 4% rule is safe.

00:31:49.220 | I disagree with that because the 4% rule does not

00:31:52.660 | assume a 30-year TIPS ladder.

00:31:54.900 | It assumes a portfolio of 50% to 75% stocks.

00:31:58.180 | However, there is a correlation.

00:31:59.940 | As interest rates come up, I would

00:32:01.660 | agree that the probability that the 4% rule will work

00:32:04.620 | comes up accordingly.

00:32:06.300 | So if I did rerun this today, 4% would be there.

00:32:09.900 | Now, what this is looking at is inflation-adjusted amounts

00:32:13.740 | at the top.

00:32:14.620 | That's the 4% rule concept.

00:32:16.140 | That's every year you're spending growths for inflation.

00:32:19.220 | And then with the capital market assumptions in the article,

00:32:22.300 | we're just looking at, well, what's the highest spending

00:32:24.540 | rate you could use?

00:32:26.060 | And we're calibrating downside risk.

00:32:29.100 | As soon as you start talking about variable strategies,

00:32:31.340 | you can't use a failure rate idea

00:32:32.820 | that the 4% rule usually uses because some variable spending

00:32:35.580 | strategies, you can never run out of money.

00:32:37.620 | So it doesn't make any sense to talk about that.

00:32:40.260 | So I use something I call the pay rule, which

00:32:42.180 | is my downside risk calibration.

00:32:45.460 | What probability do you accept that your remaining wealth

00:32:48.140 | will drop below a particular threshold

00:32:50.180 | by a certain year of retirement?

00:32:52.020 | So here, I accept a 10% probability.

00:32:55.500 | And this is all just scaled on $100 at retirement.

00:32:58.900 | So that my remaining real wealth,

00:33:00.820 | inflation-adjusted wealth, 10% probability

00:33:03.180 | that my real wealth drops below $10 by year 30--

00:33:06.900 | I think year 30 of retirement.

00:33:09.900 | With the inflation-adjusted spending strategy,

00:33:12.020 | it's a 3.62% withdrawal rate.

00:33:14.340 | Now, one time, when the Boca heads were talking about this,

00:33:16.900 | they were, oh, I always have all these conflicts.

00:33:20.740 | I changed the failure rate measure.

00:33:22.460 | So I'm just showing, if you use a traditional failure rate

00:33:25.060 | measure, this would actually be 3.83%.

00:33:28.260 | You just can't use that when you're

00:33:29.820 | comparing variable spending strategies.

00:33:31.900 | But then we just have different variable spending strategies.

00:33:34.480 | If you use a fixed percent of what's left every year,

00:33:37.620 | 8 and 1/2% is the withdrawal rate.

00:33:39.660 | And that's what you get that calibrates so that there's

00:33:41.940 | a 10% chance that you only have $10 left after 30 years.

00:33:44.980 | Again, that's 10% of what you started with after 30 years.

00:33:49.380 | There is the Bengen dollar floor and ceiling rule,

00:33:52.060 | where you could start with a 4.14%.

00:33:55.060 | And you spend a percentage of what's left every year,

00:33:57.180 | 4.14% of what's left every year.

00:33:59.500 | But if your wealth is growing, that number

00:34:02.300 | is going to start giving you more spending power.

00:34:04.700 | You apply a dollar ceiling that you're not

00:34:06.900 | going to spend more than that ceiling.

00:34:08.820 | And also, if your portfolio is declining,

00:34:11.140 | 4.14% of what's left is going to decrease your spending.

00:34:14.380 | You apply a dollar floor, you won't let your spending drop

00:34:16.780 | below a particular dollar threshold.

00:34:18.620 | And so you have variable spending within a range,

00:34:20.700 | but there's a ceiling and a floor on that.

00:34:23.180 | Gets you a higher spending rate.

00:34:24.840 | You've got the ratcheting rule, which

00:34:26.380 | is based on something Michael Kitsie has talked about.

00:34:28.780 | And these are all inspired by whatever

00:34:32.540 | Michael Kitsie's blog post was.

00:34:34.380 | He had a different way to explain the ratcheting rule.

00:34:36.660 | I just apply it as 3.59% is your floor.

00:34:40.980 | If your wealth drops so that when you take 3.59% of what's

00:34:45.180 | left, it would be less than the $3.59 real

00:34:48.980 | that you start with, then it's constant inflation

00:34:52.380 | adjusted spending at that amount.

00:34:54.160 | If the portfolio is growing so that 3.59% of what's left

00:34:57.580 | is more, you get to spend more.

00:34:59.620 | So it's basically unlimited upside on spending,

00:35:02.460 | but you're still putting in that floor.

00:35:04.700 | The spending guardrail rule, that's

00:35:06.140 | kind of like what Jonathan Guyton talks

00:35:07.820 | about with his decision rules.

00:35:09.100 | You've got the prosperity rule.

00:35:10.860 | You've got the capital preservation rule.

00:35:13.260 | How the spending guardrail rule works

00:35:15.340 | is you could take 4.53% of your initial balance,

00:35:19.300 | increase that for inflation.

00:35:21.340 | But the prosperity rule says that if your portfolio is

00:35:25.240 | growing, that spending amount is going

00:35:28.140 | to be a smaller percentage of what's left.

00:35:30.700 | The prosperity rule says you're never

00:35:32.300 | going to spend less than a certain percentage of what's

00:35:34.600 | left so that your spending can grow more than inflation

00:35:37.900 | adjusted.

00:35:38.900 | If your portfolio is doing well, the capital preservation rule

00:35:41.980 | goes in the other direction.

00:35:43.420 | You're spending that amount every year,

00:35:45.080 | but if your portfolio is declining,

00:35:46.540 | eventually your withdrawal rate based on what's left

00:35:49.140 | is getting too high, so you apply this rule.

00:35:51.580 | I'm not going to spend more than this percent of what's

00:35:53.940 | left in my portfolio.

00:35:55.980 | The inflation rule is, it's like that glide path idea

00:35:59.720 | that Dana was talking about yesterday,

00:36:01.260 | but if you have more wealth than the glide path,

00:36:04.260 | you take the inflation adjustment.

00:36:06.140 | If your wealth has fallen below the glide path,

00:36:08.300 | you don't take the inflation adjustment.

00:36:10.220 | And so that allows for a dramatically higher initial

00:36:12.540 | spending rate, but with this built-in ability

00:36:14.540 | that your spending may decline over time.

00:36:16.660 | And then the modified R&D rule is, take the R&D tables,

00:36:20.620 | multiply them by the factor that will calibrate that downside

00:36:23.620 | risk measure, which leads to at age 65, or I think age 65--

00:36:30.700 | this is not the R&D factor that you get from that age,

00:36:33.260 | but when you multiply it by, in this case, 1.56,

00:36:36.060 | you could start with a 4.25% withdrawal rate,

00:36:40.260 | and then it's calibrated to the R&D. So as you age,

00:36:44.220 | you can spend an increasing percentage of what's left.

00:36:47.220 | And in terms of just what do we get with that,

00:36:50.620 | I think that table, when you start looking at the numbers,

00:36:53.000 | it's going to become pretty apparent

00:36:54.460 | that you have a lot of flexibility about which way

00:36:56.780 | to go, but you probably don't want

00:36:58.600 | to use the inflation-adjusted spending amount strategy.

00:37:01.180 | It starts at a much lower level of spending,

00:37:04.040 | and it really doesn't have a whole lot going for it,

00:37:06.200 | other than because you usually underspend with it,

00:37:08.580 | you might leave a lot of legacy.

00:37:09.900 | So if you really value legacy, inflation-adjusted amounts

00:37:13.260 | might be an option.

00:37:15.100 | The fixed-percentage rule, start with a much higher

00:37:17.740 | initial spending, but you can really

00:37:19.740 | expect your spending to decrease over time.

00:37:23.000 | And it's really efficient at spending on your assets,

00:37:25.200 | so you're not going to be leaving as much legacy.

00:37:28.300 | The dollar-floor-ceiling rule is one

00:37:30.100 | of my personal favorites of these.

00:37:31.900 | It's a nice compromise about get a higher initial spending

00:37:34.780 | rate, and your spending stays in a more steady range.

00:37:38.500 | The ratcheting rule, it's just pretty much--

00:37:41.620 | the ratcheting rule, although the initial withdrawal rate

00:37:44.040 | was slightly less than constant inflation-adjusted amounts,

00:37:47.140 | I'd almost say that it stochastically

00:37:49.580 | dominates constant inflation-adjusted spending.

00:37:52.360 | You're pretty much the same or better off

00:37:54.340 | with the ratcheting rule.

00:37:55.400 | So if anything, use the ratcheting rule instead

00:37:57.900 | of inflation-adjusted spending.

00:38:00.220 | The ceiling doesn't matter.

00:38:01.340 | It's the floor that matters.

00:38:03.540 | And that's having that floor, but then

00:38:06.300 | being able to go above the floor.

00:38:07.820 | It's just, why not do that?

00:38:09.820 | Compared to the 4% rule concept of always increasing

00:38:13.140 | spending for inflation.

00:38:14.780 | Spending guardrails is harder to implement in practice,

00:38:17.100 | and I don't think that's fully appreciated.

00:38:19.020 | The Jonathan Geichen spending guardrail rules

00:38:21.720 | are probably the hardest of any of these rules to actually use.

00:38:24.660 | They do allow for higher initial spending,

00:38:26.420 | and if you like building spreadsheets,

00:38:28.220 | could be the right one for you.

00:38:30.060 | The inflation rule does provide guidance.

00:38:32.100 | A lot of times, you have the question,

00:38:33.060 | when should I cut my spending?

00:38:34.580 | What has to happen to make a cut?

00:38:36.660 | Well, here, it's a nice kind of rule

00:38:38.740 | around when I should not increase for inflation.

00:38:43.740 | And then the modified R&D rules, though it's not

00:38:46.940 | the true academically optimal, because you really

00:38:49.060 | need to go a little bit deeper.

00:38:50.340 | But it's closer to the idea that as you age,

00:38:53.020 | you should spend an increasing percentage of what's left.

00:38:56.020 | And so if you don't have big legacy concerns,

00:38:59.380 | something like a modified R&D rule,

00:39:01.300 | it's going to give you more variable spending,

00:39:03.220 | but it's closer to the, quote unquote,

00:39:05.940 | most efficient way to spend on your assets and retirement.

00:39:08.820 | So if your mom comes to you and asks you, which of these

00:39:11.060 | should I use, what's your answer?

00:39:13.220 | Well, and then in the real world,

00:39:14.940 | is you just spend what you need to spend,

00:39:16.900 | and it's not going to match any of these rules precisely.

00:39:21.220 | That sounds like the Taylor-Laramore adjust

00:39:23.540 | as you go rule.

00:39:25.060 | Right.

00:39:26.560 | All right.

00:39:27.060 | In the interest of time, I want to skip ahead

00:39:28.980 | to one of the controversial topics.

00:39:30.860 | Let's talk for a minute about annuities.

00:39:34.460 | And I want to talk a little bit about what annuities maybe

00:39:36.900 | people should consider, but also a question from the audience

00:39:40.900 | about SPIAs, which I'm sure you'll mention,

00:39:43.300 | a single premium immediate annuity,

00:39:46.480 | that for a very long-term retirement,

00:39:48.220 | how do you best mitigate the impact of inflation

00:39:51.580 | on the SPIA, if you can cover that as well.

00:39:54.420 | Yeah, absolutely.

00:39:55.860 | OK, yeah, let's go ahead and get to it.

00:39:57.500 | So who might consider an annuity?

00:40:00.060 | And then we'll talk about inflation, too.

00:40:01.940 | So who might consider an annuity?

00:40:06.100 | If your retirement income style is either income protection

00:40:08.820 | or risk-wrap, that's going to be something that's

00:40:11.860 | on the plate at that point.

00:40:13.220 | If you're total returns, you're not even

00:40:16.220 | thinking about annuities.

00:40:17.260 | That's where a lot of the opposition to annuities--

00:40:19.820 | I think some of the most vocal members at the forums,

00:40:23.180 | I would call total returns absolutists.

00:40:26.180 | And they don't need an annuity.

00:40:27.720 | It's not for them.

00:40:28.540 | It's not part of their style.

00:40:29.980 | It's not part of their preferences.

00:40:32.020 | But if your style is income protection or risk-wrap,

00:40:34.300 | it might be something to consider.

00:40:36.340 | Also, do you have an income gap?

00:40:38.300 | So step one is always delay Social Security.

00:40:42.060 | The delay credits on Social Security

00:40:44.180 | are much better than any sort of commercial annuity.

00:40:46.940 | So delay Social Security to age 70.

00:40:49.060 | Get your inflation-adjusted lifetime spending

00:40:52.020 | from Social Security with a survivor benefit.

00:40:54.440 | If you have other pensions, other reliable income--

00:40:56.900 | and then it's only if there's a gap where you really

00:40:58.940 | would like to have more reliable income than is already

00:41:01.460 | available to you, you might be thinking

00:41:03.540 | about filling that gap with an income annuity.

00:41:06.260 | Then you can feel more comfortable investing

00:41:08.140 | on top of that for discretionary goals.

00:41:10.660 | If you have a low risk tolerance--

00:41:12.300 | and this becomes a big issue.

00:41:14.460 | I never talk about annuities as a stock replacement.

00:41:18.060 | They're a bond replacement.

00:41:19.900 | So to the extent that you're not going to have stocks anyway,

00:41:22.860 | if you're very risk-averse, the case

00:41:25.380 | becomes stronger and stronger for the annuity

00:41:27.340 | because bonds aren't doing anything for you.

00:41:29.180 | It's really the challenges you want

00:41:31.540 | risk pulling through the annuity or the risk premium

00:41:33.460 | through the stock market.

00:41:34.460 | Well, if you're not going for the risk premium

00:41:35.920 | through the stock market, then you've

00:41:37.660 | got a stronger case for annuities.

00:41:40.540 | If you're more worried about outliving your money, what

00:41:43.220 | that means in this context, in an investments-only world,

00:41:45.780 | it means you're going to be worried about spending.

00:41:47.900 | So you're going to spend less and less.

00:41:49.620 | This gets into the idea of the annuity provides you

00:41:52.660 | permission to spend because you're not worried

00:41:54.780 | about outliving that asset.

00:41:56.460 | So to the extent that you're more

00:41:58.140 | worried about outliving your money,

00:41:59.740 | the case becomes stronger for the annuity.

00:42:01.980 | Again, emphasize this important point.

00:42:04.100 | If you're willing to view annuities

00:42:05.540 | as a bond replacement, which means

00:42:07.500 | for your remaining investments, you'll

00:42:09.100 | then have a higher stock allocation.

00:42:11.580 | That's an important aspect of at least getting the math

00:42:14.340 | to work out that this is a good way to approach things.

00:42:17.660 | If you like that idea of the commitment and the dementia

00:42:19.900 | insurance aspect of this is going

00:42:21.860 | to protect me from making mistakes later in life,

00:42:24.100 | this is going to be more helpful in preventing

00:42:25.940 | against financial fraud or elderly abuse

00:42:28.300 | because I don't have this big lump sum there that somebody

00:42:30.780 | can go after.

00:42:31.460 | I've got a monthly income coming in.

00:42:34.540 | Of course, you can still have fraud on a monthly paycheck,

00:42:37.260 | but it's harder to do that on a systematic basis

00:42:40.340 | than to go after one big lump sum.

00:42:42.140 | And then also, you do need to make sure to take the time

00:42:44.420 | to understand how annuities work.

00:42:46.380 | OK, now the inflation question is an important one.

00:42:50.180 | So you do get inflation-adjusted income

00:42:52.020 | through Social Security.

00:42:53.820 | You're not going to look to the annuity for inflation

00:42:56.300 | protection.

00:42:58.420 | That's not what it does.

00:42:59.620 | Your inflation protection can be through the TIPS.

00:43:02.900 | It can be through stocks.

00:43:05.000 | You mentioned real estate, which I usually

00:43:06.740 | didn't think to mention.

00:43:07.740 | But maybe real estate is another option.

00:43:10.020 | It's not the annuity.

00:43:11.220 | But what the annuity does as a bond replacement is--

00:43:17.180 | so TIPS is another option.

00:43:18.500 | But if we're just setting TIPS aside for the moment

00:43:21.100 | because it's like, do I want traditional treasuries

00:43:23.220 | or annuities, what annuities do relative

00:43:25.820 | to traditional treasuries is, over time, as you live longer,

00:43:30.300 | they meet more and more of your spending need

00:43:32.900 | so that you can take less distributions

00:43:35.260 | from your other assets.

00:43:37.520 | And a big way to manage sequence risk

00:43:40.460 | is to reduce the spending.

00:43:42.500 | Now, what you're doing there is you're

00:43:44.060 | reducing the spending from the investments

00:43:46.820 | because your annuity is covering more of that income over time.

00:43:50.180 | That makes it easier for your stocks

00:43:52.100 | to grow if you're taking less distributions from the stocks.

00:43:55.540 | So the annuity itself does not provide inflation protection.

00:43:59.340 | But it makes it easier for your other investments

00:44:02.780 | to not be as burdened by distributions

00:44:05.780 | to allow them to be the source of inflation protection.

00:44:08.340 | Now, they do have the responsibility.

00:44:09.960 | If you need the inflation growth,

00:44:12.340 | that's coming from the investment side.

00:44:14.100 | So your investments will be more burdened over time.

00:44:17.220 | But this is back to when I do simulations around this,

00:44:21.220 | usually by having a lower distribution

00:44:22.980 | need from the investments.

00:44:24.260 | You're building the framework for them

00:44:27.020 | to grow so that they can be that source of inflation

00:44:30.380 | more effectively in the future.

00:44:32.420 | So it's not that the annuity by itself

00:44:34.660 | provides any sort of inflation protection.

00:44:37.260 | What it does is it makes it easier for your investment

00:44:39.700 | portfolio to not be as burdened by distributions

00:44:42.820 | and therefore make it easier for them to provide

00:44:44.860 | the inflation protection.

00:44:47.540 | Let's talk about the controversial buffer assets.

00:44:50.380 | The first one, few people dislike

00:44:53.220 | how whole life insurance is sold more than I do,

00:44:57.420 | although I recognize there are times when it can be useful.

00:45:00.140 | Do you think a typical investor, maybe even a typical Vogel

00:45:03.220 | head in this room, should consider purchasing a policy

00:45:06.660 | to help pay for their retirement?

00:45:09.820 | Yeah, the answer to that is probably not.

00:45:13.060 | And I somehow have been labeled as this life insurance guy,

00:45:15.860 | which I did a couple of studies about it in the past.

00:45:19.860 | I'm not living my life thinking about life insurance every day.

00:45:22.740 | But I did.

00:45:24.940 | I became convinced enough--

00:45:26.180 | I'm still a little bit young to be purchasing annuities,

00:45:28.560 | but I did get a whole life policy

00:45:30.620 | after doing that research.

00:45:32.300 | Because my bonds are--

00:45:33.860 | I don't have a lot of bonds.

00:45:35.260 | I don't really want a high bond allocation right now.

00:45:37.460 | I've got some high bonds, and then I

00:45:39.140 | have my whole life policy.

00:45:40.780 | I don't have any other bonds.

00:45:41.980 | I'm comfortable thinking of that as my bond allocation.

00:45:45.300 | Now, after the tax deferral, I don't

00:45:48.540 | spend a lot of time thinking about bonds more generally.

00:45:50.940 | So I don't know if it's the best way to invest in bonds or not.

00:45:54.380 | I think the case is there that I can be comfortable,

00:45:57.860 | assuming I'm not being ripped off by treating it

00:45:59.980 | as my bond allocation.

00:46:02.460 | But that's not going to be for everyone.

00:46:04.460 | And in particular, it requires a very strong commitment

00:46:08.380 | orientation.

00:46:09.020 | You're really making a lifetime commitment

00:46:11.580 | to a whole life insurance policy.

00:46:13.260 | You don't want to necessarily lapse on that in the future.

00:46:16.380 | I feel like I could make that lifetime commitment to it.

00:46:19.140 | So I feel like it's OK for me in that context.

00:46:22.900 | And then, as part of retirement income, well,

00:46:25.540 | then how do you use it?

00:46:27.300 | Of course, the idea behind buy term and invest a difference,

00:46:30.260 | you don't need life insurance in retirement.

00:46:32.300 | You only need it to protect your family while you're working.

00:46:34.620 | So if you're not working, you don't

00:46:36.060 | have any human capital to protect.

00:46:37.480 | You don't need life insurance anymore.

00:46:39.260 | Well, if you have a legacy goal in mind,

00:46:43.300 | rather than trying to spend less from your investments,

00:46:45.620 | because you want to make sure you preserve that legacy goal,

00:46:48.180 | it can work to just earmark some of your potential investments

00:46:51.260 | to that life insurance policy instead to earmark,

00:46:53.940 | here's the legacy.

00:46:54.820 | And the cost of that legacy was the premiums

00:46:56.660 | on the life insurance, not I just

00:46:58.700 | have to manage my investments more carefully

00:47:01.060 | to preserve the legacy.

00:47:02.700 | Or this idea of, if you're income protection,

00:47:05.700 | it can be hard to purchase an income annuity.

00:47:08.700 | And in particular, if you're in a couple,

00:47:11.420 | you get a joint life or a single life that would pay more.

00:47:14.500 | Well, the idea behind the life insurance

00:47:16.160 | there is, if I have a life insurance policy,

00:47:20.140 | I could buy a life only income annuity, which

00:47:22.500 | is the highest paying possible income annuity,

00:47:25.300 | up to the amount of the death benefit on the life insurance.

00:47:28.260 | Because I know that when I pass away,

00:47:30.000 | the life insurance death benefit replaces

00:47:32.220 | that asset for the household.

00:47:33.860 | And then if there is a surviving spouse at that point,

00:47:36.700 | they could use the death benefit to buy an annuity

00:47:39.460 | or whatever they want to do at that point.

00:47:41.340 | But that's one way to think about it.

00:47:42.940 | The other is this buffer asset idea

00:47:45.580 | that it's worth getting into a little deeper.

00:47:47.580 | Because this is also the--

00:47:49.580 | when I was learning about this stuff,

00:47:52.100 | there's a parallel conversation that

00:47:53.940 | was happening in the life insurance world

00:47:55.900 | and the reverse mortgage world.

00:47:57.540 | This idea of this thing, this loan

00:48:00.740 | from something that doesn't decline in value

00:48:03.260 | is a buffer asset.

00:48:04.420 | So it's worth talking about that a little bit more detail

00:48:07.060 | with another slide.

00:48:08.740 | Another important aspect of this, like I was saying,

00:48:11.340 | this is not a replacement for your stock investments.

00:48:13.740 | And I think a lot of the opposition to whole life

00:48:15.780 | is, you'd be better off in the stock market.

00:48:18.940 | I'm really thinking of this as a bond replacement, not

00:48:21.540 | a stock replacement.

00:48:23.060 | And also, if you're going to face higher tax

00:48:25.780 | rates in retirement, when the policy is structured properly,

00:48:30.100 | this can be a way to have, just like a Roth IRA,

00:48:33.260 | a source of spending power that does not

00:48:35.780 | add to your adjusted gross income

00:48:37.900 | and does not cause all the other problems.

00:48:39.900 | So if you were at the session yesterday,

00:48:42.700 | it's worth just reviewing this idea real quick.

00:48:45.980 | Are you going to be in a high tax bracket in retirement?

00:48:48.580 | Well, that question doesn't just mean the federal income tax

00:48:51.120 | bracket.

00:48:51.620 | It means all these other non-linear aspects

00:48:53.820 | of the tax code.

00:48:55.300 | So there's no state income tax on this.

00:48:58.020 | This is purely federal considerations.

00:49:00.580 | If you're married, filing jointly in 2023,

00:49:03.540 | and at this point, the couple has $52,200 in Social Security,

00:49:07.260 | seems like a weird number.

00:49:08.340 | It's basically a $2,500 primary insurance amount linked

00:49:11.660 | to a worker claiming at 70, and then also their spouse

00:49:14.940 | getting 50% of their full retirement amount.

00:49:17.820 | And then preferential income of $20,000,

00:49:20.420 | that's qualified dividends, long-term capital gains

00:49:23.340 | that they're taking out of the portfolio.

00:49:25.260 | Then we're going to look at the relationship

00:49:27.100 | between ordinary income, whether that's wages,

00:49:31.180 | whether that's an IRA distribution needed

00:49:33.460 | for spending, whether that's a Roth conversion.

00:49:37.020 | But what happens to my taxes as I

00:49:38.980 | generate more ordinary income?

00:49:41.540 | Oh, are we at time?

00:49:42.940 | We're getting pretty close.

00:49:44.100 | OK.

00:49:44.600 | Sorry.

00:49:45.820 | I was really wordy.

00:49:47.140 | So it's basically then--

00:49:49.820 | what you're seeing here-- let me just explain this map,

00:49:52.060 | and then we can pretty much wrap up.

00:49:54.360 | So it's jumping to 18 and 1/2% because you're

00:49:56.940 | in the 10% bracket at a point where you're then--

00:49:59.980 | each dollar is causing $0.85 of Social Security to be taxed.

00:50:03.900 | Then you jump to 22.2% because you're in the 12% bracket.

00:50:07.820 | Each dollar is causing $0.85 of Social Security to be taxed.

00:50:11.700 | Then once you get the full 85% of your Social Security is taxed,

00:50:15.060 | you drop back down to 12% for a while.

00:50:17.420 | Then you jump up to 27% because that's

00:50:20.060 | where you're now pushing income from the long-term gains

00:50:23.500 | from 0% to 15%.

00:50:25.620 | So you're riding along 27%.

00:50:28.100 | Then for $200, you drop back down to the 22% bracket--

00:50:33.300 | no, I'm sorry, 12% bracket.

00:50:34.840 | Then you're going to 22%.

00:50:36.740 | Then you start getting hit by the IRMA thresholds.

00:50:39.220 | And then also the 3.8% net investment income tax

00:50:42.740 | as you get closer to that $250,000 of taxable income.

00:50:48.300 | That's close enough.

00:50:49.380 | And so that's what you're needing

00:50:50.780 | to manage in retirement, not just federal income tax

00:50:53.140 | brackets.

00:50:55.140 | All right, let's take maybe one minute

00:50:58.820 | and just talk about that other controversial buffer

00:51:02.340 | asset of reverse mortgages.

00:51:04.060 | I mean, I've got some neighbors who ran out of assets.

00:51:06.660 | And the family decided, OK, the way

00:51:08.140 | we're going to pay for your last day

00:51:09.420 | is because they really want to stay in their home

00:51:10.800 | is a reverse mortgage.

00:51:12.300 | Who should consider a reverse mortgage?

00:51:15.780 | So the idea here is this is the story for the intuition

00:51:18.940 | about why a buffer asset can work.

00:51:21.940 | It's another way to manage sequence risk.

00:51:24.260 | If you don't take a distribution from the portfolio,

00:51:27.540 | it allows your portfolio an easier chance to recover.

00:51:29.860 | So if you took 34 distributions from the portfolio,

00:51:32.020 | you end up at zero.

00:51:33.340 | If you skipped one, you still have close to $1 million left.

00:51:37.220 | If you skipped all three, and these are years after a big

00:51:39.380 | market downturn, you still have $2.25 million left.

00:51:42.780 | So the idea with a buffer asset is

00:51:45.140 | if it costs less than $2.25 million

00:51:47.740 | to cover three years of spending from loans from my buffer

00:51:51.340 | asset, I can pay off the loan and still have a net windfall.

00:51:56.340 | And that's where the story of reverse mortgage fits in.

00:52:00.220 | It's another way-- it creates liquidity for the home

00:52:02.460 | without selling it.

00:52:03.540 | And so just like if you spend from your IRA,

00:52:05.420 | that money's gone, well, this provides a way

00:52:07.780 | to spend from your home in a similar manner.

00:52:09.940 | That's how I like to frame it.

00:52:12.100 | Who should consider it?

00:52:13.980 | Someone who's not going to have the temptation

00:52:16.540 | to just spend it frivolously.

00:52:18.340 | But if you're going to incorporate it

00:52:19.900 | into a responsible retirement income plan,

00:52:22.460 | and there's a lot of ways it can be done,

00:52:24.620 | it could have a potential role in the plan.

00:52:27.620 | Well, I know lunch is waiting.

00:52:29.660 | So I don't dare carry this on any longer.

00:52:31.700 | There's a lot more interesting stuff about retirement income

00:52:34.460 | we can talk about.

00:52:35.360 | But I think we better stop there,

00:52:36.780 | because I'm hearing some stomachs growling out there.

00:52:39.580 | Just by way of information, lunch will be in the hallway.

00:52:43.140 | You can take it into the other room.

00:52:44.660 | There are lots of tables in there you can eat at.

00:52:46.780 | I'm guessing this entire group is not going to fit in there.

00:52:49.700 | So if a few of you need to come back to the tables in here,

00:52:52.140 | that's OK as well.

00:52:54.100 | But thank you, Wade, for your expertise

00:52:55.780 | and sharing your thoughts on retirement.

00:52:57.620 | [APPLAUSE]

00:53:00.980 | [SIDE CONVERSATION]

00:53:03.740 | [BLANK_AUDIO]

Bogleheads® Conference 2023 - Wade Pfau Discusses Retirement Income Planning with Jim Dahle

Chapters