Frontline Documentary: The Retirement Gamble

The other night, after I gave a presentation at the Howard County Library System on Managing Your 401(k), Frontline aired an excellent documentary entitled The Retirement Gamble. My friend Jim Summe forwarded the link to the documentary and I just now watched it online. As I watched I thought to myself I could have scheduled my presentation a bit later and just showed the documentary.

The documentary covers all the main points of why investors have had problems with their 401(k)s and why the country faces a retirement crisis. It covers market history since the late 1990s when investors were riding sky high making money hand over fist to getting slammed twice in the last decade - first by the dot.com bust and then the housing crisis. It explains very well the impact of fees on 401(k)s and how Wall Street has successfully hidden fees so that it is impossible to understand exactly what is being charged. It even explains the difference between a fiduciary and a broker and interviews a couple of top mutual fund executives which reminded me of kids caught raiding the cookie jar. Listening to the spokespeople  of the mutual fund industry explain fees underlines the fact that it is an industry severely lacking in morals.

An eye opening analysis by John Bogle showed that over a 50 year period a 2% difference (the industry take) between what the market makes and what the 401(k)  participant earns results in 2/3rds of the nest egg being sacrificed. Investment pros claim not to know this or say they believe the figure to be high but interestingly the documentary points out that they invest in low cost index funds - not the high priced funds they sell!

One criticism I would have of the documentary is that there are ways to invest that avoid high fees and weather the ups and downs of the market. Clearly a number of the people interviewed were not well diversified. Many admitted they didn't know what they were doing. What would really be useful is if Frontline profiled the Thrift Savings Plan and talked about asset allocation and avoiding emotional investing.

Rather than coming away thinking that Wall Street is to be totally avoided and that the 401(k) is a ripoff, investors could learn how to appropriately use the product.

I recommend that everyone watch the documentary and encourage others in their family as well.

Bengen's 4% Withdrawal Rule

Here is a nice summary article by Kelly Greene of The Wall Street Journal on William Bengen's 4% rule:  "Say Goodbye To the 4% Rule."

This well-known, widely bandied about rule is based on research analyzing 30-year periods going back prior to the Great Depression. Its key finding was that 4% was the withdrawal rate, adjusted for inflation, that would have ensured one's nest egg wasn't depleted. The study encompassed widely varying and challenging markets.

Just for the record, the number one fear of retirees is running out of money.  Typically they don't.  But many do have to adjust life style considerably below what was anticipated. 

More recently, of course, markets have experienced considerable volatility and two sharp downturns over a relatively short period.  Furthermore, individuals have had ever increasing responsibility for managing their retirement assets over this period as defined benefit plans go the way of the dinosaur. Careful management of the so-called nest egg is the order of the day.

Humans seek to simplify complex problems.  That's what we do.  Coming up with a single, one-size-fits-all withdrawal rate is a prime example.  Think about it--and you quickly come to realize that the withdrawal problem has a number of unknowns beyond the retiree's control; and coming up with a single simplistic rate is just, well, too simplistic.  There's inflation and market returns.  The big unknown, however, is how long the retiree will live.  Reflect on these unknowns, and you come away with an appreciation of the need to be careful in coming up with a single withdrawal rate number or even a simple process.  Flexibility is the order of the day.

Interpretation can also be a bit tricky.  In the article noted above, data from TRowe Price was cited for a retirement in the year 2000.  They concluded that using the 4% rule "...you would be left with only a 29% chance of making it through three decades..."  This was after the 3 years at the start of the decade. This interests me because this is a period analysts like to put forward to show that the 4% rule falls apart.

I don't have TRowe's data at hand, but I wanted to check it out myself.  I used data put out by BlackRock for a portfolio comprised of 65% stocks/35% bonds (TRowe used 55%stocks/45%bonds).  I used the 3% inflation assumed by TRowe (note:  forgoing the inflation adjustment in down markets can make a difference!).  I also assumed that the withdrawal was taken on 1/1 of each year; they assumed monthly withdrawals.

Here's my Table, extended through the end of 2012:

YEAR	65%stocks/35%Bonds	Withdrawal	Amount	Value
2000	0.989	4,000	96,000	94944
2001	0.952	4,120	90,824	86464
2002	0.902	4,244	82,221	74163
2003	1.235	4,371	69,792	86193
2004	1.105	4,502	81,691	90269
2005	1.054	4,637	85,632	90256
2006	1.13	4,776	85,480	96592
2007	1.06	4,919	91,673	97173
2008	0.772	5,067	92,106	71106
2009	1.208	5,219	65,887	79591
2010	1.13	5,376	74,216	83864
2011	1.018	5,537	78,327	79737
2012	1.122	5,703	74,033	83066

This period encompasses two sharp downturns.  In fact, the retiree is met with 3 down years at the start of retirement.  Later, the worst crisis since the 1930s hit.  And still, at the end of the period, the portfolio still retains greater than 80% of its value.  At this point, a 65-year-old retiree would be in his early 70s!

The bottom line for me is that you have to go in with a strategy.  Understand that markets go up and they go down.  Those who don't get this should stay on the sidelines.  Think about this.  This is what life is about.  You can have a great financial plan; but ,if you experience 2 serious illnesses within the next 5 years, any plan is stressed.  It's about handling the uncertainty appropriately which, admittedly, isn't easy.

The absolute worst thing is to get in, see the portfolio drop, and then abandon ship.  Many are on the sidelines today, having jumped ship in 2009 and wondering whether they should get back in.

Kitces on Spending and Retirement

For those who don't know, Michael Kitces is a rarity - the smart financial planner and an original thinker.  Most financial planners I know are really good at learning complex rules for all the various situations that come up in the financial arena but not so much at questioning the consensus view.

Here is a piece, "Retirement success is about spending, not saving," he recently wrote for MarketWatch in which he looks at the simple notion of  saving a given percentage of income starting at a young age and exploiting compounded returns to get a six-figure nest egg.  Many readily accept this as the simple key to building a sufficient nest egg.

Kitces finds two caveats with this.  First off, the simplistic analysis actually assumes the nest egg will double in the last 10 years (in the real world, sequence of returns is important whereas people like to simplify and just use averages).  Think about this:  if we assume we're compounding at 8%/year, then we are assuming that the fund doubles in the last 9 years (think rule of 72).  Over that 9-year period, the fund appreciates, for example, from $500,000 to $1.0 million.

It doesn't necessarily work out like this in the real world.  Not a good thing to realize on your 65th birthday!

Another problem is that saving a fixed amount may not keep up with lifestyle.  Consider an extreme example, where you make $40,000/year and then in the last 10 years you make $400,000/year.  Saving 10% of income/year will leave you woefully short of financincing the lifestyle you've enjoyed your last 10 years of work.  Kitces emphasizes it's not just about saving but is about spending as well.

The whole business of how much needs to be saved, and even how much can be safely spent in retirement, is tricky.  In fact, it amounts to a Rubik's cube.  We don't know how long we will live, how the markets will treat us, or what inflation will be.  Spin the cube and the results can change meaningfully.  Only the minority will come close to realizing their goals.  The rest of us will be forced to ramp down lifestyle or kick the bucket with much more left over than we would like.  We will either have to take less trips, and eat at Hardee's more, or end up so that we would have preferred more weeks at Sanibel and more creme brulees than we had.

Still, Kitces's observations point up, at least to me, the importance of ongoing financial planning.  At least twice/year plans should be revisited (even if just using TRowe's free online calculator or a similar calculator) to even have a shot at getting the process halfway right.

Recommended Holiday Gift - Latest Jeff Yeager Book

Source: Amazon

To me, experience counts for a lot.  You can have a PhD in family matters; but, if you haven't raised teenagers, you'll have a difficult time getting me to pay attention to your child-rearing theories.  For the same reason, I have a difficulty with investment advisors still wet behind the ears--I don't care how many designations they can put behind their name. But... that's the subject of another post.

A company I worked for, once upon a time, gave periodic presentations to people on the verge of retirement.  The financial planner guy would go over financial planning issues, I would talk about managing the nest egg and creating a paycheck in retirement, and finally the President of the company would pop up and answer questions.  This was the first half.

The second half would typically present a panel of retirees who had previously worked at the company.  They would tell stories on what retirement was like and hit upon their successes and what they would do differently if they had it to do all over.

Not surprisingly, the audience sat up a little straighter and blinked a few times to get refocused as the panel spoke.  This was them a few years down the road.  They were meeting their future selves.  By listening closely to the panel, the audience could very well get answers to questions they had been mulling over.  Broad questions like "can I retire early," "how do I know if I have enough to retire," "what will I do in retirement," etc.

My question to myself at the end was why this kind of thing isn't done more often.  I even thought about the "Scared Straight" program on TV where incorrigible teenagers on the path to becoming a menace to society are given a "tour" of Rahway State Penitentiary to get an insider view of prison life from the inmates.  What could be a better deterrent?

To me, experience counts for a lot.

 The Cheapskate Way

Jeff Yeager's latest book How To Retire The Cheapskate Way is filled with stories of people who are successfully going down a debt-free road, living within their means, and achieving a goal of what he calls "selfishly employed," i.e., employed doing what they want to do.  In fact, he is one!  This book is experience writ huge!

Most people who think about retirement concentrate on the income side.  I'll admit I am guilty of this.  I hammer away at investments and creating a large "nest egg."  I emphasize relating money needed to achieve an income based on what was needed in the pre-retirement years.  But retirement is different from pre-retirement - especially for people who pay attention to where their money goes.  And the financial expert guy (or gal) with "the big binder" isn't going to be a lot of help to people who truly understand their finances.  This is one of Yeager's main points!

In between the stories and Yeager's expressions that will get you to laugh out loud (not easy for authors to do, in my case), there is a serious challenge here for the financial planning profession.  He presents evidence questioning the widely-made assumptions on retirement spending needs.  In particular, if you are buying into the notion that you need millions to happily retire, Yeager will challenge your beliefs.

The focus in this book is on spending.  The stories show that many people have learned how to get along on much less than is conventionally presented.  It tells the story of people saving and creating income in unusual ways.  It tells of people thinking outside the box - one couple got their kids a dump truck load of dirt for Christmas.  The kids were thrilled!  And, you guessed it - the dirt was dumped at the low spot in the yard!

It gives some direction in dealing with the thorny issue of medical care for the early retiree.

Part way through, I was reminded of a presentation I attended put on by the local chapter of the American Association of Individual Investors.  A broker was going through a complicated explanation of what to do if a retiree's income wasn't sufficient when, all of a sudden, a hand shot up.  The audience member said that he would figure out his Social Security, his investment income, and his small pension and then do what he did his whole life--he would "live within his means."

This threw the presenter for a loop.  He clearly had not thought of the problem from this perspective. To him, if you had a shortfall, you automatically first considered taking on more investment risk.

Yeager loads his book with references to resources enabling the reader to follow the Cheapskate path. In case there is a question, Cheapskate doesn't imply that a person isn't generous.  Cheapskate Verna Oller replaced broken shoelaces with a zipper from an old jacket but in her death revealed a generosity that will surprise you.

Recommendation

I highly recommend this book for anyone on your holiday list past their midlife crisis.  For one thing, it is cheap.  For another, it will be available in January after all the holiday hooplah has died down and your giftees are looking for a good read to settle down in front of the fire with.  After they read it, they will thank you and hopefully lend it to you.

New Research on Drawing Income in Retirement

Nothing is ever as simple as it first seems.  The latest entry in this category questions basic conventional wisdom (CW) of drawing down taxable accounts, then qualified accounts (IRAs, 401(k)s, etc.), and finally Roths.

The study by Coopersmith, Sumutka, Arvensen of Rider University entitled "Optimal Tax-efficient Planning of Withdrawals from Retirement Accounts" shows that CW is not always correct.  In the critical period leading up to the RMDs at age 70 and 1/2, it may pay to draw funds from IRAs, etc.  Avoiding RMDs that throw a retiree into a higher tax bracket can have an important impact.

An overview of the study is presented by Susan B. Garland of Kiplinger in "A New Rule of Thumb for Tapping Savings."

A Retirement Calculator for Retirees

If you've looked online for a retirement calculator, you know that most online retirement calculators don't work well for retirees.  If you input a current age greater than desired retirement age, for most you get an error message.  This isn't true for the T. Rowe Price calculator. Thus, this calculator is useful for retirees and, if you are younger, is a perfect tool to get the sometimes awkward conversation rolling to check on your retired parents - "hey dad, did you know there is this neat online, free, calculator that will...."

This calculator only takes a short time but gives you an idea on whether you are on the right track in retirement.  That is, it answers the most worrisome question on the minds of many retirees - whether they are likely to run out of money.

Before beginning, read the T. Rowe Price disclosure.  The calculator provides estimates of future actions under uncertain conditions.  As such, it should be viewed as a guide.  Their disclosure is at the bottom of the first page at the link below.

To begin, go to T. Rowe Calculator and click the orange "Start" button to get :

Source: T. Rowe Price

CLICK IMAGE TO ENLARGE   Fill in as indicated (Harvey, if you're reading this, you're supposed to fill in the date you were born not the date I filled in!).  Notice that it asks explicitly if you are "Living in Retirement." Other calculators tend not to have this feature!



Click orange "Next" button:

Source: T. Rowe Price

CLICK IMAGE TO ENLARGE   Here you only have to fill in two amounts.  Note that there is a worksheet that will refine the analysis.  On the worksheet, you break out the amounts you have in qualified accounts from the taxable accounts.  This is a big distinction!  When you withdraw from the qualified accounts, such as an IRA, you have to pay taxes (federal and, in most states, state tax).  You also have RMDs from your qualified accounts (except for Roths) in your 70s.

Click "Next" to go to the "Asset Allocation."

Source: T. Rowe Price

Asset allocation is just about the percentage you have invested in stocks, bonds, and fixed income.  Two important points:  investment performance depends greatly on asset allocation, and most individuals should increase their exposure to bonds as they get older to reduce the volatility of their performance.

As you can see, there are two choices.  The first lets you pick your allocation by using the sliders, and the second automatically changes your allocation as you age.

Click "Next Living in Retirement."

Source: T. Rowe Price

Note that you have worksheets here.  Check them out.  If you are receiving a pension, work part-time, or own real estate etc., you'll want to put that in a worksheet.





If you need to check how much you'll be getting from Social Security, read this Post:  "The First Thing You Need to Know About Retirement."

Click "Next Your Results."  You'll see that the model runs a number of simulations.  It will show how much you want to spend and how much it believes you can spend and have a 90% chance of not running out of money before the age of 95.  You'll also see that there are a number of inputs you can change to see the impact on your results.

If you have never done this type of exercise, it can definitely be eye-opening.  There are a few things, though, to know about this exercise in general.  For example, you should redo it regularly - at least every 2 years.  Also, there are a lot of unknowns including life expectancy, market performance, and general life events.  This observation tends to escape a lot of people, including financial planners.  They tend to think there is some magic number that, once reached, retirement is a done deal.  Instead, as mentioned above, revisit your situation on an ongoing basis (and especially when there are major events in your life).

Do this and you will get a lot of value out of this exercise.

Telephone Consult

Last night I did a phone consultation with a couple from Oregon--a beautiful part of the country I once drove through with my son on one of our cross-country camping trips.  We motored down the coast to see the Redwoods of California.  An awesome experience I recommend to one and all.

My first clients in Oregon (Yeah!), Fred and Wilma (made-up names to protect the innocent), had done their homework and were knowledgeable about investments.  They had a really good understanding of their income sources and living expenses.  Fred is a retired contractor and receiving Social Security.  Wilma will retire at year's end, is an accountant, and is 58 years old.  Fred is a Navy veteran and receives medical care there. Health insurance for Wilma will be a challenge since she is 58 and has a ways to go to get to Medicare. She assured me they are up to the challenge because she and Fred have been self-employed for years and obtain their health insurance through the business.

Once Wilma retires (1/2013), they will need to draw down approximately 3.7% of their investment assets.  After 4 years, Wilma's Social Security kicks in.  Then they will require a lot less from their investments, and they will easily be able to live the lifestyle they desire.  In fact, they may want to ramp up their spending, then, if they so desire.

Fred was familiar with the T. Rowe Retirement Calculator and agreed with me that he should revisit it at least yearly.  Spending only a few minutes putting in the inputs quickly reveals, by generating a Monte Carlo analysis, whether you are on the right path.  This is a tool everyone approaching retirement should be familiar with.

On the investment front, they had read Solin's excellent book, The Smartest Investment Book You'll Ever Read, and had selected a portfolio conforming to their risk tolerance.  The portfolio is comprised of well-diversified funds with 60% in fixed income and 40% in stocks.

Their broker is TD Ameritrade, and I suggested they consider commission-free ETFs offered by TD Ameritrade and utilize the low-cost, index funds.  In fact, I looked them up and recommended specific funds to match the asset classes of their portfolio.  For example, their portfolio required 8% U.S. Small Cap and I recommended VB, a Vanguard ETF with an expense ratio of 0.16%.

Fred and Wilma are members of AARP, so I suggested they send in the postcard in the monthly magazine that provides a quote on a single premium, immediate pay annuity with New York Life.  My guess is that the annuity would pay Fred about 5.8%.  Thus, if he put $100,000 into it, he would get $483/month as long as he lives.  If he dies before he is paid out $100,000, his beneficiary (most likely Wilma) will get the balance.  Think of it like Social Security (except it isn't adjusted for inflation!) or a pension.  The idea is to reduce market risk.

We talked about location of investments - put stocks in the taxable accounts and bonds in the IRAs to the extent possible.  We talked about drawing down the taxable accounts first to let the IRAs (qualified accounts) grow tax free as long as possible.

In addition to their stocks and bonds, Fred and Wilma have a couple of real estate properties where they have long time tenants who are interested in buying the properties.  This gives them diversification and a wild card in the event funds are needed.

On the planning side, a couple of issues came up that couples need to think about because they have the capacity to upset the apple cart.  One I suggested they look into is umbrella insurance.  The fact that we live in a litigious society means there is always a risk we could get sued for everything we own. Umbrella insurance is a protection against this and is relatively inexpensive.  I suggested they talk to the provider of their automobile insurance and get a quote.

A second risk is long-term care.  And it is expensive.  I suggested they look into the type of policy that covers 3 years jointly . In other words if Fred used 2 years ( for example, if he got Alzheimers), then Wilma  would still have a year.

There are a lot of Fred and Wilmas out there who have worked hard, lived within their means, accumulated a nest egg, and who have given considerable thought to their financial situation in retirement.  When you think about it, planning for 25 years or longer where you don't have a work-related paycheck coming in can be daunting.

Contrary to the impression you might get from the popular press, however, many couples have thought it through and, as a result, are looking forward to an enjoyable retirement. 

Meet Your Future Self

Here is a fascinating TED Talk by Daniel Goldstein on software that ages people and the battle between present self and future self.  Seeing one's future self lessens the abstractness of saving for retirement.

Red Zone Retirement Questions

Football fans are familiar with the red zone.  Basically, that's the area within 20 yards of the opponents goal line - basically the  area where the Washington Redskins have a habit of sputtering. The same concept is used in financial planning.  It is generally the 5 years before retirement.  This is when the big cross over from full-time job status to a different life style should be given serious thought.  The questions that need to addressed and talked out with your spouse are set out in a recent article by Mark P. Cussen, "8 Toughest Retirement Decisions":

1. when to retire
2. when to start social security
3. where to live
4. whether to continue working in some capacity
5. whether to sell the house
6. when to begin taking retirement distributions
7. how to manage the investment portfolio
8. how to budget.

These are not easy questions; but thinking about them ahead of time can be the difference between scoring a touchdown, a field goal, or coming away empty-handed.

DIY Investing Wrap-Up

The last four posts have outlined the 3 steps to DIY investing:

• Pick an asset allocation model - This can be done inside or outside the brokerage firm you use ( assuming they offer it). The advantage of using the brokerage firm model is that everything is in one place.
• Choose investments - I prefer low-cost index funds but also allow for some individual stock investing. Either way, it is crucial to have a handle on how well diversified the portfolio is and how the investments fit in the overall allocation.
• Monitor the portfolio - Keep track of the allocation over time. This will enable you to rebalance when appropriate. The rule you use is up to you. At the outside, I rebalance automatically when the targeted allocation to an asset class is 5% away from target.  Monitoring the portfolio also involves tracking performance relative to a well-defined benchmark.

With this basic framework setup, anyone can  manage their own investments without having to make a major time commitment. A huge amount in fees will be saved over the long run which will accrue to the bottom line, compound, and leave  a much bigger nest egg.  Also, you will get a good feel of the overall investment process. Forget scratching your head and wondering why the heck your advisor is holding on to Fannie Mae or what the CTA fund is he or she has invested you  in. Forget wondering why your advisor isn't returning your calls.

How will you do performance wise? Well, no one can guarantee future results; but numerous studies have demonstrated that an approach that minimizes costs and is well diversified has outperformed approximately 80% of active professional managers over the long term, after accounting for all costs. Furthermore, the evidence shows that it is impossible to select the active managers ahead of time that will "beat the market."

There is, of course, more to the financial picture than managing investments. For the additional information, most individuals should consult with a financial planner. A good plan will run about $2,500 and will look at your insurance needs, financing college, estate planning, and even investments. It will go over location of investments, what you need to know to roll over accounts, and things like titling inherited accounts. Once a bit of complication enters your financial life, a plan is worth getting.

For many people, the best route is to pay for the plan and save on the investment management side. A couple of good books for those who like to read up on retirement planning (not a bad idea before meeting with a planner):

It's Not Just the Rate of Drawdown

One of the stickiest problems in personal finance is determining a safe rate of nest egg draw-down in retirement. Original studies by William Bengen  showed that 4% of the starting portfolio value, adjusted for inflation, worked in many market scenarios for a given asset allocation. This rule-of-thumb has been bandied about and debated ever since. The thing is that, because of the nature of market,s we can never be sure. By definition, we are dealing with averages and probabilities and talking about what worked in the past. The future of course is unknown. What if we (gasp!) run into a 20-year period of down markets?

This subject is presented at "Free Money Finance" and centers on a recent piece in the New York Times. The Times notes that, if you retire near a market peak, then, when the market drops, your probability of success declines as well if you continue to withdraw the same dollar amount.

As a counter, the Times suggests flexibility by allowing the withdrawal rate to vary between 2.5% and 5% depending on market experience. This, of course, borders on the ridiculous as "Free Money Finance" points out. If you can vary your income between $20,000 and $40,000, say, then you're home free. "Free Money Finance" points out more viable solutions.

My quibble with all of this is that the studies tend to be simplistic. They assume stock funds are systematically reduced in down markets as retirees get their income by selling stock and bond funds. But the subject has progressed. Most people today, especially the researchers, know that retirees need a plan in withdrawing assets. Some people say put the assets in buckets with the first 5 years in short-term funds. My approach is to put about 1 year short-term and structure the portfolio to throw off dividends and interest of at least 60% of income needs (2.4% yield) to replenish short-term fund.

Whatever the approach, enhancing the sophistication of the withdrawal strategy greatly enhances the probability of success, i.e. the probability of not outliving your money. In fact, it worked well in actual practice over the nasty downturns of the last decade. The studies need to take this into account.

It's time that studies explicitly incorporate this into their analysis.

Why Build a Nest Egg?

Source: Hammacher

Adrian at 7Million7Years has an interesting post on "The Fisherman's Fallacy."  It raises questions of what retirement is, why we save for retirement, and how our views change. I know young people who really don't see the point of struggling to build a nest egg. They're happy with a few good video games and the time to play them.

In the  fisherman's fallacy, the Wall Street banker approaches the man who fishes a few hours and spends the rest of of his time playing cards with friends and family. The banker explains to the man that, with a few years of  hard work, he could build a nice business that would enable him to retire and fish and spend the rest of the day with his friends - in other words doing what he's doing now.

Why would he even consider working hard to get to do what he is already doing? Read Adrian's post to find out.