Episode 289 - Retiring Retirement Income Myths with the Retirement Income Dream Team

25:08That's where people lose the most money. Now, consequently, we also spent a lot of time doing research on investor behavior in retirement plans. And what we see is that target date fund investors who tend to be the least financially sophisticated investors, they lower income, less education, they actually outperform everybody else because they're not doing anything. So in some cases, being blissfully ignorant is actually in your best interest as an individual investor because you're not tempted to make these changes that result in lower performance over time. I think a really important point about this notion of time-barying risk aversion is who exhibits it the most.

25:47I think that if I were to ask you, hey, who do you think is out there actively trading when the markets go, you're wrong. You would say, oh, it's probably younger people because they haven't done this before. They haven't been through ups and downs. That is unequivocally false. Our research shows that it's older investors, participants, et cetera, that exhibit this effect. And we don't know why, but if I had to guess, what is it that drives this variation in risk tolerance and trading activity. It's like the salience of retirement. I mean, I think retirement is like a mirage when you're 35 years old.

26:19It's going to happen at some point in the future, no big deal. But I think as individuals kind of move to the retirement, they're increasingly concerned about, oh my God, if my portfolio goes down by 20%, I can no longer go on vacation. So I've got to sell to kind of lock this in. And so I think that's a really important point about this. So people like Dave Ramsey say, hey, oh, stocks go up more than bonds. You should be heavily invested. He's somehow assuming that investors that have all this wealth will stay invested. I just question that assumption a lot for older individuals, for those who are retired and don't want to go back to work.

26:49So I think that this idea that people can stay in for the long term, it doesn't jive with reality, especially among retirees, older investors that don't want to go back and work and are more kind of subject to market numbers. So David, do you think it's the percentage on that amount or is it the dollar value? Like a bigger portfolio, 20 % is a much bigger absolute number. Is that what's really driving it, do you think? I just think it's just age. I think it's just the implications on lifestyle because the problem with the balance is a half a million dollars could mean a lot more to me than your$5 ,000 balance based upon our lifestyles, our goals, our preferences, our guaranteed lifetime income amounts, all these different things.

27:29I mean, again, totally could be wrong. I think what happens with this age factor is it just becomes very real. People who are 25 don't spend a lot of time thinking about how much they're going to have when they retire. What are the implications of a drop? Anyone that's a few years away, like my in-laws, every day they're checking their balance. And one day they called me up, there was a dividend in post on a call fidelity. So they're actively concerned. They're hyper-focused. And that hyper-focus, I think, actually hurts them versus, as Michael said, folks that buy targeted funds that aren't as sophisticated because they just don't worry.

28:01So you're saying older investors just by age, that's the variable we're looking at, their subjective risk tolerance becomes more sensitive to market fluctuations. And the more equities they have, the more sensitive they become. And that's really the big risk of encouraging older investors to take excessive investment risk is that they may not capture the benefit from taking all that risk. So in other words, they may get all the volatility and none of that bonus that you expect to get above bond returns for accepting investment risk, because the more risk you take, the more sensitive you tend to get.

28:36And this counters a little bit. There was a whole line of research maybe 10 or 15 years ago that talked about the portfolio size effect, which was saying that like target date funds got it all wrong. They had higher stock allocations when you were younger and didn't really save much yet. So there was really nothing at stake. If the market doubled, you maybe gain a couple thousand dollars because you haven't saved much. But then by the time you get to your target date, That's where you have 30 years worth of savings given market upturn or downturn can have a much bigger impact. But that argument was, this is your only opportunity to actually benefit from market growth.

29:13And so you should have the higher stock allocation near retirement. And yeah, that's more quantitatively trying to look at what might work best. But you do got to consider the real world implications of people's comfort and ability to stay the course, not panic. and whether that market volatility, and as the research that Michael and David have done notes, that does become harder to do with age. Okay. So you guys are like the perfect people to ask this question to. There's a paper going around right now, you may have seen it, that shows in a sort of quasi-empirical setting using bootstrap sampling of a big historical data set that being 100 % in equities with a big chunk of international equities, so big domestic international split 50-50, dominates any other asset allocation, target date, any of the stocks minus age type things, anything, anything that has bonds in it basically gets dominated by this all stock portfolio.

30:08What do you guys think about that? Well, I've seen the paper. I have the data, but I'm not a robot and people aren't robots. And it's just not realistic, right? Like no person that works with real humans would suggest that. I mean, it's also, I know the paper you're talking about. And Michael and I have been doing research on investors for longer time horizons. I just don't believe it. We don't know what's going to happen over longer time horizons. I like the fact that they took like 10 years of bootstrap data because they capture the time diversification effects over time. So it's a better way to think about it versus pure IED returns.

30:41But it's not clear how much all that's going to persist in the future. We don't know what's going to happen. There are these growing dependencies across global economies historically. so I would never recommend that for a retiree investor. I want to talk about this because I think it's a good way to revisit investment theory again, which is something that I love. First of all, a 100 % equity portfolio is never going to be the Sharpe ratio maximizing portfolio. In other words, the amount of extra return that you're getting for a given level of risk is never going to be maximized by 100 % equity portfolio.

31:18And even using the historical data, which probably overestimate the amount of equity returns that we're going to be able to get in the future. The right way to do it is to select the sharp ratio maximizing portfolio. And if we want to take a little bit of extra risk, then we can maybe leverage it. But if you incorporate these leverage constraints, then you can say, well, maybe 100 % equities is the right approach. There's a lot of reasons why equities historically might have outperformed. If we think about how difficult it was for people to invest in equities, the transaction costs, you had to trade.

31:56It would cost you$70 to make a trade back in the early 1970s. You could not put together a well-diversified portfolio at a low cost. You had very high capital gains tax rates in the United States. It was just far more difficult to even capture the equity risk premium historically. And it's one of the reasons why you would have expected it to be higher to induce investors to buy stock in the first place. Today, we've gone from like one out of every seven people owning stock to one out of every two. People do it automatically in their retirement savings account. Then the question becomes like, how much of a reward do you really need to give people today to get them to invest in stock as opposed to investing in bonds?

32:38That's going to determine then whether or not going forward that allocation of 100 % equities is the right strategy. Because if that equity risk premium is really only, say, 200 or 300 basis points, then there's going to be a lot more risk, a lot more variation in future lifestyle outcomes than has existed historically. So essentially, it all is based on this premise that there is a stock premium puzzle. So an equity premium puzzle, which has existed historically, there's just no way to justify it in any sort of rational model. And if that's going to persist in the future, then something that has no basis in efficient markets has to continue in the future.

33:24And I'm just not willing to place my bets on that. A lot of economists, I just don't think that you can get something for nothing. And essentially what they're saying is you can get an equity risk premium with very minimal downside historically. I saw the abstract of that paper. And I feel like these kinds of papers come out every few years. I haven't read this particular one to know if it's got some secret sauce that did something different. But I remember a few years ago was you should actually leverage your portfolio and be 200 or 300 percent stocks. or every couple of years, someone writes in the New York Times how retirees should be 100 % stocks because of the risk premium.

34:01And yeah, if you assume a high enough risk premium, you can get to 100 % stocks giving you the highest safe withdrawal rate. In that international study that I did with the 20 different countries, I think there were five countries that the worst case scenario was the best with 100 % stocks. Again, it's can people actually pull that off and feel comfortable with that? Or is it, as Michael's alluding to as well, can you really rely on that sort of risk premium environment as a surety for the future? I agree that the peer quantitative research usually does point to higher stock allocations. I don't know about 100 % stocks.

34:36I'd have to see exactly what they were assuming. But in practical terms, it doesn't get you very far to just tell retirees they should be 100 % stocks because mathematically it will support the highest withdrawal rates. The important nuance here, right, is if you assume returns are independent, it doesn't usually work 100%. But when you incorporate the zero dependence over time, like in the piece that you're referring to, that's where you tend to see this benefit. And I think others have very different perspectives on how that will persist in the future. And I think it will. I think there are some important diversified effects of equities versus bonds over longer time horizons.

35:07But even like the remote suggestion that 100 people should be under the equities just doesn't pass even like the most basic SNF test, in my opinion. That was good. Good comments all around. What do you guys think about Dave Ramsey's suggestion that the 4 % rule is just too depressing? I actually agree. I think that a lot of the assumptions that we use on our models are overly conservative. I think that success rates are not a great way to quantify outcomes. They ignore the fact that the portfolio is only a marginal part of someone's total assets. If you think about what Dave Ramsey is talking about, it's actually more of an endowment approach versus an initial withdrawal increased by inflation.

35:42So I think that 5 % is a more realistic a certain place than say 4 % for most Americans. When you capture the total economic balance sheet, when we quantify outcomes, when we make changes over time, I'm even okay with 6 % for a lot of people. That's out of bounds. I think that 8%, though, is just a step too far. So I agree that a lot of the key assumptions in the 4 % rule are way too conservative. But again, it depends upon your situation, your preferences, all that. Yeah. The 4 % rule was just a set of simplified assumptions to point out sequence of returns risk exists. I never really thought about it as being depressing.

36:16I guess anytime you have to tighten your belt or pay down debt or anything of that nature, that can be a little bit depressing. And yeah, I agree with David too, that one of the primary assumptions of the 4 % rule that you always increase your spending for inflation every year. If you can relax that assumption and build in some dynamism, that helps manage sequence risk. And so that can allow for higher initial spending rates. And there's other, well, David's retirement spending smile, the idea that people don't really need their spending to grow with inflation. You can definitely get yourself set at a higher sustainable spending rate than 4%.

36:50But I think it's still just a reasonable baseline. You need some set of assumptions so you can make comparisons about what's somewhat realistic versus not at all realistic. And in that regard, I think it plays its role. It was never meant to be an actual retirement strategy. It's more a research simplification. And sometimes people take it too far. And then I even see sometimes all these advisors think the 4 % rule is what you're supposed to use that I've found this secret trick that no, you use a variable spending strategy. Yeah. It's, we all understand that. It's just a research simplification, a starting point, maybe depressing, but I never had really thought about it that way.

37:27Yeah. Let's talk about some of the issues with the 4 % rule. So the 4 % rule assumes that you're going to spend the exact same amount of money adjusted for inflation every single year, no matter what happens in the market. And of course, any human being, if they got a bad sequence of returns, if they saw their money that's starting to dwindle a little bit, they're going to cut back on spending. That's just what we do. And in fact, we probably, most of us have space in a retirement budget to cut back a little bit. And that gives us the ability to start at a higher level and then adjust based on how well our investments are doing.

38:03But it also highlights one of the major inefficiencies of the 4 % rule. And that is that there is a huge amount of unintended bequests for people who didn't adjust upward. What does that mean? So if you get lucky and you started out with a million dollars, all of a sudden the market does well, you're at age 75, 80, you've got$2 million, am I going to continue to spend the exact same amount of money when I know that if I would have just simply retired today and someone was using the 4 % rule, they would have increased my spending up to a higher amount. So we have to give people the ability to spend more if that's their goal from that money.

38:45And that's why I think you have to be very clear about what your legacy goal is and what your income goal is. And once you do that, then you have to give people, first of all, the flexibility to decrease they're spending if the markets don't do well. But also, I think it's something that we just don't talk enough about. And that is that it is in some ways a fiduciary violation not to encourage your client to spend more if that's the goal of that money. So if you set the money aside, the market does well, they've got plenty, they're going to be just fine. You need to give them the license to be able to spend the money that they've saved.

39:25Because oftentimes with an advisor, they have an incentive not to basically to scare you so that you don't spend that money. But a lot of people could live better if they were going on more cruises, or if they were even giving gifts to relatives, they could live better instead of simply dying with more money. That really represents just a lot of joy that was unspent. Okay. So you guys all talked about various types of dynamic spending or variable spending. David, you mentioned potentially even a 6 % initial withdrawal rate if you're willing to take some variability. Can you talk about some of the alternative approaches to spending from portfolio of risky assets?

40:00So the 4 % rules, constant inflation adjusted withdrawals, what else could people be doing? Lots of ways to do it. I mean, you can rerun a financial plan. There's modified RMDs, there's guardrails. I mean, I don't know that there's one way that's better. I think that you could run analysis and based upon your assumptions and everything else. And one thing that I fully acknowledge is that there's a mass amount of estimation error in any kind of financial plan. We don't know where someone's going to be next year, the following five years, the following 10 years. But I think what's important is that if you run a financial plan and you use static assumptions, you're not replicating what they're going to do in real life.

40:34And so I don't get too caught up on how someone should do it. I just think it's increasingly important that as we're doing these plans for people, like using financial planning software, we somehow capture this because the retirement isn't static, it's dynamic. And what happens is this frees up money you could have spent earlier in retirement. When you acknowledge the capacity to make these changes, I think it would make people more comfortable going on those vacations and doing more when they're young. Yeah. And like David said, probably the most realistic kind of approach is people just, they spend what they need to spend or what they want to spend.

41:08And maybe if ideally they're going to do a periodic check-in, see if what they're spending is sustainable. And if it's not, if maybe that's realized as if the probability of success on the financial plan starts to dip too low, maybe they'll make some cuts at that point. Now, when it comes to doing research about variable spending strategies, you can't test that sort of ad hoc approach. So then there are clearly delineated variable spending strategies to look at. I've looked at a number of those and two of the ones that I have a somewhat more favorable look upon is Bill Bengen developed one of them.

41:41He called it the floor and ceiling rule. It's just you use a fixed percentage of what's left. The 4 % rule is really about the first year of retirement. You spend 4 % of the balance and then you increase that amount for inflation every year. A fixed percentage rule is you spend a fixed percentage of what's left every year. And so your spending is going to fluctuate, but then you have a dollar floor and a dollar ceiling that will adjust for inflation. And you don't let the spending go outside of those bounds So that's a way to build in some variability that can allow for a higher initial withdrawal rate that then ultimately the floor with that strategy may not be all that much less than you get with the constant inflation adjusted spending of a 4 % style rule.

42:21The other one I like too, and it's more for discretionary expenses, if you have a floor of income already, is some sort of modified RMD rule. And that's in the US required, well, it's basically an actuarial rule. as you age, your time horizon gets shorter. So you can spend an increasing percentage of what's left in the portfolio. And then because your portfolio is fluctuating in value, it will lead to variable spending, but it's a way to spend down the assets more efficiently. And you can use that money for discretionary types goals, or maybe even as a part of the legacy, but rather than waiting to the end of retirement, a way to share that while you're still alive and can see the benefit of those gifts and so forth.

43:00In general, how much do you think a dynamic spending strategy can improve that initial withdrawal rate? Do you have any rough sense of you met some and what you'd say how much improvement it could be? 25 % or more, I would say. I mean, again, I think what's really important is thinking about the role of dynamic withdrawals. There's at a minimum two important toggles that exist. One is how much guaranteed income does someone have? So earlier I'd said like 6 % makes sense. Well, you're getting like$100 ,000 a year from social security, whatever it is, and your 401k is$100 ,000, they got 6%. Like who cares?

43:35I mean, that's like$6 ,000. You get$100 ,000 from social security, you're going to be fine. But if for some reason you have no guaranteed income and your entire portfolio is going to fund your retirement, well, that changes things, right? And there's this question, well, like how flexible are you? Like you have all of your essential expenditures covered from existing guaranteed income. You can go crazy. If you don't have anything covered, it's going to really reduce your ability to make a change. But if you use better, more realistic models, at least what I've found is that that's why I say 5 % is like the new 4%, because incorporating just dynamic rules moves you from four to five.

44:07If you overlay how retirees don't increase their funding in retirement or spending by inflation, it can go to 6%. So I think at a minimum, it's 20, 25%, but it can be a lot more than that using other more realistic assumptions. If you increase that initial withdrawal rate at the beginning of retirement, I think it's also important to remember that it's going to affect the average slope of your lifestyle over time. So if you start out with a higher income goal and then you adjust from that higher income goal, the median is going to have a lower slope than if you started out at say 4%, you're going to be able at the median to generate a higher slope over time.

44:46But a lot of this has to do with how do you want to live? And my perspective, I want to be able to spend more money when I'm physically and cognitively able to actually enjoy it. I mean, if you think about the average retirement period for, say, a healthy 65-year-old woman, she gets 25 years on average. She may get more, she may get less. But on average, if you think about it as like two rows of 10 dots and one row of five dots. She has a certain amount of savings and she's got to fill each one of those dots with her savings. And how do you do it in a way that's going to make you the happiest?

45:25I'm going to maybe put more of my chips on some of those early years. And that is one of the reasons why I might want a higher initial withdrawal rate. But I have to recognize that I'm depleting my portfolio faster. If I get unlucky, that's going to lead to some worst case scenarios where I might have to cut back significantly later on. And also recognizing too, being related to that idea of front-loading your spending. For a lot of people, their spending doesn't keep up with inflation other than possibly uncertain health expenses. David has the retirement spending smile concept and looking at what he created with data.

45:59I tested, well, how much could your initial withdrawal rate change if you simply applied the spending smile, which is your spending doesn't keep up with inflation. It dips. in the scenario I looked at, David, it was about a 26 % real drop by age mid 80 somewhere, and then starts creeping up due to late in life healthcare expenses. But applying that pattern compared to inflation adjusted spending, you could increase the initial distribution rate by 17%. And that was still without any sort of variability based on market conditions. It was simply the variability in spending of a fixed pattern that you incorporated.

46:36So if you then added on a variable spending strategy on top of that as well, yeah, you could easily get to a much higher number. It's already a fairly conservative assumption to assume when you're 95 years old, you want to spend the same inflation adjusted amount as you did when you were 65 years old. So we talked about how much of a potential boost you can get in the first year withdrawal, how much variability year to year do people have to deal with if they're implementing this kind strategy? There's the modeling assumption, then there's like real life. So what you'll find if you model these, we're going to use the fun, fancy words stochastically, like there can be lots of variability in these over time.

47:13I think that that's just to provide directional context of where you could be heading. Like endowments do 20 quarter averages. And so I think that you can imply smoothing effects on spinning evolution. It just depends on what you're willing to do. Like one thing I just always get back to is just all the things that life throws was at you, you cannot capture in a financial plan. So I think that it's our job to do a good job and to kind of try to reflect how things evolve on average. But I think that we've got to be realistic and say, hey, like over the next 30 years, no one knows what's going to happen.

47:44So let's keep it reasonable, but not worry too much about kind of all these nuanced details about, like one thing I say is why are returns the only random variable in our projection? You could have life expectancy. I think that retirement age should be a random variable because most people retire early and that can devastate a financial plan. So, I mean, I get why, like, I think one random variable hurts most people's minds. If you had like three or four, they would just lose it and people's heads would start exploding. But there's a lot more that can happen in life than just a bad market that would devastate your retirement plan.

48:14And also the variability in spending would be less than the variability in the portfolio distribution. Because when you look at the overall spending, you probably have social security or other types of pension income that are not fluctuating with the market. So to the extent that covers a portion of spending, it reduces the variability of overall spending. And then with taxes, if you're having to cut your spending, that may also be partly offset by lower taxes as well. And so on an after-tax basis, you will see fluctuations in spending, but it may not be as dramatic as what we were talking about with what could potentially be the drop in the portfolio distribution.

48:52I'll just mention quickly that the more rigid your withdrawal strategy, the higher likelihood that you're going to run out. So a guardrail strategy, which says that you can only adjust down a certain percentage, that's going to result in, for the very unlucky retirees, a certain percent are actually going to run out because they can't adjust enough. They should have adjusted downward more. So anytime you adjust the adjustments, because you're never going to run out of money if you have a high enough adjustment, then essentially you can every year adjust your expected longevity and whatever the value of your portfolio is.

49:31As you become more rigid, as you limit the amount of adjustment, that exposes you to that risk of potential failure over time. So really what you're doing is you're widening the range of potential lifestyle outcomes by allowing a higher adjustment every year, but you're also protecting yourself against the possibility of completely running out of money. So you're saying you need to be careful how you adjust the adjustments to your adjustment? That's right. It's so, yeah. Speaking of adjustments, so we've been talking stocks and bonds. When should people be looking at other products like annuities?

50:04Yeah, it's always a consideration for retirees. I kind of look at it with, there's three basic ways you could fund a retirement spending goal over an unknown time horizon, you start with bonds. You could like build a bond ladder. If you think I want to plan for 30 years, I build a 30-year bond ladder. And then generally there's two possible ways to spend more than that. One is the investment diversified portfolio. Don't just use bonds, but have a healthy allocation of stocks. Rely on market growth to support a higher level of spending than you could with bonds. And that's mostly what we've been talking about thus far.

50:35The other approach is use longevity pooling through insurance, which can then support a higher level of spending than bonds, since those who end up not living as long will have less expensive retirements. But some of their annuity premiums then help to subsidize the payments to those who did live longer and therefore have more expensive retirements. And that raises a standard of living of everyone in the risk pool, where you can consistently spend more throughout retirement than you could with bonds alone. And so now you have an option. What are you more comfortable with? Are you comfortable relying on the market and the risk premium through the market to support a higher level of spending?

51:11Or would you prefer the protections and safety of annuities and risk pooling to support a higher level of spending than bonds? And it's really at that point up to individuals and their preferences to decide on the direction they're most comfortable with, especially when it comes to funding basic expenses in retirement, not necessarily the overall retirement spending goal, but a floor of income that they really want to feel comfortable. It'll be there. It's reliable. And it's there on a lifetime basis. That's where a conversation around annuities to fill in any sort of gaps can be more meaningful.

51:44This all feels very subjective. Is there any frameworks that exist that can help advisors figure out ways to allocate to annuities? I'm just, I'm confused here. Do you have any thoughts at all? Yeah, yeah. Well, in that regard, a big question is who prefers a different type of framework? And so Alex Murgee and I did a research study to develop this idea of the retirement income style awareness. And we found two primary factors that helped to explain how people think about these things. This is all based on statistical work, but it was what I was just describing, what we call probability-based versus safety-first.

52:17If you're more probability-based, you're more comfortable relying on market growth to fund your retirement. If you're more safety-first, you're looking more for contractual protections to cover your core expenses in retirement. The other factor is optionality versus commitment. If you're optionally-oriented, you really value flexibility above all else. If you're commitment-oriented, you actually find satisfaction. And if I can figure out a solution that will solve my lifetime need, I'd like to get that taken care of and not worry about it, take it off my to-do list. And so the investment-based approach, the 4 % rule, the conversation about it being 100 % stocks, that's the world of total return.

52:55It's probability-based and optionality-oriented. But if you're safety first and commitment oriented, we call that income protection. And that's much more the world of being comfortable committing to risk pooling and annuities and lifetime income protections to support basic expenses in retirement. And then that creates the comfort to invest more aggressively with the other assets because they're more for the discretionary types of goals in retirement. There's a different way of thinking about this. If you follow, say, a 4 % rule, a fixed withdrawal rate rule, and you have a traditional retirement portfolio that's maybe 60 % bonds and 40 % stocks, and you're going to invest your bonds in a bond mutual fund, the amount of income that you can draw from that bond, let's say you have$200 ,000, and you're going to withdraw$8 ,000 every year from that bond portfolio, but you're still going to have a certain amount of risk every year.

53:50interest rates could go up and down. It's more efficient to take that bond portfolio and instead do an LDI kind of approach where you're essentially getting rid of all the downside risk of holding a bond portfolio to fund that same amount of expenses. And if you're going to do an LDI approach, the problem is that you don't know how long you're going to live. So maybe you do an LDI to the age of 100, because if you're a 65-year-old healthy woman, you've got a 10 % chance of living to the age of 100 and you're willing to accept a 10 % failure rate. Well, if you buy an annuity, then you're buying an LDI portfolio to the average longevity and you're transferring the idiosyncratic longevity risk to an insurance company if you live longer than, say, the age of 90, which is the median longevity for a 65-year-old healthy woman.

54:43So in other words, from that$200 ,000, she might be able to spend, instead of$8 ,000, she might be able to spend$12 ,000 or$13 ,000 or$14 ,000. Now, when you think of the impact that has on her spending goal, you can cover more of your spending goal from that chunk of the bond portfolio, which means that you're pulling less money out of the remainder of your portfolio. And in fact, you can take greater risk with the remainder of your portfolio as well. So when you actually map out the outcomes with a partially annuitized portfolio, at every age, you're going to be spending more on average, and you're not going to be at risk that if you live a very long time, you're going to have to cut back significantly.

55:25And that's one of the reasons why we call the failure to annuitize the annuity puzzle, because you don't get any reward for accepting an idiosyncratic risk. And the only way to get rid of it is to transfer it to an insurance company. So why wouldn't everybody just do that? And I think one of the problems is because people don't really understand these trade-offs. Michael used lots of big, fancy words there. And to be fair, I would say most of my research, and probably our research, has really been focused on the economic benefits of allocating the products that provide more lifetime income. But I honestly believe it's more behavioral.

55:59It's very difficult to spend down your portfolio when you have an uncertain future market return. I don't want to go back to work, and I'm afraid. I don't know what to do. So I honestly believe that we could exhaust your listeners with the economic arguments behind why individuals or households should have more money that's protected or guaranteed for life. I think it's really just creates that kind of foundation where if you know that your essential expenditures, there's lots of fun words you can use there are covered, it changes your relationship with your retirement savings, with how you're going to consume things like that.

56:29So for advisors that are listening, especially like I wouldn't view the role of annuities is just that kind of economic piece. There's just that behavioral angle that you just can't overcome with a portfolio. I know that you, the advisor, help clients do that, but there's nothing that you can do that can assure them that they're going to have enough income to live off of to pay their essential expenses for as long as they're alive. Yeah, I definitely agree with the math being behind this whole idea of taking bonds and replacing some bonds with lifetime income protections that kind of support stronger financial outcomes in terms of spending and legacy.

57:04With this retirement income style awareness research, we found about two thirds of the population ultimately resonates with an approach that builds protections into the financial plan as well. But we do still find a third are comfortable with that total return investing approach. And I've been in so many battles about this over the, I mean, Dave Ramsey, he's total return. That's a clear example of this idea that there is a third of the population that just doesn't resonate with the idea of annuities. And I talked about the primary factors, but there's secondary factors as well. If you are comfortable with a purely investment-based approach to retirement income, so you're probability-based, comfort-relying on the markets, optionality-oriented, you want to maintain as much flexibility as possible.

57:46You also maintain an accumulation mindset, which is post-retirement, you're not worried about predictable income. You're still focused on risk-adjusted returns. And it implies you're going to accept a more variable spending stream because it's just not as important to you. You also tend to want to front load your expenses in retirement. You want to maximize lifestyle and make sure you can really enjoy your retirement. You also value technical liquidity, which is this idea of you just have a big pot of assets and you'll draw from it as necessary for different spending shocks, for your basic retirement expenses.

58:19You don't really try to do an asset liability matching this pot of assets is meant for this expense and so on. You draw from your pot of assets. And so when you have all those types of characteristics, that's the total return investor. And we think it's about a third of the population. And though I think the math, again, is not in favor of it as being a better way to support retirement. At the end of the day, that's what people are comfortable with. and I've stopped trying to argue that they should do something different. So we've had conversations with both Wade and David, both of you guys about this and with other people.

58:51We talked to Moshe Malevsky about it. He's got a software that actually helps you model like the optimal annuity allocation and how it relates to the optimal stock bond allocation. And we took all that and we started talking to our clients about it and nobody was interested. So either we're bad at selling annuities or there's a selection bias and we attract total return investors. I don't know what's going on there. There's a lot of self-selection going on too, that if you're mainly discussing total return concepts, the people who reach out to you are more likely to self-select into being comfortable.

59:23You may be missing out. Two-thirds of your listeners are potentially not calling you because, although I guess you are offering, it's just you got to build that audience more and get more of the income protection crowd into the audience mix as well. So the wage point, it's the language that we use to describe everything, right? I mean, in the US on statements, it's so balanced and return focused. And it's not, I mean, now we have new rules about relaying income, but we've created, especially wealthier Americans are like hyper-focused on returns in the market. And it's not the goal and how do you accomplish the goal?

59:57It's how do you get solid performance? And like the structural story behind guaranteed income, lifetime income is a bit different, right? And so I think it might require different software, different tools, different ways to have conversations that make it more acceptable for retirees. I see that that is changing if you look at surveys on perceptions of annuities over time, but I don't know that a lot of advisors that are traditional investment managers are necessarily well-equipped to tell that story. Michael, what do you think? Yeah, I think there is a loss aversion and a framing problem as well, is that people frame on the value of their savings, their nest egg.

1:00:38And if it gets smaller, then they have an emotional response to that. you need to start thinking about the language that you use to describe how you plan for retirement. Because if you start focusing on income and lifestyle, and especially early in the planning process, then let's say if you create an expectation that you're going to buy$25 ,000 of income as part of the retirement plan, you even maybe separate an account where the purpose of the account is to buy that income, then if you don't buy the income, it's going to seem like a loss. It's going to seem like you lost that$25 ,000 per year instead of you lost that dollar amount.

1:01:21So it's one of the reasons why everybody loves their pension. Any guaranteed income that we get at retirement, we don't want to give it up. I mean, in the United States, we have this political battle over cutting Social Security. Social Security is an annuity and people get bent out of shape when you try to take it away. And the reason is because you've built this expectation that they're going to get this income. And when you reduce it, you're taking something away from them. So if you can set that expectation with a portion of their savings early on enough that they feel like they own that income and that taking the income away is like a loss, then I think you can do a much better job of helping people wrap their brains around what is ultimately going to be in their best interest.

1:02:07Just that framing of it is a really interesting perspective and not something that we've tried. How impactful is the idea of deferring government pensions like social security or in Canada, we have the Canada pension plan, same kind of idea. How impactful is deferring those to later ages? Well, in the US, it's pretty impactful. It's an actuarial calculation that was done in 1983, assuming a higher real interest rate and less longevity than we see today. So in 1983, it didn't matter what age you claimed on an actuarial basis, but today you benefit from delay. And we're actually seeing a lot more.

1:02:43It used to be, we'd say half of people claim social security at age 62, which is the earliest possible age. But since 2009, that's been dropping dramatically. It's now under 30 % are claiming at 62. And if you talk about waiting past the full retirement age, full retirement age is now somewhere between 66 and 67. But if you delay until 70, you continue to get these delay credits. In 2009, it was still under 6 % of people waited past their full retirement age. But in 2021, it's not 24 % are claiming past their full retirement age. This is a point that us super nerds have been harping on for a long time as well about the value of delaying social security.

1:03:23And it really does seem like that message has been getting out there in a dramatic fashion these past 14, 13 years. I have some research with Jason Bichner that we published soon in the Retirement Management Journal using data from the Survey of Consumer Finances. And what I was really curious about is, is there any kind of relationship between when individuals claim social security and whether or not they use a financial advisor? I think if you were to ask me that question, I mean, you have to control for effects where individuals that have an advisor tend to have more wealth. But if you were to ask me, David, how does the relationship to claim claim Social Security relate to have an advisor, it's saying, well, advisors are highly knowledgeable of this effect.

1:04:00People that have advisors claim later than those that don't, right? That's like the obvious answer. Well, that is not what you actually see. There's a market difference based upon when individuals claim and the type of the advisor that they're using, whereby individuals work with brokers claim two years earlier than those who work with accounts, right? And so, But as you think about it, there's lots of ways that you can nudge someone to claim earlier or later. Like if I wanted to scare you to claim it, it's like, oh my God, the trust fund is going bankrupt. What are we going to do? How are we going to fix this?

1:04:32We can't rely on Social Security. Alternatively, you can say, hey, even if it runs out of money, they're still 80 % funded. The odds of a cut to benefits is incredibly small. And the fact that there's this market difference in claiming ages by advisors, to me, at least implicitly suggests that advisors can help drive that narrative to the extent they want to. And I don't want to get in this kind of fight about who's a better advisor, but think about the way that a broker versus an accountant makes money. They're very different business models, right? And that could, I think, be directly affecting the way that people receive advice around the benefits of delay claiming Social Security.

1:05:09And let's be honest here, like retirement academics don't always get along, but that's one of the few things we almost all say makes a lot of sense. And I was very disheartened to see that advisors, you know, I would have thought that they're having their clients are delaying years longer than average. Individuals that use brokers actually claim before the average American does. Like that does not jive with what I think anyone would expect. Yeah, there's a strand of investment advisors who think they can, quote unquote, invest the benefits better. So it's better to claim early and invest it. And they think that will help you be better off in the long term.

1:05:43That is definitely more of a total return style compared to if your income protection, you view delaying Social Security as the best annuity money can buy. And so it's a natural inflation adjusted part of the retirement income floor that you want to build into your retirement plan. Well, to loop back to our earlier comment, if you think you can earn 12 % a year without risk, you're not going to delay claiming social security. Yeah. If you can earn 12 % a year, you claim a 62. You're not, you're going to claim a 62. And so like there are really important implications, right? About, oh, he's just talking about withdrawal rates.

1:06:16Well, like individuals that utilize that advice and those perspectives are going to make poor choices in other domains potentially as well. Yeah. Just a quick point also about any sort of a government pension that is inflation adjusted, it's really the only way to buy more inflation protected lifetime income. So if you want to buy an annuity that doesn't lose purchasing power over time, the only way in the marketplace to get it is by delayed claiming of your government pension that's going to then adjust for inflation over time. I have some things that are just kind of no brainers as part of the retirement income planning process.

1:06:52And to me, delayed claiming of a government pension is a no-brainer because, A, it's annuitized income, which you should get anyway. B, it's inflation protected, which you can't get anywhere else. And C, the ability of the entity to always make that income payment is pretty good if they print the money. So it's not like an insurance company where there is some chance of insolvency risk. With the government, generally speaking, if they can print the money, then you're going to get the check. Although it is harder to print money to pay for inflation-linked claims because that can cause more inflation increasing the amount you have to pay into a negative feedback loop.

1:07:32But that just makes everything else that's not linked to inflation worth less. And so you don't be like, oh, I mean, so it's like, that's true. But I mean, everything else that's not linked to inflation will be hurt even more, right? You guys have a paper looking specifically at delaying social security for higher earning women. Can you talk about why it's more important in that case or why it's important in that case? Yeah, so when you get a delayed claiming credit, it's gender neutral. So in other words, everybody gets the same bump up in income, where if you did this in the private sector, you would give women a less of a bump than you would for men.

1:08:08Why? Because women are going to live longer. So in other words, the way you price an annuity is you take the probability that they're going to be alive to cash the check multiplied by the present value of that payment. And since women are expected to live longer by delayed claiming, they're on average going to have a higher probability of being alive to cash the check. Present value is going to be the same, all else equal. The actuarial value is going to be higher for women than it is for men. So it's something to consider that because of this gender blind pricing that goes on with delayed claiming, women actually get a bigger advantage to delayed claiming than men do.

1:08:47And also, you have to pay attention to some of the claiming rules, because if you, for example, have an older higher earner and the younger spouse can get the income benefit of the older higher earning spouse, then they should delay claiming because essentially the value of the annuity is based on the younger spouse whose expected lifetime is significantly longer. So when you delay claiming and they have the eligibility to receive that benefit when the higher earner passes away, that increases the value of that annuity. Really cool. So my final question for each of you, what final message would you have about retirement income that you might want to leave our listeners with?

1:09:29It kind of came up in the conversation. There's a lot of different ways to get it right. You really need a retirement plan that you're most comfortable with. So if you're not comfortable with an 8 % withdrawal rate in 100 % stocks, or you're not comfortable thinking about an annuity because you just don't want to make that irreversible decision. It can be hard to sort through those options. And so that's really was the motivation of really trying to identify there's these different retirement income styles. And I think people are interested to determine their style. There's definitely possible ways to do that now.

1:09:57And it's important to understand what your style is so that you can quickly cut through all these debates and find the approach that actually resonates with you. I would say that there's a really important value to just a second opinion when it comes to retirement income. If you're a do-it-yourselfer, engage an advisor. I mean, it could be like an hourly plan. If you have an advisor, I still see value in getting a second opinion. So I think that whether you're your own advisor or you work with one, just getting a gut check as you really enter retirement and make a lot of choices, that can be incredibly valuable.

1:10:28It's not that your advisor isn't competent or that you as an individual aren't competent yourself, but having someone else that can just say, hey, this makes a lot of sense is really important because you're going to make a lot of choices when you first retire that have massive long-term implications. You're going to set your spending. You might claim Social Security. You might buy a product. You want to have a high level of certainty that what you're doing is correct. I think that's where having someone else to give you ideally a second set of eyes is just really important. David, there was just an article in Barron's today about someone who hired a professional advisor and had$50 million and now has one and a half.

1:11:01So I think also when you're hiring an advisor, it's very important to find someone who you trust who is going to be looking out for your best interest, especially once you get older, because you do change cognitively when you're in your 80s and 90s. I think part of the retirement planning process is accounting for the fact that your ability to manage complex financial decisions is going to be different in your 90s than it was in your 60s. So figure out a way to protect your ability to consistently make high quality decisions. And the other thing I'd say is just to be more deliberate and to recognize that there really are only two places that your money can go.

1:11:36You can either give your money to someone else when you die, or you can spend it. And I think that one of the biggest mistakes I see among retirees is they believe that there's a third option that doesn't exist. So they preserve their assets as long as they possibly can. And if you ask them, do you want to give that money to your kids? They'll say, no, oh, you know, that's not why we're hanging on to all this money. And essentially what ends up happening is by default, the kids end up spending it because they didn't feel like they had the license to do that. And I think that's one of the parts of being deliberate is giving yourself the license to be able to spend the money you saved for the purpose of living better.

1:12:11And it didn't come up organically, but I was proudly wearing my rational reminder t-shirt for today's episode. Very nice. It's very nice. He just went full Superman on it. He just pulled it off and showed us the cape. Rational reminder. That's Wade. It's pretty good for a super nerd. I mean, that's what a super nerd would have on the shirt. Rip off the jacket. Wade, you mentioned earlier a RISA risk profiling tool, and you mentioned that there may be tools available for people to use. Where do people find that? Yeah, I'll get a link put together for you to include in the show notes. If you'd like, we'll put it at risaprofile.com slash rational reminder, and it'll be an opportunity to take the questionnaire assessment and get a report that shows your retirement income style.

1:12:55That is super cool. That is. All right. Thanks a lot, guys. We really appreciate you all coming on. I think it's a great conversation. Really? Thank you. Yeah, it was fun. Yeah, this was fantastic. I'm very grateful to have you guys join us. Thanks so much.