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The Risks of Planning Retirement With an Accumulator’s Mindset

As investors who spend the majority of our time thinking about investments, we might have a bias towards structuring our retirement with investments.

Investing ourselves gives us flexibility on the degree of returns we can get as well as how much we could spend. Most of us have a negative bias against off-the-shelf retirement income solutions but are there good reasons for having them?

Wade Pfau and Alex Murgia interviewed Michael Finke, an expert in the retirement planning space on his thoughts in this area in one of their Retire with Style podcast episodes here.

This episode is less about the advantages of having protected retirement income products and more about the impact of having the wrong planning mindset on a client’s retirement objectives.

What do advisors struggle to get right?

Advisors Do Not Get the Retirement Planning Mindset

Advisers are mainly in the Accumulation mindset:

  1. Figure out the client’s risk profile typically through a risk questionnaire
  2. Put them in an investment portfolio
  3. Keep them invested in the portfolio

The major determinant in accumulation planning is whether your client is willing to accept volatility in their portfolio and the degree to which they can accept it.

Michael Finke explains that at the American College of Financial Services, they take a goals-based approach to financial planning:

  1. Figure out the objective you want
  2. Build an investment plan around the objective to help you get there

Regarding retirement planning, the goal for clients to work towards:

Live as well as you can in retirement.

In order to live well, you would need to spend your money. This concept may be lost to many people.

Risk in retirement is rather different from accumulation:

If markets do not perform well, I would have to cut back my spending, which wasn’t how I originally envisioned when I go with this plan.

Risk in retirement cannot be measured in a similar manner to in accumulation.

The real risk is a major deviation in the income reality from your income expectations. For example, you were expecting that you have this pot of money that can give you this generous income, but one day you discovered to your horror that this was not the case.

Wade Pfau shared that if you are able and willing to cut your spending and still be happy, that is not a risk.

The Challenge of Achieve the Retirement Objective with a Volatile Investment Portfolio

If you have a very volatile investment portfolio, you would have to accept a lot of flexibility in your retirement spending. This is the trade-off for wanting greater upside. (Read Michael Finke and Wade Pfau’s 2012 paper on Spending Flexibility and Safe Withdrawal Rates)

When Wade and Michael wrote the paper in 2012, they were quite concerned that given the high bond and equity valuations, and longer lifespan, the popular 4% safe withdrawal rate may not stick and people would have to accept flexibility in their spending. (Research shows that people with higher income have made huge strides in their longevity)

Micheal highlighted a weakness in the safe withdrawal rate in that it doesn’t adjust to different expectation realities. This can be the reality of markets and life.

Lastly, it doesn’t feel very right that a retiree with the same amount of money but 1 year apart between a market peak and a lower market can enjoy vastly different retirement adequacy.

However, if you are willing to explore different financial solutions added to your structure, you can have a higher initial starting spending.

What they found in their research is that, if a retiree is more risk-tolerant, they can actually live better.

Present Risk Questionnaires Does a Poor Job Assessing Client’s Risks in Retirement

In order to give a plan that matches closer to the retirement objective, we need to assess the client’s retirement risks and preferences better.

Most risk questionnaires do not ask & capture retirement risks well allowing the planners to effectively create the ideal retirement solutions for the clients:

  1. How do you assess risk tolerance or something that can capture the sensitivity to the willingness to access variation in spending but also other income preferences in retirement?
  2. How do you capture spending shocks that could vary the plan?
  3. How much can they really cut back when they need to cut?
  4. How much of your income do you wish to insulate from the financial markets?

Failure to ask some of these questions mean the adviser is not able to tailor a retirement plan that matches close to their retirement income expectations.

How Economists Think About Retirement

  1. Retirement spending is a liability
  2. At the beginning sequence of this liability, you have a pot of money and the desired lifestyle you expect to live
  3. If you take more risks with your investments, you do it because you hope to live better in retirement or to have more money to pass on to others
  4. But when you take on more investment risks, there is a possibility that you will get unlucky, you are going to spend less.
  5. If you are unlucky, you would have to accept to adjust the future spending liability downwards or face the trade-off that you may run out of money one day.

A 2022 Retirement Couple Case Study That Shows the Issue with Using the 4% Safe Withdrawal Rate for Retirement Planning

  • A couple start at 2022 with $1 million dollars in a traditional equity and bond portfolio
  • They lost 30% of their portfolios this year (bonds and equities crashed at the same time). Micheal mentioned that “everyone” knew its the worst time to retire given the record low bond yield and high equity valuations
  • The portfolio is left with $700,000
  • They have already taken out $40,000 for spending for the year (4% initial withdrawal rate) and so the portfolio is left with $660,000
  • They will have to decide if next year, they should up their spending amount based on the current inflation rate, which is 7% (based on the safe withdrawal rate methodology), which is $43,000 next year.
  • The ironic thing is that, if the couple “forgets” that they retired in 2022, and calculate their retirement income using the 4% safe withdrawal rate in 2023, the methodology would tell them that they can only spend $26,000 in 2023.
  • The couple will have to decide whether to spend $26,000 or $43,000 in 2023.
  • If the couple decided to spend $43,000 in 2023, they would have an extremely low probability of success.
  • If the couple decided to spend $26,000 in 2023, the couple may have cut their spending so much that it may cut into their essential expenses. This is a problem if you build your retirement plan based on an expectation of spending $40,000 plus prevailing inflation.
  • Finke’s research shows that probably 66% of the expenses are inflexible and cannot vary
  • If the couple cuts out all the discretionary expenses, they have to wonder whether that is the kind of retirement they want to live.

Michael wonders if the traditional risk questionnaire is able to pick up this sensitivity of income variation tolerance and the type of retirement solutions.

The Value of Retirement Planning

A sophisticated approach to blending investments, and financial products that get rid of idiosyncratic risks in retirement such as longevity risks, and building a plan that doesn’t force you to cut back on your lifestyle so much that you are cutting to the bone.

What we can prevent is losing the lifestyle that you are expected to live.

Financial Advisers and Investors Overrate Risk Premium Too Much

In financial planning, there is this religion of the equity risk premium. Equity risk premium means stocks are ALWAYS going to outperform bonds in the long run.

To economists, this does not make any sense because the only reason why we should be rewarded for taking risks is over a 5, 10 or 15-year horizon when equities underperformed bonds.

Data from the last 30 years shows that except for the early 20s, stocks have not outpaced bond performance by a wide margin historically in the past.

Michael felt that his view and a lot of economists’ view is that the return we get for taking risks is smaller today than in the past. A few good reasons are that it is a lot cheaper to invest in stocks, so the premiums do not have to be that high.

We cannot consistently rely on the higher equity risk premium to buoy our lifestyle consistently.

The first ten years of retirement are so important that Michael felt that it’s financial malpractice to put clients in a higher equity portfolio than they are able to tolerate.

If clients cannot accept that they can be unlucky and stay with the portfolio, then they cannot accept such a solution.

If you are serious about planning for your retirement, you can take a look at my dedicated Retirement Planning, Financial Independence and Spending Down Strategies page here.

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Wednesday 6th of July 2022

I basically gave up my early retirement plan. Looking at the way markets are behaving, it is not that I am afraid, but it would be a wasted opportunity to not earn and invest in these depressed markets. Bear markets are the best time to invest. Also now is probably the best time to continue working. We are spoilt with so many options,Hybrid working, digital nomad etc The next 10 years of work are likely to be very different from the past 20 years, it is a new paradigm like moving from factory floor jobs to desk jobs, we are now moving from fixed desk jobs to work from home/anywhere.

So I plan to work another 10-12 years hopefully and make good use of these market dip opportunities.

Cheers :)


Monday 18th of July 2022

Hi Revhappy, you need to consider if you are working to have a greater margin of safety or you are working because the money is there.

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