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On today's episode, we're continuing our
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conversation from last week where we
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asked, "What does retirement failure
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look like and how can we avoid it?"
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Let's identify all the risks we might
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face or ways we might fail and only then
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decide the positive actions we should
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take to mitigate those risks. Welcome to
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personal finance for long-term
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investors, where we believe Benjamin
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Franklin's advice that an investment in
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knowledge pays the best interest both in
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finances and in your life. Every episode
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teaches you personal finance and
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long-term investing in simple terms.
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Now, here's your host, Jesse Kramer.
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Welcome to Personal Finance for
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Long-Term Investors, episode 141. I'm
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Jesse Kramer. I'm a financial planner
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and I work with retirees and busy
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professionals preparing for retirement
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across the USA. You can learn more at
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planwithjesse.com.
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This week's review of the week is from
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Ethan Gilbert, who left kind words and a
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fivestar rating on Apple Podcasts. So,
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Ethan, drop me an email to
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jessebinest.blog blog and I'll get you
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hooked up with a super soft podcast
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t-shirt. We'll mail it out to you. And
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now on with the show. If you haven't
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listened to last week's episode, that's
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episode 140. Please go listen to that
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one. That episode is really part one to
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today's part two. And in part one, I
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kind of introduced this entire exercise
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and also discussed the first seven key
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retirement risks and what we can do to
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combat those risks. Specifically, I
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spoke about longevity risk, inflation
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risk, partner or household risk, market
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risk, sequence of returns risk,
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withdrawal risk, and then health risk in
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general. Continuing onto today's
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episode, I'm going to dive into
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long-term care or other shock spending
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risk, cognitive decline risk, behavioral
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risk, assumptions risk, policy or
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legislation risk, identity and purpose
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risk, and then last, the deep risks. And
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enough preamble, let's just dive in. So,
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I'm going to start today talking about
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shock spending and long-term care risk.
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Shock spending as a general term
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describes where some sort of unforeseen
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circumstances means we are going to
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spend a really big amount of money all
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at once. And throughout most of our
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lives, these spending shocks might be
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something like medical expenses causing
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us to max out our $10,000 insurance
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deductible, for example, or a mini
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housing disaster causing us to max out
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our homeowners deductible. something
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happens to a spouse, a child, or some
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other relative causing you to spend a
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lot of money all at once. And these
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shocks are no fun. That said, a healthy
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emergency fund and proper insurance
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coverage kind of dampens the blow.
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Without that emergency fund, the or the
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insurance coverage, these kind of
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spending shocks can begin a a slippery
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slope into some of the really bad
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financial situations that we we hear
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horror stories about. But again, this is
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why emergency funds or proper insurance
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coverage are two of the pillars, two of
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the first steps of basic personal
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finance priorities. Now, in retirement,
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those same shocks could certainly apply.
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It's no fund replacing your roof if you
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weren't expecting it, whether you're
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working or retired. But there are three
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major types of spending shocks that tend
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to occur maybe more frequently for
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retirees than they occur for other
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people. They are one, health care costs
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in the gap years before Medicare. Number
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two, supporting an adult child. And
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number three, long-term care. Health
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care costs in the gap year before
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Medicare. Let's talk about that one
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first. Medicare starts at age 65. And
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retirees who retire earlier than age 65,
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they do have a few different ways they
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can fill in the health care gap until
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Medicare kicks in. Now, in episode 108
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of this podcast, I spent a good 25
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minutes tackling this very idea. And
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rather than spending 25 minutes here,
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again, I recommend you add that to your
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listening list. Again, that was episode
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108. So, now we'll move on to supporting
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an adult child. Now, unfortunately,
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there's very little you can do to
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prepare or derisk yourself from this
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occurring. It's one of those things
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that's both very unique to your
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circumstances and that nobody, such as
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an insurance company, is going to help
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you out with. The only thing I can say
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here is to offer some very similar
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oneliner that I think it applies to when
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it comes to helping your kids with
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college, for example, is that you can
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get a loan for college. You can't get a
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loan for your retirement. Now, if your
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adult child is in trouble, they might
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not be able to bail themselves out. But
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one thing I know for sure is that you
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cannot get a loan to bail yourself out
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if your retirement funds run dry. So
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that's why from a kind of cold financial
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point of view, we do want to be cautious
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about mortgaging our own retirement
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requirements to bail out an adult child
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in some way. Or perhaps a better way to
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put it is you really want to understand
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the cold financial math before you make
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what is obviously going to be a
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challenging emotional decision to help
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your child. And if you make that
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emotional decision without first digging
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into the cold finances, I do think you
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are doing your future self a bit of a
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disservice. But that brings me to the
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third one, long-term care. Now,
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long-term care is scary for a few
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reasons. Now, first, there's the human
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side of it. Long-term care is a
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depressing topic for many people because
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it represents some loss of control or
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autonomy, a loss of the familiar daily
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routines. It signifies for many people
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the end of home, right? They're moving
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out of home, probably for good. It
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requires some sort of forced dependence
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on other people for the basic needs of
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life, a loss of a sense of purpose,
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maybe it leads to loneliness and and
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social isolation, often some anxiety. So
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long-term care is just a hard topic to
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deal with even without considering one
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lick of finances. It's just hard to
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think of from a human perspective. But
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then of course there is the financial
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portion. Long-term care is ridiculously
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expensive. How expensive? Well,
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depending on your level of care, costs
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between $5,000 a month and $20,000 a
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month are very much normal. So that's
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between $60,000 a year and a4 million a
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year. But wait, there's more. Because
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depending on the source you look at,
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somewhere between 50 to 70% of
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65year-old adults will need some form of
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long-term care before they die. Women
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are more likely to need long-term care
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than men with an average day somewhere
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around three years for women and
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somewhere around two years for men. In
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other words, some retirees are going to
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need $0 of long-term expenses in their
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life, while other retirees could easily
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surpass half a million, $500,000 of
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long-term care expenses in their life.
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That's a crazy dispersion. When faced
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with such an expensive and risky coin
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flip in that way, one of the common ways
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to derisk yourself involves insurance.
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And sure enough, long-term care
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insurance is a real product meant for
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just these kind of situations. But
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long-term care insurance is very
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controversial. And I'm going to pull
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some paragraphs right now from a
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wonderful KKF article. I'll link it in
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the show notes. KKF is a healthcare
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think tank and I use various articles
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and tools and calculators of theirs all
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the time. I highly recommend if you've
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never been to the KKF website, I highly
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recommend if you're thinking about
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specifically health care and retirement
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and how they overlap. It's a good uh
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website to spend a few minutes on. And
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so anyway, now here goes a few
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paragraphs from an article from the KKF
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website. Take for example the story of
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the Gemtt family from Sacramento. For 35
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years, Angela Gemtt and her five
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brothers paid premiums on a long-term
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care insurance policy for their now
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91-year-old mother. But the policy
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doesn't cover home health aids whose
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assistance allows her, the mother, to
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stay in her Sacramento, California
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bungalow near her friends and neighbors
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who she loves. Her family pays $4,000 a
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month out of pocket for that. The
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private insurance market has proved
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wildly inadequate in providing financial
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security for most of the millions of
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older Americans who might need home
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health aids, assisted living, or other
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types of assistance with daily living.
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For decades, the industry, again, that's
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the insurance industry, severely
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underestimated how many policy holders
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would use their coverage, how long they
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would live, and how much their care
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would cost. Repeated government efforts
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to create a functioning market for
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long-term care insurance or to provide
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public alternatives have never taken
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hold. Today, most insurers have stopped
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selling standalone long-term care
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policies. The ones that still exist are
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too expensive for most people, and
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they've become less affordable each year
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with insurers raising premiums higher
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and higher. Many policy holders face
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painful choices to pay more, to pair
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back benefits, or to drop coverage
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altogether. Okay, so now back to me,
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back to Jesse and my words. That is a
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pretty sobering uh set of paragraphs
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right there, set of words. And the
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takeaway is that long-term care
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insurance is not unfortunately a good
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way to derisk yourself from long-term
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care costs and the shock spending risk.
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So, how do we tackle it instead? I've
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got a couple ideas. They're not exactly
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easy, but I think it's the best we can
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do. First, I think we need to be honest
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with ourselves and admit that long-term
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care costs almost always come at the end
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of life, as far out into our financial
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futures as could possibly be. And if you
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forced me to put a $500,000 expense
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somewhere in my financial future, I
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would choose to put it way out at the
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end of life, at the end of my financial
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plan. For example, if you need to make a
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$500,000 payment in 30 years, and you
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assume a real rate of return, so that's
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an inflation adjusted rate of return of
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say 6% maybe, right? 9% on the
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investments minus 3% for inflation. If
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you assume a rate of return of of 6%,
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then you would need to allocate about
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$90,000 today in order for it to grow
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over 30 years to your needed half a
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million in 30 years. Now, don't get me
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wrong, $90,000 is still a lot of money,
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but it's not the same as half a million.
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And the point here is that time is your
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friend inside your financial plan.
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Though it might not be your friend, I
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suppose, when it comes to to health
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itself, but time is your friend inside
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of your financial plan. And it's one of
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the reasons why I'm a big proponent of
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cash flow modeling and asset liability
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matching. I want to understand the money
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I'll be spending in the future and
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ensure that I'm allocating the right
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amount of dollars today into the right
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asset class today to grow to what I need
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it to be in the future. And that brings
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me to my second point. Speaking of cash
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flow modeling, in my experience,
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long-term care isn't purely a new
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expense. Now, what do I mean by that?
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Well, what I mean is that the typical
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retiree might be spending, we can pick a
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number, might be spending $8,000 a month
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on their normal lifestyle. And then when
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they enter long-term care, that $8,000 a
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month is going to drop down a ton
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because so much of their normal
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lifestyle expenses will change. Whatever
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the circumstances are that merit them
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going into long-term care are
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circumstances that mean they're not
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going to be spending as much money on
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their normal lifestyle. So maybe their
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their normal expenses drop down from
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$8,000 a month to $3,000 a month. And
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yes, now we have to add in a new $10,000
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a month line item for long-term care. So
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there are $3,000 a month expenses
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plus$10,000 for long-term care. That
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brings the new total to $13,000 a month.
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But our previous lifestyle expenses were
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$8,000 a month. The new total is 13. So
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even though the long-term care costs
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$10,000 a month, technically, this
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person's expenses only change by $5,000
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a month. Most of the time that kind of
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tit fortat inside of someone's cash flow
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ends up being the way reality plays out.
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Third, I'm going to ask you, what about
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Medicare and Medicaid? Now, at this
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point, this is a little funny, so I
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think I've maybe shared this before. I
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can keep straight Medicare and Medicaid.
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Now, at one point, I couldn't keep them
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straight. And I had to remember that
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Medicare rhymes with hair as in white
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hair because Medicare is for the
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elderly. And Medicaid has aid right in
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the name as in I don't have money and I
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need some aid. Medicaid is income
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needsbased. Medicare does not cover
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long-term care. Technically, there are
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some hospital recovery scenarios that
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someone might go through in retirement
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where roughly the first 100 days of
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their long-term care like services are
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actually covered by Medicare. But again,
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that's if you're recovering from a
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hospital stay for about 3 months. It's
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not the same as when someone potentially
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needs years of help with simple daily
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living activities. That's long-term
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care. But Medicaid can help you with
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long-term care. Though, depending on the
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state of your personal balance sheet,
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right, how much assets you have, you
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might qualify for Medicaid to help you
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get into and pay for long-term care.
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Some people, however, don't like this
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option because you might not get to go
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into the long-term care facility of your
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choice. It might feel like a bad
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facility. And then there's this thing
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Medicaid planning for long-term care.
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It's a very deep and complex topic, too
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deep for today's episode. You can let me
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know if you'd like a further uh deep
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dive episode into long-term care and
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Medicaid planning. But the point is that
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if long-term care is this giant risk,
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Medicaid planning can potentially be one
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of the ways to derisk yourselves of
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that. So again, if we are going to bring
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this baby home, how do we de-risk
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ourselves against shock spending risk
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and specifically long-term care costs?
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To me, the answer is is kind of simple.
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We include these costs in our financial
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plan today. Well, right now. meaning our
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current plan has to account for the
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possibility of that major expense many
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decades into our future. And I I think
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it's worth running an analysis where
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there's a 100% probability of these
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costs just to see how it looks. But if
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you do that, I also think it's equally
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important to run an analysis where those
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long-term costs aren't in there at all
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or maybe an analysis where one spouse
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requires some long-term care and the
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other one doesn't. These are such big
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numbers that to assume the worst case
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across the board is simply more
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conservative than than most of us will
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need to be. Okay, that was a lot. It was
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more than maybe I was expecting to talk
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about, but long-term care and just shock
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spending in general, it can be for some
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families, it can be such a big risk
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looming on the horizon. I think it's
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certainly worth planning for today. But
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that brings us to the next risk of
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today's episode, cognitive decline risk.
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And again, here I'm not going to talk
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about the health risks of cognitive
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decline. I'm also not going to talk
00:12:52
about the health care costs or long-term
00:12:55
care costs of cognitive decline because
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those are real. But what I really want
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to talk about is the financial side
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effects that begin to creep in if
00:13:03
someone loses their mental acuity. Stuff
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like decision-making and the ability to
00:13:07
process complex financial information,
00:13:09
the ability to evaluate risks and to
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manage someone's assets properly. You
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hear stories about people who miss bill
00:13:15
payments, messiness and disorganization
00:13:18
in their financial life. And then you're
00:13:20
right, inability to understand basic
00:13:22
information. That's a real side effect
00:13:24
from cognitive decline. You also hear a
00:13:26
lot of stories about susceptibility to
00:13:28
scams and exploitation. There's no doubt
00:13:30
that cognitive decline increases
00:13:32
someone's vulnerability to scams, to
00:13:34
fraud, to theft. Billions are already
00:13:36
lost every year by older adults who who
00:13:39
fall victim to scams. I'm really worried
00:13:41
about this one personally, especially
00:13:42
with some of the things that AI can do.
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I guess it's hard for me to even explain
00:13:45
some of the possibilities. I'm sure I
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don't even fully understand them myself,
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but they sound so science fictiony. But
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I can foresee a future where unless
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information is being transmitted face to
00:13:55
face, it's going to be really difficult
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to determine if it's real or if it's
00:13:59
fraud. Meaning, hearing someone's voice
00:14:01
on the phone, even someone who you feel
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like you know really well, might not be
00:14:05
enough to determine if it's actually
00:14:06
them because technology is getting so
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good at mimicking people's voices.
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Similarly, and perhaps even more scary,
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seeing someone's moving face over video
00:14:16
on FaceTime uh on a Zoom chat won't be
00:14:19
enough to determine if it's actually
00:14:21
them. And I know that sounds like
00:14:22
sci-fi, but I really don't think it's
00:14:24
that far around the corner. And who
00:14:26
among us would be most susceptible to
00:14:28
that type of scan? They hear a voice or
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they see a face and they think, "Oh,
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that's a person I know." It's probably
00:14:33
the people who are the least familiar
00:14:34
with the technology, meaning elderly
00:14:37
people. And cognitive decline magnifies
00:14:39
that risk even more. So that's scary
00:14:41
stuff. Cognitive decline is also
00:14:42
associated with irrational investment
00:14:44
behavior. Right? Individuals are going
00:14:46
to make drastic shifts in their
00:14:48
investment approaches probably for all
00:14:50
the wrong reasons simply because the
00:14:51
knowledge that they maybe once possessed
00:14:53
has started to escape them. Then there's
00:14:55
also overconfidence in one's ability.
00:14:57
People with declining cognitive function
00:14:59
often remain overconfident or can grow
00:15:01
overconfident in their own abilities,
00:15:03
their own financial abilities despite
00:15:05
their impairment. So where do we end up
00:15:07
after all these things are combined? we
00:15:09
end up with just straight up losses in
00:15:10
wealth, irreversible financial errors,
00:15:12
duplicate transactions, misransactions.
00:15:14
It's a long list of possibilities. So,
00:15:17
how do we combat this risk? How do we
00:15:19
combat cognitive decline risk? Well,
00:15:21
first there are are health related steps
00:15:22
we can take. I'm not a doctor. I'm
00:15:24
hesitant to go too deep into detail
00:15:26
here. Now, depending on where you look
00:15:27
in the health literature, though, there
00:15:28
are exercise and cardiovascular
00:15:30
interventions. There are diet related
00:15:32
interventions. There are sleepreated
00:15:34
interventions, too. So anyway, I would
00:15:36
say talk to someone who knows more than
00:15:37
me about health. But using health is one
00:15:40
of the ways to de-risk yourself from
00:15:41
from cognitive decline. But then what
00:15:43
can we actually introduce into our
00:15:45
financial plan to help mitigate the risk
00:15:46
of cognitive decline? I think it's a
00:15:48
simple answer. Backup systems and backup
00:15:51
people. The worst outcomes here in the
00:15:53
realm of cognitive decline come from
00:15:55
when one person and that person alone
00:15:57
has all the power, controls all the
00:15:58
buttons, knows all the information for
00:16:00
their financial life. And if that one
00:16:02
person starts to slip, there's no backup
00:16:04
system in place to bail them out. So
00:16:06
what are some of these backup systems?
00:16:08
One is establishing legal protections,
00:16:10
creating a durable power of attorney
00:16:12
document for finances, creating a a
00:16:14
healthcare proxy for health while you
00:16:16
are still competent to ensure that there
00:16:18
are trusted individuals in place who can
00:16:20
act on your behalf. The second one is to
00:16:22
set up trusted contacts. And I say that
00:16:24
in quotes because the the exact
00:16:25
terminology can change from custodian to
00:16:28
custodian. But a lot of custodians
00:16:29
meaning Schwab, Fidelity, Vanguard,
00:16:31
whoever, they have these idea, this idea
00:16:33
of a trusted contact where you can
00:16:35
notify that financial institution of a
00:16:37
trusted contact person who could be
00:16:39
alerted if unusual activity suggests
00:16:42
maybe that you're the victim of some
00:16:44
sort of financial abuse, financial
00:16:45
fraud, or maybe you're starting to slip
00:16:47
up to uh cognitive decline. The third
00:16:49
idea I have is to simplify and automate
00:16:51
your finances. you know, consolidate
00:16:53
your bank accounts. Set up automated
00:16:54
bill payments to avoid a missed payment.
00:16:56
Set up a Social Security Advance
00:16:58
designation if you don't have that for
00:17:00
representative payes. Get organized.
00:17:02
That's the fourth idea. Compile a
00:17:04
secure, accessible list of assets,
00:17:06
insurance policies, passwords, all the
00:17:08
important documents, your estate
00:17:10
documents. Really get organized and then
00:17:12
let a second person understand what
00:17:14
organization you've done, where it is if
00:17:16
something happens to you. Kind of let
00:17:18
them in on at least some of those
00:17:19
secrets, for lack of a better term. The
00:17:21
fifth idea is to establish a team of
00:17:23
trusted adviserss. Now, I was talking to
00:17:25
my wife literally today as I was writing
00:17:27
out the script for this episode, and we
00:17:28
had a little side conversation about who
00:17:30
she should reach out to if I got hit by
00:17:32
a bus. And it made me realize here we
00:17:33
are at age 36, and I need to put down in
00:17:36
writing for her some things that she
00:17:37
doesn't know. and I owe it to her to let
00:17:39
her know who wrote our estate documents,
00:17:41
who our insurance agent is for life
00:17:43
insurance, who our accountant is, who I
00:17:46
would contact as a financial planner to
00:17:47
help her if I got hit by that bus, which
00:17:49
of our friends and family I would share
00:17:51
questions with if I were in her shoes.
00:17:53
So again, that's how you derisk yourself
00:17:55
from cognitive decline risk. It's all
00:17:57
about getting backup systems and backup
00:17:59
people in place. Here's a quick ad and
00:18:02
then we'll get back to the show. Did you
00:18:04
know my written blog, The Best Interest,
00:18:06
was nominated for 2022 Personal Finance
00:18:09
Blog of the Year, and it's been
00:18:10
highlighted in the Wall Street Journal,
00:18:12
Yahoo Finance, and on CNBC. I love
00:18:15
writing, especially when that writing is
00:18:17
to share financial education. And I
00:18:19
usually write one or two articles per
00:18:21
week. You can read them all at
00:18:23
bestinterest.blog.
00:18:25
Again, the web address is
00:18:27
bestinterest.blog.
00:18:29
Check it out. Now, let's move on to
00:18:31
behavioral risk. This is a giant risk
00:18:33
for investors of all stripes. And the
00:18:35
risk here is that your own emotional,
00:18:37
irrational, biased decision-making as
00:18:39
opposed to kind of logical analysis will
00:18:41
lead to financial missteps that
00:18:43
jeopardize what would otherwise be a
00:18:44
comfortable retirement. And I think for
00:18:46
retirees in particular, this risk is is
00:18:48
amplified by other fears. I won't spend
00:18:51
a ton of time talking about the
00:18:52
individual possible behaviors, but you
00:18:54
might be familiar with them already.
00:18:56
stuff like loss aversion, recency bias,
00:18:58
herd mentality, overconfidence, the
00:19:00
status quo bias. How these very human
00:19:03
but also sometimes illogical tendencies
00:19:05
can get us to do objectively bad stuff
00:19:07
like timing the market or panic selling
00:19:09
and the like. So, how do we combat
00:19:11
behavioral risk? Well, the first thing I
00:19:13
think of is to automate our cash flow,
00:19:15
right? Set up automatic consistent
00:19:17
withdrawals like a direct deposit from a
00:19:19
retirement account into a checking
00:19:20
account rather than making manual
00:19:22
emotional decisions to withdraw money. A
00:19:24
second thing you can do is to think of
00:19:26
buckets. Now, you don't have to use a
00:19:28
quote unquote bucket strategy to build
00:19:30
your portfolio. You don't have to do
00:19:31
that. But I think you should realize
00:19:33
that there are various assets that you
00:19:34
own. And these assets do have certain
00:19:36
tendencies that place them into shorter
00:19:38
term or longer term quote unquote
00:19:40
buckets. And if your longerterm bucket
00:19:42
is behaving with extra volatility, you
00:19:45
can ignore it because that's the
00:19:46
long-term bucket and you don't need to
00:19:48
worry about it for years if not decades.
00:19:50
So whether you want to use the bucket
00:19:51
metaphor or something else, it's simply
00:19:53
important to realize that the different
00:19:54
assets you own inside of a diversified
00:19:56
portfolio are usually there at least in
00:19:59
some part because they have different
00:20:01
timelines associated with them,
00:20:02
different levels of volatility
00:20:04
associated with them. And sometimes your
00:20:06
certain assets are simply going to be
00:20:08
more volatile than others. That's by
00:20:10
design, right? That's by design. And so
00:20:11
as long as you think about it that way,
00:20:12
it can kind of help you realize that
00:20:14
some of the uh concern that you feel
00:20:16
about volatility is a again, what do
00:20:18
they say? It's a feature. It's not a
00:20:20
bug. Number three, create a written
00:20:22
investment policy statement or IPS. It's
00:20:24
a formal plan that outlines how to react
00:20:26
during market volatility to prevent
00:20:28
knee-jerk fear-driven sales. I think of
00:20:31
it as kind of a a break glass in case of
00:20:33
market panic. That's what you do when
00:20:35
things are getting tough and you're
00:20:36
getting worried. You can whip out the
00:20:38
IPS that you wrote when you were of
00:20:40
sound mind, that you wrote when
00:20:41
everything was calm, and you can almost
00:20:43
remind yourself of, "Oh, yeah, that's
00:20:44
right. Here are the reasons why I I made
00:20:46
the portfolio I made." And if you adhere
00:20:48
to that plan rather than reacting to
00:20:50
news headlines, you'll be better off for
00:20:52
it. You can set your portfolio to
00:20:53
automatically rebalance if you want to,
00:20:55
or you can set that up inside your IPS,
00:20:57
how often you rebalance, and that forces
00:20:59
you to sell high and buy low rather than
00:21:02
selling into fear. I think the fourth
00:21:04
thing on my list is to to limit how much
00:21:05
you monitor your accounts. If you check
00:21:07
your portfolio balance too frequently,
00:21:09
especially during market volatility,
00:21:11
during panicky times, well, that can
00:21:12
lead to panic selling or just bad
00:21:15
investor behavior in general. And number
00:21:17
five is to remove yourself as best you
00:21:19
can. For most of us, we are our own
00:21:21
worst enemies. And if you feel the
00:21:23
urgent need to do something drastic,
00:21:25
it's really helpful if some little
00:21:27
Jiminy Cricut voice in the back of your
00:21:28
mind convinces you just to pause. If you
00:21:31
feel like you can't help yourself
00:21:32
though, well, maybe you can't and you
00:21:34
need to outsource it to someone who can.
00:21:36
And we already discussed it here. You
00:21:37
know, automate as much as you can.
00:21:39
Automate, automate, automate. Remove
00:21:41
yourself if you need to as much as you
00:21:43
can. And whether, like I said, whether
00:21:44
it's that Jiminy Cricut voice in the
00:21:46
back of your head, whether it's a
00:21:48
trusted friend or family member who can
00:21:49
convince you to remove yourself, or
00:21:51
whether it's leaning on a professional,
00:21:53
trying to automate and remove yourself
00:21:55
from the decisions is almost always a
00:21:57
good thing as opposed to a bad thing.
00:21:59
Now, the thing about behavior risk is
00:22:01
that by the time you realize that it's
00:22:02
hurt you or that it's hurting you, it
00:22:05
might already be too late. Now, for
00:22:06
example, you could have gotten your
00:22:07
ducks in a row in in 2015, that's a year
00:22:10
old pick here, and you've been in a
00:22:11
really good spot. all your systems are
00:22:12
smooth and then March of 2020 happens.
00:22:15
You get scared, you do something that
00:22:16
only afterward you realize was stupid
00:22:19
and that's behavior risk. And the thing
00:22:21
is, you might not have realized it
00:22:22
during the panic of the spring of 2020
00:22:25
when COVID was hitting in March of 2020.
00:22:27
But by the time things calm down and you
00:22:28
realize it, it's too late. So anyway,
00:22:30
that's why behavior risk, by the time
00:22:32
you realize it that it's hurt you, it
00:22:34
might be too late. You really want to
00:22:35
get your anti-behavior risk systems set
00:22:38
up early. it can do it can undo so much
00:22:41
important work that you've already done.
00:22:43
So set up those systems, automate what
00:22:45
you can, remove yourself where you can
00:22:46
to help you mitigate behavior risk. And
00:22:49
next, let's pivot to assumptions risk.
00:22:51
And I I want to break this one down into
00:22:52
two small sub risks. The first one
00:22:55
involves the assumptions you're making
00:22:56
about your future self. And the second
00:22:58
one involves the assumptions you're
00:23:00
making about the future world. and and
00:23:01
specifically here I mean the assumptions
00:23:03
about market returns and inflation and
00:23:04
tax policy the very assumptions that
00:23:06
create your retirement projections in
00:23:08
the first place and the idea of knowing
00:23:10
your future self it's a very kind of
00:23:12
deep academic psychology topic where
00:23:14
again I am not an expert don't consider
00:23:16
myself an expert but when I read about
00:23:18
it the big takeaways are that okay
00:23:20
humans are generally inaccurate at
00:23:22
predicting their future emotional states
00:23:23
we consistently overestimate both the
00:23:25
intensity and the duration of our future
00:23:27
emotions and number two we tend to
00:23:29
project current preference references,
00:23:31
moods, and feelings onto our future
00:23:32
selves. For example, a person who is
00:23:34
currently full of food, they had a big
00:23:36
meal, they are actually worse at
00:23:38
predicting how hungry they will be while
00:23:40
grocery shopping later on than someone
00:23:42
who is currently hungry. We use our
00:23:44
current preferences and moods and
00:23:45
feelings and project them onto our
00:23:46
future self. Uh, number three, we tend
00:23:48
to focus too narrowly on single future
00:23:50
events while ignoring daily routines and
00:23:53
other mundane contexts that will
00:23:54
influence our emotional states. Number
00:23:56
four, we fail to recognize that the
00:23:58
human brain has an unconscious ability
00:24:00
to rationalize, cope, and adapt to
00:24:01
negative events. And that makes those
00:24:03
negative events feel less devastating in
00:24:06
the moment than we currently anticipate
00:24:08
them to be. And then number five, we
00:24:10
quickly return to a baseline level of
00:24:11
happiness after major positive or
00:24:14
negative life events. Because we
00:24:16
underestimate this adaptation that we
00:24:17
have, we incorrectly believe things
00:24:19
that, you know, winning the lottery will
00:24:21
bring us lasting happiness or that a
00:24:23
relationship breakup will bring lasting
00:24:25
misery. You might be familiar with this
00:24:27
one, listeners. It's called the hedonic
00:24:29
treadmill. And anyway, my point is that
00:24:31
if you assume that retirement will
00:24:33
fundamentally change who you are as a
00:24:35
person or fix the problems in your life,
00:24:36
if you see retirement as a hammer whose
00:24:38
job it is to pound in the various nails
00:24:40
that surround you, you might be at risk
00:24:43
of some pretty poor assumptions. And the
00:24:45
solution here, I think, is is kind of to
00:24:47
know yourself, right? So, how do you
00:24:49
derisk yourself? I would recommend some
00:24:51
self-study. For example, two books that
00:24:52
immediately come to mind are Stumbling
00:24:55
on Happiness by Dan Daniel Gilbert and
00:24:57
then Thinking Fast and Slow by Danny
00:24:59
Conaman. I'll link to those two books in
00:25:01
the show notes, but basically in order
00:25:03
to not make bad assumptions about your
00:25:05
future self, it's really helpful to to
00:25:07
know who you are and know how your brain
00:25:09
works and and maybe educate yourself
00:25:11
just on how human brains work in
00:25:12
general, especially when it comes to
00:25:15
predicting who we will be in the future.
00:25:16
So, that's the thought process there.
00:25:18
But now let's pivot to the assumptions
00:25:20
you're making about the future world.
00:25:21
And specifically, again, I mean market
00:25:23
returns and tax policy and inflation.
00:25:25
The very assumptions that create your
00:25:27
retirement projections. This is a place
00:25:29
where I constantly and consistently see
00:25:32
mistakes from both DIYers and
00:25:34
professionals alike. And I see five
00:25:36
major assumption categories that
00:25:38
retirees need to consider. At least when
00:25:40
it comes to kind of the the long-term
00:25:42
cash flow portfolio projection, the the
00:25:44
Monte Carlo projection type thing. There
00:25:46
are five categories that we need to
00:25:48
consider. They are social security,
00:25:49
investment returns, expenses and other
00:25:52
cash flow, inflation, and tax rates. And
00:25:54
the risk here is that you assume
00:25:56
unrealistic numbers in those five major
00:25:58
categories. Because when you do that,
00:26:00
these numbers, they don't just add, they
00:26:02
multiply. They compound inside your
00:26:04
retirement plan. And any lack of
00:26:06
realistic numbers is going to make your
00:26:08
final answers even further from the
00:26:11
truth than they ought to be. Now, what
00:26:12
do I mean specifically? Well, a very
00:26:14
conservative person might say the
00:26:16
following five things. Again, very
00:26:17
conservative. On social security, I'm
00:26:20
assuming it's not even going to be there
00:26:21
at all. It won't even exist anymore. On
00:26:23
investment returns, I could say, well,
00:26:24
historically, a 60/40 portfolio might
00:26:26
return 9% a year. I'm going to assume, I
00:26:29
don't know, 6 or 7% a year. Let's just
00:26:31
plant a flag and say 6.5% per year. on
00:26:33
expenses. I know that most people's
00:26:35
nominal spending actually goes down in
00:26:37
retirement or there's a lot of good
00:26:38
research about the retirement spending
00:26:40
smile they call it because the graph
00:26:42
kind of looks like a smile. But
00:26:43
actually, I want to be safe and I'm
00:26:44
going to assume that my spending will go
00:26:46
up in retirement. Maybe I'm convinced
00:26:47
I'm going to travel a lot. So, I'm going
00:26:49
to assume that my spending goes up by
00:26:51
25% a year. On inflation, historically,
00:26:54
it's been 3%. I'm just going to assume
00:26:56
5%. I mean, after all, 22 2022 and 2023
00:26:59
had really high inflation. And then for
00:27:01
taxes, I'm going to assume federal tax
00:27:03
rates are going up in the future. I
00:27:05
mean, why not make that assumption? And
00:27:06
so, I'm going to assume my personal tax
00:27:08
rates will increase, and I'm going to
00:27:09
use a a 20% effective tax rate. Now, we
00:27:11
all know that conservative assumptions
00:27:13
are are naturally going to lead to
00:27:14
conclusions that ask you to work more
00:27:16
years, to save more money, to spend less
00:27:18
money. That's just a natural consequence
00:27:20
of financial planning conservatism. But
00:27:22
for this specific person with these five
00:27:24
very conservative assumptions, I can
00:27:27
almost guarantee that these assumptions
00:27:28
are costing them 10 to 15 years of
00:27:30
additional work. In other words, you
00:27:32
know, if this person was simply
00:27:33
realistic, they might be able to retire
00:27:35
at age 60. But their assumptions would
00:27:37
ask them to work into their 70s. And I
00:27:39
know this is true because I ran all the
00:27:41
numbers and you can check it out for
00:27:42
yourself in one of the probably one of
00:27:44
the more viral articles I've ever
00:27:45
written called the crushing cost of
00:27:48
conservative retirement planning. And we
00:27:49
will link to that in the show notes.
00:27:51
When it comes to assumption risk,
00:27:52
retirees can also be too aggressive with
00:27:54
their assumptions. And I think that's a
00:27:56
big risk, too. I think loss aversion,
00:27:58
speaking of behavioral risk, the loss
00:28:00
aversion in our brains suggests that
00:28:02
being too aggressive is the bigger and
00:28:04
scarier risk. You know what? If I assume
00:28:06
a 9% return on my portfolio, but then I
00:28:09
only get a 7% return and then I'm forced
00:28:11
to reenter the workforce at age 80. That
00:28:13
is a little bit scary. So, what's the
00:28:16
best practice here when it comes to
00:28:17
assumptions risk? First and foremost,
00:28:19
you need to be aware that conservatism
00:28:21
compounds. Well, and I guess being too
00:28:22
aggressive, that compounds, too. These
00:28:24
assumptions, they all multiply together.
00:28:26
They all compound. Now, what I mean is
00:28:27
that if you had five inputs to a math
00:28:29
problem, and those inputs all multiply
00:28:31
together and compound, and you choose to
00:28:33
be 25% conservative with each of those
00:28:36
five inputs, then your final answer is
00:28:38
actually going to be 200% too
00:28:40
conservative. Why? Because 25* 25* 25,
00:28:44
if you do that five times, your final
00:28:46
answer is 200%. Now, instead, if you do
00:28:49
want to add some conservatism, which is
00:28:51
okay, simply to maybe create some
00:28:53
bookends or at least just understand
00:28:55
what a conservative outcome might look
00:28:56
like, you you want to do your
00:28:58
multiplication the normal way and then
00:29:00
only add on 25% at the very very end.
00:29:03
You want to use the most realistic
00:29:04
numbers that you can throughout your
00:29:06
math such that your final answer is, as
00:29:08
far as you know, totally realistic. And
00:29:10
then you tack on your conservative
00:29:12
margin, if you will, onto your final
00:29:14
number. So instead of being 200% too
00:29:16
conservative, you maybe you're only 25%
00:29:18
too conservative. Now when this topic
00:29:19
comes up, you might hear the term base
00:29:21
rates and it's important. Per the
00:29:23
dictionary, base rates are the
00:29:25
fundamental probability of an event
00:29:26
occurring within a specific population,
00:29:28
often established through historical
00:29:30
data or observation. Base rates are
00:29:32
crucial because they provide an accurate
00:29:34
starting point for forecasting and
00:29:35
decision-making. So 99% of the time,
00:29:38
listeners, assumption risks occur
00:29:40
because somebody is tampering with the
00:29:41
base rates. History says a 60/40
00:29:43
portfolio will provide a 9% annualized
00:29:45
return over the long run with an annual
00:29:47
volatility of 10%. Great. That's your
00:29:49
base rate. Now, if you decide to reduce
00:29:52
that rate of return to 8% and you decide
00:29:54
to increase the volatility to 15%, you
00:29:56
are now tampering with the base rate.
00:29:58
You're putting your thumb on the scale.
00:30:00
You're layering your brain's need for
00:30:02
conservatism on top of objective
00:30:04
reality. And that's a risky practice and
00:30:06
in general a bad practice, a sub-optimal
00:30:08
practice. Now, one little side note, one
00:30:10
more point though, because someone might
00:30:12
ask, well, what if I have a really good
00:30:13
reason to edit a base rate? And okay,
00:30:16
maybe there can be some good reasons to
00:30:17
edit your personal base rates as being
00:30:19
different from the historical precedent
00:30:20
or the global base rate. For example, we
00:30:22
already discussed back on last week's
00:30:24
episode, episode 140, that your personal
00:30:27
longevity, the age that you die at,
00:30:29
might just be the most important number
00:30:30
in your retirement plan. And your
00:30:32
lifespan, your personal lifespan will
00:30:35
almost assuredly be different than the
00:30:37
average lifespan. And I think it does
00:30:39
make sense for you to attempt to discern
00:30:41
why you specifically might live longer
00:30:43
or shorter than the average. I think
00:30:44
that's fair. Another one, we've
00:30:46
discussed at length on prior podcast
00:30:48
episodes why the 4% rule is probably not
00:30:50
the thing that you want to base your
00:30:52
entire retirement future on, but at one
00:30:54
point it was a pretty reasonable base
00:30:56
rate. So the point there being that base
00:30:57
rates can change. How about another one?
00:31:00
What if analysis? So again, your base
00:31:02
case for retirement, your base case
00:31:05
should be based on the base rates. And
00:31:07
that's actually a line from my upcoming
00:31:08
Dr. Seuss retirement book called Oh, the
00:31:11
Places You'll Nap. But of course, you
00:31:12
you probably should then run some whatif
00:31:15
analyses. For example, on the Social
00:31:16
Security front, we've discussed here
00:31:18
that your uh the current path to Social
00:31:20
Security does actually have retirey
00:31:22
benefits going down to something like
00:31:23
80% of what's been promised as of 2034
00:31:26
and 2035. Yes, that's kind of a
00:31:29
political suicide for Congress, but you
00:31:31
might want to ask yourself, what if
00:31:33
Congress doesn't step up to the plate
00:31:34
and do something about this? So, okay,
00:31:36
if it's a what if analysis and you're
00:31:38
adjusting the base rate to understand
00:31:40
that, I think that's fair. Anyway,
00:31:42
assumptions, risk, assumptions, risk. A
00:31:44
very good risk to be aware of and a very
00:31:46
good one to try to make sure that your
00:31:48
numbers are as accurate as possible.
00:31:50
Next, we have policy, legislation, and
00:31:52
tax risk. And yes, uh we just talked
00:31:55
about social security. It's time to talk
00:31:56
about social security again because the
00:31:58
biggest kind of sub risks that fall
00:32:00
under the overhead umbrella of
00:32:02
legislation and policy and tax risk are
00:32:04
social security tax rates themselves.
00:32:07
Medicare, RMDs, inflation I actually
00:32:10
think belongs in here in a way and I'll
00:32:12
explain that. And then for an honorable
00:32:14
honorable mention number six, maybe we
00:32:15
can throw the estate tax in there too.
00:32:17
So for some more specifics, social
00:32:18
security, we did just discuss that a
00:32:20
little bit. The main risk here is that
00:32:21
somehow our benefits decrease in a way
00:32:23
that we're currently not planning for.
00:32:25
taxes. We are living in a historically
00:32:27
low tax regime. It's conceivable that we
00:32:30
could live through increases to uh
00:32:32
income taxes, capital gains taxes,
00:32:34
dividend tax treatment is really nice
00:32:35
right now. We could see that retirement
00:32:38
accounts are somehow treated differently
00:32:39
in the future or that state level
00:32:41
taxation of retirement income changes.
00:32:43
You know, in most states, maybe in all
00:32:45
states, I actually don't know this. I
00:32:46
know here in New York State, social
00:32:47
security income isn't taxed. What if
00:32:49
that changes anyway? So taxes could
00:32:51
change for Medicare. I think about the
00:32:53
65 year old eligibility age. The
00:32:56
premiums themselves for part D and part
00:32:58
B, B and D, boy and dog, they have
00:33:00
premiums, coverage changes, out-ofpocket
00:33:02
costs. Again, the idea is that could
00:33:05
legislation somehow change our access to
00:33:07
Medicare and what it does for us. On the
00:33:09
RMD front, we've recently seen the RMD
00:33:13
age change from 70 12 to 72 to 73 and
00:33:17
it's soon to be 75 years old. We've also
00:33:19
seen a lot of changes when it comes to
00:33:20
inherited IAS over recent years. Number
00:33:23
five, inflation policy is a very
00:33:25
interesting one. It's a little nerdy,
00:33:27
but fiscal policy, so-called fiscal
00:33:29
policy is set by Congress, whereas
00:33:31
monetary policy is determined by the
00:33:33
Fed, Federal Reserve. And for the most
00:33:35
part, inflation is related to and
00:33:37
controlled by monetary policy. Whereas,
00:33:39
you know, Congress will certainly hear
00:33:41
your frustration if they pass fiscal
00:33:42
policy that negatively affects you. They
00:33:44
might not change anything, but at least
00:33:46
you can access your local congressperson
00:33:48
to complain. The Fed is much less likely
00:33:50
to care about your personal hardship if
00:33:53
they enact monetary policy that raises
00:33:55
inflation and hurts your retirement
00:33:57
plan. And then last, estate taxes. This
00:33:59
only affects a small portion of people
00:34:00
right now, at least on the federal
00:34:02
level. May probably more of you are
00:34:04
affected at your personal state level
00:34:06
when it comes to estate taxes, but
00:34:07
either way, these rules are certainly
00:34:09
subject to change, and that's really the
00:34:11
risk here. Someone might be all set with
00:34:13
their estate taxes right now only to
00:34:15
find that some change that occurs in 10
00:34:16
or 20 years might totally screw up their
00:34:18
retirement plans. So, what can you do
00:34:21
about policy risk? I think most
00:34:23
retirement plans are built on a set of
00:34:25
uncertain markets plus stable rules. We
00:34:28
consider uncertain markets, but we think
00:34:30
of the rules as being stable. And going
00:34:32
back to a couple minutes ago, I think
00:34:34
that should be the base rate. I think
00:34:35
it's okay and even good to assume stable
00:34:38
rules. And the reason there is that to
00:34:40
predict the instability in the rules I
00:34:42
think is way too much of a crystal ball
00:34:44
exercise than is merited. Right? I
00:34:46
cannot predict the future and we
00:34:47
shouldn't be in the business of
00:34:48
predicting the future. But I think we
00:34:50
can be realistic and admit that policies
00:34:52
have changed before and probably will
00:34:54
change again. We don't know if they'll
00:34:55
change in our favor or change against
00:34:57
us. But I think it's okay to assume that
00:34:59
they'll change again. And I think it's
00:35:00
okay if in our planning we ask those
00:35:02
whatif questions, right? The base rate
00:35:04
reflects reality. The base plan reflects
00:35:07
reality. But then we ask some what if
00:35:08
questions that might involve uncertain
00:35:10
rules. You know, what if my social
00:35:12
security benefit does decline by 20%.
00:35:14
What if my effective tax rate does go up
00:35:16
by 5%. Those kind of things. And I think
00:35:18
those are fair questions. Certainly
00:35:19
worth understanding the answers to, but
00:35:21
again, it doesn't mean that those
00:35:23
answers belong in your base rate
00:35:25
assumptions. Here's a quick ad and then
00:35:28
we'll get back to the show. Serious
00:35:30
question. Why do podcasters constantly
00:35:32
ask for ratings and reviews? Yes, they
00:35:35
do help highlight our shows to new
00:35:37
listeners. They help strangers find us
00:35:39
on Apple Podcast and Spotify. It's
00:35:41
totally true and a good reason to ask
00:35:42
for ratings and reviews, but I have
00:35:45
something more important, at least more
00:35:46
important to me. I want to know if you
00:35:49
like this stuff. I want to know if you
00:35:51
like my podcast episodes, my monologues,
00:35:53
my guests, the information I share with
00:35:55
you and the stories I tell. I want to
00:35:57
improve and make your listening more
00:35:59
enjoyable in the process. So, yeah, I
00:36:01
would love to read your reviews. And
00:36:03
sure, if you throw a rating in there,
00:36:04
too, that's great. If you like what I'm
00:36:06
doing, please share it with me. It's
00:36:08
such a great feeling to read your
00:36:10
feedback. I'd love to read your review
00:36:13
or see a rating on Apple Podcasts or
00:36:15
Spotify. Thank you. And now, let's get
00:36:17
to our second to last risk today. We're
00:36:20
going to dive into identity and purpose
00:36:21
risk. You know, there are entire books,
00:36:23
entire websites, entire podcasts, just a
00:36:25
big body of work dedicated to this one
00:36:27
topic. And you know the idea here is you
00:36:30
don't want to retire from something, you
00:36:31
want to retire to something. You want to
00:36:33
think about all the positive things you
00:36:34
get from work and ask yourself how
00:36:36
you'll replace those things in
00:36:37
retirement. You want to think about, you
00:36:39
know, the structure of your days and the
00:36:41
social interactions and status that you
00:36:43
get at work and how you were made to
00:36:45
feel useful in your life. Here's a fun
00:36:47
one. Think about all those phrases that
00:36:49
currently maybe or or used to be when
00:36:51
you were working. They're in the form of
00:36:52
I am a blank or I do blank or I help
00:36:55
people with blank. And when you retire,
00:36:57
all those phrases become past tense. I
00:36:58
used to be blank. Oh, back when I was
00:37:00
working, I did blank. Oh, yeah. I used
00:37:02
to help people with that back in the
00:37:04
day. Is it Marlon Brando in that movie
00:37:06
On the Waterfront?
00:37:07
>> You don't understand. I could have had
00:37:08
class. I could have been a contender.
00:37:12
I could have been somebody
00:37:15
instead of a bum, which is what I am.
00:37:18
Let's face it. The point here is that a
00:37:21
lot of retirees struggle with their
00:37:23
identity and the purpose that they
00:37:26
didn't realize they are missing until
00:37:27
it's too late. It might have and usually
00:37:29
does come from work in some way, shape
00:37:31
or form. And anyway, many retirees
00:37:33
struggle with that. And I think the
00:37:34
takeaway or at least the solution is
00:37:35
that it takes legitimate work to
00:37:38
mitigate identity and purpose risk,
00:37:40
mental work, thought. It takes
00:37:41
legitimate thought. Back on episode 106
00:37:44
of this podcast, I spent most of that
00:37:46
episode talking about just this topic.
00:37:47
The episode is called The Big
00:37:49
Disconnect: Pre-retirey Expectations
00:37:51
Versus Retirement Reality. I think
00:37:53
there's the one stat from that episode
00:37:55
that I come back to time and time again,
00:37:56
which is that the average pre-retiree
00:37:59
ranks finances as their top concern, but
00:38:02
the average postretire finances is
00:38:05
something like number six. And all of
00:38:07
their top concerns as an actual retiree
00:38:09
as a post-retire, almost all of their
00:38:11
top concerns have to do with identity
00:38:13
and purpose. But back in that episode, I
00:38:15
talked about three exercises you can do
00:38:17
to help on this front. They're called
00:38:19
the perfect day exercise, the icky guy
00:38:21
map exercise, and then the rocking chair
00:38:24
test. So, I I highly recommend you go
00:38:26
check out that episode and and make sure
00:38:27
you've done all three exercises if
00:38:29
retirement is kind of on your horizon.
00:38:31
Purpose and identity risk is the driver
00:38:32
behind why retirement increases the
00:38:35
probability of depression by about 40%.
00:38:37
I mean, just think about that for a
00:38:39
moment. You know, most people probably
00:38:40
assume retirement is like an extended
00:38:42
vacation, right? free time, travel,
00:38:44
tennis, seeing the family, doing
00:38:46
crosswords on a calm morning than a hot
00:38:48
coffee in hand, loons calling to each
00:38:50
other in the distance on the lake. I
00:38:51
mean, that is what people think about in
00:38:53
retirement. And how could that image
00:38:55
elicit more depression than the 9to-ive
00:38:57
grind? So clearly, I mean, what I'm
00:39:00
saying is that many of our assumptions
00:39:01
about retirement must be misplaced, just
00:39:04
not meshing with the actual realities of
00:39:07
retirement. And I think that purpose and
00:39:09
identity risk are probably a really big
00:39:11
reason why. So anyway, that is an
00:39:13
important thought process when it comes
00:39:14
to purpose and identity risk. And that
00:39:16
brings us to the final risk of this two
00:39:18
episode series which are called the deep
00:39:21
risks. Now many people put Bill
00:39:23
Bernstein on their Mount Rushmore of
00:39:25
investment communicators. He mostly does
00:39:27
writing, you know, along with the the
00:39:29
Warren Buffetts and the John Bogles and
00:39:30
the Jason Swags of the world.
00:39:32
Bernstein's most well-known books are
00:39:33
are probably the four pillars of
00:39:35
investing, the intelligent asset
00:39:36
allocator. He has a really short book, I
00:39:39
think it's only 15 or 16 pages long,
00:39:41
called If You Can, and it's targeted
00:39:43
toward, I believe, investment beginners.
00:39:45
He also has a couple interesting books
00:39:46
that are more about economic history, a
00:39:48
splendid exchange, and the birth of
00:39:50
plenty. But in 2013, he wrote a book
00:39:52
only 56 pages long, and it's called Deep
00:39:55
Risk: How History Informs Portfolio
00:39:57
Design. And Bernstein's main point in
00:39:59
that book, Deep Risk, is that standard
00:40:02
investment strategy, the kind of stuff
00:40:03
that we talk about here, to be candid,
00:40:05
the kind of stuff that almost all
00:40:07
personal finance and investing content
00:40:09
talks about, looks at relatively
00:40:11
short-term volatility and thinks about
00:40:13
bare markets that last, you know, a few
00:40:15
months, maybe a couple years, 3, four
00:40:17
years, that kind of thing. But Bernstein
00:40:19
says that real world investors are
00:40:21
subjected to sometimes long horizon
00:40:23
perils that we ought to be much more
00:40:25
focused on. These perils can stem from
00:40:27
both economic and military concerns and
00:40:30
they can actually cause sometimes
00:40:31
multi-deade hiccups in our retirement
00:40:34
plans which let's be honest multi-deade
00:40:36
might just be the full tenure of your
00:40:38
retirement plan in the first place and
00:40:40
these perils are what he would call deep
00:40:42
risks and Bernstein writes these risks
00:40:45
have names inflation deflation
00:40:47
confiscation and devastation and any
00:40:49
useful discussion of portfolio design
00:40:51
incorporates their probabilities
00:40:53
consequences and costs of mitigation.
00:40:55
Now, we already talked about inflation
00:40:57
as one of our major 14 risks. That was
00:41:00
last week on episode 140. So, I'll leave
00:41:02
inflation there. But let's talk about
00:41:03
deflation, confiscation, and devastation
00:41:05
real quick. If we're going to discuss
00:41:07
deflation, we probably should just look
00:41:08
at the Great Depression. Falling prices,
00:41:10
collapsing demand, a financial system
00:41:12
that's under stress. Whereas inflation
00:41:14
makes you want to invest all of your
00:41:16
cash, right? Deflation is where cash is
00:41:18
king. So, how do we combat deflation?
00:41:21
You probably want to hold some high
00:41:22
quality bonds and cash. You want to
00:41:24
maintain your liquidity. You want to
00:41:26
avoid excess leverage if you can. Then
00:41:28
again, right, deflation has almost never
00:41:30
happened. It's really only happened in
00:41:31
one consequential way here in the US.
00:41:34
But that's part of Bernstein's point is
00:41:36
that these deep risks are very damaging
00:41:38
when they occur. They can occur over a
00:41:40
long timeline when they occur, but
00:41:42
they're also kind of rare. And that's
00:41:44
part of the really hard part about deep
00:41:45
risk is like how do you handle something
00:41:46
that if it occurs could really screw you
00:41:49
up, but it's just probably not going to
00:41:51
occur. That's a hard problem. Anyway, we
00:41:53
we'll come back to this idea. I I told
00:41:54
you it's a hard problem. Bernsteeen has
00:41:56
some thoughts on that that I'll share
00:41:57
with you at the end. But first, let's
00:41:59
talk about confiscation as a topic and
00:42:01
it tends to make people a little
00:42:02
uncomfortable if we zoom out to a global
00:42:04
perspective. History is full of
00:42:05
governments who change the rules or just
00:42:07
large institutions who change the rules.
00:42:09
Sometimes it might just be higher taxes.
00:42:11
Sometimes it might be asset seizures or
00:42:12
like nationalization. Confiscation is a
00:42:15
risk that someone more powerful than you
00:42:16
changes the rules to your disadvantage.
00:42:18
So, how do we combat this risk?
00:42:20
Bernstein admits it's not easy and at
00:42:22
times not even worth doing. In other
00:42:24
words, it might be one of those risks
00:42:25
that we simply have to live with. But we
00:42:27
certainly want to diversify across
00:42:29
jurisdictions if it's easy. We want to
00:42:31
hold assets from different parts of the
00:42:32
world. And if you want to really get
00:42:34
crazy, and it's certainly crazier than
00:42:35
anything I have done or am doing, you
00:42:38
could even choose to custody your assets
00:42:40
in different jurisdictions. I I guess
00:42:42
that means, you know, have a brokerage
00:42:43
account in the US and in Switzerland and
00:42:45
in Japan. I don't know. Like I said,
00:42:47
that's it's too much complexity for me.
00:42:49
But technically it does reduce your
00:42:50
exposure to confiscation risk in a in
00:42:53
one particular country. And that leaves
00:42:55
us with the last one, devastation risk.
00:42:57
You know, war, revolution, societal
00:42:59
collapse, situations where entire
00:43:01
markets are wiped to zero or where your
00:43:03
your citizens property rights are simply
00:43:06
erased. Those are probably situations
00:43:08
where, frankly, financial planning
00:43:09
doesn't even really matter anymore. Now,
00:43:11
if your home, your country, your society
00:43:13
collapses, yeah, I'm not sure there's
00:43:15
much you can do. But it's possible that
00:43:16
in a globally diversified portfolio that
00:43:18
some portion of your investment holdings
00:43:20
do go through some form of devastation.
00:43:22
I think as an example, you could look at
00:43:24
the country of Venezuela over recent
00:43:26
decades, the really 30,000 foot
00:43:28
highlights or low lightss. The oil
00:43:30
industry in Venezuela grew and grew and
00:43:31
grew until partially in the 1970s and
00:43:35
then it kind of finished off in the
00:43:36
early 2000s led by Ugo Chavez. the oil
00:43:39
companies in Venezuela had their assets
00:43:41
seized by the government and were
00:43:42
basically forced out. That's
00:43:44
nationalization. Maybe that's not a
00:43:45
devastation risk, right? Maybe that's
00:43:47
certainly more of a confiscation risk.
00:43:49
But then I guess you could say what's
00:43:50
going on in Venezuela today is much more
00:43:52
similar to a devastation risk than
00:43:54
anything else. And certainly the the oil
00:43:56
nationalization and what happened there
00:43:58
was a bit of a preceding event to what's
00:44:00
occurring today in in modern Venezuela.
00:44:02
It's not good. Now, assuming you
00:44:04
listening that you're not Venezuelan,
00:44:05
these events probably don't impact you
00:44:07
too much in your day-to-day. But as a a
00:44:09
globally diversified investor, yeah, you
00:44:11
probably had some exposure to these
00:44:13
energy companies when Venezuela kicked
00:44:15
them out. And you might have some
00:44:16
exposure to some side effects of some of
00:44:18
the devastation that's going on in
00:44:19
Venezuela. It's probably a small
00:44:21
exposure that you have because Venezuela
00:44:23
is a relatively small country, but that
00:44:24
risk is there. Now, the big insight when
00:44:27
it comes from Bernstein's wisdom on the
00:44:29
deep risks is that no single asset
00:44:32
protects you from all the risks, let
00:44:34
alone from all the deep risks, right? We
00:44:36
talked about 14 different risks over
00:44:37
these last two episodes. Stocks help
00:44:40
with some risks, but stocks actually
00:44:42
expose you to other risks. Bonds help
00:44:44
with deflation, but bonds get eaten
00:44:46
alive by inflation. Global
00:44:48
diversification helps out, but not
00:44:50
perfectly. Some risks are totally out of
00:44:52
your hands. Some risks are deeply
00:44:54
personal, tied to our health or tied to
00:44:56
our happiness. Some risks are tied to
00:44:58
markets. Some are tied to the
00:44:59
government. Some are tied to the other
00:45:01
people in our lives. Right? There's no
00:45:02
silver bullet when it comes to combating
00:45:04
all these risks. But I hope that this
00:45:06
exercise over the last two episodes has
00:45:08
helped you conceptualize these 14 unique
00:45:10
risks that I think most retirees face or
00:45:13
could face and has given you some ideas
00:45:15
about what you might address in your
00:45:17
personal retirement plan. Maybe where
00:45:18
some of the holes are. Maybe as Charlie
00:45:20
Munger would have said, "Show me where
00:45:22
I'm going to die to make sure I never go
00:45:24
there." I've shown you a lot of the
00:45:25
risks that could face you in your
00:45:27
retirement. Now, it's up to you to
00:45:28
decide if you're exposed to that risk or
00:45:30
what you can do to quote unquote never
00:45:32
go there. So, thank you as always for
00:45:34
listening to Personal Finance for
00:45:35
Long-Term Investors.
00:45:36
>> Thanks for tuning in to this episode of
00:45:38
Personal Finance for Long-Term
00:45:40
Investors. If you have a question for
00:45:42
Jesse to answer on a future episode,
00:45:44
send him an email over at his blog, The
00:45:46
Best Interest. His email address is
00:45:48
00:45:51
Again, that's jessevestinterest.blog.
00:45:55
Did you enjoy the show? Subscribe, rate,
00:45:57
and review the podcast wherever you
00:45:59
listen. This helps others find the show
00:46:01
and invest in knowledge themselves, and
00:46:04
we really appreciate it. We'll catch you
00:46:06
on the next episode of Personal Finance
00:46:08
for Long-Term Investors. Personal
00:46:10
Finance for Long-Term Investors is a
00:46:12
personal podcast meant for education and
00:46:14
entertainment. It should not be taken as
00:46:16
financial advice and it's not
00:46:18
prescriptive of your financial
00:46:19
situation.
