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Let's experiment with an interesting approach to retirement planning that borrows from one of history's greatest
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problem solvers. Most of us ask ourselves, "What does success look like and how can I achieve it?" But what if
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instead we asked, "What does failure look like and how can we avoid it?"
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Let's identify all the risks we might face or ways we might fail and only then
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decide the positive actions we should take to mitigate those risks. Welcome to personal finance for long-term
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investors, where we believe Benjamin Franklin's advice that an investment in
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knowledge pays the best interest both in finances and in your life. Every episode
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teaches you personal finance and long-term investing in simple terms. Now, here's your host, Jesse Kramer.
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Welcome to Personal Finance for Long-Term Investors, episode 140. I'm Jesse Kramer. I'm a financial planner
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working with retirees and busy professionals prepping for retirement across the USA. You can learn more at
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planwithjesse.com. This week's review of the week is from Steve Stewart, who left kind words and a
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five-star rating on Apple Podcasts. Steve, drop me an email to jesseb bestinest.blog and I'll get a supersoft
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podcast t-shirt mailed out to you. Now, on with the show. I was listening recently to one of Charlie Mer's famous
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parables. Probably the the 10th time I've heard him tell the same story. Charlie dropped out of Michigan to serve
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in World War II and he entered the Army Air Corps, which was the predecessor to the US Air Force. And with Munger's math
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background, he was a math major at Michigan. He was sent out to Caltech in California to learn how to be a weather
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forecaster for the Army. Now, working for the Army Air Corps, he famously thought to himself, "How can I kill
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these pilots?" Yes, how can I kill these pilots? He kind of turned the problem on
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his head, and he came to two overwhelmingly strong conclusions. The most accidental yet obvious ways that he
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could get pilots into trouble were by either one sending them too far a field kind of against the wind such that they
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would actually run out of fuel before returning back home. And then number two was sending them into cold and wet and
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icy conditions such that ice would build up on their wings. It would weigh down the planes and cause them to crash. So
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those were the two most obvious and most common death mechanisms that Munger identified and he then became fanatic
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about reverse engineering the best practices to ensure that he helped his pilots avoid those two fates. You might
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have heard me discuss Charlie Munger's principle of inversion. This is the principle of inversion that we're
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talking about. You might have heard me discuss it before, but we're going to
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double down on the principle of inversion today. I'm going to walk you through the most common ways retirees
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and long-term investors can fail at achieving their goals. We'll identify the biggest risks they face and the most
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obvious failure points along the way. And then only after thinking about how we can get ourselves into the biggest
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trouble will we invert our issues and find the smart solutions. So first my thought was let's identify these risks
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that we're going to be talking about today. And I should say before we go any
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further today's going to be part one because I've got a list of 14 risks and
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we're going to dive into them with with some detail. We're going to cover the
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first seven risks today on episode 140. We're going to cover the second set of
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seven risks next week on episode 141. So, let's first compile this massive list of the 14 risks that retirees and
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long-term investors face. And I'll do a kind of just a really quick description
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before diving into more detail. So, number one, longevity risk. I think it's
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probably the biggest, most obvious risk that I can think of when it comes to retirement. It's the risk that you live
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so long that you run out of money. That you've only built a retirement plan assuming you'd live until 75 or 80 and
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then you end up living till 95. That's longevity risk. Number two is inflation
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risk, which a lot of these risks are going to be interconnected in some way. And inflation risk certainly has a
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connection to longevity risk. But inflation risk is this everpresent and kind of modern economy's risk. Meaning
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that today's dollar is going to lose spending power over time. And combined with living longer than expected,
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inflation risk means our current dollars simply won't go far enough into the
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future. That is inflation risk. And number three, I call it partner risk or household risk or stakeholder risk.
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Maybe partner risk for short. And the idea is, you know, are you and your spouse or you and your kids or you and
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whomever is important in your life. Are you guys on the same page? Could disagreements throw off your plan, your
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financial plan in some way or could an untimely death, you know, the death of a partner throw off your plan in some way?
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So basically the idea is there, you know, how contingent is your plan on the other people in your life and is that a
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risk? That is partner risk. Number four, market risk. And just kind of in general, market risk. The idea here is
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that investments can go down in value, meaning that there is a risk that investments actually hurt your plan more
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than they help your plan. That's market risk. And then fifth is a specific type
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of market risk that we've heard many times on this podcast before, I know, sequence of returns risk. That's number
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five. It's a particular market risk. Even if your investments go up over the
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long run, if they go down too early in your retirement, it can create this chain reaction that you never actually
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recover from. That is sequence of returns risk. Number five. Number six, withdrawal risk. Your cash flow needs
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are too much for your portfolio and you're simply withdrawing too much too quickly. That's withdrawal risk. Number
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seven I have is health risk. And again, it's a general risk. Will you find yourself at 70 years old too weak or too
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sick to, you know, hop on a plane to play with your grandkids to live whatever version of an active retirement
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that you've been hoping for? That is health risk number seven. Number eight,
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I call shock spending risk, but most specifically, I think of it as long-term care risk. It's the care of this sudden,
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unforeseen, extremely large spending need. So, these kind of unforeseen large expenses are one of the biggest
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derailers of a retirement plan. One of the most common culprits happens to be long-term care, which often costs more
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than $10,000 per month for multiple years at a time. So, that's the eighth risk, shock spending/ long-term care
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risk. Number nine, cognitive decline risk. It's related to health risk in general. It's also related to behavioral
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risk, which we'll talk about next. But the idea here is that cognitive decline,
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sure, it's got its own health risks associated with it. We'll talk about
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those in the health section. But it also exposes us to maybe some irrational behavior, less logical behavior, more
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susceptibility to scams and things like that. So that's why cognitive decline
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risk has its own category here. Number 10, behavior risk. Will you get in your own way and make irrational decisions?
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Will you let fear or greed or following the herd guide your decisions to your own detriment? That's behavior risk.
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That's number 10. Number 11, I call assumptions risk. It's an interesting
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one that sits kind of underneath a lot of the other risks. It's that overly optimistic return assumptions or
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underestimating inflation or ignoring taxes or assuming a static spending rate over time. It's the risk that our model
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itself, our retirement model is wrong. That's assumptions risk number 11. And
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it's pretty prevalent among the DIYer community, I've got to say. Number 12,
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policy, legislation, and tax risk. So think about tax rates, interest rates, social security policy, which I know is
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a really hot topic for those people who are worried about if social security will somehow change in a big way over
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their retirement. RMDs is another big one, estate taxes. There are a lot of vital inputs to retirement that are
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frankly out of your hands. They involve the government in some way. So what can you do to kind of mitigate your risk in
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these situations? That's number 12, policy, legislation, and tax risk. Number 13, I call identity and purpose
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risk. If I can't scuba, then what's this all been about? What am I working
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toward? >> Create from the office. So, forget about finances. What about your life excites
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you? You know, is there any chance that you're going to find yourself with this
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mid-retirement crisis because you're not sure what it's all about for you?
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There's an interesting stat. I'm going to steal it real quickly from Fritz
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Gilbert. I think it's that 28% of retirees at some point self-describe their feelings as depressive in some
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way. Maybe they don't have full-fledged depression like a a psychiatrist would
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diagnose, but they actually feel kind of this melancholy about their retirement.
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So, that presents identity and purpose risk number 13 today. And that brings us to number 14, perhaps the most unique
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one that I've added to this list. It's called the deep risks. Deep risk is a
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term coined by Bill Bernstein, very famous investing writer, and it covers four massive risks to long-term
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investing. Inflation is the most common deep risk and deserves its own call out which we've already done here. But the
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other three are what I'm going to talk about here with number 14. The other three deep risks are deflation,
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confiscation, and devastation. And I'll explain those all in detail when we get
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to number 14. And the question here is, how will your retirement fare in the face of one of those sociopolitical deep
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risks? So those are my 14 risks. And today I'm going to deep dive into the first seven of those 14. And we'll
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finish the list next week on episode 141. So, let's work through the first seven risks to consider the the ways we
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could mitigate and combat those risks. And as we step through this exercise today and next episode, here's what I
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would encourage you to do. I do not think you need to take what I'm about to
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say as some sort of dire warning that you must change your ways. I don't want
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you to hear these 14 risks and these 14 sets of solutions and and think to yourself, you know, oh my god, I'm at
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risk and I have to immediately act because our financial plans, our retirement plans, we do we should
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measure them in decades. They are these kind of metaphorical uh aircraft carriers, right? That are slow to gain
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momentum, slow to change direction, slow to do just about everything, but yet also very powerful over the long run.
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And so for just about every aspect of our financial plans, we can and should take our time with these decisions. And
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these risks that I talk about today and and the responses are something that perhaps you should take under
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consideration, you should think about, but I don't want you to think that there's some sort of burning fire that
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you must address today. So with that preamble, let's discuss our first risk,
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longevity risk. Again, to me, the biggest, most obvious retirement risk that I can think of, it's the risk that
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you live so long for one reason or another, that you run out of money. That you built a retirement plan, assuming
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you'd live until age 75, but then you end up living to age 95. Now, the real
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nasty part about longevity risk is that it's it's a risk magnifier. It's not
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just about how long you live. It's really about how that extra decade or extra two decades of life interact with
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many of the other risks that we've talked about today. Inflation, market volatility, health care costs, changing
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spending patterns, etc. So longevity can sometimes magnify your exposure to the other risks. Nevertheless, let's talk
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about some of the smartest financial planning strategies to mitigate and combat longevity risk specifically. So
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here in the USA, every retiree, at least every retiree who's worked at least 10
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years contributing into the social security system, every retiree has social security available to them. And
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every retiree who has that social security available to them can choose to delay social security to age 70. That
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is, in my opinion, the biggest single way to combat longevity risk. For a quick numerical example to explain that,
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let's compare someone who claims social security at age 62 versus 67 versus 70.
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And then let's think about longevity. So if we're talking about longevity risk,
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we should probably think about someone who lives a long time. So for this example, they'll live to age 90. Now
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using typical social security benefits, for those of you listening right now, a normal average scenario would see
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someone claiming at age 62, they might collect $610,000 between age 62 and age 90. If they
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delay, if that same person based on that benefit size, if they delay social security until age 67, they would
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collect $720,000 by age 90. And if they delay claiming until age 70, they would collect
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$780,000 by age 90. Now, so that's, you know what, between the worst case collecting at age 62 and the best case
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collecting at age 70, that was a $170,000 difference in in how much they collected
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over those years. And if this person lives to age 100, the total difference in benefits between the two claiming
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strategies could easily surpass $300,000. Now, that's guaranteed income. Guaranteed income from social security.
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It's a fantastic tool for longevity insurance for most retirees. But what else could we do? Well, we can also
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build growth and inflation protection into the assets that we own. Now, the problem with that particular answer is
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that growth and inflation protection aren't ever truly guaranteed. It's never
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like a silver bullet. The assets I'm talking about here, for example, would be stocks. Stocks have a a great kind of
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growth engine built into them that if you're diversified enough, should kind
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of float on the rising tide of inflation over time. That's the way that stocks
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behave. Real estate the same way. TIPS, which are Treasury inflation protected securities, have a small measure of
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inflation protection built into the products themselves. And history would tell us that these assets hold up well
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over the long run, even in the face of inflation. And to me, most of the time, that's kind of the best that we can do.
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We use history to guide us into the future. But that's not quite a guarantee, at least not in the same way
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that social security benefits are a guarantee. You could choose to also look at simple annuities here. Something like
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a SPIA, a single premium immediate annuity. Or some retirees also like using a MIGA, a multi-year guaranteed
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annuity, similar to a SPIA, but usually only lasts up to 10 years. Now, on episode 131, I recorded a deep dive on
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annuities, including why most annuities in this world, I think are not good for investors like us. But I also admitted
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in that episode that there are some annuities, including SPIA, including MAS, that at the very least I would
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qualify, classify as acceptable. I don't know if I'll ever recommend one, but I'
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I'd understand if someone chose to buy one. And the reason is that SPIA especially provide longevity insurance.
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They provide guaranteed income for life. Now, most of us will die early enough such that the SPIA math does not work in
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our favor. But some of us will live long enough to see the SPIA fundamentally improve our retirement finances. That's
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how insurance products work, right? Most of us buy insurance and we don't get as
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much money out of it as we put in. It's a losing deal for us. But for some people, insurance tends is a winning
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deal. It saves their lives in some way. And annuities are that. What are they insurance against? Longevity risk.
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Annuities are longevity insurance. Now, as for the rest of what we can do to combat longevity risk, it really
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involves talking about some of the other risks. It talks about battling inflation, battling sequence of returns,
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choosing spending and withdrawal flexibility, building protection for long-term care costs. But if there's one
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major risk I think most retirees should focus on, it's longevity risk. Here's a
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quick ad and then we'll get back to the show. I send a free weekly email to thousands of readers that shares two
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simple things, just two. The first are my new articles and podcasts, so you'll
00:14:36
never miss when I publish new content. And the second is my favorite financial content from other corners of the
00:14:41
internet, so you can see what's been helping me the most. But Jesse, I don't
00:14:45
want another email. >> I hear you. I make this newsletter short, sweet, and full of essential
00:14:50
information, and readers enjoy that. About 85% of newsletter subscribers are engaging with the newsletter more than
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once a month. They're enjoying it, and you will, too. You can subscribe for free on the homepage at
00:15:00
bestinterest.blog, blog and you'll get a free PDF of my white paper titled the
00:15:04
step-by-step guide to building your retirement paycheck. That's right, a free weekly email that thousands of
00:15:09
people like you are already reading, a free white paper to help you plan for retirement. And you can sign up for free
00:15:15
at bestinterest.blog. And that brings us to our second risk, inflation risk is the second one I want
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to talk about. Inflation again is this everpresent phenomena in modern economies, meaning today's dollar will
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lose spending power over time. And combined with living longer than expected, inflation risk means our
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current dollars simply won't go far enough into the future to meet our needs. Now, the number one tactic, I
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think, to combat inflation risk is to own assets that traditionally outpace inflation and minimize your exposure to
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assets that get decimated by inflation. Bonds and cash, for example, they get decimated by inflation. There's no sort
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of inflation adjustment built into cash and bonds. But with stocks and the companies that stocks represent, there's
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a natural pricing mechanism at play where the companies will slowly but surely increase their prices over time,
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increasing their revenues over time, meaning that your returns as a stock owner have this kind of tether to
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inflation rates. Think of it as a buoy that floats up and down with a tide. If inflation rates are just going up up up,
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the tide's going up up up, stocks in general tend to rise with that that rising tide. But that brings up this
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really amazing interesting thing about stocks and bonds in particular. And the amazing thing is there's no perfect
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asset for our long-term needs. Stock returns cannot be relied upon in the short and medium-term. We must use a a
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more dependable, less volatile asset for those short-term cash outlays. Cash or bonds are a suitable choice for that.
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And we must accept the lower returns from those assets as a price to pay. And we also must accept that we we might
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lose pays to inflation. We might lose some ground to inflation, I should say, at least over the short run if we're
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holding cash and bonds to meet our short-term needs. That's just the price we pay. Nothing is free in the world of
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investing. For higher growth, the cost is more volatility, but for greater stability, to meet our short-term needs,
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the price is less growth. And so cash and bonds help us fight sequence of returns risk, which we'll get to in a
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minute. Cash and bonds ensure our financial plan has this really strong foundation over the near-term and the
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medium-term years, but cash and bonds also expose us to inflation risk. So, we need to find a balance between fighting
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inflation risk and then fighting sequence of returns risk and fighting market risk. And my point is that I've
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got 14 unique risks I'm talking about today and between today and next episode, I should say. And some of the
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tools we use to fight risk Actually expose us more to risk B. And some of the tools we're going to use to fight
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risk C expose us more to risk D. And a big part of financial planning is finding that right balance where how do
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we in general kind of minimize our exposure across this broad spectrum of risks? How do we identify which of these
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specific risks we're kind of uniquely most exposed to in our situation? Anyway, it's why I think it's such a fun
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exercise. That said, you know, stocks aren't necessarily the only asset that
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tends to be kind of inflationproof over time. real estate, infrastructure, commodities. Generally, these assets
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have some sort of income stream connected to inflation or simply go up in value with inflation. Real estate,
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infra, in infrastructure, and commodities. But I do have some issues with these assets, I will say. So, if
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you're owning individual real estate, you're subjecting yourself to a really
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big concentration risk and quite a bit of hassle usually. If you decide to own real estate through a REIT, a real
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estate investment trust, well, in that case, your investment risk actually looks a lot more like equity risk like
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the stock market, then it looks like real estate. So, that's not necessarily
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what you're going for. With commodities, you're not really owning an income
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producing asset. I think the only economic argument for owning commodities is that you'll keep up with inflation
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itself, nothing more compared to stocks. I don't really like that trade-off. But
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at the same time, there are many plenty of long-term investing ideas that include real estate, include
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commodities, include other alternatives, and they look good over historical back
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tests. So to each your own, to each their own on this topic. The point is that inflation risk is a real threat in
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retirement, and you need to make sure that your financial plan combats that risk. And number three here, I want to
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touch on partner risk or household risk or or stakeholder risk. And again, are you and your spouse, are you and your
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kids, are you and whomever, are you on the same page? And could some sort of disagreement or maybe an untimely death
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throw off your long-term plan, your retirement plan? I think about different ages, different lifespans, different
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spending habits, different levels of financial literacy, different priorities in life. This risk is much less about
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any sort of investment decision, but really mainly solely about communication and the financial plan itself. So, first
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you need to plan for both lifetimes, not just average outcomes. I think it's
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important that you need to plan out and model a scenario where maybe one spouse lives significantly longer than the
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other. Especially important if there's an age gap, if there's a health difference. It ensures that the
00:20:03
surviving partner doesn't run out of money later in life. And you also need to model out the the widow widowerower
00:20:09
scenario because you know what happens financially when one person dies. Some key things to evaluate could include a
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loss or reduction of income because pensions might cease to exist or might be diminished after the pensioner passes
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away. Social Security benefits can change a lot before and after a death. Changes in expenses are a major one,
00:20:29
right? Some expenses might drop away when one partner dies, but some expenses don't go away at all. There's some
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pretty good stats out there that suggest that if the average married couple is spending 100%. Then after the first
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partner dies, the surviving spouse is still probably spending somewhere between 60 and 70%. Because some
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expenses don't get cut in half when one partner dies, they they remain the same.
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Tax filing status is a big one, right? Filing jointly is more efficient than filing single. And after uh the first
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spouse dies, I believe that the surviving spouse has a a full year to file jointly still, but then they have
00:21:05
to start filing single and that's less efficient than filing jointly. So these
00:21:09
kind of things, these issues are common points of failure, at least common points of inefficiency in otherwise
00:21:14
solid financial plans. Next, I think it's important that both partners truly
00:21:18
understand the plan. You know, a classic risk is that one person runs everything,
00:21:22
runs all the numbers, and the other partner says, "Yeah, well, I trust you.
00:21:25
You're the finance person. and you're the money person. But I don't like that.
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I think both partners at least ought to know where assets are held, how income is being generated, or really what I
00:21:35
should say is kind of like how the retirement paycheck, so to speak, is being created, who to call for help. I
00:21:40
don't think that both partners have to be deep experts. That's maybe unrealistic, but you don't want one
00:21:45
partner to feel totally financially lost. Next, I think that every retirey couple should be on the same page about
00:21:51
spending. What's essential spending? What's flexible spending? How might you
00:21:55
adjust spending in bad market conditions? What does that cut back kind of look like? Because spending, as we'll
00:22:01
get to in in a few minutes, spending leads to withdrawing, withdrawal rates. Withdrawal rates are a slippery slope
00:22:06
toward heightened retirement risk. There's some other, you know, aspects of financial plans that are less have to do
00:22:11
with numbers, more have to do with documentation that both partners ought to know. updated wills and estate
00:22:16
documents, powers of attorney, beneficiary designations, clear account titling, and then you might not want to
00:22:22
always figure this out alone. Even if you are the most hardcore DIYer, your spouse might not be. So think about
00:22:28
building some sort of circle of trusted adviserss or at least trusted contacts. Whether it's an estate attorney, a
00:22:34
financial planner, an accountant, a trusted family member. The key is to have a surviving partner to have
00:22:40
hopefully somebody in the loop who they already know and trust. You know, there's a a decentsized list. Maybe I'm
00:22:46
I'm a little surprised by how long the list is, but there's a decent sized list
00:22:49
of listeners like you who have written to me with a perfectly nice email saying, "Jesse, I'm a DIYer. I plan to
00:22:55
be a DIYer until I die, but I told my spouse to call you when I die." Well,
00:23:00
thank you very much. That's an honor. I will say at times it might be important
00:23:03
to start those kind of conversations before death just to establish a little bit of a trusting relationship and maybe
00:23:09
get some ideas for improvement in place earlier rather than later. But the point
00:23:13
is that uh you don't want to overexpose yourself or your family to this partner
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risk, household risk, stakeholder risk. Whether it involves one person dying sooner than anticipated, whether it
00:23:24
involves one person having all the information and the other person having none of the information, or maybe it
00:23:28
just involves disagreements between how the two of you want to approach your your spending, your investing, how you
00:23:33
approach the money side of retirement. Partner risk is a really big one that you want to mitigate over the long run.
00:23:39
Next up, number four on our list is market risk. In a very general sense, market risk is the idea that investments
00:23:45
can go down in value. Meaning that there's a risk that investments hurt you more than they actually help you. And
00:23:51
market risk is in a very kind of dictionary definition kind of way. It's a risk that you cannot diversify away
00:23:57
entirely. Market risk is the price of admission for long-term investing. If you want the long-term returns that the
00:24:03
market has to offer, you have to accept that sometimes those markets will fall. So, the goal isn't to eliminate market
00:24:10
risk. It's to survive market risk, to avoid being totally undone by market risk. And some of you might think, well,
00:24:16
market risk, sure, this is why I diversify, isn't it? This is why I I diversify my assets. And and yes, you
00:24:21
want to own thousands of stocks across different industries, geographies, market caps, etc. And that reduces the
00:24:27
risk that any one company's failure will derail your plan. But you still face
00:24:31
market risk. Even diversified stock portfolios drop by large amounts with, in my opinion, unsettling frequency.
00:24:37
Diversification means that you avoided kind of additional unnecessary risks, but you cannot diversify away market
00:24:43
risk. So to truly kind of defeat market risk, I think the first thing you need to realize is that time is your biggest
00:24:49
ally. Time. If you need money in two years, the stock market is a dangerous place to be. But if you need money in 20
00:24:56
years, the stock market's volatility really becomes your friend. Market risk
00:25:01
can be totally eliminated or very close to totally eliminated as long as you're
00:25:05
not forced to sell your stocks at the worst times. I think you can and should rebalance to combat market risk. That's
00:25:12
a big tool that you can use in your favor is rebalancing. I spoke about this in depth on episode 138. Generally, as
00:25:18
the stock market rises, especially as it rises quickly, market risk increases. Rebalancing though forces you to sell
00:25:26
what's gone up and buy what's gone down, thereby reducing your exposure to market
00:25:31
risk. A dollar cost averaging helps combat market risk, too. So whether you're in accumulation mode or de
00:25:37
accumulation mode, dollar cost averaging money in or out of the market helps diversify your your market risk through
00:25:42
time. diversifying through time over time. Dollar cost averaging, it smooths out the various entry and exit points
00:25:48
with money going in and out of your portfolio, and it decreases the likelihood that you'll need to sell or
00:25:53
buy some big dollar amount of of investments at the quote unquote wrong time. And last, I would say that that
00:25:59
the pain of market risk is almost always, not always, but is almost always accompanied by bad investor behavior.
00:26:06
And again, it's not that market risk itself has to be incorporated with bad behavior. It's that feeling, the pain,
00:26:12
actually recognizing the downside of market risk is almost always due to bad investor behavior. So that's selling
00:26:19
during a panic, right? That's chasing performance. It's abandoning your your
00:26:23
predetermined plan. Plans and portfolios fail if the investor can't stick with
00:26:28
them. So again, market risk. Market risk isn't a bug. It's a feature that creates
00:26:32
returns. It's everpresent. We all face it. If markets were stable and predictable, then returns would be
00:26:38
lower, right? That's just a the fact of how markets work. So market risk and
00:26:42
then volatility, we want it really and it's the cost that we pay for long-term
00:26:47
growth. That's market risk. Here's a quick ad and then we'll get back to the
00:26:51
show. I love getting your questions and some of you ask me questions about the wealth management firm I work for in
00:26:55
Rochester, New York. Others ask about the best interest blog and this podcast, Personal Finance for Long-Term
00:27:00
Investors, which operate without advertising, without pushy sales, and with no payw walls. How can the blog and
00:27:05
podcast stay afloat without me dumping my own money into it? Well, to answer both those questions, I want to point
00:27:10
you to episode 78 of Personal Finance for Long-Term Investors. I intentionally recorded episode 78 to shine light on
00:27:16
those topics and inform you how you are actually helping and can continue helping these projects carry forward.
00:27:22
So, if you've ever been curious about the business of my blog and podcast, or
00:27:26
if you're curious about my day job in wealth management, please check out episode 78 and let me know what you
00:27:30
think. Next up, number five on our list here is sequence of returns risk, which is a particular type of market risk. So
00:27:38
even if your investments go up over the long run and even if market risk is something that you can easily tackle
00:27:43
behaviorally, if your investments go down too early in your retirement, it can create this chain reaction that you
00:27:49
never really recover from. So I'm going to borrow from what I discussed in episode 126 because I have discussed
00:27:55
sequence of returns risk a bunch. We also did a deep dive on sequence risk back in episode 87 and I'll link another
00:28:01
article in the show notes about the the interaction between sequence risk and uh
00:28:04
required minimum distributions RMDs. For those unfamiliar, I think the one sentence definition of sequence risk is
00:28:10
that bad market performance hurts you disproportionately more in the early years of retirement than in your later
00:28:15
years such that we all carry a risk that our retirement will suffer an unlucky streak of bad returns early on
00:28:21
potentially derailing our long-term retirement dreams. Yes, that was one run-on sentence. So, let's talk about
00:28:27
how much it matters how sequence risk actually declines in time and what you can do to protect those early years. So,
00:28:33
in Wade Fowl's book, Retirement Planning Guide book, he attempts to quantify the
00:28:36
magnitude of sequence risk yearbyear leading into retirement. And we'll throw
00:28:40
a link to to Wade FA's chart into the show notes. And my takeaway from the study is this. The first six years of
00:28:46
retirement carry more sequence risk than any pre-retirement year. and Wadefoul study looked at a 60-year period 30
00:28:53
years before the retirement date, 30 years after retirement to evaluate each year's relative impact on final
00:28:59
portfolio value. So again, the first six years of retirement carry this really significant sequence risk and the first
00:29:05
year carries the most risk by far with each subsequent year falling off pretty significantly. And by the time you're at
00:29:11
year 10 of retirement, your sequence risk is actually far lower than it was for the entire decade before you
00:29:17
retired. Or put another way, if you're listening to this and you've been
00:29:20
retired for more than 6 years, I'd feel pretty great about that. If you've been
00:29:24
retired more than 10 years, you should feel really great about that. But going back to today's topic, thinking about
00:29:29
this risk, the risk itself, and how do we mitigate this risk? What do we do about sequence risk? In my mind, it's
00:29:35
actually pretty simple because as I've mentioned before, sequence risk is not
00:29:38
just a function of market returns. Of course, it is a function of market returns. It's also a function about how
00:29:43
much money we withdraw when our assets are depressed. Selling our assets when they're down 40% off their all-time high
00:29:50
will cause a major sequence pain in our retirement plan. And that's why we want
00:29:54
to build in some sort of safer or non-correlated assets into our retirement portfolio. In an ideal
00:30:00
scenario, it might look like well, it could look like a bunch of different things, but one example could be 6 to 12
00:30:04
months of pure cash, 2 to 3 years of short duration bonds, another 2 to three years of longer duration bonds. And when
00:30:11
we zoom out, we see right there, you know, five, six, seven years of spending in cash and relatively low-risk bonds.
00:30:18
And that should get us through most of that really risky sequence window. And most retirement portfolios, or at least
00:30:24
many retirement portfolios, already have this. So if you're entering retirement
00:30:27
with say 30% or more of your portfolio in cash and bonds, 30% or more, you almost certainly have at least 6 years
00:30:35
worth of spending right there in cash and bonds. Now, if you're retire entering retirement with 20% or 10% or
00:30:42
barely anything in cash and bonds, well, then you might have to make a hard decision because on the one hand, if you
00:30:48
own 100% stocks, let's say, you're not really that exposed to inflation risk,
00:30:52
and good for you, but you're very exposed to sequence of returns risk. And this goes back to that trade-off I was
00:30:57
talking about earlier. You've decided to combat risk A, but you're exposing
00:31:01
yourself to risk B. So the question for you is, do you intentionally accept the lower expected returns of cash and
00:31:08
bonds? Do you intentionally accept a little bit of additional risk exposure to inflation risk, but in order to
00:31:15
dissipate your exposure to sequence risk? Financial planning is chock full of those types of trade-offs. And
00:31:21
financial planning is also all about understanding and at least somewhat decreasing your range of potential
00:31:27
outcomes. So, here's a situation where if you're entering retirement with 100%
00:31:31
stocks, I would wager that rebalancing a little bit to give yourself some way to
00:31:37
combat sequence risk by adding some cash or bonds to your portfolio is probably is usually going to be a beneficial
00:31:44
trade-off for you. So, those are my thoughts on sequence of returns risk and how we can combat it. Our next risk
00:31:49
number six is withdrawal risk. you're simply withdrawing too much money too quickly, which most of the time I will
00:31:55
say is simply hidden language for you're spending too much money or it could be
00:32:01
hidden language for you didn't have enough money to retire in the first place. I I don't really think that
00:32:05
there's a big secret here when it comes to withdrawal risk. But as I said before, measuring your cash flow, right,
00:32:11
measuring the money that's coming into your life and going out of your life is
00:32:14
a simple lowhanging fruit that all of us can do. And yes, it can be a little tedious. It can be a little annoying.
00:32:20
There's a reason why I should say some people find it challenging to measure
00:32:23
their cash flow. Budgeting is a curse word to them. We're talking about the same thing here. But avoiding that
00:32:29
exercise, avoiding the measurement of your cash flow can lead to big retirement issues. The solution for
00:32:36
withdrawal risk is to stop withdrawing such large percentages of your portfolio every year. And one way to do this is by
00:32:42
spending less. Another way to do it is by increasing the cash that's coming in
00:32:46
the door, which might look like a part-time job. Another way to do it is by not retiring in the first place,
00:32:51
choosing to work a few more years and actually adding more money to your portfolio by saving than taking money
00:32:56
out by withdrawing it. And I realize that none of those solutions are too exciting. They aren't. Right? If my
00:33:02
answer to your problem is you got to spend less money, you got to get a part-time job. And actually, now that I
00:33:07
think about it, you shouldn't retire in the first place. Nobody wants to hear
00:33:10
that news, but that's at times the simple reality and the simple arithmetic of certain financial situations. But
00:33:16
withdrawal risk is a a serious risk in retirement and one that again there aren't really any silver bullets against
00:33:22
it. It's just some simple arithmetic about how do you take less money out of
00:33:26
your portfolio on an annual basis, but it's certainly something you need to be
00:33:29
aware of. And that brings us to the last risk number seven for today's episode.
00:33:34
Health risk. In a general sense, health risk. I think to myself, will you find yourself at 70 years old too weak or too
00:33:41
sick to hop on a plane to play with your grandkids or live whatever version of active retirement that you've been
00:33:46
hoping for? I'm not even focusing on the possible expenses of health issues right
00:33:50
here. I'm not even thinking about dying early right here, although those are
00:33:54
both serious risks worth considering. I'm just thinking about pain and suffering. I'm thinking about the loss
00:33:59
of lifestyle flexibility. Again, no longer able to sit in a car for 4 hours or pick up your grandbabies. There's
00:34:06
nothing financial we can really do when your body betrays your wishes. That's
00:34:10
kind of a scary thought. At least I I think it is for me. I know nothing about health in any sort of real capacity. So
00:34:16
So what follows here is mostly me just paring what other experts have to say or just kind of doing that anecdotal health
00:34:23
talk that some of us tend to do. It does seem from what I've read from some real
00:34:26
experts who know what they're talking about. It does seem that the biggest weapon we have against health risk
00:34:31
because that's what we're here to talk about. The biggest weapon against health
00:34:34
risk is to invest in your own health early and often. Simple things, exercise, nutrition, sleep, preventative
00:34:41
care, they're more than just lifestyle choices. We can and I think we should
00:34:45
think of them as the pseudo financial strategy. Certainly something that aligns perfectly with the topics that we
00:34:50
talk about on this podcast. In fact, episode 79 and episode 122, Dr. or Phil Pearlman stopped by to talk very
00:34:57
specifically about the intersections of wealth and health. Now, what does it actually mean to invest in your health
00:35:03
early and often? Which exercises are best? Which diet? How much sleep do you need? Those topics I'm way out over my
00:35:08
skis. I'm not going to pretend to prescribe to you good exercises, good diets, and how much sleep you need. But
00:35:14
I think it's worth asking yourself about what exercises, what diet, and how much
00:35:19
sleep you ought to be getting. There is something though that I go back to. I I think of it as the thousand person test.
00:35:25
It's very basic. Imagine we have two groups of 500 people each. So a thousand
00:35:29
people in total. Group A, those 500 people are what we'll call super healthy. Group B is what we'll call
00:35:35
unhealthy. So group A, they eat really well, they stay active, they get good sleep, they have positive relationships.
00:35:42
Group B is just the opposite on every metric. And then I think will there be some members of group A, the healthy
00:35:48
group, where they end up in a place where surprisingly they have some bad health outcome like cancer or dementia
00:35:54
or heart disease. The answer is probably after all 500 people is a lot of people
00:35:58
and some of them will have some bad outcomes. And then I think about group B and will some members of group B end up
00:36:03
in a place where surprisingly they actually have a good health outcome? They live until age 95 and they die of
00:36:08
natural causes and everything is fine. Well, probably because there's 500 of
00:36:12
them and it's a lot of people. the law of large numbers, there are going to be
00:36:15
some outliers. But if you measure outcomes across the entire group, I am willing to say despite my total lack of
00:36:21
medical expertise that group A is going to look way better and we all are going to wish we could end up in group A. So I
00:36:28
think it reframes our question a little bit. It's not necessarily, you know, how
00:36:32
do I make sure I avoid a heart attack? How do I make sure I avoid dementia? I mean, of course, if there were again
00:36:36
silver bullets, we probably ought to be taking those silver bullets, but I'm not
00:36:41
sure there are. I think therefore the question that at least I ask myself is what would a person do to end up in
00:36:46
group A? And when should that person start working toward ending up in group A? And as I've moved through life and
00:36:53
interacted with more and more people in their 60s and 70s and 80s, I just find it so fascinating that some people they
00:36:59
haven't even claimed their social security yet. That's how young they are.
00:37:02
But you can see their labored movements or their fatigue, their loss of independence, their cognitive fog, and
00:37:08
that's a little heartbreaking. And then there are people who are 85. They're
00:37:11
still moving around well. They've got presence and and posture and mental acuity and sharpness, and that's amazing
00:37:18
to see. And so, while we're here talking about finances, ask yourself, would you
00:37:23
rather have an A+ financial plan combined with a a D on physical health? Is that something you want? Or if you
00:37:30
had to refocus some of your time and energy and and resources, would you rather be willing to dial down your
00:37:36
finances to a B+ if it meant bringing your health up to a B+? Now, obviously, this isn't a game where we simply get to
00:37:43
dial our attributes up and down, but my point is that retirement is about more than just finances. Health risk, which
00:37:50
yes, is a cousin of longevity risk. To be sure, it should be one of the more important risks that you choose to steal
00:37:56
yourself against. Your 3% withdrawal rate means very, very little if you're dead at 68 years old, or even if you're
00:38:02
just kind of semi-incapacitated at 68 years old. Wealth without health, I think, loses a lot of its luster. Again,
00:38:10
wealth without health loses a lot of its luster and we need to ensure that we're
00:38:14
doing what we can to minimize that health risk. So, thank you for listening. I'm going to pause here today
00:38:18
and I'll continue in our next episode covering long-term care risks, cognitive
00:38:23
decline risk, behavioral risk, assumptions risk, policy, legislation, and tax risk, identity and purpose risk,
00:38:30
and then the so-called deep risks. Thank you so much for tuning in to this episode of Personal Finance for
00:38:36
Long-Term Investors. Thanks for tuning in to this episode of Personal Finance for Long-Term Investors. If you have a
00:38:42
question for Jesse to answer on a future episode, send him an email over at his blog, The Best Interest. His email
00:38:48
address is [email protected]. Again, that's jessevestinterest.blog.
00:38:55
Did you enjoy the show? Subscribe, rate, and review the podcast wherever you listen. This helps others find the show
00:39:02
and invest in knowledge themselves, and we really appreciate it. We'll catch you
00:39:06
on the next episode of Personal Finance for Long-Term Investors. Personal Finance for Long-Term Investors is a
00:39:13
personal podcast meant for education and entertainment. It should not be taken as
00:39:17
financial advice and it's not prescriptive of your financial situation.