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