Becoming Educated for Retirement. Paul Breaks Down 30 Years of Lessons (Part 1)

Paul Winkler: Welcome, Evan. Playing air drums over there. It’s “The Investor Coaching Show.” Evan Barnard, myself, Paul Winkler, here talking money and investing from our Relax About Money studio.

Evan Barnard: I know.

PW: This is the first time you’ve been in our Relax couches here.

EB: It is. I have to practice sitting up straight so I don’t look too sloppy.

PW: Hey, that’s why I got you those pillows. If you need more than one pillow, man, grab one. You ought to be just fine.

EB: I’ll figure it out.

Recent News and the Stock Market

PW: Oh, man. So yes, I think we got some good stuff today. I think we have some really good stuff today.

EB: Man, there’s always. There’s been plenty in the news, that’s for sure.

PW: Yeah, you think?

EB: I do. I do.

PW: Open AI trying to beat SpaceX to the IPOs. We’ll talk a little bit about that. One of those things, I was going to be on TV this week, and somehow the schedule got messed up. I don’t even know what it was, but I had a bunch of stuff prepared.

So we’ll talk about it today instead. But that was one of the topics, the IPO, and I have some really good stuff on that. The other thing that I think is … well, gosh, what’s coming in the news that we just don’t know about yet?

EB: That’s why they call it news.

PW:

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Yeah, that’s why we call it news. And how that affects the stock market can be anybody’s guess. 

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And I had this thing, Evan, I was thinking about in terms of people we have the basics of investing, so probably we’ll get to this sometime today, is ETFs versus mutual funds, difference between these different investment vehicles, how they differ, how the various companies, how big of a difference there can be between companies that are investing in the same exact area of the stock market, but how big of a difference you can have in the returns over periods of time and in the risk and in the number of holdings in different types of investment vehicles. So I thought we’d talk a little bit about that as well.

EB: Yeah.

PW: Now there’s one thing that I thought I would start with today. I think this will be fun. I don’t know how long this is going to go.

EB: It’s all right. We got a couple of hours, man.

PW: We got some time. But this one, I was watching this video, and I actually really enjoyed the premise, not necessarily the details, but the premise of this guy’s video. He was talking about financial planning, and he was going to try to pack everything he knew from 30 years. So apparently that’s how long he’s been doing it.

What I’m trying to think of is, how long have I been doing this? Thirty-seven years, something like that, and try to pack it into 20 minutes. I don’t think so.

But anyway, that was the premise of the video: “We’re going to pack all of this experience into a 20-minute video.” And some of the things, the common questions that people have. So I thought I would actually walk through some of these things and then give my own twist on it and expand on it pretty significantly and fill in some blanks I thought that he left out.

EB: Yeah.

The Issue With Retirement Calculators

PW: He started off talking about retirement calculators and the issue with retirement calculators, and he said that they lie. And I thought, Well, that’s kind of a weird way of saying it. A calculator lying? Or maybe just not necessarily being as helpful in giving you the information you need about retirement planning.

But your 401(k)s, if you have a 401(k) with a major mutual fund company. And you’ve been on there, Evan.

EB: Right.

PW: How much money are you going to have, how much income are you going to have, based on your account balances and the assumptions?

EB: Yeah.

PW: So kind of your thoughts on the ones that you’re seeing?

EB: Well, if you look for the assumptions.

PW: Well, yeah, you probably won’t see them. No, that’s a really good point, actually. You don’t even see the assumptions.

EB: Yeah.

PW: 

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So you don’t even know when they’re telling you this how much income you’re going to have. 

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But how has your experience been when it comes to these calculators and how reliable they are for the end investor?

EB: Yeah. It’s hit or miss.

PW: And this is a 401(k) one, by the way.

EB: That’s okay. Yeah.

PW: So a big mutual fund company.

EB: Frankly, it’s hit or miss. I think the issue becomes the difference in input on, to use the term, an “official financial plan,” or looking at a forecast, because that calculator has that participant’s expected income and so forth.

But that doesn’t factor in whether his or her spouse works, and so that’s going to affect their retirement. I mean, there’s a lot of stuff that’s not in there. Some of the calculators I’ve seen include an estimate of Social Security in that number.

PW: Oh, yeah, yeah, yeah, yeah, yeah, yeah.

EB: And so you don’t really know if that’s coming from my bucket of money, 2,000 a month.

PW: Or if it’s your actual Social Security benefit.

EB: Or if that’s my total everything plus the bucket.

How Social Security Is Calculated

PW: Oh, that’s a really good point. That brings up something I hadn’t even thought about. But when you’re looking at Social Security, how it’s calculated, it’s based on 35 years of income.

EB: Right.

PW: And they are looking typically at your most recent income because that’s all they have when they’re doing that calculation in their calculator, and they may be way off.

EB: Absolutely.

PW: Yeah. So that’s a really good point. I hadn’t really thought about that.

EB: And really, the biggest issue for me thinking about that is you don’t know it’s off until you’re 65.

PW: And you retire. And you’re, “Whoops, wait a minute.”

EB: You’re like, “Wait a minute.”

PW: “They said I could retire.”

EB: Right. You got to nip it.

PW: “Walmart, are you guys hiring?”

EB: Nip it in the bud. Yeah.

PW: The other thing that I find, Evan, is that the ones I’ve seen, it has used recent history as far as returns, and it continues to project out at that.

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It may give you a false sense of security that you’re going to have more money than you really are going to because they’re using a shorter period of time.

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EB: Yep, totally.

PW: And I’ve seen some that I think that the number is too low. I’ve seen a little bit of both.

EB: Yeah.

PW: Yeah.

EB: They don’t know. A lot of this, the answer, I think, does boil down to the assumptions. They don’t know you’re going to work there till you’re 62.

PW: Oh, sure.

EB: They don’t know you.

PW: Yeah.

EB: None of that factors in, say, merit stuff of, “Well, I’m going to be a division head and then I’m going to be a director,” significant changes in income and all of that.

PW: Right. Right. Right.

EB: But it’s better than nothing.

PW: Yeah, marginally.

EB: Yeah.

The Issue With Linear Calculations

PW: Now so the issue I have with the retirement calculators, and I’ve used them, I remember teaching a class on this stuff. Gosh, I think I taught my first class to financial advisors on this particular topic. I think it was like 27 years ago that I did that.

EB: Wow.

PW: I remember being brought in to teach a round table discussion on that. And the issue I always had was the linear nature of the way they do calculations.

So when you’re talking about a linear calculation, you’re saying, “Well, what if my return on my investment portfolio was expected to be 9% per year?” Just to use as an example. If my return is 9%, the next year is 9%, the next year is 9%, it’s 9%, it’s 9%, it’s 9%, it’s 9%, on and on.

EB: Right.

PW: And then when I get to retirement, maybe I assume that it’s going to be 5%, 5%, 5%, 5%, 5%, 5%. And so the problem you’re taking out of that is the risk, the volatility.

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You can have very, very distinctly different amounts of money based on whether you have low returns early and high returns later.

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So if I have low returns in the first part of my accumulation for retirement. Let’s say that my average return is 10, let’s say my average annualized return is 10%, but the way I get there is negative 10%, negative 15% and then 5% and then negative three and then 20 and then maybe 15, and then it goes up from there.

My average return may be 10 because it was low returns followed by very, very high returns. But if I’m putting money away for retirement, I’m buying more shares of stock or more shares of mutual funds, whatever I’m investing in your ETFs. I’m buying more shares with that same amount of money, and then just before I retire, I own the greatest amount of shares, and then the market goes way up, and I go, “Yippee. My market timing is wonderful.”

EB: Right. “I’ve been bummed for 20 years, but now I’m happy.”

PW: Exactly. And that’s assuming you stay disciplined during the bad years, right?

EB: Yeah.

When the Market Comes Down

PW: So that’s one way. Or if I have really high returns, think let’s say 1990s, very high returns followed by a period of lackluster returns in the 2000s. So you could have that situation where it’s really great followed by not so great.

Well, I kept buying at higher and higher prices in the 1990s if I’m putting money away on a regular basis. This happened to a lot of people, where they got to 2000, 2001. The market comes down, and then they have to go back to work.

EB: Yeah. Typically, when we’re looking at a portfolio, somebody comes in and we see in their statement, they’re heavily concentrated in large U.S. companies.

PW: Oh, yeah.

EB: And at that period of time, it was heavily concentrated in tax.

PW: Almost always.

EB: Just personally, I think the people that retired in 2000 fared worse than the people that retired even in 2008 or during COVID, because it was much shorter lived on a market basis.

PW: True.

EB: And the people that retired in 2000 and got effectively a zero return on probably a significant piece of their assets for 10 years —

PW: Ten, 12 years, sure. Yeah.

EB: — is devastating.

PW: Yeah. Yeah, absolutely. And that did, it hurt people an awful lot.

EB: Yeah.

PW: So that was number one.

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It’s like poor assumptions in the way the calculators do things, they’ll do a linear return. And the other thing is risk. 

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And this is what I always found: I would have to tweak, I would have to look at the risk assumptions, and often when I’m looking at a calculator, the risk assumptions, they don’t know how to measure risk or they put the wrong number in for the risk measure, which is standard deviation. And it’s garbage in, garbage out, is my point.

The Level of Volatility of a Portfolio

PW: If you don’t know the level of volatility of a portfolio, if I don’t know how much this could go up or go down in a given year or what the range of returns would be at a 68, 95, or 99% confidence level, which is by definition, those of you that took a stats class in the past 20 years may remember that that’s how it works. You got to look at the confidence levels and that’s what that is, is 68 is your one standard deviation, 95 is two, and 99 is three.

So you’re going, “Well, if I don’t know how big of a variance I might have in my return, I can’t tell whether this is going to be successful based on the level of income I’m taking out. If the market goes down, I have to sell assets to get that same level of income.” Now the other thing is the results, the return results that they assume in the programs, and they could seriously be overstated depending on the investment approach.

It’s quite often the investment approach being used is of, let’s say, well, if you actually look at how the investments, the portfolios are being managed, it’s active stock picking, market timing, which we know, historically, you got 94% of professional managers failing to match market returns with large U.S. companies and then something like 97% of them failing to match market returns in this small-cap market. And if you’re assuming market returns, but the portfolio is being actively managed or if there is market timing going on inside there.

EB: By the participant, you mean?

PW: Or by the investment manager.

EB: Or like a target date fund or … oh. Oh, yeah, inside the fund.

PW: Oh, even target day funds. I mean, sure, you look at target date funds. I remember Fidelity actually had their top holding in their target date fund in 2007.

The top holding was commodities, and it was the biggest holding in the portfolio. Why? Because commodities had a big run-up.

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They added it in, brilliant, and then all of a sudden, commodities just nose-dived. 

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I mean, it was just like, crash. And you go, “Wow, that, what an impact that has on a portfolio when they’re engaging in that.”

EB: Yes.

Assumptions About the Return of a Portfolio

PW: You hear people say, “Well, I’m holding this investment portfolio, and I’m going to let the manager figure out which stocks and when to get in, when to get out, what to do in the portfolio.” Or more than likely, they don’t even know it’s happening.

EB: Right. Yeah.

PW: But their assumption on the return of the portfolio is up here on what it’s going to do in the calculator; the assumption being used for the calculator may be way up here, but the actuality may be way the heck down here. And where do we see that? We see the research from DALBAR and asset allocation funds, and we see that their rate of return is barely above the inflation rate on what investors have gotten in asset allocation portfolios.

EB: Yeah. It would be interesting to know how these calculators, if there’s any adjustment at all, because the other thing we see in 401(k)s a lot is we see, “Well, we’re getting rid of these three funds, and we’re bringing in these three new funds.”

PW: Yeah, survivorship bias. Yeah.

EB: And generally, what I say to clients all the time, “Do you think they’re getting rid of the ones that did great or the ones that suck?”

PW: Right.

EB: Okay. And so do you think they replace —

PW: Yeah, they’re getting rid of the ones that stink for the record, okay?

EB: Yeah.

PW: And they’re selling low.

EB: And do you think they’re replacing it with one that stinks or one that just really knocked it through out of the park?

PW: They’re going to buy high. They’re going to buy the thing that just did well, and they’re going to get rid of the thing that did poorly. Yep, you’re totally right.

EB: 

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So even if they’re using market returns, kind of to your point, they’re not managing the ingredients the way to actually get market returns.

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PW: Right, right, exactly.

EB: Yeah. Hadn’t even thought about that, that the calculator would change with a new fund or not. That’d be interesting to see.

PW: Yeah. Yeah. And they’re using, what I have seen, they’re using the funds that they’ve got, and they’re using short-term past performance and telling you whether they’re going to be any good.

And then the other thing I was thinking about was that they’re assuming that you’re going to be increasing spending forever. Now this is the one that can actually play in your favor as an investor.

And what I mean by that is that if we look at what people really do with money, I’ve talked about this many times, but it bears repeating. We look at what people actually do in retirement. They tend to spend lots of money in the early years doing all the stuff that they wanted to do forever, traveling to the places that they wanted to go to, spending time with the people that they want to spend time with, maybe spoiling the grandkids or whatever, as you like to say.

EB: Absolutely.

PW: As you like to say, right?

EB: That’s the black hole in a retirement plan, is grandkids.

The Go-Go, Slow-Go, and No-Go Years

PW: But here’s what people do in their 60s: They’re spending, spending, spending. They’re going places, they’re doing things, they’re going on cruises, they’re hanging out and having a good time with friends and things like that.

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Then they get into their 70s, and they start to slow down a little bit. So you’ve got the go-go years, as we call them, and then you’ve got the slow-go years.

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And the slow-go years is where, “I’m just starting to, I’ve been there, I’ve done that, I’ve done that, I’ve done that trip over here, I’ve done that cruise. Okay, I don’t want to go again. I don’t need to go again.” And it’s ever so subtle that you tend to slow down.

Then there’s the no-go years, which is later on, you get into your 80s and you’re just like, “Okay, I really don’t have the energy to do anything. I don’t feel like doing anything.”

And it’s not necessarily terrible. It’s just you don’t want to do.

EB: Yeah, you’ve seen the Grand Canyon, “I’ve done this, done that.” Now I have to share a personal story on the no-go years.

PW: Okay. Yeah.

EB: About 10 minutes before we started, I got a text from my stepsister, and so my dad, who is 91, and his wife, who is also 91 —

PW: Wow. I hadn’t seen him in forever.

EB: — just went to Buc-ee’s for the first time.

PW: Yeah.

EB: So they just went to Buc-ee’s for the first time.

PW: Oh, did they? Well, they beat me there.

EB: And so they’re driving somewhere. I don’t know where.

PW: They beat me there.

EB: They’re at least not no-going.

PW: All right.

EB: But yeah, that’s probably the high point of the day, though.

PW: Oh, that’s funny.

EB: Is Buc-ee’s, not flying to France or something like that.

PW: That’s funny. Well, tell me, I’d love to hear their experience on that one. I heard it’s big. Is it a big place?

EB: I’ll call them.

PW: Isn’t it a big place?

EB: Oh, it’s really cool.

PW: Is it?

EB: I mean, it’s like a lot of cultural phenomena. You either love it or you hate it kind of a thing.

PW: Oh, it’s not your thing, huh?

EB: But I’m an enormous fan of Buc-ee’s.

PW: Okay, interesting.

EB: Mainly because it’s an Aggie that founded it.

PW: Oh, okay.

EB: It’s just a very well-run organization.

Smile Retirement

PW: Yeah. Yeah. So we look at the smile retirement, and what are the implications of that?

Well, the implications of that are that, hey, maybe I ought to have a bunch of money. I have this money accumulated for retirement, let’s say, and maybe what I do with this bunch of money is I bifurcate it or I separate it up into a couple different points or a couple different pieces and I have some of my money that would be spent down.

And we’ve done this in financial plans in the software, we’ll typically do this in financial planning software, where we might have somebody that says, “Okay, this is my budget. This is what I want to spend. But in my first five years,” they might say, or first 10 years or whatever, they’ll come up with a number, “of retirement, I want to spend another extra 10,000 or 20,000 a year,” or something like that.

EB: Yeah.

PW: You do that too?

EB: Absolutely.

PW: Yeah. So you might have a certain amount that you want to spend, let’s just put a number on it. Let’s say that your number is $70,000, just to have something to work with.

So let’s say that’s your baseline, that’s what you want to have for your retirement. Well, smile retirement basically says that maybe in the first year you’re going to spend 90 and the next year it’s going to be 88 and then you’re going to drop down a little bit and you’re going to inflation-adjust all this stuff.

But you’re going to be spending at a higher level in those first years to do all the travel that you wanted to do. And then you get that out of your system, now you’re going to get back down to the 70, and that’s the sustainable amount.

Well, how do we do that? Well, it may be that I have an extra bucket of money over there that I have, and let’s say that the number in the first year of retirement is 90, I take 20,000 out of it. I got my 70 as my base, and I got 20 over here, and then I spend that down and then at that point I’m like, “Been there, done that, got the T-shirt, I’m good.”

EB: Yeah.

PW: And that’s one way of actually handling that. So do this.

Well, let’s take a quick break and we’re going to come back right after this and talk a little bit more about it. Because I want to get into Social Security and implications for Social Security and when to take it and how to take it and just some of the things to think about regarding that. And there are no hard-and-fast rules.

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You’re not going to get out of Evan or me that you always take it early, you always take it late, you always take it at any point in time, because it really depends. 

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We’ll give you some criteria to just think about regarding this right after this.

Financial Education Programs

PW: We’re talking money and investing and just going through just the implications of I just saw this guy taking all of his life experience and trying to put it into a short video. And I thought, Well, you can’t quite shorten it up. You can’t shorten this stuff up at all.

I mean, we’re looking at how many years for you to get through your CFP, Evan, how long did it take you? You’re a certified financial planner.

EB: Well, it took me a year to get my CFP.

PW: You went that fast?

EB: Yeah, but I had been in the business probably 10 years before.

PW: So you had a lot of experience already.

EB: Frankly, I kind of poo-pooed the designation for several years.

PW: Oh, did you?

EB: Finally, it was like, “Okay, I’ll do this to see if I could do it.” And yeah, I probably finished in about eight or nine months.

PW: Wow. So that’s interesting. Everybody makes that out to be such a difficult designation.

I think that’s a starting point. There’s so much you learn.

EB: Well, if you were brand new, it’s a very difficult thing.

PW:

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I was going to say there’s so much you learn from actually doing planning.

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EB: The hardest part, because at some point you took the Series 7 as well, correct?

PW: I did Series 6, Series 63.

EB: Six. Okay.

PW: Series 7, and then I got life health licenses and property and casualty licenses.

EB: I never did property and casualty.

PW: You never did property and casualty?

EB: No.

PW: That’s homeowners insurance, for those who don’t know.

EB: But anyway, the hardest part for the CFP exam was following the curriculum answers that they want you to give.

PW: They want you to give as opposed to what you really do.

EB: Versus what’s been happening for 10 years in my case of, well, that’s not how the world works.

PW: No. Yeah.

EB: So I think that’s why the test is so complicated or challenging: The entire exam is on the exceptions out there in the financial planning world.

PW: Yeah, stuff you never see.

EB: So your client has $18 million that’s a former football player and they live in a community property state and they’re getting divorced.

PW: And now they started a company that got stock options.

EB: Yeah, these people just fall off trees. So frankly, that’s what made it challenging, was trying to answer what I knew the exam wanted versus what I really wanted to say.

PW: That’s funny. Yeah. And for me, that was a starting point.

I did charter financial consultant, which is the same curriculum. You got the same classes.

There are a couple others on risk management that are added on top of that. It’s the same college that teaches the material, and somehow, the CFP just did the best marketing job.

EB: It’s like the Marine Corps. We’ve got better PR.

PW: Better PR. That’s right. Everybody knows who the CFP is.

I went for CHFC, though, charter financial consultant. Then I would collect designations on top of that. And the thing that I found helpful is getting into Social Security planning and then the wealth management stuff and retirement income certified professional. So a lot of the different education programs out there.

Try to get all of that junk into 20 minutes in a presentation, everything you know about financial planning. No, it’s not going to happen, but I like the premise of what this guy was trying to do anyway.

When To Take Social Security Benefits

PW: So then talking about Social Security was another topic that came up, and the idea of when to take it. If you take your Social Security benefit at age 62, recognize that the way Social Security is calculated, they’re going to look at your average index monthly earnings. They’re going to determine what your benefit is based on 35 years of data.

Then, if you take it at age 62, if your full retirement age is 67, if you’re born 1960 and after, you’re basically looking at a 67 as your full retirement age. Now what happens is you get a reduction for life of 30%.

So it’s 20% for the first three years and then another 5% per year for each year earlier than that. So you’re taking it five years early. So it’s a 30% reduction in your benefit for life.

And just to give you an idea of what that means. If you delay it, let me just say this before I go into these numbers. But if you delay it past your full retirement age, 67, you get an 8% increase per year, simple interest for the next three years.

So you’ll have a 24%, three times 8% increase in your benefit from 67 to age 70. Okay?

So let’s say that your full retirement age benefit’s $2,000. Well, if you take it at age 62, that’s $1,400. Your benefit drops down to $1,400.

And you just take that and annualize that. Instead of a $24,000 income per year, now you’re only looking at about $16,800. That’s a pretty big difference in income.

And that’s basically what, that’s it. It doesn’t pop back up later on.

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If you’ve taken it early, it’s forever at that lower level.

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If you delay it to age 70, it’s 2,480. So it’s $2,480 per month, or that works out to just shy of 30,000 per year.

So you go, “Okay.” Now, the difference between taking it at 62, 16,800, versus about 30,000, you’re almost cutting your benefit in half. Think of it that way.

Taking Your Benefit Early

PW: 

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But the other thing you want to think about is your COLA, your cost of living allowance, on your benefit. 

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Your cost of living allowance is going to be based on that number or whatever it is your benefit was. So let’s say that you have a 3% COLA, 3% increase because of inflation. If you took the benefit early, your increase over the course of a year, if your benefit goes up by 3%, is about $500. You get a $500 increase.

But that person that waited to age 70, they have about a $900 increase due to the Social Security COLA. So not only do you have that permanently lowered benefit, but also your COLAs, your cost of living allowances, are a lot lower as well.

Now that doesn’t mean necessarily that you don’t ever take your benefit early. I mean, some of the examples, Evan, what might cause somebody to take the benefit early?

EB: Yeah. Well, I mean, the easiest answer on that one is they need the money.

PW: Exactly.

EB: I mean, if they can’t keep the lights on, can’t get all the groceries and pay for prescriptions, then you’ve got to turn on the faucet if you have left the workforce.

PW: You don’t have enough savings, and you’ve got to have income.

EB: And so that makes it a no-brainer. There’s really not a decision at that point. It’s survival. The other things I look at, you say to take it early, right, was the question?

PW: Well, yeah, take it early. Now look at health.

EB: It’s your longevity.

PW: Yeah. Very good. Yeah, go with that.

EB: I have a client, and we were talking, it’s probably been three or four weeks ago, that everyone, all the males in his family haven’t made it past 74. And he walks in and just says, “I’m living on borrowed time.” I’m like, “Well, just in case you’re not, let’s keep planning.”

PW: Right, right, right, right. Right.

EB: But someone like that, I would encourage them to take it early because whether you take it at 62, 67, full retirement age, age 70, those benefit lines cross around age 80.

PW: That’s right.

EB: And so if you don’t think you’re going to even make it to 80, or if you’re going to go climb Mount Everest, if you’re a parachutist, then I would encourage you to take it early.

Advisory services offered through Paul Winkler, Inc an SEC registered investment advisor. The opinions voiced and information provided in this material are for general informational purposes only and not intended to provide specific advice or recommendations for any individual. To determine what investments are appropriate for you, please consult with a financial advisor. PWI does not provide tax or legal advice. Please consult your tax or legal advisor regarding your particular situation.