Larry and I discuss his new book, Your Complete Guide to a Successful and Secure Retirement.
Larry Swedroe is the Lead Director and Director of Research of the Buckingham Family of Financial Services. Buckingham Strategic Wealth is a Registered Investment Advisory firm, currently managing $15 billion in assets, with offices in 30 cities. BAM is also provider of Turnkey Asset Management Services through the BAM ALLIANCE to about 135 financial advisory firms across the U.S. with approximately $19 billion of assets under administration and through Loring Ward which serves about another 1000 advisors and has about $17 billion of assets under administration.
Larry has authored or co-authored 17 books. The latest is Your Complete Guide to a Successful and Secure Retirement co-authored with Kevin Grogan.
To learn more and purchase Larry’s book visit the links below: https://buckinghamadvisor.com/
Below is the full transcript:
Announcer: Welcome back, America, to Sound Retirement Radio, where we bring you concepts, ideas, and strategies designed to help you achieve clarity, confidence and freedom as you prepare for and transition through retirement. Now, here is your host Jason Parker.
Jason: America, welcome back to another round of Sound Retirement Radio. So glad to have you tuning in this morning. You’re listening to episode 196. I have an amazing guest lined up for us this morning. But before I bring him on, as you know I like to start the morning right two ways. The first one is by renewing our mind, and sometimes you just pick up your bible, and you open it up and you read the first verse that comes out and you’re like, “Oh, that’s exactly what I needed to hear.” That’s what happened to me last night. This is the verse, it’s John 14, one. “Do not let your hearts be troubled, you believe in God. Believe also in me.”
Jason: Then, of course, we have a joke for you this morning. Emilia picked this one out. She’s not joining us this morning, but I think you’ll get a kick out of this, it says why didn’t the cow have any money? Because the farmer had milked it for all its worth. Okay. All right. Let’s get into this show. This is going to be an excellent one, we’re bringing back a very popular guest. This is episode 196. The title is Your Complete Guide to a Successful and Secure Retirement. Because that is the title of Larry Swedroe’s new book. Larry, he doesn’t need a introduction for many of you, but we’ll go ahead and give one anyways.
Jason: Larry Swedroe is the Lead Director and Director of Research of Buckingham Family of Financial Services, Buckingham Strategic Wealth is a registered investment advisory firm. Currently managing $15 billion in assets with offices in 30 cities. BAM is also provider of turnkey asset management services through the BAM Alliance to about 135 financial advisory firms across the US with approximately $19 billion in assets under administration and through Loring Ward, which serves about another 1,000 advisors and has about $17 billion of assets under administration.
Jason: Larry has co-authored, authored or co-authored, 17 books. The latest is Your Complete Guide to a Successful and Secure Retirement, co-authored with Kevin Grogan. Larry Swedroe, welcome back to Sound Retirement Radio.
Larry: Great to be back with you, Jason.
Jason: Man, I’m glad to have you back. Actually, the reason I had you back on, Larry, you know, I was a little disappointed that you had such a good joke for us the first time that I was expecting something from you this time. So I have to come up with my own. But what’d you think of the joke this morning?
Larry: I [inaudible 00:02:52] the cow joke, my grandkids will love it, I wrote it down.
Jason: Okay, good. Hey, this is going to be a great interview. I want to make sure we provide our listeners with as much value as possible, and you’ve agreed that if we go over the 25 minutes that we have available for the radio, that you’ll stick around for a little bit longer to discuss your new book for our podcast listeners as well. So, thank you for that. The first thing I wanted to ask you about, I’ve read much of your new book, I have not completed it yet. But I noticed the introduction, the foreword, was by Dr. Wade Pfau. So I was just kind of curious, it’s a small world, we’ve had Dr. Pfau on this program before. What’s your relationship with him? How did that come to be?
Larry: I don’t really have a relationship with Wade, of course I know him, and I’ve read lots of his work. When we were completing the book, I was trying to think of somebody who was extremely well-thought of, that might be interested in writing the foreword for the book. Wade is considered certainly one of the leading experts on retirement planning, so I couldn’t think of anyone better than him. We were really pleased when Wade read the book and thought it was certainly worth putting his name on it. We’re very proud that he decided to write the foreword.
Jason: All right, good. So we’re going to get into the details of your book, chapter by chapter, but before we do, there are some just general, specific questions that I, general specific, but some questions that I want to ask you that came to mind as I was reading your book and thinking about our time together this morning. The first one is, what should a good retirement plan include? As people are putting together a plan, not necessarily just an investment strategy, but as they’re making this plan to transition, Larry, what should they be thinking about looking for?
Larry: Yeah. That’s one of the things that we really try to address in the book here, because there are many books on retirement, some of them focus on generally one topic like investing. Another might be on a state planning and minimizing taxes. So those are the kind of books there are out there, but there was no book that I was aware of that really was a comprehensive guide, covering all of the issues we think are critical and need to be included in a well-designed plan. So you can start with an investment plan, but a plan can fail for reasons that have nothing to do with investing.
Larry: For example, you die early, and therefore you don’t have the income generated to build assets, or you live to 100, well beyond the expected life, so you have to plan for “the risk” of living longer than expected. You also need to have proper documents in place not just wills, which many people even don’t have, sadly, but you need what I call durable powers of attorney for health and financial matters in case you become either physically or mentally incapacitated. As we are living longer, the risk of cognitive decline, Alzheimer’s, dementia, increases greatly, so that becomes critical.
Larry: Then, the other item I would say is related to social security, Medicare, those issues, and incorporating that into your plan, and then finally, how do you begin to withdraw assets from your portfolio in the most tax efficient manner, withdrawal strategies require much more integration of your taxes and investment strategies than accumulation strategies. So we try to address all of them in the book, obviously you can’t go into great detail on some of these subjects, so we provide people with references to books where we think more detail is required.
Larry: Finally, really proud that we did recruit a team of experts to help us write some of these chapters. So several authors were written separate books [inaudible 00:07:17] on one topic are included in the book.
Jason: Yeah. You may not know this, Larry, but one of the reasons that I thought of having you back on the program was my book, Sound Retirement Planning, was recently relaunched, updated and revised, and we were number one on Amazon hot new releases, and I looked at the number two book and it was yours, and then number three was A Random Walk Down Wall Street. If you visit SoundRetirementPlanning.com, I’ve got a screenshot of that right on the top of the screen. So it’s one of the things that triggered my memory, I said, “We got to have Larry back on the program.”
Jason: So your reference to a book that talks about retirement planning, I would be curious to hear what your thoughts are after you get a chance to read my book.
Larry: We’ll do.
Jason: One of the things you just mentioned there is withdrawal strategies in retirement. Sound Retirement Radio, Sound Retirement Planning, is really about helping these folks that are trying to make this transition, they’re just getting ready to and making a transition into retirement. One of the concepts that’s been very popular is probably best known as buckets, or laddering, so having different pools of money that you’re going to be drawing from and taking different risk with each one of those segments, we call it time segmented diversification. What are your thoughts about a buckets approach to a withdrawal strategy in retirement?
Larry: There are actually some academic papers that look at this subject, so I’m going to give you the academic answer and then I’ll lay out some commentary. The academic answer is it makes no sense. Only right way to think about the portfolio is in its entirety, and a bucket approach can lead people to having too much money in fixed income assets, and unable to rebalance effectively. However, a bucket approach can have this purely psychological benefit of helping people stay more disciplined in a bear market, because they may have five or 10 years, whatever that bucket is designed in terms of its length, of cash on hand. That may help them psychologically. But that’s the only real benefit there. There really is no logic to it other than that.
Larry: I actually wrote a paper for Advisor Perspectives, which your readers could find there on explaining why a bucket approach, while may have psychological benefits, so I’m not dismissing that totally, for some people staying disciplined, not panicking and selling, can override the negatives of the [inaudible 00:10:04].
Jason: Let me ask you about that, because the last time I had you on the program, we talked a lot about evidence-based investing, but we also talked about behavioral finance. How important of a component do you think behavioral finance plays a role in maintaining a good strategy?
Larry: I think it plays a huge role in fact in my 25 years now advising individual investors, I’ve come to believe that we spend more time managing people than money. Having the perfect investment plan is irrelevant if you don’t have the discipline to stick with it. So what I tell people is, “Choose an investment strategy that you’re most likely able to adhere to in bear times. That’s far more important than getting ‘the perfect’ asset allocation.” Behavior trumps intelligence all the time. In fact, Warren Buffett, who I love to cite, because people respect him, said, “When it comes to investing, emotional intelligence trumps intellectual intelligence all the time.”
Jason: We’re going to talk, because you also referenced Warren Buffett in another area in your book that I want to ask you about. But on our last interview, I asked you for a couple of books that you recommended that you were reading, and I’ve read both of them, so thank you for those recommendations. One of them though was, I think it’s called Your Money and Your Brain by Jason Zweig.
Jason: It was a great read, thank you for that recommendation.
Larry: Jason is a great writer. Anything he writes is worth reading.
Jason: It was good. I think it really speaks to this idea. Now, we had Dr. James Cloonan on the program some time ago, and we were asking him this question about having different buckets of money as a withdrawal strategy in retirement for this psychological benefit that you’re speaking of. So that when the market’s declining people aren’t in panic mode. They know where that income is coming from. The question that people have, because I have to tell you, what you just said there, it’s going to be pretty controversial saying that buckets is illogical based on the academic research.
Jason: It’s controversial because of the behavioral component, I think that’s what you hit on. But the question that I have for you, and this is what we asked Dr. Cloonan. He was a fan of having some money in a cash bucket when you were withdrawing funds. I don’t know if you know Dr. Cloonan, he’s with AAII, he was the founder of AAII. At the time, we were interviewing him about his book Level 3 Investing. But what he said was that, he thought in that bucket if you were going to have some money in cash, he recommended three years, maybe four years, just based on historical draw-down patterns of the market. What are your thoughts? If somebody is going to take that approach where they want to have some cash to draw from, what’s the right amount of cash?
Jason: Should it be one year, two year, three year, five years of cash? What do you think is appropriate there?
Larry: Well, I will say this. Certainly, you can look at history, and about three years is a pretty long time, bear markets like 2002 and in markets then tend to recover. However, that makes a very common error of treating the unlikely as impossible, and without considering alternative universes. For example, if Dr. Cloonan had been living in Japan, he now would’ve had 29 years of no returns to equities in a much longer bear market that Nikkei index hit almost 40,000 in 1990, and today I just happened to look, it’s under 22,000. So I think three years is way too short a period.
Larry: First of all, I would never sit on cash anyway, and I don’t think he actually meant that. I’m going to assume he’s talking about safe, high quality, shorter term instruments that you can get liquidity on, you don’t want to be sitting [inaudible 00:14:15] on cash. But I think if you’re going to do a bucket approach, the absolute minimum I would choose is five years, and even suggest possibly going longer. But I don’t believe in a bucket approach at all. I think it’s better to just get educated on the benefits of looking at the total return of a portfolio. A bucket approach can lead you to also a dividend, or cash flow approach, and buying things like high dividend paying stocks and REITs, and other things, and living with dividends, and there literally is no logic to that either. That can lead to bad mistakes like chasing risky investments.
Larry: I’ll just add this. From 2008 on, we’ve been in a period of very low interest rates, and people who take that approach could not survive on zero or 1% from their bank accounts or CDs, so they ended up buying things like high yield bonds, dividend paying stocks. If they had a bear market, I mean another repeat of 2002 or 08, they really would’ve gotten severely hurt and their plans would’ve blown up. They just got lucky. So we really urge people not to take this cash flow approach [inaudible 00:15:39] total return, and the key then is having enough safe income in your portfolio, 40%, 50%, 60%, whatever is the appropriate for your level.
Jason: Yeah. Boy, I love this. You’ve hit on some many things that I was planning on asking you about just in that last little bit. So I’m excited to dig into this a little bit. So you talk about evidence-based investing as the foundation for making decisions regarding asset allocation. Now I’m going to pick on you just a little bit here with this, but before I do, I want to help our listeners understand, when you say evidence-based investing, what do you mean by that?
Larry: So, if you go to a doctor and you’re sick, the doctor hopefully is going to tell you, if you ask questions, why he’s prescribing certain medication, or treatment course, he’ll be able to cite, say, a recent paper in The New England Journal of Medicine, not referring to you something he read in Reader’s Digest. Well, investment [crosstalk 00:16:44] that the equivalent of the Reader’s Digest is Barron’s, or CNBC, or whatever. On the other hand the equivalent of The New England Journal of Medicine are publications like The Journal of Finance, The Journal of Portfolio Management, et cetera. Everything that you’ll find in my books and everything we teach at Buckingham is all based on evidence that appears in those types of peer-reviewed academic journals.
Jason: Yeah, so I think that’s a really great foundation to build from, but it also gets me some … I’ve got to ask some hard questions around that. But before I do, I want to remind our listeners, Larry, you may not know this, but we created some software called Retirement Budget Calculator, which can be found at RetirementBudgetCalculator.com, one of the things that I believe it’s so important to understand your spending as you put in together a good retirement plan, because ultimately we’ve got to match your spending up with your income to really have a lot of confidence in retirement.
Jason: It’s just one piece, I find a lot of high net worth investors, or high income people, really don’t understand this, how much they really spend. So we wanted to help people dial that in. But I wanted to come back to evidence-based investing. One of the arguments within this realm of evidence is that over a long period of time, value trumps growth. However, the last decade growth has trumped value. So my question to you around this is at what point do we make adjustments to what the evidence shows to say, “Hey maybe this is the way that it was for 90 years, but something’s changed.” I mean, when do we shift away from a value emphasis and towards a growth emphasis? How do you use the evidence to make those decisions?
Larry: It’s a great question. I wrote a paper on this, which your readers can find on the internet called What Do You Do When a Strategy Performs Poorly. The problem is that people confuse strategy with outcomes. When we have a world that we live in, where there are no clear crystal balls, only cloudy ones, a strategy can only be judged to be right before you know the outcome. So I’m going to imagine, Jason, that if … are you married with children?
Jason: Very much so, I have a great, great woman, who I can’t believe she married me 22 years ago, but yes, sir.
Larry: I’m going to assume you have life insurance, right?
Jason: Yes, yes, yes, sir.
Larry: Okay. I’m assuming you don’t expect to die in the near future, and you are basically transferring assets likely with say 95% probability over the next decade to the insurance company, yet you buy the insurance for a reason.
Jason: Yeah, that’s a good point.
Larry: So, 20 years from today, you’re still alive, obviously you didn’t need the insurance, your kids are grown, out of the house, you no longer need it, and do you look back and say the strategy was wrong? Of course not, we don’t think of it that way. So the same thing should apply in investing. Let me address your issue specifically. Instead of using the words value and growth, change it to buying what’s cheap and avoiding what’s expensive. Growth stocks tend to be expensive, meaning high PE, and value stocks are low PE. They have a low PE for a reason, that’s because the investors think they’re riskier, that means they have a higher cost of capital and the flip side of that is a higher return to investors, at least in terms of expected return, not a guarantee, of course.
Larry: So that should never change. Same thing true with small stocks versus large stocks. Emerging markets versus US stocks. I don’t care how long the evidence, that should be always the case. So I would ask this question, the problem is that investors, when it comes to looking at their investments, think of three years as a long time, five years a very long time, and 10 years like infinity. [inaudible 00:21:11] know that’s nothing more than noise, and you should ignore it, unless something has changed … that caused your belief to change. So here’s three examples that should answer your question.
Larry: There are three periods in the US of 13 years or longer where the S&P 500 underperformed totally riskless one-month treasury bills. 17 years from 1966 to 82, 15 years from 29 to 43, and 13 years just recently from 2000 through 12. I believe it’s safe to say, Jason, you would not have given up on your belief that stocks should outperform T-bills going forward, in the same way that Japanese investors should not believe that their stocks are going to underperform their equivalent T-bills, even though it’s done so for 30 years. That’s the way you have to think about it. If there’s risk, the risk is it might show up for a long time, and the key then is you want to diversify your risks, not have all your eggs in one basket, whether it’s Japan, the US, value stocks, or any other type of investment. Diversification is your [inaudible 00:22:38] of safety in the storm.
Jason: Okay. Now, we only have about a minute left for our radio listeners, so I just want to give them a little bit of a teaser on what we’re going to continue talking about in the podcast extra. So, if you want to listen to this show remember you can go to SoundRetirementPlanning.com listen to episode 196, find us on iTunes, or Stitcher, or iHeartRadio, or any of these places that carry podcasts. But we’re going to be talking about the book, the other book that Larry recommended to me, which is The Happiness Advantage with Shawn Achor. We’re going to be talking about Japan and their 29-year, where they’ve been in a down market for 29 years. We’re going to talk about biases towards home country investing.
Jason: I’m going to ask him some more questions about his argument against dividends that he makes in his book and the reference that he makes to Warren Buffett. We’re going to talk about how to begin shifting from an accumulation methodology to more of a preservation mode. And at what time in your life should you think about making that switch to really more of a preservation versus an asset accumulation. Larry, we’re going to be right back, we have to go to a quick break for our radio listeners, and I’ll be back to ask you some of these additional questions.
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Jason: Okay. Everybody, welcome back. This is Jason Parker, we’ve got Larry Swedroe continuing on for the podcast extras. Larry, thanks for being willing to stick around a little bit longer for our podcast listeners.
Larry: My pleasure.
Jason: Hey, so I wanted to … we were talking about, and this is something you mentioned in the last time we had you on, and for those of you that have not listened to the last episode of Larry Swedroe, one of the most popular ones we’ve done, episode 175, and one of the things you talked about was home country bias. That US citizens tend to invest more heavily in the United States, and Japanese investors tend to invest more heavily in Japan. So the question I have for you along those lines is we’re talking about asset allocation, and you bring up something like the Nikkei that for 29 years those investors, you were saying, having five years of cash just isn’t long enough if you look at something like the blue-chip stocks in Japan, because it’s taken 29 years and they’re not back to even. I don’t think the index is back to even yet. But 29 years is a long time.
Larry: Yeah. The index is actually still only about a little more than half of where it was, but dividends gets you to about a zero return. So you earned absolutely nothing for the last 29 years, that’s just nominal, and there was some inflation in Japan, even though it was low, there was some, so you’ve actually had very large negative real returns for the last 30 years almost.
Jason: So the scary and the hard part for a lot of people that are trying to make this transition into retirement is most of them only have social security. Many of them don’t have pensions anymore. So they’re depending on what we would call evidence-based investing, depending on past performance of asset classes to assume that they’re going to perform in somewhat similar fashion going forward to try to provide the returns that they need so that they can support the withdrawals from their portfolio. But is that making a home biased mistake? Because we look at how the asset classes had performed historically, should we be looking at something like Japan’s Nikkei and say, “Look, we could end up with a 30-year period of time where the market is flat. If you do, how is that going to impact your retirement?” How do people plan for something like that?
Larry: The first thing I would say is looking at past performance without understanding context is a horrific mistake, or can be. Perfect example is if you go back to 1950, stocks at that point had returned something I think like 6% historically in the US. But by 1999, that number was overall 11, and the problem is how did you get there? It was because valuations had jumped so much from where the PEs were down to like 6% all the way up into the 40s and that is not going to be repeated. Today we have the problem bonds have historically returned let’s say 5.5%, but safe bonds today are yielding more like two to two-and-a-half.
Larry: So, it’s crazy and obviously could lead people to make big mistakes if you plan on earning more than two or two-and-a-half on your safe bonds, and equities are priced much higher than they have been historically. So you should project future returns to equities based upon current valuations. Today, most financial economists think stock’s supposed to return something in the neighborhood of 4%, maybe 5% in the US in real terms, which would be six to seven or so in nominal terms. That’s way below the historical 10, and of course bonds are in the 2% or so, so a typical 60-40 portfolio, you should be looking at more like 5% maybe when historically it’s gotten eight-and-a-half. That’s one of the things we focus on in the book is what we call the four horsemen of the retirement apocalypse, you can’t expect historical returns to be repeated, that would be a big mistake.
Larry: The second thing very briefly is you have to be careful to avoid what’s called the triumph of the optimist. You look at the US data, you got lucky, you were born here. If you lived in the UK, or Russia, or many other countries, you would not have got anywhere near 10% for your returns. Just because it hasn’t happened here, doesn’t mean it can’t. So that’s why you want to build a globally diversified portfolio. Today the US represents about half the global market cap, and that’s what I think you should target. 50% US for your equities, and the remainder about 3/8 for the rest of the developed world, and then 1/8 for emerging markets.
Larry: You shouldn’t think you’re smarter than the rest of the world at allocating capital. That’s the way my personal allocation is as well.
Jason: That’s interesting. I want to ask you about that book, Shawn Achor’s book, you recommended that one to me too, The Happiness Advantage. We get back into the numbers here, but I’m worried that we’ll lose people if we just talk facts and figure the whole time. So this Happiness Advantage, I have to tell you, I love that book, there’s a group of men, business owners, I meet with every Friday morning, every one of them read it, and we talked about it. It really influenced us. I appreciate that recommendation that you made as well. What was a big take away from that book, The Happiness Advantage, that you would hope people would try to implement in their life? What’s one of the biggest takeaways you took from that read?
Larry: First, I would recommend people watch Achor’s videos, you can find them on YouTube, and the book is great. It shows you how much our behavior is impacted just about how we even think about ourselves, and focusing on positive things, which is what Shawn talks about throughout the book, really can help. Even things like making sure you get out and exercise, not doing a treadmill in some gymnasium, that’s better than sitting on your couch, but being out, walking outside is better than the treadmill at the gym. Walking outside in a beautiful park, or on the beach is better than walking on a city street.
Larry: It’s just being out in nature and enjoying it really elevates your levels of good feeling, your hormones in your body that get released, that really can psychologically help. They found that that helps greatly people who are depressed even get benefits just from being outside and walking in nature. So it’s a whole series of things around that, and I highly recommend the book.
Jason: Awesome. Now, I know you’re a big time reader, so what are some books you’ve read recently that might influence or shape our lives?
Larry: I would recommend anything by Adam Grant, he wrote a fabulous book if you’re a leader in an organization, I would read his book including one called Give and Take. He’s also got a series of great videos. That would be another book that I would recommend, or another author that I would recommend as well.
Jason: All right. Larry, we’re having you on today, you have a brand new book out, will you tell our listeners the name, the title of the book, where the best place to buy that is and then also maybe some ways to follow you and the work that you’re doing if they’re interested in learning more?
Larry: Sure. The book is my 17th, Your Complete Guide to a Successful and Secure Retirement, co-authored with my colleague Kevin Grogan, who has co-authored two other books with me. Pretty much the only place you could buy books almost these days is on Amazon. You can follow me in a few places. I write three times a week on Monday, Wednesday, Friday, typically for ETF.com. Regular column. You find me on their lead page. I also write once or twice a month for I think the best site for those of you who are geeks in finance called Alpha Architect, run by a fellow named Wes Gray and his partner Jack Vogel. Every once in a while I write also for Advisor Perspectives, so those are the three places you could find me.
Jason: All right. Hey, I want to ask you, we rolled out a brand new feature in the Retirement Budget Calculator that we created at the retirementbudgetcalculator.com. It’s to help people understand their time horizon. What we did with that tool Larry is you put in your age, I’m sorry, your birthday, and your gender, and then we use the social security tables to give you some idea as to what your life expectancy could be. Then we break that life expectancy down and we show you the number of days you’ve been alive, and then we show you the number of days you may have remaining based on this tables, the life expectancy tables, that the Social Security Administration puts out.
Jason: How important is it do you think that people have some kind of idea for a time horizon? What do you think about looking backwards using social security actuarial tables compared to medicine, science and technology and what we should be thinking about life expectancy going forward.
Larry: Well, first thing I would tell people is you have to be very careful in thinking about life expectancy. Here’s a good example. If you’re a 65-year-old male, your life expectancy, if you’re normal, healthy, might be say 18 years. I put you, say, age 83. That would be a huge mistake if you planned on having money to last 18 years, because 50% of the people live longer than the average. Therefore you probably should plan on at least say 23 years, or 25 years, because the cost of being wrong there, meaning you live longer than expected, and you’re out of money is unthinkable.
Larry: Second thing is, if you’re married and have a spouse, in this case, so your wife is also 65, the second to die life expectancy is closer to 90. So now you have to plan for 25 years and then there’s the 50% chance someone will live longer. If you happen to make it to 90, your life expectancy at that point may even be six, seven or eight years
. So, I tell people at 65 really need to plan if you’re average health or better for 30 years of living and even that may not be enough because science continues to advance.
Larry: The last thing I would add is this, sadly, 80% of the money we spend in our life on our healthcare is in the last year of life. You could have massive expenses if you live several years with cognitive decline, Alzheimer’s, et cetera, where you’re needing to spend 100 grand or more a year for decent care. That’s a risk of living longer and the need for long-term care that should be considered. We talk about that in a chapter on long-term care in the book as well.
Jason: Awesome. Hey, that brings me this discussion about longevity. In your book you talk about two tools that can be controversial, among financial advisors at least. One of those tools is an annuity to help with longevity risk. The other one is a reverse mortgage. So, will you maybe just take a minute, talk to our listeners your thoughts about using an annuity for some guaranteed cash flow to help alleviate that concern of living too long, and also this biggest asset that most people have is the equity in their home, and using the reverse mortgage. Because both of those, you say annuity or reverse mortgage and all of a sudden people stop listening. So what do you think about that?
Larry: That both could be very good tools. Certainly annuities are a great tool. But the only times you should buy, or what I call [inaudible 00:37:41], or Single Premium Immediate Annuity, is the first time you make a payment, and then you get a fixed dollar amount, or possibly inflation adjusted for the rest of your life. It’s not my favorite, although it’s worth considering. Certainly once you’re in your mid 70s or older. But to me we buy insurance not for the expected, but the unexpected. Think of a car. We don’t buy insurance for an oil change, we buy it for a major accident.
Larry: So you should be budgeting for your life expectancy, and then buying insurance for living longer than expected. That’s where this deferred annuity comes in and might start paying out say at age 80 or 85, and that really helps overcome a big psychological hurdle for people who are concerned about giving up their heirs’ inheritance, because you can put down dramatically smaller amounts and then invest the rest and hopefully it could grow. So, that’s one thing that can be done. For people
much room for error, this deferred annuities really are a good tool.
Jason: I’ll tell you, when we had Dr. Pfau on the program, that was an argument that he made. He said, “If you annuitize a portion of your retirement savings,” he says then that may allow you to take more risk with your investments, which could mean additional longevity and how long your money is going to last just based on the risk profile. It’s also what Robert Shiller said in his book, Irrational Exuberance. He said that people have become too dependent on market returns. He said that more people should be buying inflation adjusted bonds, and annuities as part of a retirement cash flow plan. That’s what a pension was. What about the reverse mortgage, what are your thoughts on those?
Larry: Yeah. First I agree both with Shiller and Pfau, they’re underutilized. One reason may be advisors are not acting in their client’s interest, they don’t want to see the client give up those assets and then they can’t charge on them. So that may be a bias there. If you’re a true fiduciary, you should give advice that’s in the client’s best interest. Reverse mortgages are not a great product still, they’re a bit expensive. But they are worth considering as a [inaudible 00:40:08] last resort. Say you want to live in your home, and die with dignity, not end up in some old age home, you could tap into that equity in the home and get paid a cash flow until the home is sold when you die.
Larry: So if you do have equity, it’s not going to be the cheapest thing, but it is certainly worth considering. It’s a pretty complex product, you really should get help with an expert, we cover some of the issues in that chapter.
Jason: All right. Okay. So we’re going to kind of make a shift back into evidence-based investing, asset allocation, and some of these things you really hit hard on in the book. The next one is, I’m going to set this up with a little bit of a story. So there was a gentleman recently who was saying he, and of course I’ll love to hear your response on this, but he says he loves dividend paying stocks. What he says, this guy is retired, he said, “Jason, if the dividend paying stock that I own is kicking off 5% income,” and he owns a basket of these individual dividend paying stocks, he’s own them for a long time. I don’t know if his 5% was based on cost or the current yield. Probably cost.
Jason: But anyways he says, “If I’m getting this cash flow from this stock and the value, the price of the stock, declines, why do I care as long as it continues to pay me the income?” You had some, in your appendices, you talked about dividend investing versus total return. So maybe you would take a minute and talk to our listeners your thoughts about a total return approach where you’re selling shares to generate the income that you need versus this gentleman who says, “Look if I just have income coming from the portfolio, I don’t really care what the price is, as long as the cash flow is there to support the income that I need.” Take it away.
Larry: Yeah. First of all, it’s important to understand dividends are not safe, just think about the people who relied on the dividends from GE as one recent example. Or PGNE-
Jason: Oh yeah, good good. Great recent example.
Larry: [crosstalk 00:42:18] bankruptcy.
examples. But second thing is this, and again, I like to rely on evidence not opinions. There was a paper written back in the 1960s by two famous economists, and they said dividend policy is irrelevant to stock returns, and that paper has never been questioned or refuted since. So we have 50 years where no one has found any evidence that dividends matter when all else is equal. The mistake that people make is they think it’s sort of a free lunch. Say your friend has a stock, it’s at $100, and it pays the dividend, let’s just make it simple, once a year five bucks.
Larry: All else equal, the stock will drop to 95, and my stock, which was also trading 100, exactly same company, that’s paying no dividend will remain at 100. If neither of us needs the cash, your friend just got taxed by the US government and has to pay a tax on his dividend. I have no tax at all to pay. Now, if I do need that $5, I could sell a number of shares to generate that same number cash, and now I only pay a tax on the gain, which may be zero. Clearly, I’m better off. We end up in exactly the same place.
Larry: The other problem is this. In the 1950s and ’60s something like 80% of stocks pay dividends today because corporations recognize it’s inefficient way to return cash to shareholders. Much better to buy back your stock, which pushes the stock price per se up or prevents it falling. There’s no tax there at all. So today something like only 30% of companies even pay dividends. So by focusing on dividends you’ll end up with a much less diversified portfolio, and very likely a US centric one, so you lose the benefits of global diversification. If you want a cash flow, it’s simply better to take a total return approach.
Larry: What people don’t understand is that when the stock is down, say that stock we talked out as 100, and it went to 50. Let’s just say they’re still paying that $5 dividend, now your friend is selling the stock in effect, because it will go down to 45. The company is in effect forcing you to sell shares by paying a dividend. It’s exactly the equivalent which is why Modigliani and Miller said there’s no difference, it’s irrelevant, it’s only tax inefficient. Therefore it makes no sense to have a dividend paying strategy.
Larry: One last comment I’ll make. There is some benefit psychologically for people, that’s why papers had been written about what explains this behavior. People say, “I’m not selling stocks when the market is down.” It helps them stay the course because they have this cash flow. But they are in effect selling stock because the stock went down and price goes to the dividend. But if it helps you psychologically, okay, but I think it’s far more intelligent to understand what’s happening and know what’s going on and understand you’re selling anyway. Just that you haven’t acted to physically sell the shares.
Jason: Okay, okay. Then I want to bring it back, because you mentioned Warren Buffett when you talked about this in the appendix. You say, Warren Buffett in 2011 with Berkshire Hathaway, he caught a lot of heat from people because he’s sitting on all this cash, and he said he’s not going to declare a dividend, and he says, “If you want money out of the company, just sell some shares.” So you make an argument saying, “Warren Buffett’s saying take a total return approach.” However, the flip side to that is you look at the stocks that Warren Buffett owns, and I don’t know was it 80% of them all pay dividends? That’s one of the reasons he has this big cash hoard, it’s because of the income that’s coming from them.
Jason: So, in one sense he’s saying, “Look, I’m not going to pay you a dividend.” But on the flip side, the companies he’s buying, many of them do pay dividends. How do you reconcile that?
Larry: I don’t think there’s anything to reconcile. I don’t think he buys the stocks at all because they have dividends, he’s buying the stocks because they have cash flow and he’s buying in effect an interest in that cash flow, whether the companies pay dividends or not is really irrelevant and in fact he would probably prefer if they didn’t, because then he wouldn’t have to pay taxes on the dividend income that he receives as well. It’s you’re buying cash flow that a company is generating not buying a dividend.
Larry: Again, Warren Buffett, if he wanted to, could create that same cash flow that he’s recommending individuals. If you want the cash flow, just sell a certain number of share, that’s far more tax efficient way to get the same result. It’s a purely psychological problem that people have. Can’t be a free lunch, it’s not like there’s a magic pair of pants where you take the money out and declare a dividend, but the stock doesn’t go down. Clearly, companies worth less when they give away their cash. It’s simple. It must be worth exactly less by the amount of that cash.
Jason: Yeah. Okay. Here’s the next question I have for you. This one has to do, again, these are real questions from real people, the gentleman, he’s 55 years old, he’s thinking he wants to retire at 60. He’s been investing very aggressively up to this point in his life. The question becomes when should he start shifting that investment strategy from this accumulation mindset that he’s had, this very aggressive approach, to a more conservative approach, because now he’s worried about having to begin taking withdrawals from a portfolio? How far out before he makes that transition?
Larry: That answer, we address in a chapter on what’s called the asset allocation decision. It talks about three key issues. One, the length of your horizon, which is even at 65, we said you should be looking at 30 years. So you don’t want to get too conservative. You have to talk about your willingness to take risk and as you approach retirement that’s likely to start to shrink your tolerance for that risk knowing you don’t have as much time to recover and put new money in. Lastly, your need to take risk, hopefully, is declining over time in that as well.
Larry: So, once you stop working, of course, your ability to take risk is going to fall. There’s no right answer to that question, this really is one that each individual should look at. What I have found is that people make lots of emotional errors here by just thinking about the problem. I think the best way to address it is what we use as a tool called the Monte Carlo simulation. It looks at many thousands of possible alternate universes and says, “If my asset allocation is say 40%, 50%, 60%, 70% equities different options, then what withdrawal strategies I’m going to take, whether I’m going to take 3%, 4%, 5%, whatever,” and it will tell you what your odds of running out of money are over say a 30 year horizon.
Larry: You want to choose the period, the asset allocation and the withdrawal strategy that gives you the least amount of risk of running out of money that’s acceptable to you.
Jason: Okay. Folks, if you’re just tuning in, this is, you’ve been listening to episode 196. I have Larry Swedroe on the program. We’re talking about his new book, Your Complete Guide to a Successful and Secure Retirement. Larry, that’s all the questions I had for you, thanks so much for being a guest. Any parting words you’d like to leave with our listeners before we finish up today?
Larry: I would just hope that investors take a great interest in being educated on these issues. I think that’s a great tragedy we have in this country. Our education system has failed the public. So they get much of their education by watching CNBC and Barron’s and that’s the equivalent of getting a medical degree by reading the National Enquirer. You want to make sure you’re reading good books. I’ve written 17. Others authors like John Bogle, and William Bernstein are other great authors I’d recommend. Read books that are based on the evidence, not people’s opinions.
Jason: All right. Very good. Thank you so much, Larry, I appreciate you being a guest again today.
Larry: My pleasure.
Jason: Take care.