This one is going to ruffle some feathers, I know it. I'm ok with it though because, in my opinion, there are some "financial entertainers" who are great at helping people who have lots of debt and are feeling hopeless, however they can be detrimental to families who are in the upper echelon of income earners with significant potential ahead of them.
It's about to get spicy, so on to my rant...
There's a new video going around which is about a 10 minute segment from a popular "financial guru", and they are discussing the financial industry standard's "Safe Withdrawal Rate" of 4%.
Aside from being condescending and quite passive aggressive, the rant is also horrendous advice which can be easily refuted with some simple math. It's the equivalent of your doctor telling you to eat Reese's Cups and cinnamon rolls for every meal. Or your farmer telling you to eat an apple and chase it with a shot of pesticide. Terrible advice that may have catastrophic consequences down the road.
If anyone who has a license to give financial advice actually gave this advice to their clients, I would imagine they would very soon be out of a job and possibly on the wrong end of a lawsuit. To my knowledge, most "financial entertainers" and "influencers" have no finance licenses, so they cannot be held liable for any advice they give to the public. There are no consequences to their actions.
Let's break down this strategy...
A direct quote from the video is, "If you're making 12% in 'good mutual funds' and the S&P 500 is averaging 11.8% and if inflation for the last 80 years is 4%, if you make 12 and you need to leave 4% in there for average inflation raises, that leaves you eight. So I'm perfectly comfortable drawing eight. But if you want to be a little bit conservative, seven. But, sure, not five of three."
Ok there's a lot to unpack there.
First off, I'm not aware of any mutual funds that offer a 12% return every year without fail. However, it is stated as if it's a given. Like you can walk into the Stock Exchange and pick the 12% returning mutual fund off the shelf. That would be awesome if it was possible.
Second, is the S&P 500 really averaging 11.8% per year? Let's check with the "Don't Quit Your Day Job" S&P 500 calculator1:
So over the last 30 years, assuming you've reinvested all dividends (which most do during their accumulation years), the 11.8% figure is off by just about 2% each year.
Now I do agree with the inflation estimate of 4%. It may even be a little higher, whether you like it or not, but we'll go with the 4% for now.
Third, how many people in retirement have 100% of their money invested in 100% equities? Not many, if any at all. People using their assets to generate income aren't comfortable taking on that much risk (more on that in a minute).
Those "Target Date Retirement Funds" in your 401(k) are designed to automatically sell equities as you get closer and closer to that "retirement date", which means you are going to own more bonds as opposed to equities as you get closer to retirement. And over the last 25 years, bonds have returned closer to 4%2. This simply means you are less likely to get close to that 9.7% number above, and more likely to get closer to that 4% number the closer you are towards retirement, assuming that you stay in that same target date fund.
Now typically, the more equities you own, the more volatility you may have in your portfolio. That's a big reason why people own equities. They want the volatility (or risk) given their expectation of a higher return over time. That works quite well when you are adding money to a portfolio. When stocks, or equities, fall in value during periods of volatility, you are still adding to the portfolio which means you are buying more shares at lower prices.
Volatility is not your friend in retirement, though, because you need income, and you'll still need income in years when the market is down.
Let's go through a simple example. For this, just grasp the concept of volatility and withdrawing retirement income at the same time. We're not going to factor in taxes. We're not going to factor in inflation. We're not going to factor in mutual fund fees. We're stacking the deck in favor of the idea that, "A million dollars should be able to create an $80,000 income for you, boys and girls, perpetually! Forever! You should be able to pull $80,000 forever."
You have accumulated $1 Million, and you are in your first year of retirement. You need $80,000 per year for retirement income. And you're going to get 10% a year on average (like we reviewed in the calculator above). Simple math tells us we can just live on the interest/gains (of 10%) each year and be just fine. We'll there's a difference between averages and reality.
In year 1 of retirement, let's assume you pull off the $80,000 at the beginning of the year (because you need income for the year), and you leave the rest ($920,000) to be invested. And you get a 40% return that year. That means your $920,000 grew by 40%, or $368,000, for the year. So at the beginning of the next year you have a total account balance of $1,288,000.
Now in year 2 of retirement, at the beginning of the year you pull your $80,000 that you need for income at the start of the year, and the market has a 2022 and falls by 20%. So your $1,208,000 account balance takes a $241,600 hit in value and your account balance drops to $966,400.
Well guess what we still need to do in year 3? We need income. We have to pull out the $80,000 of income at the start of year 3, so we can live for the year. This means that you start the 3rd year of retirement with an account value of $886,400.
Over those first two years in retirement, what's the average return your portfolio received? Well, a +40% year and a -20% year over two years gives us an average of 10%. You got your 10% average just like the S&P 500 calculator tells you. However, what's the problem?
Your account balance is down 11% after you pull out your income at the start of year 3, and in order to get back to the $1 Million mark, you would need a return of at least 13% in that 3rd year. You still need income in year 3 and have to pull money out even though the market was down. Going forward in retirement, you have to start making decisions.
1) Do we continue pulling out the same income each year, or are we forced to start living on less?
2) Do we now have to start taking more risk to capture more upside potential with the market and recapture the drops in income?
3) Do we start looking for jobs and go back to work?
4) Do we now, at a lower account balance, decide to be more conservative with investments; therefore leading to a potentially lesser chance of getting back to $1 Million?
Those are a few decisions most retirees end up having to make. Why?
Because sometimes the advice from "gurus" isn't based in reality.
This is setting people's expectations to be unrealistic, and has the potential to cause people to go bankrupt in retirement, or they're going to be forced to live on less money, or forced to take more risk at a time in life when risk is their foe.
The excuse for this terrible advice comes later in the interview. “So when you tell people that a million dollars creates a $40,000 income, you go ‘oh, I’ve gotta have $2 million and I can’t make that,’ then the system doesn’t work. So what you’re doing with this bogus math is you’re stealing peoples’ hope. That’s why I’m pissed about it.”
Now, I'm a big fan of giving people hope. The belief that something is possible often helps people achieve things that were previously thought of as insurmountable acts.
However, hope and math are two different things. Math doesn't just magically work because you have hope, and that's the point a lot of these people are missing. They often assume that life works like math.
Making up numbers to "give people hope" doesn't help, it actually hurts. If a fortune 500 company made up their earnings because they want their investors to have hope that the company is doing well, those people may find themselves in jail (see Jeffrey Skilling of Enron serving a 24 year prison sentence).
So let's run this scenario through an analysis model that is used to predict the probability of a variety of outcomes when the potential for random variables is present (called Monte Carlo Analysis), with no mutual fund fees, no taxes, and no inflation, and $1 Million dollars invested 100% in an Ultra Aggressive Portfolio (i.e. 100% stocks) which has an annual return of about 10.32%.
We have a 30 year failure rate of about 43%. That means that almost half of the people who do this will run out of money while they are still alive, which is one of the biggest fears for retirees. And remember the assumptions - no fees, no taxes, and no inflation.
If we change one variable, and use that 4% inflation rate, the failure rate jumps to over 80%.
And if we add a tax rate of just 15%, the failure rate jumps to over 90%.
So this strategy, of spending 8% of your assets for 30 years in retirement, with inflation and taxes included, results in 1 out of 10 people succeeding.
Ninety percent of people following that advice may fail.
I don't think that these people have the intent of causing people to fail.
I think they are just doing this for clicks. How many times does something on social media go viral because it's absolutely absurd? Nothing boring goes viral. It's the controversial, insane, looney toon comments or actions that gets people talking.
And with that, I congratulate them. They won, because here I am talking about this absurdity.
But who lost?
The ninety percent of people who follow this advice. Ninety percent have run out of money and have no hope for the future. They have lost that one thing that a lot of these "gurus" have hoped (no pun intended) to give them.
And here's the reality:
Most people are feeling hopeless with their finances and the prospect of a bright financial future.
Most people are feeling the increase of expenses and it gives them a suffocating feeling.
Most people are struggling to save money and those who do are often drastically under-saving. The national average for household savings rate is 3.9% of their income3.
Most people just aren't saving enough money to where accumulating one or two million dollars is even possible without taking significant risks during their accumulation and distribution years. Again, it's the math.
Most people sacrifice tomorrow for today, which is why the average credit card balances today are at a 10 year high4.
But you don't have to be most people. You don't have to be the target market of hopeless people. There is no "get-rich-quick" scheme to accumulating wealth.
So let's take action and right the ship. Blanket advice for the general public is not advice tailored to you and your family.
Together, let's design a path forward, build habits that build hope, and accomplish things for our family that allow us to be different than everyone else.
Feel free to use this link to book time on my calendar or send me an email at email@example.com and I'd be happy to share more ideas with you!