Alliance Director of Research and author, Larry Swedroe, exposes what he calls “Wall Street marketing BS” about active management, dollar cost averaging – which he says is a dumb strategy – and more. Plus, 5 Mistakes to Avoid in Retirement, an update on the Department of Labor Fiduciary Rule, and… Pikachu eggs.
- (00:58) Department of Labor Fiduciary Rule
- (10:15) Larry Swedroe on “Active, Passive and the Low-Return Imperative” and Dollar Cost Averaging
- (21:29) Larry Swedroe on Active Management
- (31:00) Big Al’s List: 5 Mistakes to Avoid in Retirement (Kiplinger)
- (41:27) Big Al’s List Continued
- (50:40) Big Al’s List Continued
“We don’t need that many active managers to get prices set correctly, or at least the best estimate of the right price. We certainly don’t need 8,000 mutual funds and 10,000 hedge funds to do it. Maybe we could get by with 10% or less. So 90% of the industry could certainly disappear and investors would certainly be far better off.” – Larry Swedroe
BAM Alliance Director of Research and author Larry Swedroe is on FIRE today on Your Money, Your Wealth, exposing what he calls the never-ending stream of marketing BS from Wall Street about active management, why he thinks dollar cost averaging is a dumb strategy, why 90% of the industry could go away, and more. Yeow! Also, Joe and Big Al discuss 5 Mistakes to Avoid in Retirement and the latest on the DOL Fiduciary Rule. Now, here are Joe Anderson CFP and Big Al Clopine, CPA.
:58 – Department of Labor Fiduciary Rule
JA: So, I’m just going to get this out of the way right now, because I don’t want to talk about it. But the DOL… because this show is all about information. (laughs) People turn to Your Money, Your Wealth for breaking news, Al.
AC: So let’s explain. The Department of Labor.
JA: Yeah, the DOL seeks 18-month delay on the fiduciary ruling. 18-month, a couple of years.
AC: So we’ve had this thing where the advisors – an advisor who is supposed to help you and me, whoever, with retirement plans, is supposed to be a fiduciary. And now, there’s been a lot of fighting, I guess, over that ruling, and so you’re saying that even the DOL says they’re going to delay it?
JA: I guess so. Phase 1 of the DOL rule took effect June 9th. It requires advisors and agents to act as fiduciaries, make no misleading statements and accept only reasonable compensation.
AC: That doesn’t sound like a bad thing.
JA: Still, opponents are far more concerned with Phase 2 rules that establish a class action right to sue.
AC: That’s what they don’t like. They don’t want to be sued for not giving you good advice.
JA: I guess so. Without the latest delay, the BICE, the best interest contract… exemption. (laughs)
AC: That sounds right, maybe. (laughs) I always have to look it up. The BICE.
JA: I know it’s best interest contract for sure.
AC: Exception, I bet.
JA: Exception? Instead of exemption? (laughs) See Al and me, we always work as a fiduciary.
AC: We don’t need to worry about BICE, or rice, or mice. I don’t care. We’re going to give you the best advice. We’re fiduciaries already, but a lot of the industry is not. And that’s what’s surprising, Joe, to a lot of people, I think.
JA: So right now, it requires significant disclosures, and a signed contract with the client, that contract forms the basis for litigation liability. So removing the class action lawsuit from the BICE, best interest contract exception, is a good possibility. So this is Bradford Campbell said this. Basing his opinion on statements that the DOL has made so far if the class action right isn’t scratched, it will cause problems in the courts, he predicted. So the delay will make even more likely the DOL and the Securities Exchange Commission end up working together. So I don’t know, there was some argument there too, is that why is the Department of Labor involved, versus the Securities and Exchange Commission?
AC: Yeah. Well, that is a reasonable argument, I suppose. What do you think? Do you think this should be delayed 18 months? Or maybe the SEC should come out with something since they’re really the governing body?
JA: Here’s my opinion. I think the cat’s already out of the bag, you know what I mean? I think there’s a lot more information and education on it. I remember, we started Pure Financial Advisors 10 years ago, and a lot of the messaging that we would talk about was based on, kind of the foundation of how we establish Pure Financial Advisors. I mean, there’s a reason why we are called Pure Financial, is because we just give pure advice. We try to eliminate a lot of the criticisms and conflicts. We would be in meetings with clients and we would say fiduciary, and they would be like “fiduciary what?”
AC: Sounds good. What is it?
JA: So I think today, fast forward 10 years, I think there’s a lot more information, education out there for the public, which is a really good thing.
AC: Yeah. And if you don’t know, a fiduciary as it relates to an advisor, what it means is the advisor has to give the best advice possible for you, not the best advice that’s going to help the advisor with a commission and so forth. It needs to be the best advice for you.
JA: Yeah, but I still think that a commission product, you can still act as a fiduciary.
AC: I don’t disagree with that. As long as it’s the best solution or product for the client. But right now, a lot of the industry is under the suitability standard, which simply means as long as the product is suitable for the client, I can sell it to you. It may not be the best one. And that’s the change. It’s now under fiduciary, it has to be the best one, at least in your opinion. That’s subject to opinion, of course. But if there’s a product that’s much better for you than the other one, and you’re sold the other one because it’s a higher commission, then that can be a problem under this new DOL rule.
JA: Sure. So, we’re a fee only financial planning firm. We don’t accept commissions, but I’ve been in this business almost 20 years, and so I’ve seen all sides of the business.
AC: And you have, in your past life, sold products where there were commissions.
JA: Yes, because fee only was unheard of.
AC: Yeah and I had a very short stint doing that, as well, in between my CPA practice days and getting into financial planning, I had a short stint where our firm did that, and so it doesn’t have to be horrible. It depends upon the advisor that you’re getting, and on the other hand, we know, as in any industry, I’m calling out ours as solely, but there are going to be people that take advantage of clients, and this is an attempt to try to curb that.
JA: Exactly. And if I had a choice, would I rather work with a fee-only advisor versus a commissioned advisor, I’d probably choose the fee only because I would feel a little bit more comfortable that that person, there’s no barrier there. “Hey, I’m paying this individual a fee for service, and hopefully that service is worth the value that I’m paying.”
AC: And fee-only, it would be synonymous with fiduciary. Could you be fee-only and not be fiduciary?
JA: Well, maybe. I don’t know. Well, it’s all for interpretation I suppose because you and I have a very strong belief of what good financial planning is. What good tax strategies are, how a portfolio should be invested.
AC: Right. Which we’ve tried to articulate over the last 10 years.
JA: Right and not doing a very good job. (laughs)
AC: Maybe 10 years from now we’ll be really good. Keep listening.
JA: But there could be, let’s say, a fee-only fiduciary that has an investment philosophy or an investment strategy, that is not necessarily in line with what we feel is the best way to manage assets. They could be doing all sorts of derivatives, or options, or more sophisticated strategies, that you and I and our team members, and our partners have researched, and research shows that there’s very little value there. It sounds sexy, but it might not necessarily produce the results that you might think it does. Are they fee only? Sure, they might be just saying, “Hey, I’m going to charge you a fee, and I’m going to do this crazy investment scheme.” I guess scheme is a little bit kind of a hard word.
AC: But options, derivatives, there’s a good example of other strategies where you can make a lot more money than what we might recommend, which is a globally diversified, low-cost portfolio. On the other hand, you can lose a lot more money too. And since we talk to most people that are retired or close to retirement, it’s like they don’t really want to gamble with their retirement nest egg, so those kinds of strategies are not necessarily appropriate, usually for that age group.
JA: Right. In our opinion. Someone else’s opinion could be totally opposite and that’s fine. That’s why we live in the great ol’ USA.
AC: And you get to pick.
JA: They could be trying to time markets, getting out, what’s going on in North Korea, what’s going on with the President. Hey, let’s get out of the market now. Which I think a lot of people might have a little anxiety at this point, this week has been a little bit volatile, to say the least. Not just markets, just general life. (laughs)
AC: (laughs) Especially, we live in San Diego, and we’re close to the target zone. Well I mean, Guam and Hawaii.
JA: Oh come on. I am not worried at all.
AC: Well he said he can hit Chicago, so if he can hit Chicago, he can hit San Diego. (laughs)
JA I knew I shouldn’t have even brought it up. (laughs) But anyway, that’s kind of the latest. I know everyone was tuning into Your Money, Your Wealth just to hear our bit on the DOL.
AC: I’m pretty sure that wasn’t happening.
JA: I’m sure you’re right.
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10:15 – Larry Swedroe on “Active, passive and the low-return imperative” and dollar cost averaging
JA: Alan, it’s that time, for our good friend Larry Swedroe. I love having Larry on the show. He’s been on the show multiple times.
AC: I do too, and I know he’s kind of fired up today. We’ve got some good stuff to talk about. He’s always fired up.
JA: Well, when is he not? Larry, welcome back to the program.
LS: Thank you. And it’s a never-ending stream of marketing BS that Wall Street puts out, so I’m never short of material. The fun is exposing it. What is the interesting question is why do people write stuff that is so easily exposed, and makes them look bad, when you do that?
JA: (laughs) I think, for the most part, most people probably take it as gospel.
AC: Yeah, they don’t know, and then they don’t read the rebuttal. They don’t even know that it was bad.
LS: Well that’s one explanation for sure, but that’s why I exist, right? To play the role of Toto in the Wizard of Oz and expose the man behind the curtain.
JA: (laughs) Yes.
AC: (laughs) Well that’s a perfect analogy.
LS: Now you guys got a new nickname for me, you can call me Toto.
AC: (laughs) We could have never called you a dog, but okay, we’ll go with that.
JA: (laughs) I love it. So what do you got for us this week, Toto?
LS: Well, there was an article by Jeffrey Hussey, who happens to be the Global Chief Investment Officer at Russell Investments.
JA: So that’s a pretty big company, right, Russell?
LS: Yeah. They advise directly on over $40 billion of assets, you can find that at Morningstar.com, but they’re actually a much bigger influence, because they advise on hundreds of billions of dollars of assets run by institutional money programs, like endowments, etc., and pension plans, and so they’re really a big influence here. And he wrote this piece, which is called Active, Passive and the Low-Return Imperative. And he makes the case, which I’m sure we all agree with, that today’s valuations for stocks are higher than historical averages, and that predicts, in general, you should expect lower than historical returns. It’s not a guarantee of that, but that’s the likelihood, and of course, bond yields are way below their historical averages, which virtually guarantees you’re going to get much lower than historical returns on bonds. And so he says, lots of people aren’t going to be able to make their goals because they need a higher return. And so he says the way out of it is active investing. So, what do you guys think of that idea?
AC: (laughs) We think it’s crazy. But you, I think, do a really good job articulating why. I mean, maybe start out with passive versus active.
JA: I think it’s even more than that because I think this is the problem is, right now you hear in the media Larry, the market is at an all-time high. We’re probably going to go to war with Korea. Interest rates are at all time lows, they’ve been this low, how are you going to create yield. You’ve got 10,000 baby boomers retiring, and blah blah blah blah blah. And most people don’t have enough saved, so they need to figure out a way to create the income, and of course, let’s write an article about how do you create higher yields, and you’ve got to be smarter than the market, so hire us. I mean, I think that’s the whole marketing play, isn’t it?
LS: Well that’s one of the ones, and he offered three ideas to support his argument. Of course, he says that indexes can’t beat the market. Of course, we agree. And therefore, if you want to have a better chance of outperforming, you should use active management. Of course, anything that gives you more than a zero chance of outperforming is good, from that perspective. But let’s remove the curtain and see, what does it do to your odds of underperforming the path of benchmark? And active is really bad from that perspective. And I would point out the following: instead of using active strategies, let’s say you chose to use Vanguard index funds. For the last 15 years, on average, their ranking put them at 21, which means they outperformed, even before we considered taxes, 79% of actively managed funds. Which means if you went from active to passive, your odds of outperforming the active just went way up, because you went to 79%. But DFA funds, the ones we both use, did even better, their numbers were 10% average ranking. So you had a 90% chance of outperforming, versus a 10% chance of underperforming, which odds do you liked, the 10 or the 90, Joe?
JA: Yeah. This is so good because I think we focus on outperforming the market, then it’s like, well what’s your alternative? And then you hear, if I want to buy the market, you’re not going to outperform it, but you have a 90% chance to outperform everyone else.
LS: That’s it. That’s the magic. That’s why we have to give people the right perspective. The way I think about it is this article is just like the street con artist who uses means to try to shift your attention from what they’re doing, use sleight of hand, if you will, like a magician. So you’re not focusing on what’s really going on and can see how they’ve hidden the coin or whatever. And so we need to give people the right perspective.
AC: Larry sometimes, some people will think, “then I’m just going invest in what the 10% that beat the market did.” In fact, even some advisors will say, “we’ve got the secret screens to figure out who the best advisors are, who the best investment managers are. We’ll just show you them, and then you’ll outperform that way.”
LS: Well that’s obviously true. And you and I would certainly do that for our clients if we had that secret sauce. Unfortunately, there’s no evidence that anyone has that. Sure, you can invest with the 10%, but there’s no way to know ahead of time exactly who they’re going to be.
JA: Question for you here, with our listeners, there’s a lot of kind of doom and gloom in a sense going on, and we got a little bit more volatility. We talked about this in the past. But I think it’s good just to refresh our listeners. If you look at valuations here in the U.S., some people will say that they are high. If you take a look at P E ratios or the Shiller ratio, and then that’s all you hear in the media is markets are of all time highs, all time highs. What should investors be listening to, and what should they be doing, in a sense what their overall portfolios, hearing all this noise – besides ignoring it.
LS: That’s the first thing, ask yourself are you likely to come out ahead by paying attention to that noise? And the answer is definitely not. I just did a little piece I wrote up it, has not been made public yet. So it asks the question that lots of your clients are probably asking, and that’s why I wrote the piece. I was getting this question. With valuation so why, aren’t I better off waiting if I have new money to invest, let alone engage in a panic selling, which lots of people probably have been doing. And there was a recent study done showing that the problem is when you wait. We know there will inevitably be a correction, let’s say we’ll define it as 10% in a bear market of 20. So, if it’s going to come, and the odds are great by the way. If based on history, in the next three years, at some point, we will see a correction of at least 10%. The odds of that happening are 56%. So people say, well shouldn’t I wait? And if I do, it turns out you will get a 10% benefit. The problem is, that that doesn’t happen necessarily from today’s level. The markets can go up, say, another 15-20%, then get that correction. And by the end of the 10 years, you’re now behind the average if you delay investing.
JA: What do you feel about dollar cost averaging?
LS: It’s a dumb strategy.
JA: Because if you need to be in the market, you need to be in the market. And dollar cost averaging, new monies into the overall portfolio, I agree with you, because you could miss on significant run ups and so on.
LS: Well here’s an interesting thing, guys. There was a paper addressing this question about 50 years ago. A Professor Constantinides of the University of Chicago, and he asked this question, which is better? And he gave a very simple, intuitive answer, and showed that it must be true, that not timing, and investing immediately, must be better. So I’m going to walk you through the simple logic to help your listeners. So Joe, why do you invest in stocks?
JA: Because I want a higher expected rate to return than cash.
LS: What’s the magic word, the most important word you said in that phrase?
LS: Expected return. Are you guaranteed to get that return, higher than?
LS: No. OK. And so, why do you get that higher return that is expected? What’s the reason for it?
JA: I’m taking on risk.
LS: Right. And so stocks, are they always riskier than bonds?
JA: I would say, depends on the bond, but yeah.
LS: Yeah, in general, say, safe treasuries, they’re always riskier. So that means all of the time, if you wait a day, you’re giving up an expected risk premium that must be there. Every day you wait. And so, therefore, the right answer must be, unless you have a perfectly clear crystal ball, you should invest and avoid giving up that risk premium. It’s very simple math. And the research shows exactly the same thing. Unless you have an incredibly accurate timing mechanism, you should avoid doing that.
Hey, Larry, we’ve got to take a short break. We’re talking to Larry Swedroe. We’ll be back in just a second.
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21:29 – Larry Swedroe on active management
LS: I do want to come back to Russell because I haven’t finished having fun with them here.
JA: Let’s blow ’em up, let’s do it.
LS: We wanna blow this one up a little bit more. So, they mentioned two other things in this piece, and one is that they say active investors could target their exposures much better, and they can be dynamic in their asset allocation, meaning we’ll jump to small cap stocks when they do better, cash when it does better, and then value. Well, unfortunately, there’s no evidence that that’s true, because I just gave you, earlier, the evidence on Vanguard and DFA’s funds, which engage in no dynamic allocation, and they outperformed in both cases the vast majority. But so then I asked the question, well, the average active fund doesn’t do it, right? And the average active fund (unintelligible). But what about Russell? So I looked at their funds for the last 15 years and compared them to DFA’s and Vanguard funds. And when I compared them, equal weighting, creating a portfolio, there were three cases where they had similar funds in the same asset class. Russell’s three funds portfolio would have returned 8.2%. DFA’s three would have returned 9.1%, so DFA wins by 90 basis points, and Vanguard’s fund, they actually had four cases where they were similar. And Vanguard outperformed Russell by 1.1% a year compounded. So Russell clearly isn’t showing any skill set there either. And then I did one last task as a regression tool that’s available to your more sophisticated clients, on a website called Portfolio Visualizer. And I took their five domestic funds and looked to see if they were adding alpha on a risk adjusted basis. And by that we mean, counting their exposure to small caps and value stocks and momentum. And the average alpha of the five funds was minus 1.7% a year.
JA: So that means they are not adding anything.
LS: They’re subtracting big value. And yet they have the unmitigated gall to write a paper saying how good active is and applying, of course, you would invest with their strategy. And then I did one more thing. I keep a track record of Barron’s annual rankings of mutual fund families, and two years ago, after 2014, so the 2015 ranking, out of all of the mutual fund families that they had a 10 year track record for – so they were 48 of them – guess which one finished in dead last place?
AC: (laughs) Russell.
LS: Russell. Now this year, so I checked back and I look at this year’s, and they did manage to move up slightly. They were now 48 out of 53. So the average active fund we discussed does miserably and compared to that low benchmark, they do miserably.
AC: Yeah but they’re going to say it’s cyclical, this is going to turn around.
LS: Today Russell is managing, I told you, $41 billion. Two years ago when I last looked at Russell they were managing $47 billion. The markets have clearly gone up quite a bit. So their assets should have grown quite a bit over that period, and yet theirs are down instead of being up. So investors are clearly recognizing that they’re getting a bad deal here. So maybe there is more than one Toto in the world.
JA: Hey, one last question for you Larry. There’s a big shift, I would say, over the last, I don’t know, 10 years, of getting out of active funds into more passive type vehicles, such as exchange traded funds, index funds, smart beta funds, and so on and so forth. And so with that shift, I think now a lot of active managers might be saying, hey, well the pendulum is going to turn back to us, because so much more money is going into a passive, where no one’s necessarily managing that. You’re just buying a basket of stocks with a certain characteristic, where we have the analysts that are basically taking a look. Do you ever think the pendulum would shift? If more and more dollars went to more of a passive type approach?
LS: I should hire you to be my straight man. I actually just wrote a paper on that question the other day. If you’d have called me and told me, I would have written it a while ago, Joe. (laughs) So first of all, I would encourage your readers to pick up The Incredible Shrinking Alpha which actually addresses that question. The book, my co-author Andy Birken and I wrote, and the answer is, while we’ve had this trend over the last 20 years – when I started in this business over 20 years ago, indexing was about 1% of the individual money and about 15% of institutional assets. Today that number is about 15% individuals, and over 40% for institutions, so there’s clearly been this trend that you identified. However, during that period, if you buy their argument that you just made, that with this trend to passive it should become easier for active management, then how do you explain the fact that 20 years ago, about 20% of active managers were generating statistically significant alphas over the long term? And today we have several studies showing that it’s down to 2%. It’s actually getting harder and harder to outperform, and we explain why in the book. Let me add this. Fifty years ago, how many mutual funds do you think existed, Joe?
JA: Fifty years ago?
LS: Yeah. I’ll give you a clue as a starting point. There’s something like I believe 7 or 8,000 today, and there are, by the way, about 10,000 or more hedge funds. So with that as your benchmark, how many mutual funds do you think existed?
JA: I don’t know, a thousand.
LS: About 150.
JA: Really? See, you set me up. (laughs)
LS: The hedge-fund industry was Nation. There were hardly any. And yet, even in that environment, when the competition was much easier, because of all these suckers, these retail investors, who weren’t sophisticated and could be exploited. So you could exploit these people, and yet, even then, the numbers were maybe 20 or 30% of active managers were outperforming. So the markets were reasonably efficient. So that tells us, we don’t need that many active managers to get prices set correctly, or at least the best estimate of the right price. We certainly don’t need 8,000 mutual funds and 10,000 hedge funds to do it. Maybe we could get by with 10% or less. So 90% of the industry could certainly disappear and investors would certainly be far better off, maybe fewer mansions in Greenwich, or a few more for sale. But the average investor would be far better off.
JA: Just to wrap this up, I love the analogy with Wilt Chamberlain. When Wilt played, whenever how many years ago, he scored 100 points and he averaged about 36 rebounds a game. The best NBA player last year averaged 16 rebounds a game and no one’s ever come close. Someone came a little close, but not really, to 100 points. And then if Wilt played in the NBA today, would he be as dominant? And I ask a lot of individuals that, and my students that I teach, and public speaking arrangements that I’m in, and most people say no. I mean, he was a really good player then. I go, why? I mean, what happened? Because the competition has built so much, and then now it’s not necessarily Goldman Sachs going after the retail investor, it’s Goldman Sachs competing with J.P. Morgan. And so, the level of sophistication and information and education and everything else in between has made this game of trying to pick stocks, and looking at the diamonds in the rough, and only picking those, it’s almost extinct for that matter.
LS: Well I told that story, that exact one in my book, Wise Investing Made Simple.
JA: I steal a lot of stuff from you, Larry. (laughs) That’s Larry Swedroe folks. ETF.com is where you can find him. He writes great articles. Thank you so much for joining us.
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It’s time now for Big Al’s List: Every week, Big Al Clopine scours the media to find the best tips, do’s and don’ts, mistakes, myths and advice to improve your overall financial picture – in handy bullet-point format. This week, 5 Mistakes to Avoid in Retirement
31:00 – Big Al’s List: 5 Mistakes to Avoid in Retirement (Kiplinger)
Shooting for the stars, ignoring taxes.
AC: What do you make of this? The Employee Benefit Research Institute says that 60% of American workers feel confident about having enough money for a comfortable retirement. 60. Seems a little high, doesn’t it, based on what we know? And the author of this is an investment advisor, he goes, “and frankly, based on the people I talk with every day as a financial advisor, that number seems high.” Which you and I would agree with.
JA: Yep. Rose colored glasses is what that’s called.
AC: But there are some mistakes that we are making as we get close to retirement, and that’s what this article is all about. The very first mistake that this author – this is Josh Leonard – he says, here’s five mistakes to avoid: shooting for the stars. What he means by that is, when the market is up, as it is currently, although last week it wasn’t, it actually went down a little bit. People with a moderate risk portfolio often voice disappointment that they’re only getting 7 or 8% rate of return. Maybe they have a golf buddy that tells him he earned 18% last year, or at some neighborhood barbecue someone bragged about getting 14%, and then you start thinking, “why am I only getting 6 or 7 or 8%?”
JA: And then what do they do? They sell, and then they try to get into something else, and then they buy high, and then they realize this is not giving them the expected return that they thought, so they sell that, and then they buy another investment that’s high. And then they sell that, and then they’re wondering why they have such a miserable investment experience.
AC: Right. And then, there’s a market correction, because they’re all in, 100% in the market.
JA: Yeah. Or let’s say that I’m behind the eight-ball in retirement, it’s just like I only have $200,000 I need to make this $400,000 in five years, so I need to get a very high expected rate of return on my assets. So they’re taking on way too much risk, and they don’t understand the impacts of those risks because all they’re thinking about is the return, not necessarily the downside. And guess what, the downside happens as you just said, and now they’re done.
AC: Yeah they’re down. The the last down market was in 2007-2008, where the U.S. market went down approximately 50%. So if you had a million bucks, now you got $500,000.
JA: Yeah, if they were all in. I hear that crap all the time too. I’m feisty today. This is what drives me nuts, “yeah, your portfolio is going to drop 50%.” Yeah, if you were all 100% in stocks.
AC: (laughs) True. You’re talking about people like us on the radio that tried to scare folks. Yes, I agree with that. And the thing is, here’s why I brought that comment up. It’s because when you’re getting a globally diversified portfolio rate of 6 or 7 or even 8%, and everyone else is getting what seems like 15, you’re thinking, “well this doesn’t work. Diversification doesn’t work. So maybe I should switch to something else.”
JA: The next time you hear someone say they’re getting 15% or 12% or 10%, ask for their statement. Look at what the hell they’re doing, because I’m telling you what, they’re probably BSing you
AC: Yeah. And as a former tax preparer, I know they’re BSing you because I got the tax returns.
JA: Right, because one stock probably did that, but then they had 10 others that blew up.
AC: Right. And I saw their stock, where they got 20%, or 40%, or whatever the number was. That’s legit. Yes. But they forgot to tell you about the five other ones that lost 20%.
JA: This all boils back to, what are you investing, to begin with. Why are you investing your money? Is it for growth? Is it for income? Is it for legacy planning? Is it for retirement? Is it for college?
AC: Is it for you? Is it for charity? The kids later?
JA: Right. And then you back it out and say, “OK well what expected return do you need? Is it 4%, is it 6% to do your goals?” And then they’re shooting for something higher, because of the greed factor.
AC: Right. And I think that’s the key. That’s just exactly what you said, is figure out what rate of return you need, and then figure out the safest portfolio to achieve that rate of return. Because a safer portfolio is going to be less volatile, and less sensitive to the downsides of the market. And so, as you said, if you need 4 or 5 or 6%, why not devise a portfolio that’s designed to earn that rate, instead of 10 or 12%, because, with a 10 or 12%, you’re going to be taking a lot of risks. Now, on the other hand, we see this a lot of times, where people are in their 70s, they’ve got plenty of fixed income, and they’re basically saving for legacy – for kids. And the kids aren’t probably going to get the money for 20 years, so why not have higher expected returns, which is more volatile, because it doesn’t matter so much.
JA: Right. You got that rule of 100 or whatever, take your age minus 100, that’s how much money you have in stocks and bonds. That is just so ridiculous.
AC: Yes. I was asked that at a dinner a week and a half ago.
JA: What, you were having dinner with a friend or neighbor or something like that?
AC: Yeah and they were asking what do you think of the 100 rule.
JA: Did you slap them?
AC: (laughs) No I was nice. I told them why that’s not a very good rule, and I gave him a couple examples, just like we’re doing right now.
JA: Oh, you sat them down. Did you say please don’t ask me work questions while I’m trying to have a dinner?
AC: (laughs) No I’m nicer than that. Yeah, that’s what you would’ve done.
JA: “Shut your mouth. If you want to talk sports….”
AC: “I’m eating. (laughs) Sports. Cars. What else do you like to talk about?
JA: “See this? This is called a meal. We are in a restaurant. We’re not in my office.” You think I talk about cars? Oh my gosh!
AC: Well you talk about your Jaguar. (laughs)
JA: Oh whatever.
AC: The second mistake in retirement, I think you’ll agree with this, is ignoring taxes.
JA: Because taxes don’t stop when your paycheck does. (laughs)
AC: (laughs) It doesn’t. Wow, you just set me right up. Because retirees often underestimate how the lack of a tax efficient plan can affect the taxes that they pay.
JA: Yes I think because most individuals will definitely pay very little tax, if any, in retirement.
AC: Yeah, and explain why you make that statement.
JA: Because most people don’t have any money saved. So if you don’t have any income you’re not going to pay a lot of tax.
AC: Yeah. If you have no savings and no pension, just Social Security, and if that’s your only income, your Social Security is going to be tax-free. And unfortunately, that’s probably at least a third of retirees are living solely on their Social Security.
JA: Then you’d look at another third. They have less than $100,000 saved.
AC: Right. And so, income that they generate from that is very low/
JA: Because, unless they blow it out all in one year, now they have the tax for one year.
AC: Now they’re in the third that has Social Security. (laughs)
JA: Right. They’re back to the other third.
AC: What about the other third? The top third?
JA: Well no, those people have a lot of planning to do. There’s a lot of consideration of what they should be doing with their money, how to mitigate the tax as much as they possibly can because that will be one of their largest expenses. But the problem is when you listen to the general media, or if you read the papers, or anything else, they’re trying to communicate to the masses. So the masses, yes, you will be paying lower taxes. And so this rule of thumb kind of came about is that you put money into a retirement plan, you save money in taxes today, that’s great, and have all that money grow for you, and then you’ll be in a lower tax bracket in retirement. Like I said, that is true for two-thirds of the population. But the other third, no. They have a problem because they hear, OK, here are the rules of thumb. Let’s save into the retirement accounts, which I’m not telling you not to. But you just don’t want to have your blinders on, in a sense, to say, I’ve got $1 million, $2 million or whatever that you have inside your 401(k), IRA plans. Trust me, you don’t have that much money. Because every dollar that comes out of there is taxed at ordinary income rates. And if you’re trying to replicate your paycheck, what you’re comfortable with, well the likelihood of you being in a lower tax bracket, Al and I’s experience is we find that that is not necessarily the case.
AC: I would agree with you Joe, and what we find is, for people that have saved, they tend to save more of their assets in retirement accounts, and by the time they retire, then it’s Social Security. Some people have pension plans, and then they got their IRAs and 401(k)s that are all taxed at ordinary income rates. And then some people have savings outside of retirement, and they’ve got those invested in high income producing vehicles, that is also ordinary income – we see that too.
JA: But how often do you see someone with a very large portfolio, outside of retirement accounts? It’s not common unless they own a business. Stock options. Inheritances. Or real estate transactions.
AC: I agree. Those are the four that we see. It’s hard for people to save a lot of money outside of retirement accounts.
JA: Because it’s accessible. People complain about retirement accounts, saying well it’s locked up, it’s tied up, and everything else. Well, there’s reasoning behind that, because as humans, we’re not good with money. We’re just not. And if you could go to your checking account or a brokerage account and say hey, send me some money, and not necessarily worry about a 10% penalty or ordinary income tax, and everything else, it’s a lot easier to spend that money, versus a retirement account. No, I’m going to hold that for later. So it’s difficult for people to systematically save outside a retirement account.
AC: It is. And so as a consequence people get to retirement, the ones that have saved, and they don’t have any tax diversification. It’s all ordinary income tax from Social Security, pensions, and from their IRA and 401(k). And it’s like if you could kind of switch things around a little bit if you could get some money into a Roth IRA and have tax-free income, or to the extent that you do have money out of retirement, you how to invest that tax efficiently, it makes all the difference.
Speaking of taxes, we’re told that the biggest tax cut ever is on its way, but the President and the GOP remain divided on a number of key policy questions. How might income tax, estate tax, and business tax change? Visit the White Papers section of the Learning Center at YourMoneyYourWealth.com and download the white paper, “Tax Reform: Trump Vs. House GOP” to find out. Are your tax strategies at risk? Get year end tax-planning tips that can help you stay on track in the midst of uncertainty. Download the Tax Reform white paper to find out more. Visit the White Papers section of the Learning Center at YourMoneyYourWealth.com
41:27 – Big Al’s list continued
We’re talking about five mistakes to avoid in retirement. The third one is not knowing how much money you’ll need, and not adjusting for inflation. The people that we talked to anyway, maybe it’s better than one out of 100, maybe it’s one out of 50 has actually done any kind of calculation to figure out how much money they’ll actually need in retirement, and how this is going to roll out. And the computation itself isn’t really that complicated. Like we talked about before, it’s looking at your retirement spending, what you want to spend, it’s looking at your fixed income, comparing those two numbers, and you probably have a shortfall, and the shortfall needs to come from your own investments, from your own savings. So take that shortfall, multiply it by 25, or divide it by point 04, that’s the same number, and you’ll at least have an idea whether you’re in the ballpark. And of course, this works best if you’re right near retirement. If you’re 30, this makes no sense at all. If you’re 30, save. Save save save save save!
JA: Inflation though. That is the what blows people up.
AC: That’s a tough one because we have a tendency to think I need $100,000 a year for retirement, but we’re thinking in terms of today’s dollars, not realizing that in 20 or 30 years, that number is going to be $200,000.
JA: Yeah, but then you show someone that, they won’t believe it.
AC: They say that’s ridiculous.
JA: There’s no way I’m going to be spending $150,000.
AC: There’s no a utility bill is going to be $1,000.
JA: It’s like, yes it is! (laughs)
AC: Because what was it 20 years ago. They go, “well yeah.” And then sometimes you get them thinking then.
JA: So everyone driving their car right now. For those of you that are driving, how much is the car that you are in right now? So just think about it. What did you pay for your car? And if you are over the age of 65 years old, think about now, how much did your first home cost to you? Are those numbers similar?
AC: Yeah it’s a good question. I think in my own case – now I’m not over 65, fortunately…
JA: Close. (laughs)
AC: (laughs) Thank you for that. I can say this, the last car that I bought was more expensive than the home my parents bought.
JA: Well that’s two generations, Al. How much did your first home cost?
AC: My first home, it was a condo. It cost $117,000.
JA: $117,000 in Southern California.
JA: $117,000, and real estate prices don’t necessarily grow as high as markets or inflation, but $117,000, that same home today would cost you what?
AC: Well, I would say…
JA: $122,000? (laughs)
AC: Probably went down since I wrecked it. No. (laughs) No, probably $350,000.
JA: What year was that, in the 80s?
AC: Yeah. ’85 is when I bought it. But I do know exactly the home I’m living in now, I bought in 1996 for $329,000 and it’s worth over a million now. So there you go. Three times.
JA: So I’m from Minnesota.
AC: Yeah. And what would a million dollar home buy you there?
JA: You would buy the state. Half the state. (laughs) There are some really nice areas in Minnesota. But yeah, where I grew up? I’m selling my mom’s house now.
AC: For what, $220,000?
JA: Oh, no. Maybe $117,000! (laughs) Probably! They probably bought their house for maybe 20 grand.
AC: Oh well that’s like five times.
JA: But they bought it… I’m 43. So I was born in that house, that’s 43, and then my brother’s 40…. They lived in that house 50 years. And they probably bought it for 20 grand, and it’s worth $100,000. So not that great.
AC: Yeah. Well is not bad though.
JA: I guess that analogy works better in Minnesota than it probably does in Southern California.
AC: True. So in this article…
JA: Motel 6, why did they call it Motel 6?
AC: Yeah, $6 a night.
JA: What is it now.
AC: It depends. I just went up to Santa Barbara last weekend, and you know what the Motel 6 was? Granted, a summer weekend in Santa Barbara on Saturday night, and it was this big festival going on. But it was $290 for a Motel 6.
JA: You stayed at a Motel 6 for $290?
AC: No, that was the cheapest choice.
JA: Are you kidding me?
AC: I stayed at some other dive for about $360. But it was better than Motel 6. (laughs)
JA: $360. Wow. I haven’t stayed in the hotel lately.
AC: But that was the Viva La Fiesta in Santa Barbara. You know what they do there? There are all these vendors, It’s kind of like walking through Mexico, like Revolucion Street, where you bargain with all this stuff that you want? Like if you want to buy skulls and stuff.
JA: Yes that’s exactly what I love to do on weekends. (laughs)
AC: (laughs) Buy plastic ukuleles and skulls and a couple other things – turquoise jewelry, whatever.
JA: I can tell that you’ve been working on your Spanish there too. You got the tongue rolls going. (laughs)
AC: Yeah, Viva La Fiesta. (laughs) Also along the street, there were all these people with egg cartons everywhere. Opened up, like if you go to Costco, you can get like 60 eggs. That’s what they were, they were egg cartons, they were all colored eggs.
JA: No, the cartoons themselves.
AC: Cartons were gray.
JA: Not the yellow ones that are styrofoam. More cardboard. I’m trying to get into the mood, here on La Valencia Street in Santa Barbara, buying skulls and turquoise jewelry. (laughs)
AC: So let’s get it right, it was State Street. (laughs)
JA: OK whatever. (laughs) And I just woke up from the La Foletafata hotel room and had my coffee. (laughs)
AC: (laughs) So I’m walking through the streets, and all these colored eggs – in the gray cartons, does that help? (laughs)
JA: Yes thank you. (laughs)
AC: And some of them, it was like someone just did a little coloring on them, really cheap. Those are like 4 for a dollar. And other ones, these eggs, they were made up like Pikachu, and characters like Superman and they’re little eggs. They’re all dressed up, and you think of what the heck?
JA: What’s Pikachu?
AC: You haven’t? You don’t have a kid, do you? So you don’t know. It was a game that kids played about 20 years ago.
AC: Yeah. Anyway, it’s still big. I saw a bunch of Pikachus. (laughs)
JA: What the hell are we talking about? Pikachus? (laughs) So they have the eggs and what, they did some arts and crafts around it? It wasn’t painted as Superman, but they like a little cape on them?
AC: Right. Some had hats and capes…
JA: So how many eggs did you buy? (laughs)
AC: A hundred. (laughs) But then, get this. So they drill the bottom of the egg. They take out all the stuff. Sure. And they put in confetti. And then you’re supposed to then hit your friend on the head with the egg, and then confetti goes everywhere. And so that was kind of fun. So we were walking through town, and some were like $5 each, they’re really elaborate, and Ann said, “five bucks?! Let’s get the one that’s four for a dollar.” So we got the one that was 4 for a dollar. And I cracked it on Ann’s head and it didn’t break. And she goes, “ow!” And Robbie goes, “do it harder.” And Ann goes, “no!” We got the defective ones. (laughs)
JA: You got the rotten ones. See you do what you pay for. (laughs)
AC: I guess so. But anyway, I had to crack it on the sidewalk, and then I dumped it on her head. So that’s what we did last weekend. We avoided the Motel 6.
JA: Got it. So there’s inflation for you. That’s our story on inflation.
AC: We only got through one item in this segment. We still got two more. (laughs)
Pikachu eggs… I have a feeling Big Al’s list is doomed this week, what do you think? Visit YourMoneyYourWealth.com and sign up for free financial assessment with a Certified Financial Planner and make sure your retirement isn’t doomed! How much money will you need? What Social Security strategies are available to you? How much income can you get from your portfolio? Make sure your retirement strategy is aligned with your retirement goals. Sign up for a free two-meeting assessment with a Certified Financial Planner at YourMoneyYourWealth.com
50:40 – Big Al’s list continued
AC: So I’m doing this list, Joe. Five mistakes to avoid in retirement. Number four is not planning for long term care, or increased health costs. And I’ve got this, according to the Peterson Center on Healthcare and the Kaiser Family Foundation, they are predicting that health costs are set to increase about 5% annually through 2025, and it’s actually been more than that up to this point. I guess the point of that though, is that inflation for medical care is increasing faster than regular inflation, and that’s been going on for a long time. Which it seems, I mean, just being a logical person, that’s got to slow down at some point. But it’s not slowed down for years. So I don’t know when it’s going to happen. So anyway, these foundations and center, are predicting it’s going to continue to increase at 5%.
JA: What do we do ours, 7% I thought?
AC: We do 5.7%. Because we’re trying to be on the conservative side. And when you look at Fidelity studies, you trust them right? Fidelity Investments?
JA: Sure, of course.
AC: Yeah. (laughs) So they look at a 65-year-old couple. $250,000, it’s usually plus or minus 10 grand, 20 grand.
JA: So what do you think, everyone is thinking about this, health care when you get in retirement, it’s going to cost you $250,000.
AC: And they’re thinking I’ve got $100,000 in my account. so I can’t afford even health care let alone food.
JA: So I can’t eat. (laughs) So I’m going to need health care because I’m not eating.
AC: Yeah. And what you need to realize is that would be a cost over time, and you would have sources to fund that – whether it’s pension, Social Security, rental income. It’s not like you need a lump sum. And every time I read that, that’s exactly what I think, and I think that’s what everyone else thinks too.
JA: OK well here I have X amount of dollars. Now I need another $250,000 on top of that just to cover my medical? No. If I look at $250,000 divided by a 30-year retirement. What do you think that is?
AC: That’s around $5,000 a year per person. Give or take.
JA: I got $8,000.
AC: $8,000 for the couple.
JA: $250,000. So $8,333.
AC: Yes. So I said five per person, it’s about 10. It’s pretty close to your number, for quick off the cuff. The other thing, Joe, is the cost of long-term care. And a lot of people don’t realize that Medicare does not cover long-term care. That’s something you need to cover unless you are completely broke. And then there’s Medicaid or MediCal.
JA: Medicaid for our podcast listeners, MediCal for our California listeners.
AC: Yeah. True. Very good. And this is Genworth Cost of Care survey. So here’s what they came up with. The cost of a semi-private room in a nursing home in 2016.
JA: Here’s what it says. All of your money.
AC: Just pay it over, we’ll take it all.
JA: Just cut me a check.
AC: It says $6,800 per month, that’s about $82,000 per year. They’re saying that’s the national median, which means half of them are less, half of them are more. That’s the cost of a semi-private. That’s like sharing a room.
JA: You get a room with a buddy. (laughs)
AC: You get a curtain. (laughs)
JA: You got a new best friend. Guess what. Here are the remaining 3 years of your life. (laughs)
AC: With this guy that never shuts up.
JA: You got a curtain that’s costing you a hundred thousand bucks a year, and you are now living with Ralph. (laughs)
AC: You can’t believe it.
JA: Guess what, Ralph, he’s got all sorts of ailments, and guess what Ralph likes to do. Talk about his ailments. “Oh man! My bunions!” (laughs)
AC: The good news is you’ll probably pass away quicker because of all the misery.
JA: Just pull the plug. I’m going to put that in my estate plan. I just got it done/ if I’m ever in a room with a guy that talks about his ailments, just pull the plug. That’s going to be my DNR.
AC: And if they don’t pull the plug, you’ll pull it yourself or have Ralph do it. (laughs)
JA: “Hey Al! Big Al!” (laughs)
AC: “I listened to you forever on the radio!” (laughs)
JA: “Man I listened to you back in the day, you were great.” (laughs)
AC: “Now you’re here with me. You got nothing. Except $82,000 a year.” (laughs)
JA: “How did you get stuck in a semi-private room?” (laughs)
AC: “I thought you’d be in an ocean view private room?” (laughs)
JA: Yeah, that’s expensive man, that’s tough. Well, we kid about it, but that should motivate you to at least get a plan, right? I think people need to plan for this because it happens to so many people. We’re living a lot longer. What that means is that some of our body parts are kind of going bad, where we need help! (laughs) We need some care!
AC: They’re out of control. (laughs) Well, I think a lot of times when advisors talk about long term care, the individuals that are on the other side of that conversation, they immediately think about long term care insurance, and then a lot of people tune out because they don’t want to get it. That’s a way to go, yes. But there are other ways to go too.
JA: So here was my training in long term care insurance. So this is 15, 17 years ago.
AC: And this is why people don’t like to listen. “You’re going to have to pay $82,000 a year.’
JA: No. This is how it works. This is long term care specialists come in, super insurance sales guy. So he’s like, “So you guys need to sell some long term care insurance.” I’m like two years in the business, and I was like, “OK I don’t even know what the hell long term care insurance is, but I’ll sell it. Whatever. Whatever I need to do.” So he’s like, “OK, so this is what you do. So you get the couple there in your office. And so you got the woman and you got the man. And then you tell the husband, ‘lay down on the ground.’ OK. Then you tell the wife, ‘now, pick him up! Pick him up!'” And he goes, “it works every time because she can’t pick him up.”
AC: So she needs the insurance.
JA: And I was like, “Get me out of this business! How the hell did I get myself caught into this room sitting with this guy!” (laughs)
AC: You should’ve got into accounting.
JA: I should have. That’s why not a commissioned sales broker.
AC: I think we’re running out of time. But I just wanted to say, it’s not just long term care insurance, maybe you can self-insure. Maybe you can use the equity in your home. Maybe you’ve got a spouse that’s willing to care for you, maybe not. So there are all kinds of ways. But the point is you need a plan to figure out if this happens to you.
JA: Yes. You’ve got to map this thing out. And you’re not buying long-term care insurance for yourself, in a sense. You buying it for your spouse because guess what. Let’s say you’ve saved X amount of dollars, and all of a sudden you need some care, and you are spending $100,000 out of the nest egg per year because of your care, that’s going to blow up the surviving spouse.
And folks, thank you, even more for joining us. We’ll be back again next week with more fun facts about your overall finances. For Big Al Clopine I’m Joe Anderson, show’s called Your Money, Your Wealth.
So, to recap today’s show: The Department of Labor is proposing to delay the fiduciary rule’s compliance deadline by 18 months. I guess that gives advisors a year and a half to keep working in their own best interests instead of ours. And Joe and Big Al had so much fun with Pikachu eggs and the black humor realities of long-term care that they didn’t even make it to the 5th Mistake to Avoid in Retirement, which is letting your kids clean up the mess. Make sure your beneficiaries and estate plan are up to date.
Special thanks to our guest, Larry Swedroe, for exposing Wall Street marketing around active management and dollar cost averaging for what it is: BS. Search for Larry on ETF.com to read all his latest articles.
Subscribe to the podcast at YourMoneyYourWealth.com, through your favorite podcatcher or on iTunes, where you can also check out our ratings and reviews. And remember, this show is about you! If there’s something you’d like to hear on Your Money, Your Wealth, just email firstname.lastname@example.org. Listen next week for more Your Money, Your Wealth, presented by Pure Financial Advisors. For your free financial assessment, visit PureFinancial.com
Pure Financial Advisors is a registered investment advisor. This show does not intend to provide personalized investment advice through this broadcast and does not represent that the securities or services discussed are suitable for any investor. Investors are advised not to rely on any information contained in the broadcast in the process of making a full and informed investment decision.