Set forth below is a Guest Blog Entry by Chuck Yanikoski, editor of the Integrative Advisor and Executive Director of the Association of Integrative Financial and Life Planning. These words were taken from an e-mail that Chuck sent me during a discussion of an article that I wrote for his publication:
I am actually more radical than you about the safe withdrawal rate issue, because I don’t like the entire concept. It assumes that people are going to have essentially level (or smoothly inflating) withdrawal needs for the remainder of their lives, no matter how long that may be. In most instances, we know for certain that this is not going to be the case, because we already know of income or expense items that are going to arise, disappear, spike, or suddenly shift significantly and permanently in amount. To give the simplest and most common example: most people these days who own homes have refinanced at some point, and probably a majority of retirees today (unlike in our parents’ day) still have a mortgage when they retire. When that mortgage is finally paid off, their cash flow needs are going to suddenly drop. Using an SWR calculation at the time of retirement results in such a family running an unnecessarily tight budget while the mortgage is still there, then having oodles of cash to play with once the mortgage is paid off – not the ideal plan for most households. There are dozens of similar examples. Like you, I have been trying to get this message out for a long time (my first paper on this subject goes back to 2002, and is available on my company’s website, http://www.stillriverretire.com/Downloads/Needs-based_Withdrawals.pdf. And like you, I have my own solution to it, which is sophisticated retirement financial model called RetirementWorks II.)
Your comments about valuation seem to me to be even more applicable to the standard asset allocation models, which not only don’t take current valuation explicitly into account, but to the extent that they take it IMPLICITLY into account, they do it in exactly the wrong way. Most “sophisticated” asset allocation models look at up-to-date historical performance of investment categories, or even of specific mutual funds. They calculate the “alpha” and “beta” for each, and use these return and risk indicators to balance projected returns and risk in ways that are intended to maximize the overall return while minimizing the overall risk. This is an interesting concept (though I think it has a lot more merit for institutional investors than for individual investors), but it has an interesting consequence: investments that have done well in recent years have high alphas, and so are favored in the asset allocations, the opposite being true of poor-performing investments. This totally ignores the cyclical nature of markets, which is bad for the investor, and also bad for the market because it silently but dangerously promotes the excesses of the boom and bust cycle. Six years ago I actually built an asset allocation model based on the idea of regression to the mean (and wrote about it: http://www.stillriverretire.com/Downloads/Asset_Allocation_revised.pdf), but I never got any response to it, and didn’t really push it because I knew I was bucking the tide. Maybe you and your partner could build a better model, and get people to use it. My own opinion is that this would be a better service than your SWR model.
If anything, I think you are too nice to the non-humble experts. I have so little faith in them that I pay no attention to them myself, so I can’t even comment on them individually. But my impression of financial journalists in general is that most do NOT think about the internal assumptions and logic of the theories and models that come out of the financial industry, but tend to accept them more or less on faith. Likewise, the financial industry itself has few members who really think things through. And I think that all of these phenomena are largely, though perhaps not entirely, a result of the “cover your ass” model of advising. AS LONG AS YOU GIVE ADVICE BASED ON THE SAME PRINCIPLES AS THE INDUSTRY IN GENERAL, YOU CANNOT BE BLAMED (OR SUED) FOR DOING SO, no matter how transparently stupid the common wisdom is, and no matter how badly the results turn out. But if you take a contrarian position, and things don’t go well (and of course, they won’t, a significant portion of the time), you CAN be blamed and there is a good chance you WILL be sued. The securities industry, therefore, despite the adventurous image they like to present, is one of the stodgiest and most immovable of all.
I also feel that we all tend to suffer from the normal tendency to find merit in ideas and arguments that put money into our own pockets, and to discount those that would take it out. Another of my own pet peeves is that the securities industry, and the financial press that mostly echoes them, have been telling retirees lately that they need to continue to invest fairly aggressively in retirement, because they may live long and experience a lot of inflation. This is just plausible enough that people will buy it, and the fact that it benefits the securities industry is a pleasant side-effect, if you are in that business (or in the variable annuity business, by the way). So hardly anyone bothers to think about whether it is really sensible to advise people who are already facing acknowledged risks (mortality risk, inflation risk) to solve their problem BY TAKING ON MORE RISK. There are very good reasons, I believe, why the new standard wisdom on this topic is wrong and dangerous (OK, one more: http://www.stillriverretire.com/Downloads/Half-Baked_Investment_Concepts_for_Retirees.pdf), but it is not in most financial professionals’ interest to think very deeply about it – so they don’t.
Larry Weber says
This is a very thought provoking article. It pays to look under the surface and question traditional asset allocation model assumptions. It is hard to understand why anyone would continue to risk their retirement dollars in traditional buy and hold asset allocation models.
Valuation informed investing makes a lot of “cents”. The P/E 10 tool helps with asset allocation by identifying excess risk in the market. Traditonal asset allocation models really don’t address this kind of price risk. They don’t focus on the current valuation/ price of the market.
The return on shareholders equity in the average S&P 500 company does not justify a P/E of 19. Why would you buy an inflated asset and take that kind of risk? The mathematical odds are clearly not in the individual investors favor. Price matters.
Rob says
It is hard to understand why anyone would continue to risk their retirement dollars in traditional buy and hold asset allocation models.
Thanks for sharing your thoughts with us, Larry.
There are always reasons why people do what they do. And people are not dumb. I have seen zero evidence of that in our investigations.
People obtain the information bits that inspire them to action in different ways. One is through the processing of logic bits. But that is only one. Another is through emotion-rooted clues that they have learned through experience can generally be relied on.
For example, how do you decide if a restaurant is worth trying out? One way is to read a review. But another way is just to notice as you walk by whether there are lines to get in or not. If there are lines to get in, a lot of us will conclude that the restaurant serves good food. This is an indirect sort of proof. But it is compelling to the human mind.
So it is with stocks. We see a good value proposition in stocks when many others are buying them. That’s how our brains work.
In the case of stocks, popularity is a bad thing. Popularity pulls prices up and high prices pull the long-term value proposition down. But our brains have a hard time processing the concept that popularity can be a bad sign.
My view is that it is the job of investment experts to help us process information properly, to help us overcome the tendency we have to view stocks as safe when lots of others are heavily invested in them. The best way to do this is through use of the historical data because this is an objective source of information (it transcends questions of popularity — the historical data tells us what is so, not what the humans might think is so because of their flawed information processing equipment.
My problem with Buy-and-Hold is that it pushes us in precisely the opposite direction of the direction in which we need to be pushed. We need to be pushed to give price more consideration than we are inclined to give it but Buy-and-Hold tells us that there is no need to take price into consideration at all, that it is somehow “okay” to stay at the same stock allocation despite dramatic price changes.
Not good.
Rob