Three researchers discuss some of the key challenges for retirement planning: inflation, longevity protection, and safe withdrawal rates in a volatile market environment.
This week we’re pleased to bring you a special “State of Retirement Income” episode, which we recorded live at the annual Morningstar Investment Conference held recently in Chicago, Illinois. For this discussion, we turn the tables on Christine, who is part of an expert retirement planning panel that also includes David Blanchett, managing director and head of retirement research at PGIM DC Solutions, and Karsten Jeske, the founder of Early Retirement Now. Both were guests on past episodes of The Long View.
In this panel discussion, recorded before a live audience, we delve into a number of retirement-planning topics, including the impact of inflation on spending patterns; the implications of the recent selloff on asset allocation; sequence-of-returns risk; optimal Social Security-claiming practices; the role and importance of guaranteed income sources; and a lot more. Without further ado, please enjoy this special episode of The Long View.
“Karsten Jeske: Cracking the Code on Retirement Spending Rates,” The Long View podcast, Morningstar.com, Oct. 14, 2020.
Karsten Jeske’s blog, Early Retirement Now
Karsten Jeske’s bio
David Blanchett’s bio
“David Blanchett: If You’re Retiring Now, You’re in a Pretty Rough Spot,” The Long View podcast, Morningstar.com, Sept. 18, 2019.
“Christine Benz and John Rekenthaler: How Much Can You Safely Spend in Retirement?” The Long View podcast, Morningstar.com, Dec. 21, 2021.
“How Much Should You Worry About Inflation in Retirement?” by Christine Benz, Morningstar.com, March 26, 2021.
“Exploring the Retirement Consumption Puzzle,” by David Blanchett, financialplanningassociation.org, May 2014.
Safe Withdrawal Rates
The Trinity Study
“The Safe Withdrawal Rate Series—A Guide for First-Time Readers,” by Karsten Jeske, EarlyRetirementNow.com, Nov. 15, 2021.
“The State of Retirement Income: Safe Withdrawal Rates,” by Christine Benz, Jeffrey Ptak, and John Rekenthaler, Morningstar.com, November 2021.
“What’s a Safe Retirement Spending Rate for the Decades Ahead?” by Christine Benz and John Rekenthaler, Morningstar.com, Nov. 11, 2021.
“Drawdown From Financial Accounts in Retirement,” Vanguard Research by Thomas J. De Luca and Anna Madamba, vanguard.com, July 2021.
Retirement Portfolio Construction
“Cliff Asness: Value Stocks Still Look Like a Bargain,” The Long View podcast, Morningstar.com, May 31, 2022.
“Bonds May Be Down, But Some Annuity Payouts Are Up,” by David Blanchett, thinkadvisor.com, May 13, 2022.
“Inflation at 7%! Here’s Why I’m Not Running for the Hills (Yet)!” by Karsten Jeske, earlyretirementnow.com, Jan. 13, 2022.
“The Bucket Approach to Retirement Allocation,” by Christine Benz, Morningstar.com, Jan. 25, 2021.
Christine Benz’s model bucket portfolios
What Is a Monte Carlo Simulation?
Guaranteed Income and Social Security
“Guaranteed Income: A License to Spend,” by David Blanchett and Michael Finke, papers.ssrn.com, June 28, 2021.
Open Social Security
“Laura Carstensen: ‘I’m Suggesting We Change the Way We Work,’” The Long View podcast, Morningstar.com, Sept. 14, 2021.
“Eight Centuries of Global Real Interest Rates, R-G, and the ‘Suprasecular’ Decline, 1311-2018,” by Paul Schmelzing, bankofengland.co.uk, January 2020.
Hi, and welcome to The Long View. I’m Jeff Ptak, chief ratings officer for Morningstar Research Services. And I’m Christine Benz, director of personal finance and retirement planning for Morningstar.
This week we’re pleased to bring you a special “State of Retirement Income” episode, which we recorded live at the annual Morningstar Investment Conference held recently in Chicago, Illinois. For this discussion, we turn the tables on Christine, who is part of an expert retirement planning panel that also includes David Blanchett, managing director and head of retirement research at PGIM DC Solutions, and Karsten Jeske, the founder of Early Retirement Now. You’ll remember David and Karsten, who were our guests on past episodes of The Long View.
In this panel discussion that we recorded before a live audience, we delve into a number of retirement-planning topics, including the impact of inflation on spending patterns; the implications of the recent selloff on asset allocation; sequence of returns risk; optimal Social Security-claiming practices; the role and importance of guaranteed income sources; and a lot more. Without further ado, please enjoy this special episode of The Long View.
David, Christine, Karsten welcome. Thanks so much for participating, in this year's, Morningstar Investment Conference we're very pleased to have you.
I think we'll start with what is the topic of the moment. There are many, but certainly inflation probably is at the top of our pecking list of concerns. Christine, I'm going to start with you. Let's suppose I'm a retiree. I've targeted a 4% real spending rate. If I want to keep up with rising prices, that means withdrawing 8% more this year, give or take than I did last. Do you think that's advisable or is it better to spend less than that?
Christine Benz: I think the starting point, Jeff, when people think about this is to not just take 8% and run with it but take a look at personal spending. There's been this ongoing research about how older adults spend. The Bureau of Labor Statistics has been calculating this parallel statistic called CPI-E that looks at how older adults spend. And when you compare that to the general CPI figures you see some changes in the consumption baskets that they use. So older adults tend to consume less energy. They tend to be commuting less. I think everyone's commuting less right now, but older adults always have been commuting less. So rising energy prices have affected them relatively less. They tend to spend a little bit less on food.
I would urge anyone who's working with retirees to go through that personalized calculation. I think they may find that in some categories they're spending more than the CPI figures would embed, but I think that is the starting point for this exercise. Rather than assuming that if inflation, if CPI is 8%, I'll naturally give myself that bump up. So, I think that that is the starting point. Another thing I think about is David's really influential research, which I know we're going to talk about, which is the trajectory of spending over retiree's life cycles. And David's research has shown that retirees do tend to spend a little bit less in the middle years of retirement. I think that argues someone's in the early phases of their retirement life cycle, they could potentially take more from their portfolio with the knowledge that they're spending will naturally come down.
Ptak: That's actually the next place I wanted to go with you, David. As Christine alludes to you've been a pioneer in studying how retirees spend. My question is, how does inflation potentially scramble that picture? For instance, could we see a scenario in which retirees are tempted to accelerate spending?
David Blanchett: The big uncertainty I think with retiree spending is healthcare. If you look at the retiree consumption basket, about 10% of spending is on healthcare when you're 65, about 20% at 85. And so, retirees in general actively choose to spend less over time. But healthcare is this rising share of overall spending. From my perspective, I think it is pretty safe to say hey, the average retiree spends less as they age, but the big uncertainty is where healthcare costs are going in the next say five, 10, or 20 years.
Ptak: I wanted to talk about the supply side, which is the nest eggs that we try to build up to fund our retirement spending. One question is, should I consider adjusting my approach to conserving and growing my retirement assets to mitigate the danger inflation poses to my net assets? That's a question that you've addressed relatively recently, Karsten. What's your take on that?
Karsten Jeske: First of all, I think we should resist this temptation that just because we have an economic shock, we don't have to throw out everything we know about retirement planning just because we have the shock, because it's still within the bounds of the historical spectrum of what we observed in terms of equity valuation. Yeah, it's higher than average, but remember the Trinity study and a lot of the retirement research on safe withdrawal rates has been calibrated to the historical worst-case scenarios, not the average scenarios. So, we are obviously worse than the average—higher equity valuation, still very low bond yields, high inflation—but we are not out of the bounds of the historical intervals of what we've seen, say double-digit inflation in the 1970s.
I don't think we have to reinvent everything from scratch. Just because we have 8% inflation. The first concern would be well what if the future is worse than the past. So, it's like that Simpsons joke where Bart says, “Today is the worst day of my life.” And Homer says, “Your worst day of your life so far.” The future could be worse than the past. But I don't quite see that we're going to have another 70% drop in the stock market like in 1929 to 1932. I don't quite see that.
I think the bigger concern is that even though historically the 4% rule might have been safe, there were also a lot of cases where the 4% rule in the end worked, but it was a very scary ride in between. I always use this analogy: Trinity Airlines, they have a 2% chance of crashing, but the other 98% could still be very scary plane rides and you don't know in real time if you're going to make it so this could be the reason why we probably tread a little bit lighter. So, for example, Morningstar had this study where they said, the safe withdrawal rate is probably about 3.3%, it’s not 4%, and it might still mean that the 4% rule works in the end. But with a 3.3% rate you might be safer, and it might be a more pleasant ride, and it doesn't look quite as bad as some of the historical cohorts. For example, in 1972 you had a cohort that depleted almost 70% of its assets over the first 10 years. In the end they made it. But they probably would have maybe gone back to work or would have changed their withdrawal rate halfway or one third into retirement.
So, one way to hedge against uncertainties, and not just running out of money, but also the volatility in between is obviously do lower withdrawal rate like you suggested, like I've suggested in my studies.
Ptak: I also wanted to ask, and we'll talk some more about portfolio construction sequence of returns risk and then consider your suggestion for what it is we should take up as part of this panel. Before we did that, though, I think it's become writ that people should bump up their savings rates to offset paltry yields and what appear to be lofty valuations. But now yields have risen, stocks have sold off, and multiples are maybe a bit less stressed. And so, do you think that takes some of the pressure off to step up savings? Or do you think that's inadvisable to be sending that kind of message to retirees at this point? And maybe I'll turn to you, Karsten, for that one.
Jeske: As I said, people use this 4% rule of the 25x spending. Well, if you do 30x spending so you have at least that cushion if the market draws down in the near term and maybe after the first little bit of the drawdown, then you have the 4% rule, then you'll probably have a safer and a safer-feeling retirement. And don't just worry about your making it after 30 years; also think about how scary the ride might be over the first 10 years, which is where really the sequence of return risk comes in.
Ptak: Christine, when you've gotten questions like that—can I go a little bit easier on my savings now that bond yields are higher and my money is working a little bit harder for me, what kind of counsel have you offered?
Benz: I think for people in accumulation mode, Jeff… We were talking to Cliff Asness yesterday and he made the very good point that, for accumulators, this is kind of what you want, that you want to be a buyer in down markets, and you want to be selling that stuff when the market's elevated. So for people in the accumulation phase, yes, I think that perversely it hasn't felt good, but I think that the fact that we have seen stock valuations come down a little bit, that bond yields appear to be going to lend more of a helping hand than they have in the past, that argues that potentially savers could take the pressure off themselves a little bit, but I think inflation is still a headwind, which argues for certainly maintaining ample equity exposure for people who are still in the accumulation/saving phase.
Ptak: David, wanted to turn to you for the next one, which is a tough one. Bonds have gotten whacked recently and that probably has been a rude awakening for retirees who've come to depend on income streams and also the diversification benefits, I should say, that they confer from it. What, if anything, do you think that they should do in the face of the selloff in fixed income? Stay the course?
Blanchett: I think staying the course is key, I think that thinking about alternative investments or other ways to diversify portfolio. But I don't think that bonds are dead. I think they play an important role in portfolio and it's kind of foolish this notion that the 60/40 is no longer a valid portfolio because it really has stood the test of time, not just in the U.S. historically, but also across the international markets.
Ptak: And, Karsten, I take it that you concur as well when it comes to something like the traditional U.S. 60/40 portfolio or even a global 60/40. You think that will stand the test of time? Or do you think people should be considering modifications to it?
Jeske: I'm tempted to do a little bit of what Cliff Asness said yesterday. You almost have no choice but to raise your risk a little bit, so maybe the new 60/40 has now become 70/30. That could be one option. The other option is, of course, now that bond yields are again at least 3%, if we have a slowdown, probably they have some room to go down. They could be a diversifier again. And so, it's don't run now, don't sell at the bottom of the bond market because now it actually looks like bonds can have this diversification feature again.
Ptak: I did want to ask about sequence of return risk, which is the bugaboo for many about to retire or early retirees. Christine, for those folks, they're potentially facing a bad scenario. They've only recently retired, they're about to, markets have sold off—that heightens their sequence of return risk. If you're one of them confronting this, what, if any, adjustments should they be thinking about making to ensure that they don't outlive their savings?
Benz: A few things. I think the starting point would be to be thinking about some sort of flooring for the retirement plan. Thinking hard about Social Security strategy, thinking about whether there is a role for some sort of an annuity product to just provide the fixed expenses that the household is requiring. And so, I love that as the starting point to think about, how can we supply lifetime income sources to meet those very basic needs? And then from there I think the idea of employing some sort of a variable withdrawal strategy makes a lot of sense. In our research, we explored a variety of different variable withdrawal strategies, but being willing to vary that withdrawal based on what's going on with the portfolio, and unfortunately, that means taking a little bit less in weak market environments. And then I think in terms of the portfolio composition, making sure that there are enough safe assets to draw upon so that you're not having to touch depressed equity or fixed-income assets.
I know we're going to talk about the bucket strategy. I've been thinking about that Jaws line: “You're going to need a bigger bucket.” But I have been thinking that cash for someone's active spending needs, I think even though inflation will eat it alive over time, I think the bucket strategy because it does call for having those liquid reserves to meet near-term cash flows—I think can provide not just those living expenses, but also a lot of peace of mind to put up with the volatility that's going on with the long-term portfolio.
Ptak: Why don't we bring back up the polling question. And we can see what you've had to say, and it looks like it's B) the 4% spending rule, can it be sustained? David, we'll turn to you on this. The 4% spending rule, which I think many of you are familiar with. Can it be sustained? And then more generally what is a good framework by which to think about a sustainable withdrawal rate?
Blanchett: So, I'm probably more like team 4% or even 5%. And I'm going to caveat that real quick. Because there's lots of assumptions you have to use in a model to figure out what is a safe withdrawal from a portfolio. And you want to use realistic returns, realistic mortality periods, and the key is that the way that we measure outcomes that I think is incredibly flawed. If you all run a Monte Carlo simulation for clients and most early research in retirement did this, you do a success analysis. You say, “It's a binary outcome: one, if you pass; zero, if you fail. You average those together. There's no context around the magnitude of failure, and that's really important in the context of 1) Almost every retiree has guaranteed income. Some of that covers most or all of their nondiscretionary spending; and 2) households have the capacity to cut back on spending in retirement.
It's very different liability than say, a pension liability. And so, when I think about 4%, does it work? To me the questions are, how much of your income goal is covered from guaranteed income? And what is your flexibility? If you have very little guaranteed income and no flexibility, while 3% is the new 4%. But for most Americans who have a significant portion of their retirement income via things like Social Security and pensions, and have some flexibility, I think 5% is actually not too off base, as a starting target for retiree.
Ptak: Karsten, what do you think?
Jeske: You would be shocked how many people, for example, in the early retirement community say, “I'm going to completely ignore Social Security,” and then they run their retirement simulations and then they come up with 3.5%. Of course, there's some people in the early retirement community where they try to outdo each other. One retires at 29 and then somebody is 28. I think now somebody retired at 22, but that's not the norm. The norm in the early retirement community is people my age. In their 40s, maybe even early 50s, they'll retire. If they don't take into account that they have Social Security in just a decade or a decade and a half—they should take that into account and they basically have this two-stage process or maybe even more stages than that.
So first you withdraw only from your portfolio, then Social Security compliments your retirement. And then you might even further drawdown, further scale down your expenses later in retirement, so you have this multistage process taking into account future cash flows, future reductions in spending. Absolutely most people can actually start with something like a 5% or 6% withdrawal from their portfolio. And then, of course, the withdrawals from the portfolio they will be scaled down even though your consumption might even stay the same. I'm completely with you. Of course, the 25-year-old retiree shouldn't go at 5% with today's equity valuation. It should be more personalized, and the personalization obviously has to go in two dimensions. One is the macro picture and then one is this idiosyncratic of your parameters. How old are you? What supplemental cash flows do you have? Do you have Social Security, government pension, a corporate pension? Once you factor that all in, very easily you can get 5% or more for some retirees.
Ptak: David, you alluded to some research that Christine and I and a colleague of ours, John Rekenthaler, had done on sustainable withdrawal rates. We did come up with less than 5, in fact, less than 4. It was 3.3%. But to your point, we were focused on that pot of money as if it was going to sustain the retiree throughout retirement. So that is a very useful distinction to draw. Christine, I wanted to turn to you for a minute and maybe widen out. You talk to retirees on a very regular basis. What are the biggest mistakes you see people make in setting their withdrawal rate and do you think they more often overspend or underspend?
Benz: Well, I think it depends on the cohort and it depends on the time period. But research from Vanguard and others have shown that in fact, underspending is, I think, a significant issue with many retirees, especially as we've had this steady march upward in terms of equity prices. We have many retirees who probably quite underspend relative to what they could spend, and that may be a choice. They may have a strong bequest motive that is motivating them to spend less, but I think that when we look at the data over the past decade and I would guess that it's true of many of the advisors’ clients, that tendency to underspend is a bigger deal and a bigger problem. I sometimes will meet an 80-plus-year-old retiree who will come up and proudly tell me that he spends 3% of his portfolio per year. So, he's just taking out that fixed percentage of that portfolio and I'm thinking holy cow. I hope that your quality of life is good at that level, because to me that sounds way too small of a percentage, especially at that life stage.
Ptak: Maybe turning to the psychology of withdrawing. What do you think are some of the most useful tools retirees can use to manage through the psychology of withdrawing? I'm sure that one of the things that will come to mind, Christine, because you've done so much work on it is bucketing. Maybe you can talk about why it is you think bucketing has the merit that it has?
Benz: I was initially introduced to bucketing, talking to Harold Evensky, probably 12 almost 15 years ago. And Harold was a financial planner, he's largely retired now. He was a professor of financial planning. And he mentioned this bucket approach that he used with his clients, which was basically a cash bucket that he bolted onto the long-term portfolio that he was managing for them. And his comment to me was that it just gave his clients an extraordinary amount of peace of mind with the long-term plan. So, he would call them up in environments like right now and say “How are you feeling? Your portfolios dropped quite a bit. Are you still comfortable with this?” And they'd say “Yes, because we have our cash needs set aside in this bucket, number one,”—whatever you want to call it, the liquidity bucket. “And so, we know that we can still take that cruise that we had planned with our family for next year. We can still keep going out to dinner on Saturday night.” The things that really constitute quality of life for his clients. Those needs were all being met because they had that liquidity bucket set aside.
I always think with bucketing, advisors don't have to use buckets at all, but I do think that it's a helpful construct when talking about, well, here's the asset allocation that I'm recommending. Here's how we're doing things to help the client understand whatever asset allocation that you're recommending, and also just how the volatility in the market is not going to disrupt any near-term plans.
Ptak: David, maybe to build on an earlier comment that you made. It sounds like one of the tools that retirees could use to manage through the psychology of withdrawal is understanding the totality of their wealth, the sources of their cash flows and their durability. Other things come to mind that you think are particularly worthwhile tools that retirees should consider just to make sure that they can withdraw in an orderly way and with peace of mind?
Blanchett: I think that to me the reason it's so fascinating, when you see people underspend because they've undersaved. So how is it that you are underspending when you've under saved it's because it's just so hard to take money from a portfolio when you have an uncertain life span. You don't know how long you're going to live. And so, when you read, you see the surveys that ask retirees: How do they think about their savings and their spending? They don't want to deplete their capital, and so I think that creating behavioral mechanisms to help someone do that is incredibly valuable. Like buckets, for example, I'm a huge fan of them, because I think that they're very valuable behavior way to help someone improve how they think about market risk. That being said, I don't know that there's huge academic benefits to them, you can create synthetically—the same thing with the portfolio, I think that's the key. It's the psychology of clients, and I'm sure you see a lot, helping them make better choices that, even with an advisor, they wouldn't make on their own.
Jeske: Right. One is, have a plan. That gives you confidence. Then update your plan. So, for example, if you're 80 years old and you're still spending that 3%, well, have you updated your plan along the way? And obviously in defense of that 80-year-old, you can say well, the equity returns were probably so spectacularly above expectation, so your portfolio outgrew your spending. But regularly updating your plan and imagining three years into retirement, imagine you were to retire today again. With your current portfolio and your current spending, does it still work? Am I still confident?
And yes, I agree. So, the bucket strategy in some way is window dressing because if you rebalance the buckets, of course your money is fungible. You take it out of the cash bucket, but then your risky assets have to replenish the bucket. But it's helpful, of course, in the sense of coming up with an asset allocation because we can't be 100% equities, we have to have some safe assets and there are different ways of gauging what is the right percentage of safe assets. One would be the bucket, where you have the bucket in the sense that, well, I want to make it through this length of a recession and this length of a weak economy like the 1970s, but you can't be overly bond heavy because you want to hedge against the supply side shock in the 70s. But you want to have some bonds in there because you want to have the diversification benefits if we have a demand-shock recession.
So, you want to have some equity, some bonds, some cash. And I look at it from a historical simulation point of view. Some people do the Monte Carlo simulations, but you could arrive at the same results, roughly and very intuitively, through the bucket strategy. So, in that sense it helps, obviously.
Ptak: Christine, I wanted to ask you about flexible withdrawal approaches, which I think have come up several times during the course of the conversation. They can support higher withdrawals by as you put it, putting spin on the ball. Can you talk about the pros and cons of these approaches and who they might be right for?
Benz: That was a big thrust of our paper. Everyone took that 3.3% number and ran with it. We did spend a lot of time looking at these variable strategies because we began with the argument that well, in a lot of ways these fixed real withdrawal systems are a little bit of a straw man because people don't spend that way. David, your research has shown that, and then we also know that the variable strategies do tend to do a better job of helping a portfolio last throughout a 25- or 30-year time horizon. So, we tested a lot of different variable strategies and we're basically testing a couple of things. One, is can this variable strategy help enlarge lifetime withdrawals?
If we're using that 3.3% as a starting withdrawal rate. If we are able to be variable, can we lift that starting withdrawal and in turn lift lifetime withdrawals? And indeed, we found that the variable strategies do just that. They help the retirees’ cash flow calibrate up and down based on what's going on with the portfolio. Jeff, I should credit you because you did all the work on this, but when we looked at the strategy that did the best job of the ones that we tested of enlarging lifetime income, the guardrails system did the best job of ratcheting up and down. And it's a ratcheting system that is based off of the portfolio's value, annually updating. And we found that it did the best job of delivering the highest lifetime cash flow.
The downside of a strategy like that is that for bequest-minded retirees it'll tend to leave less leftover at the end because the name of the game is that you're spending less in down markets, but you can also spend more in up markets and that means that you're going to consume your whole portfolio because you are annually revisiting this. That was the strategy that showed best of the four that we tested. Another really simple strategy that we looked at that showed reasonably well—it's just a modest variation on the 4% guideline—the fixed real retirement spending where we simply said in a down market, in the year after a down market, forgoing the inflation adjustment in that year after the portfolio incurs losses, is another way to help lift that starting withdrawal rate and lift lifetime withdrawals.
I would say the big negative of that is that if you're in an environment like this one after a year like 2022, would an advisor want to turn around and tell their clients, “No inflation adjustment for you this year,” where you have a down market that's running in tandem with inflation, I think that that is the downside to such a strategy.
Ptak: Wanted to talk a bit about guaranteed income. It was actually one of our polling questions. Should retirees be considering tools like annuities? Maybe we'll broaden that out a little bit, David. Can you talk about the best framework for determining whether or not you're a good candidate for a guaranteed income product of some sort, like an annuity, and related to that for those who are candidates, what type of annuity do you prefer?
Blanchett: Before we start throwing out the “A” word, I think delaying claiming Social Security is the place that every person today should get guaranteed income. Its tax advantage, linked to inflation. I'd love to be in an environment where every advisor says half of my clients delay claiming to age 70. I think lot of the tools that exist out there right now that help you figure out when to claim, don't do a very good job. If you delay claiming to age 70 and you die at 71, your kids get all your stuff. That's not a bad outcome. The bad outcome is living to age of 110 and depleting their resources to keep you doing well.
When I think about guaranteed income, that's the first place that I start. And I think the key question with all of it is how much certainty do you need to have in terms of income every year, no matter what? I think that where you see the biggest problems with withdrawal rates and spending is when someone says, “I need to have $100,000 a year in nondiscretionary spending. I only get $30,000 from Social Security.” They're the ones who really need guaranteed income. Now, there could be benefits to have, beyond that "needs goal" but I think that a very basic framework does a really good job figuring out how much do you need in terms of lifetime guaranteed.
Jeske: Maybe until a year and half ago I would have said so. The SPIA, or single premium immediate annuity, it's not such a bad deal. Yields are a little bit low, but again, for somebody who needs that safety net, who needs that consumption floor, who has the non-negotiable consumption floor, maybe invests in an annuity. Sure, it's going to be depleted and decayed over time at a relatively constant inflation rate. Back then everybody thought it's 2% and then every year it's kind of range-bound between 1% and 3%. It doesn't really go much above, doesn't go much below, and if it goes above 3% one year, then the next year it reverts back and it's probably 1% the next year. And then this slow decay of 2% over time might be even desirable. You get a little bit more upfront and then you decay it over time, but of course right now we're in this inflation environment—nobody knows how long this 8% inflation is going to last. Nobody knows is inflation going to go back to 2%.
The previous speaker Sammy, he made this really good point. Is there a concern that the Fed might say 4% inflation, we're happy with that now, because we don't want to risk a recession. We are happier with 4% inflation and 6% unemployment, than 2% inflation and 10% unemployment and causing a recession. So now there is actually this uncertainty about what are inflation rates over the next 30 years. So, the Fed has definitely thrown us a little bit of a screwball here. And I'm not that optimistic anymore about the SPIA, but I used to be.
Ptak: I'll throw this to the whole panel, building on some of your comments on Social Security. There's the question of when to start claiming—that's a key question. Social Security payments are inflation adjusted and so now that we have higher inflation, does that change the calculus at all about when someone should claim? For instance, should someone be a bit more eager to claim if they covet the inflation protection that Social Security payments confer? Or do you think the same math, the same rationale toward claiming applies? Anybody?
Benz: I would say one point to make on that front is that you get the inflation adjustment on your delayed claim. Once you’re full retirement age, that is counted toward your eventual benefit, so I…
Ptak: You get it anyway.
Ptak: So, it shouldn't factor at all in your claiming decision.
Benz: Right, I don't think so. But I would urge people to, especially for married couples it does make sense to. I would use one of the calculators that helps you look at ideal claiming dates because it does get complicated for married partners with two sets of earnings histories, so there's a free tool that I like called Open Social Security, but there are a variety of other, I think mostly paid tools. But I think that that's well worth investing in because the decision is just so impactful in terms of the health and longevity of the overall plan.
Blanchett: And so just one quick note there is no private annuity today that is offered that explicitly links to inflation. There used to be a few SPIAs back in the day. So, I think the only thing there is all of a sudden if you are really affected by inflation, you're freaking out by it. Social Security is the one place you can go to get protected lifetime income that gives you that explicit hedge.
Jeske: So back to your original question: Social Security is more valuable now. We have more uncertainty about inflation. Social Security is the hedge, so it's more important and it probably pushes more people into that upper constraint—the claim at age 70.
Ptak: I'd be remiss if I didn't ask about FIRE, Financial Independence, Retire Early, Karsten. Naturally, I'll turn to you on this. This is arguably the first time since the global financial crisis that some in the FIRE movement have been tested by difficult market conditions. We did have March of 2020, but that was such a brief plunge down, and then we zoomed right back up that maybe they didn't have time to dwell on it. What are you hearing from FIRE proponents who are trying to adapt to the new realities that the market is presenting?
Jeske: You always hear these rumblings. For example, 2018 was another case. I retired in 2018 and right around that time, we also had the Fed scare in 2018 in the fourth quarter. And it's amazing how quickly people lose their nerves, and obviously some people fell off the wagon there. But I think, overall, because a lot of people in the FIRE community are not yet retired, so they found out about this maybe two to three years ago. They started at net worth zero, they're planning a retirement date, maybe 2030, 2035. So, for them they could actually use some of this dollar-cost averaging. For example, when I started my 401(k) contributions was in the year 2000, right around the market peak and I stayed the course and used the dollar-cost averaging.
So, I think that there are obviously always these naysayers who will say, “Well, there's a market drop, so that's the end of the FIRE community.” I think it's the opposite. People will still come in because the pandemic taught us that we don't want to work until age 67. There's also another within the niche movement of FIRE. There is another niche, which is this extreme frugality movement. A lot of people will come in there because they see, “I get a 3% pay raise and now we have 8% inflation. I have to cut my spending. So how do I do that?” And they Google and then they find the frugal movement and then maybe through that, through the back door come into the FIRE movement. So, I think the FIRE community is alive and well and I think we’ll still grow.
Ptak: What do you think of the key applications of FIRE to the broader retirement public? Maybe someone who's retiring in their 60s, what could they learn from a FIRE adherent?
Jeske: The biggest challenge obviously for early retirees is that we can't really use the Trinity study—this fixed 30-year retirement horizon with fixed spending because you retire, say at age 45, and then you have this multi-stage process where first you withdraw from a portfolio, then you get the supplemental cash flows. So, there's a huge demand for personalizing your retirement strategy. It has to be different for the 28-year-old and the 48-year-old. It has to be different for somebody who is 48 years old, who expects Social Security and the company pension, or maybe a government pension. Because we have these different stages in retirement, but traditional retirees face that, too. They have potential spending shocks either up or down. They might have to think about sending their grandkids to college. Or they might scale down their spending when they go from the go years to the slow years to the no-go years.
This personalization aspect should be the same for both cohorts. Of course, the horizon is different, but a lot of the bells and whistles that we should be thinking about—the idiosyncratic parameters and then also the market conditions that we face right now. I think we can definitely learn from each other there.
Ptak: We're going to turn to audience questions in a moment here, and thanks to those of you who have already submitted it using the app. If you haven't done so, feel free to hop in and pose a question and our moderator will try and funnel it to us in our remaining time here. Before we do that, though, Christine, I wanted to turn to you. On the podcast we've talked to a number of experts who study what leads to a fulfilling retirement. Looking beyond the dollars and cents, what has your research and experience with retirees taught you is the key to a happy retirement?
Benz: Jeff and I interviewed Laura Carstensen, who's the director of the Stanford Center on Longevity, and I think that was one of our favorite interviews that we've ever done. Just so thought-provoking about living, throughout our lives, and she made the point that this sort of border between work and retirement should be more porous. That she feels like and really throughout our lives that there may be times earlier in our careers where family demands might require us to pull back on work. So super thought-provoking interview with her about what gives retirees happiness.
I think the key theme from her and from Michael Finke—who, David, I know you've collaborated with for many years—is engagement in some sort of pursuit. Doesn't need to be paid work, but some sort of pursuit that provides you with the sense that I'm providing value here on Earth and that might be engagement with family, grandkids, whatever it is, social bonds. Laura's work certainly shows that staying engaged socially is absolutely essential to our happiness throughout our lives. But especially as we age. And interestingly she pointed out that retirees tend to bring down their social circles a little bit. They cast off some people who maybe weren't true close friends and so their friendships become higher quality as they age. And I love that advisors increasingly are embarking on this journey with their clients, where they are thinking about them holistically from the standpoint of not just making sure their portfolios last but making sure that their time-on-Earth allocations are just as thoughtfully made as those financial allocations.
Ptak: Given the fact that we are at 10 minutes to go, why don't we open it up for audience questions? So, you want to take it away.
Question Moderator: Yes, we've received several versions of the following question from Caleb Bird. Many retirement-savers I talked to think Social Security won't be there for them by the time they retire. Is this fear warranted?
Blanchett: No. I think anyone that reads the news knows that it's not. It's not fully funded. But even then, if you look at the PAYGO statistics, about three fourths of benefits can be paid. I just have a really, really hard time believing that we're going to cut grandmom’s Social Security check. I think there are going to be structural changes to the system. I think it's going to affect younger Americans. But I have a really hard time believing that it's not going to be there, in its mostly full form as it exists today.
Jeske: I think you have to make it to age 55. That seems to be historically, because you're not going to do that rug-pull from existing retirees or people right before retirement, and then even at age 55. That's where the changes will be slowly phased in. It's not going to be boom, January 1st, that year is your birthday, you lose 20% of your benefits. It will be slowly rolled in. Probably anybody who will be between the ages of 55 and 35 at the time when the changes have to be made, that's where there's going to be a phase-in. I cross my fingers 2029, it's going to be after that, and I'll be safe.
Question Moderator: What is the current state of the art in dealing with potentially catastrophic long-term-care expenses in retirement?
Ptak: Who would like to take that? Christine?
Benz: I can take that. I'm obsessed with this topic. As many of my colleagues know, both of my parents had a long-term care need later in life. Thankfully, they had the funds to cover it, but experienced just how high those costs can be, especially where you have two partners. And, unfortunately, the state of funding long-term care, there aren't any good answers. I think the long-term-care insurance market is quite troubled. We've seen the purchases of pure long-term-care policies go way, way down. These hybrid life insurance/long-term-care policies have increasingly taken up the slack. But I always urge people to plot themselves on a spectrum, so at the low end in terms of having very modest assets, you'd want to think about relying on government-provided care. Medicaid is the largest payer of those expenses in the U.S. Not a great solution, but the solution for many people.
And then at the other extreme would be more affluent people, who will likely have the funds to supply or defray any long-term-care needs. What I always say is, if you're in that camp, I think it's important to maybe set aside a separate bucket, perhaps a fourth bucket for the end of life, whether it is a really long life span or long-term-care need. Or if you don't have either of those eventualities, maybe the money then is going to your heirs. But I like the idea of thinking about what those expenses might look like. I think if you're looking at a married couple, you would maybe want to take a two-year long-term-care need per partner and then look at the Genworth statistics about the expenses, which would maybe get you to 400,000, 500,000.
What I don't like is when I hear these one-size-fits-all cutoffs about, oh, if you have $2 million or whatever it might be you're fine to self-fund long-term care. And the reason is I don't know what you're spending from that $2 million portfolio. If your spending is overly generous, that may not be enough. So, I think it's really valuable for advisors to do that customization for clients and to really talk it through, because this is such an area of angst for older adults. In fact, when I speak to groups of retirees, this is the one question that gets people really energized and not in a good way. They are very, very worried about these costs eroding their portfolios entirely.
Question Moderator: David mentioned that the 60/40 portfolio has stood the test of time here and abroad. Few of the datasets contain a period where a 50-year decking interest-rate super-cycle reverses. How might this change the role of fixed income in a portfolio?
Blanchett: I think that there is this prospect of rising yields. There's this great study that the Bank of England did that came out a year or two ago that shows that interest rates have been going down pretty consistently for the last like 700 years. I don't have all the answers. I don't think anyone knows where the markets are headed next month versus next year. But I think the right portfolio does require some combination of safe and risky assets. I think that those safe assets are likely to be bonds, and then how you build the portfolio can vary by client. I think that buckets make a ton of sense for retirees and similar strategies can work through for folks in accumulation.
Jeske: Obviously the reason why we had the super-cycle is because we had that runup in interest rates between 1960s and 1982. So again, the 60/40 portfolio would have survived that negative, that bad super-cycle up to double digits. And obviously it helped a lot on the way down. One of the historical worst-case scenarios where, say, a 60/40 portfolio with a 4% withdrawal rate worked more or less, it included double-digit interest rates and interest rates at almost 20%. So that's something we should still keep in mind.
Question Moderator: Large asset managers are starting to create retirement-income offers for plan participants through product service offers. What are your reactions to these solutions?
Ptak: Who'd like to take that one? Christine, go for it.
Benz: I have felt like this is the area that asset managers need to work on because there is so much that is suboptimal about our current system where it's like, “Hey, you're 65, we know cognitive decline is a thing, and here's your pot of money and figure it out.” Especially in this really quite low, still quite low interest-rate environment. I love the idea of—and of course they won't all be good—but turnkey paycheck equivalent retirement-income solutions are completely needed in this marketplace, and maybe it's the kind of thing that advisors do for their clients. But I love the idea that increasingly we're seeing this adoption of retirement-income solutions in 401(k) plans to really make this simpler because it's so overdue.
Blanchett: I am super-pumped as well.
Jeske: I'm waiting for some sort of a crowd-funded innovation of, not a pension fund, but basically a sequence of return hedge between savers and retirees. For example, a buy-and-hold investor doesn't care about sequence of return risk. If you take one saver and one retiree, you lump them together, you have again a buy-and-hold investor that doesn't care about sequence of return risk. And, because depending on how your sequence is, sometimes the saver benefits, sometimes the retiree benefits, and if you could lump them together and they could form a team, say over the next 10-15 years, we match up one retiree with one saver. Then we have, it's not a pension fund, because it doesn't hedge against longevity; it just hedges the sequence of returns. It doesn't even hedge equity risk. Because the average return still determines what's your final portfolio value. It purely hedges the sequence of return risk if we lump together. But I don't know how you would do that. Somebody in Silicon Valley should think about that.
Ptak: I think we have time for one more so if you've got one.
Question Moderator: It might be a little hairy. What does the panel think about probability Monte Carlo analysis—can these systems be improved? Are they assessing enough?
Blanchett: I think it can definitely be improved. I just think that I like the idea of stochastic models, but I just hate the fact that we, almost everyone, quantifies outcome as success or fail and doesn't incorporate dynamic spending, doesn't actually reflect reality.
Ptak: I have one final question to ask you all and you can answer it really quick. What do you think the pandemic has revealed about retirement planning that wasn't as apparent before? Christine, anything come to mind? Emergencies, spending money in reserves is that one?
Benz: For sure. This is kind of separate from the decumulation question, but I love the idea of using healthy mental accounting like the bucket system for emergency savings. I love the idea of helping workers save for rainy days that they can tap those funds that might not necessarily get any tax benefits. But I think there's more to be done in the realm of healthy forms of mental accounting, and I think that emergency funding embedded within the employer-provided context can make a ton of sense. I'm excited to see more uptake of that.
Ptak: We're up on time, so we'll leave it there. Christine, David, Karsten thanks so much for your insights. Please join me in thanking the panel.
Thanks for joining us on The Long View. If you could, please take a minute to subscribe to and rate the podcast on Apple, Spotify, or wherever you get your podcasts.
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Benz: And @Christine_Benz.
Ptak: George Castady is our engineer for the podcast and Kari Greczek produces the show notes each week.
Finally, we'd love to get your feedback. If you have a comment or a guest idea, please email us at TheLongView@Morningstar.com. Until next time, thanks for joining us.
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