Ep 102: Interview with Retirement Researcher Dr. David Blanchett (Part 2)

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Kevin Kroskey – About – Contact

Intro:

Welcome to part two of our series here on Retire Smarter, where we interview retirement researcher Dr. David Blanchett. In part two of the conversation, Kevin and data will touch on Monte Carlo simulations. They’ll talk about guarantees in retirement income planning, and things like annuities. And, of course, we’ll touch on some cryptocurrency just for some fun before wrapping things up for the day. Get ready for some more great education about investing, finances and retirement. Let’s get things over to Kevin for part two of our interview with David.

Kevin Kroskey:

I guess when you look at some of these observations, for me, there was, for a long time, more than 10 years, we’ve always been having those multiple goals, maybe even some different inflation rates on some of those goals like healthcare and what have you, and some really emulating that go-go, slow-go, and no-go, that sort of spending decline that you mentioned over time, about 1% to 2% on an average basis, on a real return basis. But when you look at some of the implications from, say a traditional financial plan, how does this sort of modeling, if you will, or using this retirement spending data, what does that do to financial plans in terms of maybe when people can retire, how much they need to save, how much they can spend?

Dr. David Blanchett:

Well, so I think that’s the key is if you start using a collection of more realistic assumptions, what it tends to do is result in higher spending levels or lower required savings rates. Now, again, there is just a ton of assumptions that act as levers that move the outcomes in different ways when it comes to a financial plan. But if you just more address this idea of flexibility, it really can change your perspective on how you want to fund your retirement via investments and everything else. I think that individuals that do have those “needs” covered more from guaranteed income, really have a lot more freedom.

Dr. David Blanchett:

Maybe you don’t need more guaranteed income. Maybe you don’t need to worry so much about spending more from your portfolio because you can cut back if you have to. Because as we’ve seen in 2022, the markets can do crazy stuff. I mean, it is stressful to have to think about what is healthcare going to be in 20 years from now? No one knows. But the one thing I do worry about too often is that individuals do financial plans to age 110 with a 99% success rate, and they just don’t enjoy the experiences when they’re a younger retiree that they likely could have enjoyed.

Kevin Kroskey:

Yeah, I agree. You have to be able to live in the present but also that you’re okay in the future. And I’m completely going from memory here, I actually did try to do a long-tail Google search, but I couldn’t find it. But if I remember correctly, I read an article, I thought you were the author, I think you were the author, talking about success rates and something to the effect that a 50% success rate may be okay. Does that ring a bell, or am I completely misremembering here?

Dr. David Blanchett:

Well, no. So I don’t know that I wrote that one, but I actually 100% agree because I’ve done things that are very similar to that. And to be honest, I’m not necessarily a big fan of success rates as an outcome metric for a financial plan. It’s incredibly common today. It’s something that we often call Monte Carlo analysis, where you run a projection and you count the number of times someone completes their goal, and then you just average that out over the total number of runs or trials. So let’s say you’ve got a goal of $50,000 a year in today’s dollars, you do a Monte Carlo projection, and half the time you succeed, you have a 50% success rate. And some might say, “Well, oh my gosh, that’s way too low.”

Dr. David Blanchett:

The problem is, there’s no context there whatsoever for if you “fail” or don’t accomplish your goal, what it actually means for your lifestyle and retirement. It could be that you’ve assumed retirement lasts like 35 years, and you only ever have a tiny shortfall in the last two years of retirement. Well, that’s totally fine. I think what’s really, really important to understand is the magnitude of failure. So when things “go wrong” what does that mean in terms of your lifestyle? And so, for a lot of folks, 50% is going to be totally fine, but for other folks, it needs to be like 95%. And I think that really gets down to what is your existing coverage of things like guaranteed income? How flexible are you? What is your consumption basket? And that’s a pretty complex question that really requires the help of a knowledgeable financial planner.

Kevin Kroskey:

Yeah. No, I completely agree. I mean, we, in practice, I think pretty much every financial planning software that I’ve seen uses Monte Carlo, at least I’m thinking of the big ones that are out there in our industry. And we’ve long been users of it too. And like anything, it’s a tool. Certainly, it has its limitations. And I always liken it to a radiologist looking at a film. You still have to… radiologists are known as the doctor’s doctor, and if you have something that you’re trying to figure out, maybe the film is going to tell you something and you’re going to confer with the other doctor, and you’re really working through it together to triangulate the information and make a good decision or good diagnosis.

Kevin Kroskey:

I’d love to see some of the software having more of a dynamic modeling approach, but it just doesn’t seem like we’re there yet. But one of the things that you mentioned about having guaranteed income relative, maybe a higher floor or higher foundation, if you will, is said another way. I completely agree. And it goes back to that idea, I guess, in my practical experience, where you still have to measure that lifestyle. And everybody’s different. What’s a need for somebody is maybe not for somebody else. So it’s one thing to go ahead and measure what somebody’s lifestyle’s costing. It’s something else to really rank those priorities.

Kevin Kroskey:

But this is really where it can really be a benefit when you do get down to sort of this modeling and just thinking about, “Hey, if things go bad, what is the worst case?” And then just trying to make it very clear, it’s not my judgment as the advisor to go ahead and tell the client that that’s okay, but I perceive it as my job to make sure that I understand the situation, convey it very clearly, so they can make a concrete decision on what’s best for them. Whether that worst case would be it unlikely or not, if it were to manifest, is that okay? Or do they want to keep working a little bit more, spending a little bit less, or whatever the case may be. It’s all about trade-offs, right? When you get into the retirement income, and you mentioned sort of the guarantees to it, I guess let’s open up that part of it. But I mean, how do you think about that? What are some of the tools or products that you see being most effective in that space?

Dr. David Blanchett:

Yeah. I mean, I think one thing, to piggyback one of your comments you made, is that I’m all into this idea of needs and wants, and where you’re… and you can even do like needs, wants, wishes and dreams. I think that it’s really important to decompose the retirement spending goal or liability into that framework. And to your earlier point, I’ve got a buddy I work with, and I make the point I couldn’t care less about golf, but for him, golf is an absolute need. He is not willing to cut back on that. And so, really, it does take conversations because everyone’s different. You just can’t generalize things in terms of what expenses are really important and those that aren’t.

Dr. David Blanchett:

But I do think that, to me, there’s such a super obvious answer today, where you want to cover the needs, delay claiming social security really is just, to me, it’s an absolute no brainer. And often, people will say, “Well, David, the trust fund is underfunded.” And I say a few things. First, the odds of them cutting my grandfather’s benefit is approximately zero, right? Old folks vote. No one wants our older generation to have to live off less. It’s not a viable political option. I think there’s going to be a lot of changes to the program that I eventually receive in 25 or 30 years, and that’s okay. Right?

Dr. David Blanchett:

I think what’s also important is that you cannot buy anything that’s nearly as good as delay claiming social security today, even if they cut benefits. And a reason for that is that social security isn’t priced based on market interest rates. And so everything else you buy, a bond, a private annuity, is based upon prevailing interest rates. Well, social security isn’t. Right? It’s tax-advantaged. It’s linked to inflation. There’s a survivor benefit. I think that virtually every client who engages a financial advisor should likely be delaying to age 70. And people will say, “Well, David, what if I’m not healthy?” And I say, well, if you think about bad outcomes in retirement, this gets to our earlier discussion about, about risks. If you happen to delay claiming to age 70, assuming that you can, and you die at 72, your kids get all your stuff. Right? They have no worries. And maybe they would’ve gotten a little bit more had you claimed at say 62, but the kids, all of your life savings that you spent 40 years accumulating, they get almost all of it. Okay?

Dr. David Blanchett:

To me, the really, really bad outcome is someone claims at 62, and they live to age 105, and at some point spends all of their savings down, and the kids have to support them. So I think that when you start reframing this definition of what is the bad outcome, for things like social security, it isn’t a break-even age of 78, it’s even if at age 70, I only live to age 74, if that happens to occur, I know that my kids are still taken care of in terms of what I have left to leave them, versus what they may have to do for me and support me if I live a long time. So I think that the key when making decisions about do I allocate more to guaranteed income and delay claiming social security is really like, what is that downside? And I worry that a lot of breaking analysis doesn’t correctly reflect what that negative event could possibly be.

Kevin Kroskey:

Yeah. In practice, we’ve had a lot of very happy clients. We’ve long been proponents of social security deferral. I don’t want to say my claim to fame, but I had a new client in 2009, repay their benefits, and so they could go ahead… and you can’t do this anymore, but back then, you could. And the social security administration had a stat that only 49 people did that in the year 2009. So I was like, well, that’s pretty cool. Now, to actually get it done and walk into the office with a check was a little bit interesting, but we were able to do that. And now with inflation being where it’s been and where it seems like it’s going to continue to be for at least some period of time, we’ve gotten a lot of… clients were happy.

Kevin Kroskey:

I haven’t had anybody that has waited and deferred, say to age 70 or a later age, where once they got there, they were unhappy about it. They’ve all uniformly been really happy about it. And now that the inflation adjustments, what they were last year and what they’re likely to be, are on track to be for next year, they’re really happy that they’ve done it. So it’s one of those things. And it’s that behavioral part too. It’s like they have that mental accounting retirees do, we all do about, Hey, it’s easier to spend guaranteed income. They don’t like spending their own money necessarily, but at the same time, to go ahead and defer social security, they have to get over that hurdle of, Hey, I’m going to have more guaranteed income down the road, but I have to get over that behavioral hurdle now and spend some of my money today to go ahead and bridge that gap.

Kevin Kroskey:

And thankfully, we’ve been successful in the vast majority of cases of doing that. But it’s tough. It definitely requires conversations and a lot of brute force sometimes to get people there. But I completely agree. And I think this environment that we’re in is certainly showing that to be true. So I guess I’ll say what you said, maybe a different way, but pretty much everybody has some guaranteed income, whether they have social security, or if they were in one of the states where they didn’t have social security, but they maybe have a state-based pension plan or something along those lines, that’s certainly guaranteed income as well. But then, maybe there’s a choice of, Hey, should I actually buy more guaranteed income through an annuity or something like that, or should I just go ahead and keep it invested? And what I would say is to take a more probability-based approach to retirement planning. How do you think about that decision?

Dr. David Blanchett:

Yeah, I mean, so it’s funny, it’s very anecdotal, but both of my parents were public school teachers. And I was actually talking to them like two weeks ago, and my mom was saying the best choice they made was to buy extra years of pension benefits. It’s just radically simplified for them, retirement. They don’t have to worry about the markets and everything else because they know what they’re going to get. Now, that’s a bit different because that was a relatively generous payout. And we’re using the word annuity, and people react to that word very differently. And the first thing I have to say is, like, there was a legit Dateline special about annuities. And so I think anyone that is aware of the category, in general, knows that there are a lot, or at least some bad actors out there and not-so-great products. Right?

Dr. David Blanchett:

But the thing is that in any space that exists, whether it be mutual funds, even ETFs, there’s always bad products out there. Right? The key that you have got to be aware of, it doesn’t mean that they couldn’t possibly benefit you as a retiree or an investor. I think it’s important to understand where and how that product works though. And I mean, just to be honest, the recent kick in inflation hasn’t necessarily helped other protected products because social security is the only “annuity” that has benefits for retirees that are linked to inflation, right? Every other thing out, every other product out there, you might get a raise if the investments do well based upon the structure given inflation, but the fact that a lot of them are nominal benefits, to me, is a bit scary right now.

Dr. David Blanchett:

If I go out and buy what’s called a SPIA, or a single premium immediate annuity, I might get a nice healthy amount of income today, but if we do see persistent inflation over say 5%, the actual value of that income in 20 or 30 years is going to be a lot smaller. And I think that right now that’s gotten a lot of folks worried about a lot of these more traditional structures because no one knows where inflation’s going to head in the near future and it can have a material benefit on annuities or other types of pensions that aren’t explicitly linked to inflation.

Kevin Kroskey:

So in annuities are a… it’s been a while since we’ve spoken about them, I think. Oh man, it’s been a couple of years. But we probably talked more along the lines of the Dateline episode, which I haven’t seen, but I definitely have to look up. And a lot of just the sales incentives, conflicts of interest, so on and so forth. We did talk about SPIAs and deferred income annuities, the benefits of those, particularly for a more conservative investor. I remember talking about that when rates were even lower, and thus expected returns were even lower on the fixed income portion of the portfolio. When you think about annuities in general, there’s others too, the variable annuities and some of the fixed index annuities. When you think about annuities, though, if you do have somebody that has already deferred social security but still wants to or feels like they need to acquire additional guaranteed income, do you have a preference over what type of annuity that you would go ahead and utilize for that?

Dr. David Blanchett:

Well, I mean, if you were to ask any academic, the overwhelming response, it’s called a deferred income annuity, they’re also called longevity insurance. If the product meets certain requirements, it could be what’s called a QLAC, or a qualified longevity annuity contract, where you buy the annuity and income starts at some later age. So I buy it at say age 60, but if I’m still alive at age 80, the income kicks in. Here’s the problem. People do not like that structure at all. It is incredibly painful behaviorally. And when people buy these, I’m just going to call them a DIA, deferred income annuity. When they buy a DIA, they almost always include what’s called a cash refund provision, where if the person dies, they get all their money back. That effectively destroys the value of the product.

Dr. David Blanchett:

And so if you’re that rare robot out there, who is Vulcan-like and super-rational, yeah, buying a life-only deferred income annuity could be a valid strategy. But then the problem is, and I’m looking at this right now, is that only people that are super healthy actually buy these. And so I think that when you think about what is the true best insurance product, it really does require thinking about all these different dimensions. Like there is the academic perspective, but there’s also the behavioral stuff and the product stuff. And what you tend to see is a lot of the products that academics tend to talk all lovingly about really don’t do very well in the operational behavioral buckets. And then that dramatically affects the overall efficacy of the product in the real world.

Kevin Kroskey:

I’m curious, I know the single premium annuities, what I guess I recall was the most pension-like, right? You give insurance companies some money and they’ll give you an income stream for life. If it’s a life-only SPIA, so call it a private pension or whatever you will. I know those historically, and it’s been at least a few years since I looked, but I think those traditionally, maybe around 2% of the total market. I don’t know, one, if that’s still the case, and if so, I’m curious how that compares to the deferred income annuities?

Dr. David Blanchett:

So I think that last year, I forget the exact number, was it $8 billion in sales of SPIAs, and only 2 billion of DIAs, versus like 250 billion total in the entire industry. And so I think one important point about the word annuity is that it doesn’t really mean anything today. I think that the vast majority of annuities sold aren’t actually used for retirement income. And that’s actually the purpose of the word, right? The word annuity, I forget the Latin root, but they’ve been around for 2,000 years, providing protected lifetime income. That’s not what most annuities are today. Most annuities today are used more for accumulation, taking advantage of that taxed deferred structure.

Dr. David Blanchett:

So I think that, to your point, and the funny thing too is that a lot of the strategies that people talk about, again, when academics write about these, they’ll often assume you can buy an annuity linked to inflation. They don’t even exist. So I think that just one thing that I love to point out is like a lot of the products that are used in research are not economically viable for a host of reasons. And so, you really have to put on that behavioral lens and understand how insurers develop products and what they look at to understand what actually makes the most sense.

Dr. David Blanchett:

I think that where the market’s moving are to more products, where there’s more, you can call it risk sharing, where if the market does well, you have the possibility to have a higher lifetime payout. If the market does poorly, it might be a lower payout. And people get a little bit queasy, “Oh, what do you mean it’s not a fixed payout for life?” And I say, “Well, you already have a fixed, guaranteed lifetime income if it is either from social security or some private pension. You can actually take a little bit of risk, usually on other sources of income if it’s much more efficient and it can create a lot more income over your lifetime.” So I really do see this space evolving in the near future because there’s a huge interest in adding solutions and the defined contribution space and helping advisors and retirees better tackle this question about longevity risk.

Kevin Kroskey:

So it seems like the innovation is maybe more likely to come through changing regulation in the 401k space, and then maybe that trickles over to the individual market as well?

Dr. David Blanchett:

I think what you have, is you have 10 plus trillion dollars in the defined contribution market that is largely untapped for lifetime protected income solutions. And so, just even 10% of that is incredibly attractive for insurers. And I also think that, to your point, a lot of advisors don’t actively consider annuities for a host of reasons. So I think what the industry is really trying to do is create strategies that advisors, that defined contribution plan sponsors, that the industry itself just finds more attractive. And I think that’s going to be a huge net positive for retirees and investors because the more institutionally priced high-quality products out there, the higher the chance that those are what the average person gets put into versus some of the products that were featured on that Dateline special.

Kevin Kroskey:

Yeah. Makes sense. Well, we’re winding down here, maybe about five minutes left or so. So I know I can’t close out without asking you about a recent paper that you did on crypto. So cryptocurrency, so can you share a little bit about what you wrote about there?

Dr. David Blanchett:

Sure. So I think that cryptocurrencies and the underlying technologies there have absolutely phenomenal potential. I always want to open up when I talk about crypto and digital assets with that up top because I am by no means dismissing the efficacy of especially the technologies involved in creating these. My concern is more of, should I be thinking about buying this as part of a portfolio? When I’m thinking of a portfolio, it’s established asset classes like stocks and bonds and real estate. And I think that for a host of reasons, cryptocurrencies just don’t check those boxes. And so if you want to get out on the space and you want to actively trade, that’s okay. I mean, it can be okay to day trade stocks, as long as it’s not a material portion of your portfolio.

Dr. David Blanchett:

But I worry about individuals going “all in” to cryptocurrencies. It’s ironic or funny, but just before we jumped on this call, I saw an article on the Wall Street Journal talking about individuals who lost their entire life savings investing in different cryptocurrencies. And so, what they did, is they viewed the potential to run up and they went all into these “stable” coins or other cryptos like Dodge coin, and they didn’t understand the risks. And so I think that when I’m talking to advisors and talking to investors, and retirees, it’s okay to view it as a fun speculative asset. But I just really get concerned when folks talk about “investing in crypto”, because I see it as more kind of gambling, at least right now.

Kevin Kroskey:

That’s great. That’s helpful too. You got to be careful, if you put that out there on Twitter, you might get mobbed by a bunch of crypto-

Dr. David Blanchett:

You do. You do. Trust me, you do. So it’s funny, actually, I wrote a piece for Think Advisor, and somehow it popped on my wife’s Facebook feed, and she looked in the comments. And I never got to see the actual comment, but she said there were some people that were very disappointed in my article.

Kevin Kroskey:

I’m looking at just the last few papers you have on your website that you wrote, “Income Investing in a Low Yield Environment”, we talked about that maybe a little bit. “Into the Unknown: Best Practices for Return Assumptions in a Financial Plan”, we certainly touched on that. “How to Estimate the End of Retirement”, which sounds incredibly insightful. I’m just curious, when you look back over things that you’ve recently written or currently working on, anything that’s really interesting you think to share to more pre-retiree, retiree audience that we have?

Dr. David Blanchett:

The one thing that I’ve consistently seen, and a topic I’ve researched for at least the last decade, is how individuals respond to market volatility. And whether you look at the 2008’s crisis or the most recent 2020 COVID downturn, older investors, without a doubt, are the most likely to trade. In theory, they shouldn’t be. I think that the reason is that they’re afraid, right? If you’re 40 years old and your 401k goes down, it’s almost like, who cares? I’ve got 20-plus years to make it back. If you’re 62 or 75, then that loss is a lot more real to you. And so I think it’s absolutely critical for individuals who are in or at retirement to have some professional helping them figure out what they should be doing because left to their own devices it appears they make the worst decisions. So the one recurring theme throughout a lot of my stuff is there can be a value for individuals to get help through advice, and that appears to be especially important around retirement.

Kevin Kroskey:

That research, I know Morningstar has done some research there. Vanguard, I think they called it “Advisor Alpha”. But I guess real quick in closing, can you just highlight some of those areas where, empirically, those studies have shown that advisors, I would say at least have the potential to add value, assuming that they’re well educated, execute, trustworthy, competent, all that good stuff.

Dr. David Blanchett:

Yeah. So when I was at Vanguard, I actually wrote the research that they did. It was on a concept that I called gamma, which is, it’s just thinking about all the ways that it gets to accomplishing a goal, right? You hire an advisor to help you accomplish a financial goal. And individuals don’t always need help. A lot of folks are good on their own, but in reality, there’s all these decisions you have to make. How do you invest intelligently so that you reduce your taxes? How do you know when to claim social security? How do you stay invested in the market when things get volatile? How do you have a truly diversified portfolio? Where do you save money for retirement? How do you withdraw assets? How much can you withdraw?

Dr. David Blanchett:

These are all incredibly complicated decisions that only get more complex as you age. And so the marginal value of advice actually tends to increase, especially around retirement, because there’s so many choices you have to make, and a lot of them are somewhat irrevocable. So again, I would never suggest that everyone needs help, but the value of that help really is highest around retirement.

Kevin Kroskey:

All right. Well, Mr. Dr. David Blanchett. I really, really appreciate you being on the show today and sharing your wisdom. The work you’ve done makes me feel lazy, quite honestly, looking at all these papers you wrote. Really impressive. Keep up the great work. And again, thanks so, so much for being on the show today.

Dr. David Blanchett:

Sure thing.

Walt Storhalt:

This concludes our two-part series on Retire Smarter with retirement researcher Dr. David Blanchett. I hope you enjoyed the conversation. If you have any questions for Kevin Kroskey about your particular financial and retirement plan, don’t hesitate to reach out. In fact, if you want to schedule a 15-minute complimentary conversation with an experienced financial advisor on the True Wealth team, all you have to do is go to truewealthdesign.com. Again, that’s truewealthdesign.com, and click on the “Are We Right for You?” button to schedule your call. Or you can dial 855TWDPLAN. That’s 855-TWD-PLAN. Thanks for listening, and we’ll look forward to talking to you on the next episode of Retire Smarter with Kevin Kroskey.

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