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The Smart Take:
Dr. Michael Finke is a professor and chair of Economic Security Research at The American College of Financial Services. Finke has published more than 50 peer-reviewed articles and is widely quoted in many of the nation’s leading consumer publications, including The Wall Street Journal, The New York Times, Time, and Money Magazine. He’s not just smart but a great communicator as well.
Listen to Kevin and Michael chat about a wide range of key retirement issues, the research behind them, as well as current topics: Life expectancy differences for average vs. wealthy people, what makes a retiree happy, why Social Security is such a good deal, how inflation impacts retirees differently than workers, why the current market environment contains much bad news for retirees, and much more.
A big “thank you” to Dr. Finke for sharing his original research and wisdom. No doubt this is one of those episodes you may want to find yourself listening to twice.
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Kevin Kroskey – About – Contact
Intro:
Tune in to hear our conversation with Dr. Michael Finke, professor and researcher on retirement satisfaction, spending, and investing. Listen to insights and evidence on longevity, how to combat inflation, why Social Security is such a good deal, why the news is so bad for retirees in 2022, and what you can do about it. That and more on this next series on Retire Smarter.
Kevin Kroskey:
Today on Retire Smarter, and for the next few episodes, we are very lucky and a great deal of gratitude to have professor Dr. Michael Finke, who is the Frank M. Engle chair of economic security research, economic security research, that sounds awesome, at The American College of Financial Services. Michael, welcome to Retire Smarter, very happy to have you. Economic security research, so what does all that entail exactly?
Dr. Michael Finke:
Wow. I do a lot of research on retirement, that’s my main subject, but I also do research on issues that are related to general retirement security. Are people saving enough for retirement? What are they investing in when they invest for retirement? When they get to retirement, what is the right way to take money out of their savings to create a lifestyle, and what actually makes people happy in retirement? What I’m interested in is how people use money to be happier, which I think is the goal of money. A lot of people think that the goal is just to have more, but honestly, it’s just green paper, it’s just numbers on a computer screen. The real goal is to actually live better.
Kevin Kroskey:
Living better, that’s great. I recently learned that you had an interesting foray into your current professional endeavors. You actually spent your first decade or so, of your career, as a food consumption researcher, is that correct?
Dr. Michael Finke:
That is correct. I studied what motivated people to eat healthy foods. Now, when you eat a healthy food, when you go to, let’s say, a fast-food restaurant for lunch, and you see that there’s Baconators and then there’s chicken sandwiches that don’t taste quite as good. What makes someone choose the grilled chicken sandwich instead of the Baconator? And I had found a lot of evidence that higher-income people, and especially people who save more money, tended to eat healthier diets. I wanted to learn more about finance theories so that I could understand why there was this correlation between healthy eating and saving money. And what I found was that… First of all, I found that investment theory was fascinating. I took a Ph.D. class in investments and ended up getting a Ph.D. in finance because I was so interested in the topic of investments. But I continued to do research that really is related to this human aspect of saving and investing.
Dr. Michael Finke:
What motivates people to invest, and very often, how people become wealthy over time is a combination of motivation. They want to live better in the future, it’s the same thing that motivates us to eat the healthier sandwich at lunch, we want to live better in the future, but also by accident. And if you look at the wealth data in the United States, you see that most people build wealth by accident, simply because they decided to save more in their 401(k) plan, or they built a business and they just continue to build the business over time. They put their profits back in the business, it grew, or a home.
Dr. Michael Finke:
We keep paying our mortgage, and by accident, over the next 30 years, now, we finally paid off our house and we have wealth in our home. There’s really two sources of wealth in the United States. One is a purposeful choice, and the other is by accident. But I think that’s one of the biggest things that a financial advisor provides is the opportunity to sit down and think about what you want in the future, and then make some of these automated choices that will allow you to get there because who wakes a up in the morning and says, “I really need to save more money in my 401(k)?”
Kevin Kroskey:
Not many. What you just shared reminds me of the old, fabled marshmallow test. Would you say that that’s somewhat in alignment with that first part, the non-luck part?
Dr. Michael Finke:
Yeah. Let’s talk for a moment about the marshmallow test. There was a scientist, Walter Mischel, who put kids in a room and offered them a marshmallow, and said that if you can wait five minutes, I’ll come back and give you two marshmallows. And so I don’t know, if you’ve never seen those videos on YouTube, watch the videos of the kids struggling for five minutes to defer gratification, to wait so that they can get two marshmallows. Some kids are fine. They’re very disciplined. Other kids have developed skills that allow them to defer gratification, even though they have a difficult time resisting temptation, so some kids will just put their chair in the corner of the room and stare at the wall. Other kids will lick the marshmallow, but they won’t eat it.
Dr. Michael Finke:
And what you’re seeing is by the kid… First of all, the kid who turns their chair around and stares at the wall, it’s like tying yourself to the mast. It’s recognizing that you have a problem with succumbing to temptation and then avoiding opportunities that are going to force you to actively choose to resist those temptations. And I think, so much of life is habits and developing a process for avoiding these types of temptations. And I think, especially when it comes to saving and spending, we’re so much better off if we, first of all, are conscious. We’re actually using a different part of our brain, our prefrontal cortex when we’re making decisions about the future. And so when you sit down with a financial advisor and they ask you, “What are your future financial goals,” you’re actually using a different part of your brain than you use to make financial decisions very often during the course of the day.
Dr. Michael Finke:
You’re projecting, you’re imagining what your life is going to be like in the future. And you’re not using those emotional parts of your brain. And the great example of this is a snooze button. So, the night before we go to sleep, we have an idea of what the optimal time to wake up will be the next morning. We’re actually… Again, we’re projecting, we’re using that rational part of our brain, but when we get up the next morning, we’re using the emotional part of our brain. And the emotional part of our brain says, “I just want some more sleep, I’m cranky.” You hit the snooze button. You want to create a system where you aren’t forced to make the choice about using the snooze button. There is in fact this thing called a Clocky where if you hit the snooze button too many times, it’s actually…
Dr. Michael Finke:
It’s an alarm clock on wheels and it will run off your side table and you’ll have to chase it down. And essentially, what you’re doing is you’re trying to force yourself not to make decisions using the emotional part of your brain. And I think the same thing happens over and over with money, that there are people who are making choices that are going compromise their long-term goals, it’s like the person who chooses the Baconator when they go to the restaurant, but you can make decisions ahead of time. You can pack your lunch, you can do whatever it takes to avoid having to make a decision where you’re liable to succumb to temptation. Very often, we over imagine our ability to resist temptation. We see other people succumbing to temptation. We say, “Oh, that wouldn’t be us,” but then we do. The key is really to avoid situations where we might fall into that trap.
Kevin Kroskey:
One of the things that comes to mind, and this is probably the other side of that coin and maybe a bit of a conundrum, when you get into retirement spending and you have had some of these strong behavioral, smart decision-making, perseverance, persistence type rational brain sort of thinking that has accumulated into more wealth and financial independence, and then you get to the point of retirement and you have way more money than maybe you need to go ahead and meet your goals, and comes back down to what you said about economic security and really utility. It’s like those habits can almost be a double-edged sword because how do you flip the switch and just start spending at the other side of it?
Dr. Michael Finke:
Yeah, we see that. We actually have done research on workers that we call ants. And the ants are the ones who consistently spend less than their income. And they actually feel a certain amount of satisfaction because they see their wealth growing over time. They get to retirement and all of a sudden, they have all this wealth. And you might ask them, in fact, I’ve done interviews with retirees, and I asked retirees who are continuing to save money. So, into their 70s, they had a pretty good nest egg, they’re not spending it down, they’re very proud of the fact that they’re continuing to save money. And so I asked them, “Well, you must really want to pass on your wealth to your kids.” And they say, “Well, no. They have enough money. We paid for their education. They make more money than we ever did, so that’s not our primary goal.”
Dr. Michael Finke:
And then I sit there and I say, “Well, there’s only two places your money can go in retirement. They can either be used to live better or it can be passed on to someone else, but there’s no third choice.” You have to make a conscious decision about how you want to live in retirement and how much you want to pass on. And I think, really, the first stage of retirement planning is making a conscious decision about how much you want to pass on as your one goal. You’ve only got two goals, right? Lifestyle is your second goal. And how much do you actually want to spend? And for the ants, for the ones who have carefully been saving for… I mean, it’s the old parable of the grasshopper and the ant. The ants have been carefully saving for the winter. They get to the winter, and then they don’t feel like actually spending.
Dr. Michael Finke:
I think it’s a big psychological problem. I mean, it’s preventing people from living as well as they could live in retirement. And it really, I don’t see… Especially in the 401(k) era where people arrive at retirement with this big pot of money in their IRA. Very often, when you follow them over time, especially wealthy retirees, you don’t see them spending down those assets. And I think, especially, in a low-interest rate, low asset return environment that we’re probably going to experience over the next decade, you’re going to have to spend it down. You’re going to have to become more accustomed to the idea of seeing that nest egg get smaller if you want to meet your lifestyle goals. But for a lot of people, that’s a real challenge.
Kevin Kroskey:
That makes me think of retirees, and I can think of several that I serve personally and as a firm that we take care of and see how things change over time. We have more than 300 clients that we take care of and that’s our small sample. But some of the research that you’ve done has obviously been over a much wider range of people. And can you talk a little bit about those sorts of surveys and where some of this data comes from and what you’ve learned about what makes people happy in retirement?
Dr. Michael Finke:
We use a publicly available data set that was actually created by the University of Michigan, and it’s a great disappointment to me being an Ohio State graduate, that anything useful came out of the University of Michigan. We used this data set that began in 1994, it’s what is known as a longitudinal data set, so it’s the same people over time. And we can follow them through retirement, and we can see how they end up. And by the way, we just did a study on longevity. Don’t smoke. The likelihood that you’re going to make it to the age of 75 if you’re still actively smoking in your 50s is it’s… Maybe you’ve got a 60% shot of making it to the age of 75. Smoking is one of the worst things that you can do. Just this as an aside.
Dr. Michael Finke:
What we do… I mean, we do things like look at longevity, what predicts the likelihood that you’re going to be alive at a given age. Because we want to know when you’re making decisions about how to plan for spending, are you going to be around for more years? Because if you’re going to be around for more years, then you probably need to spend a little bit less to make it last longer. But we can look at things like life satisfaction, what actually makes people happy in retirement. We can look at how they spend their money down over time. We can look at how they invest.
Dr. Michael Finke:
We can even look at things like how having a guaranteed income source, like a pension or a bigger Social Security check, how that impacts their life satisfaction and their spending. These are all… It’s so fascinating when you get into the data because you get to see how people actually live in retirement. Now, there are other sources of data. For example, Chase Bank has done some really great research on retiree spending so they can use their credit cards and their bank statements to confirm some of the research that we’ve done using the health and retirement studies, and they tend to match up pretty well.
Kevin Kroskey:
For some of the insights that you’ve gleaned from the HRS or the Chase study over the years, you mentioned some differences between like pension or Social Security income, or maybe even earned income or portfolio income and retirement. Can you elaborate on that? What does the study show?
Dr. Michael Finke:
Yeah. When it comes to income in retirement and spending in retirement, what we see is that people spend almost the exact same amount of money the year after they retire as they did before retirement. The other important thing to remember is when you’re thinking about something like a replacement rate, what is a replacement rate? The replacement rate is how much of your pre-retirement gross salary you need to replace in terms of lifestyle. And now that we have electronic records, it’s a little bit easier for us to estimate what our actual lifestyle spending looks like as a percentage of our gross income. But what we find is that for high-income families, the actual lifestyle replacement rate maybe is lower than they might have expected, so it’s not 80%. So if you’re making $200,000 a year, then you don’t have to spend $160,000.
Dr. Michael Finke:
Why? Because you may already be saving 20% of your income in your 401(k), especially if you’re doing catch-ups. You have payroll taxes that you no longer have to pay. And a lot of people who are making more money just naturally save more money. We found that the replacement rate for high-income Americans is probably closer to about 60% of your gross income, maybe more like $120,000, but it’s going to be different for everybody. It’s worth checking your credit card statements, looking at your bank statements, to be able to estimate, come up with a closer idea of what your lifestyle is going to look like. You’ll probably continue to spend $120,000 a year after you retire. You’re going to live in the same house, you’re going to pay the same property tax. You’re going to go to the same grocery store. You’re going to shop at the same places, you may go on a few more vacations.
Dr. Michael Finke:
Some retirees are going to go a little bit nuts. They’re going to buy a motor home or have some other big expenses at the very beginning of retirement. But generally, what we see is that those expenses start petering out after a couple of years. And then there is a gradual decline in spending over time. You tend to spend the most in your late 60s and early 70s. Spending declines at a rapid rate during your mid-70s. And then the rate of decline of spending is more modest in your late 80s and 90s, mainly because healthcare expenses are high, but when healthcare expenses are high, very often, you’re not spending much money on anything else.
Dr. Michael Finke:
There is this gradual decline in after-inflation spending in retirement that it’s really just a natural part of aging. You experience cognitive aging, you experience physical aging, which means that you’re not quite as mobile as you were in your 60s and 70s. And I think it’s another reason why retirees really have to become accustomed to this idea of living well in their 60s and 70s, because… It’s okay to spend money on things like vacations in your 60s and 70s, that’s what you saved all this money for during your working life, because you may not be as capable of spending that money for the same types of things in your 80s and 90s.
Kevin Kroskey:
The old saying go-go, slow-logo, and no-go seems to have some validity to it, I suppose.
Dr. Michael Finke:
It does. And it’s so interesting that if you look at even half marathon times by age, what you see is you can be the healthiest… We all have this feeling that it’s not going to happen to us. If we just work hard enough, we’re not going to experience this natural aging that occurs over time to a human body. But the reality is that even the healthiest people in the world experience this same change, and it’s a physical change, it’s a cognitive change. By the time we’re 90, we’re not really the same person that we were when we were in our 60s. You have to be very conscious of the decisions you make to live well. You can’t put off, say, that two-month European vacation until you’re in your 80s, because you may not enjoy it as much as you could in your 60s.
Kevin Kroskey:
One of the things that you mentioned about the high-income people… These are traditionally probably more apt to be clients of financial advisors like myself, but in the study terms, in dollar terms, what does high income actually mean?
Dr. Michael Finke:
That’s a great question. If you look at incomes in the United States, probably top decile, top 10th percentile, is somewhere in the range of an income of a hundred thousand dollars plus. If you’re a family now to a lot of clients of financial advisors, they make a lot more than that, so that’s going to seem relatively modest. What we see is though that once your income starts creeping into the six digits, there are a lot of similarities among pre-retirees when they retire. I mean, they don’t spend on average that much more than someone who made 70 or $80,000 a year once they retire. That’s a real surprise because one of the big questions is why did you save all this money during your working years if not to spend a lot more in retirement?
Dr. Michael Finke:
But they generally don’t… I would include… My mother is a great example of this. She has a pension, fortunately. She feels free to spend her pension every month, her pension income, but a little less comfortable spending down her assets from her IRA. And that’s another phenomenon I notice is that when it comes to money that recurs every month, that populates your checking account, it’s never going to run out, and Social Security is a great example of this, you feel perfectly comfortable spending that money, but people very often don’t feel comfortable spending money out of their IRA, seeing that balance get smaller.
Kevin Kroskey:
Yeah. And the pragmatic experience that we have in working with people, that is so true. We’ll talk about Social Security a little bit later in claiming strategies, but that’s the double edge sword, I suppose, that comes out when I think about that. But be before we go there, one of the things that we started with your research is a food researcher, food consumption researcher, about the differences in longevity and having these people living longer. Similar where you’re talking about maybe an average income person versus a high-income person. Can you talk about, really, what age should we be planning for when we’re thinking about retirement, and maybe what are some of the differences that you see between, say, average and then above average or high-income people in terms of the long life expectancy and longevity?
Dr. Michael Finke:
There has really been an amazing trend in the United States over the last 20 to 30 years. And that is that higher-income Americans are now living much longer than lower-income Americans. The biggest gains in longevity are among those higher-income Americans. And when you look at some of the reasons for it, mainly, the gains are coming among men. And the biggest change is that higher-income men don’t smoke and they also exercise more, they also eat better. They have access to higher-quality healthcare. There have been studies that have been done. It’s not really the access to healthcare, it’s mainly the behavioral differences that are driving this change in longevity. But men in the top 10 percentile of income have gained six years of longevity of over the last 20 years. That’s an amazing phenomenon, but the same thing occurs among women.
Dr. Michael Finke:
A lot of people think that women, especially those who have gone back into the workforce, they’re experiencing a lot of the same stresses that men experience in the workplace, so they’re not going to live as long. In fact, that is the exact opposite of what happens. Women who make more money over the course of their lifetime also live longer. And women in the top 10th percentile of income have gained about three years of longevity over the last 20 years. And so I spend a lot of time looking at these what’s known as a mortality table. And the society of actuaries, they’re the people that insurance companies hire to estimate how long people are going to live based on actual experience among people who buy life insurance and annuities. We can look at these tables and estimate the likelihood that, for example, one member of a healthy couple is going to live to the age of 95.
Dr. Michael Finke:
And in fact, a healthy couple of the age of 65 has pretty close to a 50-50 chance that one of them is going to live beyond the age of 95. A healthy woman has about a 29% chance that she’s going to live to the age of 95. That’s remarkable and it really means that if you’re going to be planning for retirement… If you’re a healthy couple, you have to plan to age 100, at least. And that means that you have to spread your wealth over if you’ve retired 65 over the course of a 35-year time horizon. It may not be the case for someone who is in a lower income bracket, who’s less healthy, who smokes. They’re planning horizon is not going to be as long, but for someone who is healthy, they have to plan for the possibility that they’re going to live into their 90s.
Dr. Michael Finke:
And especially a couple, there’s probably about an 80% chance that one of them is going to live into their 90s. Their planning horizon has to be a lot farther. And by the way, I hear it all the time, people say, “Well, my dad only lived to the age of 80 or 75, so I should only plan on living to the age of 75 or 80.” Well, imagine the life that your dad had, what sort of choices did he make that are different than the choices that you made over the course of your lifetime? Not to mention the fact that if you get diagnosed with cancer, survival rates right now are so much higher than they were 20 years ago. So, medicine has changed over the last couple of decades. Your behavior has probably changed. You’re a different person, you’re more likely to live longer, so you need to plan for a longer time horizon.
Dr. Michael Finke:
In fact, there’s a question in this health and retirement study where people are asked what is the likelihood that you are going to live to the age of 75? And they’re asked to when they’re in their 50s. And then we can actually go and see who among the people who said that there was a 0% chance or a 10% chance, what was the likelihood that they actually make it past the age of 75. And what we see is that it’s consistently about… For those people who don’t think that there’s any chance that they’re going to make it to the age of 75, about half of them do. So, we’re really terrible at estimating the likelihood that we’re going to live to a certain age. And very often, we live longer than we expect.
Kevin Kroskey:
I couldn’t agree more. Oftentimes, when you’re sitting down with somebody for the first time, and particularly, if they haven’t had a direct family member to live to be at a later age, or if they’re dealing with some sort of we all get our kinds of bumps and bruises and have more health issues and see the doctor more as we age. But if you can’t visualize planning for, say, a 30-year retirement, or perhaps even longer, and you’re planning for a 20-year retirement, I mean, it’s just a completely different retirement plan, different spending plan, different investing plan. Getting that right mindset is… Well, I mean, it’s a precondition, I think, to having the likelihood of a good retirement plan, otherwise it may just be… I guess, there’s always a luck factor, but I’d rather try to put the probabilities of my favor as best as I can.
Kevin Kroskey:
I couldn’t agree more. I’m just curious, with some of the research that you’re seeing, do you have any thoughts about longevity looking… And maybe COVID aside, I think everybody, almost everybody, most rational people, I suppose, know that COVID detracted from mortality, but presuming that it doesn’t continue to become a persistent issue in that vein. I hear some things about, with all the biomedical engineering and some of the life expectancy predictions today. I mean, I don’t want to say it’s scary, but you’re having a lot of smart people and maybe you did 30, 50 years ago too, seeing that we’re going to live much, much longer where it’s not just going to be a linear sort of accretion to our lifestyle, but maybe even something a little bit more exponential, if you will. Any thoughts on that?
Dr. Michael Finke:
Yeah. First of all, that’s not outside my area of expertise. I’ve read David Sinclair’s book. I know there is a chance that medical science is going to come up with a regimen that’s going to allow people to live a lot longer, that’s going to reduce the rate of aging or even halt it. What we’ve seen over the 20th century is this very consistent, predictable improvement in average longevity in the United States, about a year every decade. I think that’s reasonable to expect in the 21st century. Now, a pandemic is going to have a big impact on that. We already know that average longevity in the United States suffered considerably because of COVID. If you look at the experience of insurance companies that have group insurance policies, you see that mortality rates have spiked as much as 20% during the pandemic, so that’s going to have an impact on longevity.
Dr. Michael Finke:
Now, if you made it through the pandemic, you are going to live longer than the average American, because the pandemic very often took the lives of people who were probably not going to live as long on average, they were a little bit less healthy on average again. What you can expect is that you’re going to live longer than the average American, if you are in retirement right now. And nobody knows what improvements in longevity are going to look like, but we can also expect these regular improvements of about a year, every decade. Where it really becomes important is that today’s retiree should expect to live longer than a retiree from 20 years ago. And if you’re younger, you can continue to expect that there’s going to be those mortality improvements, which means that you’re probably going to need to either save a little bit more, or you’re going to need to retire at an older age, if you want to fund the same number of years of spending in retirement. A millennial today may expect to live four years longer than a retiree who’s in the boomer cohort.
Kevin Kroskey:
Anytime we talk about life expectancy or longevity, Social Security always comes to mind. And we’ve spoken about Social Security in different fashions, quite a bit over time with clients and on the podcast, and certainly, have been an early adopter of different Social Security deferral strategies and claiming strategies in general at our firm. But I guess, said in a very plain way, why is Social Security such a good deal?
Dr. Michael Finke:
Well, first of all, it is the only inflation-protected annuity that exists right now. Let’s unpack that. First of all, what does inflation-protected mean? It means that your Social Security income is going to rise by the average rate of inflation. If inflation goes up 7%, which it just did, your check, your Social Security payment is going to go up by 7%. That’s really valuable. It’s great to have a source of income that’s going to rise when the prices of goods and services also goes up.
Dr. Michael Finke:
The other aspect of Social Security is that it was designed to be actuarially fair. What does that mean? That means that the government can expect to pay out the same amount of money, whether you claim at age 62 or age 64, or age 66 or 70, but that was based on numbers in the early 1980s. And in the early 1980s, the average rate of return on government inflation-protected bonds was higher than it is today. And also, people were expected to live… Well, not live as long in the early 1980s as they live today.
Dr. Michael Finke:
And consequently, the gain that you get from delaying Social Security from age 65 to age 70 is more than actuarially fair. What does that mean? That means that you can expect to get back, with interest, more money if you delay claiming for an additional year. It means that you have more wealth to spend in retirement if you delay claiming Social Security. So, you’re doing the right thing by encouraging clients, especially, healthy clients, to delay Social Security, because essentially, what they’re doing is they’re buying a higher income every year in retirement that is adjusted for inflation.
Dr. Michael Finke:
You also have to remember that getting an extra $2,000 a year from Social Security is a lot more valuable than just getting $2,000 a year in what’s known as non-inflation-protected income. A pension that is not inflation-protected that pays you $30,000 a year is less valuable than a Social Security income that pays $30,000 at the beginning of retirement, because that income is going to rise every year by the rate of inflation in retirement. A lot of people think that their pension income is comparable to their Social Security, it’s not.
Dr. Michael Finke:
Social Security is more valuable. Other people think the government is going to go bankrupt and not be able to make those Social Security promise, Social Security payments. Now, anybody who understands politics recognizes that people are going to get very upset if in the year 2033, year 2034, the government just cuts everybody’s Social Security payment by 22%. That’s not going to happen. So, there’s going to be some sort of a fix. And by the way, even if the Social Security system goes bankrupt, the worst possible outcome is everybody’s income gets cut by about 20%. That’s the worst possible outcome that’s not going to happen.
Dr. Michael Finke:
What is going to happen is that we’re going to see some combination of increases in payroll taxes, especially people who make more money are going to have to pay more into the Social Security system. We’re probably going to see continued delays of full retirement age. It’s currently 67 for someone who was born in 1960, it’s probably going to rise over time. We may also see that inflation adjustment is maybe recalculated so that there is what’s known as a chained CPI, which recognizes the fact that the Social Security recipients can be a little bit flexible when it comes to how they spend money in retirement.
Dr. Michael Finke:
If beef goes up by 30%, like it just did over the last year, they can switch to chicken, which only went up by about 9% over the last year. That’s what’s known as a chained CPI that’s probably going to get implemented as part of this solution. But the bottom line is that that Social Security income is incredibly valuable and it’s going to continue to be incredibly valuable, so you have to pay attention to whether it makes sense to delay your claiming. And from any healthy person in the United States, it makes sense right now.
Kevin Kroskey:
That’s great. And the chained CPI, I like to remind people, it did already make its way into the tax code, in The Tax Cuts and Jobs Act. And I don’t know about you, but anytime you can make a change mathematically something that is less salient that people may not understand so clearly, it’s probably easier and more palatable for Congress to do than something that’s a direct increase in somebody’s taxes. These indirect sort of ways seems just to be more palatable, but I suppose I digress there. One of the things that you said when you were explaining Social Security, and in practice, I find is very… It’s often a stumbling block for people to get over. Usually, we’re successful in getting over it, but nonetheless, it’s there, is when you talked about the Social Security deferral, one of the key phrases I think you said was it’s every year you have a higher income.
Kevin Kroskey:
What I find in practice is a lot of times when we’re talking about the Social Security claiming strategy, and maybe we’re looking at deferring one or both benefits, if there’s a couple, they think that they have to wait later to spend the money, that they can’t spend the money now. And you have to unpack that and walk them through and show that’s not the case. But I think it maybe even gets back to some of the conclusions, observations that you see in the HRS study, where people, it’s easier and they like spending the Social Security or the pension income rather than the portfolio income. And we have to get them over that stumbling block to say, “No, you can spend more money now because of the actuarially” unfair, I suppose, benefits of Social Security and the fact that how it works and when it was priced back in the ’80s.
Kevin Kroskey:
That’s a quick aside anyway. It’s something that I would say probably seven times out of 10, we run into. Social Security planning seems to have gotten a lot easier over the years, now that there is more education out there, at least among the people that we work with. But yeah, we completely agree. Particularly, if somebody is of more of a, what I will call qualitatively a conservative investor. If they do prefer more fixed income type assets that are low yielding and actually have returned negative returns over the last several months as interest rates have risen. For those people, we tend to push even more so on the Social Security deferral because, arguably, their opportunity cost is much less. When I think about Social Security as well, and the inflation-adjusted component… And I didn’t realize that you can’t [inaudible 00:35:54] an inflation-adjusted annuity anymore.
Kevin Kroskey:
So, apparently, they weren’t big sellers, so the insurance companies got rid of them or they didn’t like the risk. But inflation has been really a hot topic, I would say for the last several months. Candidly, I mean, I think I and most people thought it was going to be more of a… What was the fed term? A transient issue, but it certainly has persisted and been higher and been exacerbated by the whole Russian issue with Ukraine and some of the energy prices. But what’s going on with inflation, what are you seeing recently?
Dr. Michael Finke:
Inflation. Normally, when you go through these periods of very high inflation, you see a little bit more uniformity than you do over the last year in the United States. What we see is that some categories of spending have gone up a lot. As you mentioned, gasoline has gone up a lot. Also, the price of cars has gone up a lot. Red meat has gone up a lot. I’ve called it manflation. Over the last year, everything that men love has gone up in price by this huge amount. Now, part of the reason is because people have just returned to work after the pandemic. And that’s going to, obviously, have an impact on demand for things like cars. And especially, if there’s supply chain issues, you’re going to end up with really high prices and gasoline. There’s also been supply chain issues that have hit some industries more than others.
Dr. Michael Finke:
As I mentioned before, you see much higher price increases for red meat than you do for chicken, for whatever reason. And for seniors, price increases have actually not been that bad. If you look at drug prices or healthcare in general, it really hasn’t gone up over the last year. You haven’t seen that big increase in the cost of a lot of things that seniors spend a bigger share of their budget on. Now, seniors can also be more flexible. They can, if gas prices go up, they can just not drive as much. Whereas someone who has to go to work, they have to spend money on gas, so they’re stuck with that high rate of inflation on what they spend money on. But for a lot of seniors, they can be a little bit more flexible.
Dr. Michael Finke:
And that’s part of that whole chained CPI conversation is that if you are a retiree, you can respond actively to changes in prices in different consumer groups. Now, nobody knows if this is going to continue, if this is just a transitory phenomenon, or if we’re going to continue to see high rates of inflation over the next few years. I think we can be reasonably certain that those supply chain issues are not going to work themselves out in the next year or so. As you mentioned, the conflict is also contributed to those. We have to be conscious of what we’re spending money on, but we also have to not overreact. We see things like… You mentioned this idea of saliency. Things like gas prices are highly salient. When we go to the gas station, we pay 75 bucks to fill up our tank.
Dr. Michael Finke:
It hurts, but we can go out to dinner the next night and spend a hundred dollars on dinner, $20 at which is a tip, and not bat an eye, not think about it as much. Maybe because it’s somewhat less salient. Or another category may be flat, and we don’t really notice it, even though healthcare is a big share of our budget it in retirement. We have to be also cautious about some of these behavioral aspects that we pay too much attention to things like gas prices, not enough attention to how much we’re spending in our overall budget. And that can cause us to cut back on spending when we really don’t have to.
Kevin Kroskey:
When we’re constructing a retirement plan for somebody, we have to make assumptions. We have to make assumptions. Hopefully, we’re measuring, we’re making assumptions on spending, but then we’re measuring it. We have to play pick some age for the income to last, and certainly, rule number one of retirement planning is to have your money last at least a little bit longer than you do, or I suppose if you could bounce your last check, that might be optimal. But when you think about some of these expectations that need to be fed into a retirement plan, as it relates to inflation, I mean, in your opinion, what’s a good way about going to do that? How do you form inflation expectations?
Dr. Michael Finke:
Let’s talk about how high inflation has been historically. We, over the last 20 years or so in the United States, we’ve gotten really lucky. Inflation has been very low. We got to the point now where we started just incorporating a 2% inflation rate when we were doing our simulations. But if you go back a little farther into the ’90s and ’80s and ’70s in the United States, what you see is that retirees faced a real significant risk that the purchasing power of their income could fall significantly. And maybe someone who retired in the mid-1960s, they had a $20,000 pension in today’s terms. It may have only been worth $6,000 in terms of purchasing power 20 years later. Whereas someone who maybe retired in the 2000 saw that $20,000 go to maybe $14,000 of purchasing power after 20 years. So, that purchasing power is what we want to preserve in retirement.
Dr. Michael Finke:
Now, the good news is that by the time you get to your mid-80s, you’re not spending quite as much, a lot of it is on healthcare. So, it’s on a very limited category of expenses. But we also see that riskier assets tend to perform better over long-term time horizons. One way of dealing with that risk is using something like a strategy where you time segment your investment so that you start thinking of riskier investments as something that you’re not going to touch for another 15 or 20 or 25 years. You take a little bit more investment risk and that allows you to… At least, it doesn’t ensure that your investments are going to keep up with inflation, but it gives them a higher probability that they’re going to keep up with inflation later on in retirement. But the best way to deal, especially with near-term inflation, is to delay Social Security because that is going to be that foundation of spending that’s also going to adjust for inflation over time.
Dr. Michael Finke:
The two best responses are to delay claiming Social Security as a way of dealing with that variability of which you do not know it is a source of risk at the beginning of retirement, just like investment risk. A lot of people don’t see inflation risk as being comparable to investment risk, but it is exactly the same thing. Investment risk is if you get unlucky you’ll, your lifestyle is going to be negatively affected. The same thing happens with inflation risk. If you get unlucky and inflation is high, that is going to affect or standard of living later on in retirement. You can do things to protect yourself against both of those risks.
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