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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:
Hey, this is Walter. Thanks for joining us again on Retire Smarter, Kevin Kroskey will be along in just a moment for part two of the conversation with Dr. Michael Finke. If you missed the previous episode, please go back and check it out. Kevin and Michael chat about a whole wide range of key retirement issues, including the research that backs these things up as well as current topics like life expectancy differences for average versus wealthy folks, what makes a retiree happy and why social security is such a good deal. Plus, they talked a lot about how inflation impacts retirees differently than workers, and on today’s show, they’re going to continue to get into conversations about why the current market environment contains much bad news for retirees, and they’ll cover a lot of other topics as well as they continue their conversation. So again, part one, go back and listen to the previous episode, otherwise get ready for part number two in the conversation between Kevin Kroskey and Dr. Michael Finke.
Kevin Kroskey:
Early in our conversation we talked about, or you mentioned at least briefly with interest rates being low and arguably equity returns potentially being low for some time too, I know one of the things I did prior to our call was I just jumped on your two Twitter profile and I noticed your pinned tweet, and I’m not a big Twitter user, but I found it helpful, quite frankly, particularly preparing for our call today. But your pin tweet was about the Shiller PE. So what’s the Shiller PE and why is it important?
Michael Finka:
When you invest in stocks, you are buying a little slice of a company and that company can earn profits, and those profits can either be paid back to you in the form of a dividend, or they can be reinvested in the company. But what happens over time is that we go through these periods like the last few years where stock prices as a multiple of profits go up. And what we see historically is that stock prices in their high as a multiple of profits, again, those profits can either be paid out in the form of dividends to you, or they can be reinvested in the company.
Michael Finka:
A great example of this is let’s say that you’re thinking about a dry cleaner and the dry cleaner earns a hundred thousand dollars of profits after all expenses every year. Well, historically it would cost you about 1.6 million dollars at the historical valuations of the stock market to buy a hundred thousand dollars worth of profit. Today, it can cost about 3.7 million dollars to buy a hundred thousand dollars of profit every year from a company. Now, do you expect that over the next 20 years, if you pay 3.7 million for the dry cleaner, your return on your investment is going to be the same as if you paid 1.6 million for that dry cleaner? Obviously not. The same phenomenon occurs in the stock market, that if you pay more for a stock as a multiple of its average 10-year earnings, that’s the Shiller cyclically adjusted price to earnings ratio, then you can expect that your returns are going to be lower over the next decade. And in fact, since 1995, over 90% of the 10-year returns in stocks can be explained by the price of stocks when you first invested in them.
Michael Finka:
So if you’re investing, when the PE ratio is 20, on average you might get somewhere in the range of 8% returns over the next decade. But if you’re investing, when the PE ratio is more like 35 or 40, then returns are probably going to be less than 5% over the next decade. So that’s just on average, but we find that the distribution is relatively tight. There just simply aren’t historical periods that look like today, where investors over the next 10 years have gotten more than 5% returns on their stock investment. They don’t exist.
Michael Finka:
So that means that you probably need to be a little bit more reserved about your expectations of the bonus that you’re going to get for taking investment risk over the next decade, and it’s probably going to be less than stock investors were able to achieve historically. The PE ratio is surprisingly predictive of long-term 10-year returns, so when you’re making plans about how much you can safely spend in retirement, you have to adjust your expectations of the amount of returns that you can get from your investments downward. And that means you’re probably going to spend a little bit less than if you had been investing in a period where bond returns were higher and the expectation of stock returns were higher, or you’re going to have to save more for retirement to get the same lifestyle. Assets are just simply expensive today, and when assets are expensive, they don’t generate much income for you.
Kevin Kroskey:
I think this is one of those interesting conundrums about this profession and these sorts of decisions. If you get say some sort of discount coupon or something for your favorite restaurant, you can see that, hey, you’re getting a better value, you’re getting a discounted price, but often when it comes to stock markets or funds or stocks or any sort of investment, it’s often the reverse. There’s like this weird behavioral thing where hey, higher prices mean higher returns. When the thing that’s been causing some pain in your portfolio maybe now is a better value, is that a lower price, those are the things that we often want to go ahead and shed and buy more of the higher price thing. So I’m never surprised by how much of a regular conversation this is even amongst people that are really smart.
Kevin Kroskey:
I mean, just because you’re smart, I suppose, doesn’t mean you have some of these behavioral biases, but all of these things from what you just shared and what I followed up with to deferring social security and getting over the hump of having to use your money and not quote-unquote, the government’s money and those sorts of things, it really makes the rational or the empirical application of planning and investing quite more difficult. I guess if I circle back to what you started with early on about your food consumption research, it’s like a knowing-doing gap, right? Maybe we know what we should do, but actually doing it behaviorally, doing it, having the discipline in those things to do it is often something very, very different.
Kevin Kroskey:
So one of the things that you mentioned with the Shiller PE and spending, and maybe having to adjust our spending down, you hear about some of these roles, we talked about replacement rates, we talked out some other sorts of guideposts in terms of retirement and what have you, when it gets to retirement spending, I know there’s been a lot of research. You mentioned both, I think in the HRS study, as well as in the Chase data about how we’re spending less as we age. So is it reasonable to think that being that we are having higher inflation right now, and maybe we also need to expect lower investment returns, the fact that we tend to spend less as we age will be a bit of a saving grace?
Michael Finka:
Yeah, it is one of the upsides of the research that most of the news is terrible, frankly, for retirees in 2022, in a sense that we’re now experiencing higher expected inflation, returns on investment portfolios are less, people are living longer, that’s good news, but it means that they have to fund more years of spending in retirement. The only good news is that generally speaking spending does decline later on in retirement. One of the problems I see right now, and you talk about behavioral issues, a lot of people may be retiring early in the baby boom generation because they get to a number. They get to a million dollars of savings and they think, well, I have enough to retire at the age of 62 or 63. A million dollars today will not buy you the same income in retirement that it could buy you in the mid-1990s.
Michael Finka:
And that’s, what’s known as the dollar illusion. We have this idea that once we reach that mountain, that pinnacle that we had, that goal, that threshold that we had set for ourselves, we’re ready to retire. But frankly, I work a lot in estimating the amount of income that you can generate from an investment portfolio. And there is what’s known as this sort of 4% rule, right? That we probably have to adjust that downward to account for the fact that interest rates are so low and assets, financial assets are so expensive right now and people are living longer. Morningstar just came out with a study that said maybe 2.7% or 3.2% is right. And if that’s the case, then you’re only going to be able to generate $30,000 from a million portfolio where maybe historically you were able to generate significantly more.
Michael Finka:
And then if you’re just taking money out of dividends and interest, then, maybe you were getting a one and a half percent dividend payout rate from your stock investments. And maybe your bonds are generating 2% or maybe a little bit more, but again, that’s maybe $20,000 of income that you’re generating from a million-dollar portfolio, whereas historically, you were able to generate maybe closer to $60,000 from an investment portfolio, and certainly the other thing that I hear from investors is that if I just invest in high dividend stocks, I can treat that as income. Well, that’s not a realistic way to think about how to generate income because a dividend is really, I mean, it’s a stock investment and the dividend is just a way to pay investors back from the profits that the company earns and stocks are risky. Stocks can go down in price. And that means that the dividend can go down.
Michael Finka:
So the risk is real, and investors also need to take into account as they’re making decisions about how to allocate their money in retirement. If you invest in risky assets, even if it’s a dividend-paying stock, you have to be willing to be more flexible about how you spend money in retirement because if you get unlucky, you’re going to have to spend less in retirement. I think the bottom line is that investors can expect less from their investment portfolio in terms of lifestyle. Inflation is the source of risk that many of us hadn’t thought much about, but it’s reared its ugly head, and we have to face that potential risk. And it’s going to take more to be able to create the same lifestyle in retirement than it did in the past. So retirees have to have a more realistic I about how much lifestyle they can generate from their savings.
Kevin Kroskey:
Yeah, and I think flexibility is definitely the word of the day and ongoing monitoring and prudent planning, and I guess the other risk too, that is out there and who knows exactly to what extent, but with most people’s money and most retiree’s money being in these yet to be taxed accounts and some of our budget deficits growing and being as high as they are if tax rates do go up, then not only after inflation and after taxes, that spending could be even less. We’ll see. Certainly don’t want to make getting predictions on what’s going to happen, but all those things we definitely see as risks that certainly want to be proactive about, but you can’t predict the future. You need to make your best guess and plan for some different scenarios. But it’s an ongoing aspect. It’s an I-N-G word.
Kevin Kroskey:
Now that you’ve dealt us all this great news for retirees and pre-retirees in 2022, maybe we can finish up with two more bad things. But one of the things that I liked about your research that I’ve read over the years was about, I don’t want to say I like, but I found it very thought-provoking, was about cognitive impairment as we age and even our confidence and our ability to make financial decisions as we age. Can you touch on that? And then I figure maybe we can talk about RMD jail to finish up.
Michael Finka:
Yeah. We did a big study about 10 years ago on financial literacy across 10,000 Americans. And what we found was that there was this really interesting decline in financial literacy scores as people started getting into their seventies and eighties and nineties. And in fact, when we matched that up with cognition scores, so we actually, did our own study, and then we went back to the health and retirement study and we looked at how cognition changed over time. We saw the exact same phenomenon going on. And so this is just, I mentioned before, that this is just a natural part of aging that we experience a physical decline in old age. And part of that physical decline is our ability to retain new information, to process information quickly.
Michael Finka:
Now, the one problem is, and this is very similar to driving, that we don’t recognize when it happens so gradually as it does in retirement, and it’s only about one to 2% per year, the lower cognitive scores. So when it happens this gradually, we don’t perceive it as happening, but if you’ve ever been in a car with a relative who’s 90 years old, old, and you haven’t driven with them in a long time and you get in the passenger’s seat, after a couple of blocks, you start realizing that you probably are in the wrong seat. That person who is 90 years old is not driving with the same level of skill as they had when they were 75 years old or even 80 years old. But they don’t recognize that it has happened. And in fact, there’s research that shows that if older people are given unbiased objective information about the rate of decline in their capabilities, in other words, if they go to a driving simulator and they are shown that their driving skills, their ability to really react to a stimulus are not what it was 10 years ago, then they’re actually going to make changes in how they drive.
Michael Finka:
They’re not going to drive during rush hour. They’re not going to drive at night. You can do the same things with your finances. If you recognize that we are going to lose our ability to make financial decisions later in life, then we can make decisions when we’re in our sixties to automate when we hit our nineties or find someone who’s going to help us make financial decisions, who is going to look out for our best interest, because our ability to manage an investment portfolio and decide how much we can safely spend every year in our nineties is not going to be the same as it was in our sixties and seventies. So part of the retirement planning process is accounting for this inevitable decline in our capabilities, and then creating some sort of a system that minimizes that risk. Again, it’s just like investment risk. It’s the risk that our bad financial choices are going to impair our ability to maintain our goals in retirement, our lifestyle goals, or even our charitable or our bequest goals because we’ve made investment mistakes in our eighties and nineties that we otherwise wouldn’t have made early on in retirement.
Kevin Kroskey:
It’s interesting what you, I wasn’t aware of the data about driving and being presented with that evidence. I’m aware of some technology that has been in our profession developed more recently in conjunction with different aging groups or what have you, where it’s really just trying to get those measurements over time and actually have that evidence of whether there is cognitive impairment or what have you. And it’s been a few years since I spoke with that technology maker, but one of the things that they intimated was that men typically were a little bit more difficult to engage in that, maybe more of ego or something of the sort where women were definitely more open to doing that. I’m curious, have you ever encountered anything like that or have any updates to that?
Michael Finka:
Well, you certainly don’t see that with driving capabilities, do you? That older male drivers are happy to admit that their skillset is perhaps diminishing? Yeah. It seems pretty on-brand. And again, it’s a source of risk. And I think this, this idea that people don’t recognize it and this gap between our perception of our abilities and our actual abilities getting larger in our eighties and nineties, that gap is really a source of risk. And again the real strategy is that the beginning of the environment before that gap exists, how do we create, and how do we tie ourselves to the mast? How do we create a plan that ensures that we’re not going to be vulnerable when we get into older age?
Michael Finka:
Now it’s something like a third or close to a third of those over the age of 85 are experiencing cognitive impairment or significant enough cognitive impairment that it makes it very difficult to even make basic financial decisions such as paying bills. And many of us don’t want to admit that we’re ever going to get to a point where something like paying bills is a challenge, but it happens, and it’s random, it’s a source of risk and we’ve got to plan for it ahead of time. Otherwise, we may end up making mistakes.
Kevin Kroskey:
No, that’s great. Definitely good advice. And then I guess in closing, I remember when I first heard you speak probably about 10 years ago now, and I had you as a guest speaker at a study group that I was part of, which by the way you were, I think if not at the time, the highest, most rated speaker we had, certainly one of them, we’re definitely up there, but one of the things that struck the stayed with me was the idea of this RMD jail. So maybe we can close on a bit of a lighter note. What is RMD jail, and how can maybe we use it for those answers for those grasshoppers?
Michael Finka:
Well, I mean, let’s think about RMDs. I’m a big fan, by the way, of required minimum distributions. What is a required minimum distribution? Well, you put a lot of money in an IRA, and you get this tax sheltering benefit but eventually, want its money back. So it makes sure that you start pulling money out of it. And that the amount of money is dependent on how old you are, they expect that you pay it back over the course of your expected lifetime and the asset returns you get. Now, RMDs also have this major psychological feature. So part of that psychological feature is that if you are an ant in your are not spending very much money in retirement, you get this check from your investment company, and all of a sudden you’re like, wow, I can spend this money. And so you actually see this in the spending data.
Michael Finka:
So for ants, their spending goes up when they start receiving that RMD check. So all it is is the government forcing you to take money out of your IRA. And so your investment company knows about it, they send you a check, you don’t have to spend it, but a lot of people do spend it because it’s a check. And it’s almost like the same check they get from social security. They feel like they have a license to be able to spend that money. Now, if you’re a grasshopper, then you also get a benefit because grasshoppers are the ones who spend more before and after retirement. They’re the ones who are at most risk of running out of money. But for them, the RMD actually creates a reasonably efficient spending plan that is based on your expected longevity. And if you follow that plan, then you’re not going to be at risk of running out.
Michael Finka:
And if you, if somebody that is a grasshopper, one of the things you can mention to them is that the government will only allow you to spend your required minimum distribution every year in retirement, whereas of course you can spend the entire amount of your IRA anytime you want to, but you’ll get taxed on it. And if you start framing it as the government says, this is the amount that you are able to spend. Then even someone who has a tendency to overspend in retirement is now going to be on a plan that actually makes some sense it’s based on your investment amount and your expected longevity. And for them, it provides a good guideline, but just don’t tell them that they can spend the whole thing, they’re going to go to jail.
Kevin Kroskey:
Yeah, no, that’s, that’s great. Actually, I know a few people in the study group that I mentioned that have used that with clients in certain situations. So I think that’s a nugget for sure. The fact that and I know you mentioned it, but to just make it maybe a quick reminder, the fact that our investment accounts, our IRA balances are moving over time. Your RMD is obviously going to change over time, both as a function of your remaining life expectancy and that account balance. So it kind of ties back to this whole idea of flexibility. If the investment account goes down, for example, as it did particularly in say 2008 and 2007 even, you’re spending less the next year. If you have the wind at your back, like really we have pretty much for the last more than 10 years, particularly in the US, you’re obviously being able to spend a little bit more, but you have to go ahead and pull all this together and coordinate it in light of not only what we currently have, that money or that dollar illusion that Dr. Finke spoke about, but also these forward-looking and uncertain expectations around interest rates, about longevity, about investment returns.
Kevin Kroskey:
Really flexibility, and I think planning and really having a good measurement of what somebody is spending and being able to measure that over time, making sure that we can focus on the things that we can control, like shorter-term tax planning particularly is a good thing, and then just really bringing this all together and integrating it. I mean, it’s planning in a nut box, but it’s great. And Dr. Finke, one, you’ve been great and generous to share your time today, and I can just say from an industry perspective when I was studying this and doing like my certified financial planner training back in the two-thousands, you just, I didn’t particularly see any research about retirement satisfaction, about some of these very, very important aspects that you’ve been spending a lot of time and yielding a lot of great research and insights into.
Kevin Kroskey:
And I couldn’t agree more that it’s not about how many dollars that you have, or you die or you leave on your kids, but it’s about the experience that you have, it’s about that satisfaction, which I think that’s what most people want. Certainly, we don’t want to die destitute and broke, but the other side of the coin too, where you have so much, and you really haven’t experienced much isn’t exactly the best path either. So whether it’s balanced, whether it’s about flexibility, whether it’s about your trying to be in the present while making sure that your future’s okay, you’ve done a tremendous, tremendous benefit for the industry, for people like myself, and the clients that we help and serve every day. So a big, big debt of gratitude. Thank you for sharing your time today and for everything that you’ve done.
Michael Finka:
My pleasure, Kevin, it was great it to be on the show.
Walter Storholt:
Walter Storholt jumping in once again here, hope you enjoyed the conclusion of today’s conversation with Dr. Michael Finke and Kevin Kroskey. This will conclude the two-part series. And boy, if you’ve got any questions, I know we covered a lot of ground on these last two episodes, but don’t hesitate to reach out. You can always schedule a time to visit with Kevin and the True Wealth Design team by going to truewealthdesign.com and click the are we right for you button to schedule a 15-minute call with an experienced financial advisor on the true wealth team. That’s truewealthdesign.com. We’ll also link to that in the show notes or the description of today’s episode, and we’ll also put the phone number there it’s 855-TWD-PLAN. You can also call and schedule that time to chat as well if you prefer. 855-TWD-PLAN is the number. For Kevin Kroskey and Dr. Michael Finke, thank you so much for tuning in, and we will see you next time on the next edition of Retire Smarter with Kevin Kroskey.
Disclaimer:
Information provided is for informational purposes only and does not constitute investment tax or legal advice. Information is obtained from sources that are deemed to be reliable, but their accurateness and completeness cannot be guaranteed. All performance reference is historical, and not an indication of future results. Benchmark indices are hypothetical and do not include any investment fees.
