There Is No “Risk-Free” Option
I recently swapped guest posts with Jared Casazza at “Fifth Wheel Physical Therapist”. Jared in turn got a response to my guest post written by Joe Reinke, CFA. Joe’s post critiqued how I manage risk and offered an alternative strategy.
I disagree with the premise and conclusions strongly. However, I am happy to share opposing points of view and encourage honest debate. Jared presented the post to me a few weeks ago, and I offered to publish the post here with my rebuttal. Considering that the writer was referencing and critiquing my ideas, I thought that made sense and was fair. The writer refused. Here is a link to the full article published on FWPT to avoid the idea that I am twisting his words or quoting him out of context.
What follows is my rebuttal. This post is primarily for the benefit of those of you early in your financial journey, trying to overcome the overwhelm of figuring out if and how to manage your own finances. I think this serves as a perfect case study as to how the financial industry works to make financial issues complex to justify their existence. However, I would appreciate feedback from anyone, particularly if you disagree with me, think I am oversimplifying, or am missing the boat completely with my response.
I originally started this site to try to simplify the complex in investing and financial planning. I was sold half-truth after half-truth by the financial industry for years, before getting the courage to take control of my own finances. It was only after finding other sites written by consumer advocates and true educators like JL Collins, Financial Mentor, Can I Retire Yet?, and The White Coat Investor that I got that courage.
Tactic #1–It’s Too Complex For You
In the introduction to the referenced post, Jared, notes that “Joe is a very intelligent guy who spoke way over my head in the conversation that we had…” and then goes on to say that Joe offers a “conservative and foolproof way of determining net worth needs for retirement.”
I have exchanged many e-mails with Jared and we spent a day together discussing finance, physical therapy, and life. I can tell you Jared is also a “very intelligent guy” with a very legitimate and solid, if not “foolproof”, plan to achieve FI quickly. If he can be wowed by someone talking way over his head, then we are all susceptible. I certainly have fallen prey.
Tactic #2–Building Fear
The author gets major points here for combining a bit more complexity with a little scare tactic with the statement: “Traditional ways to calculate how much you need for retirement have three large problems (note: there are many mathematical problems with the traditional approach but I will spare you the boring details and state the high level problems)”.
OMG! I am going to run out of money and the reasons are so complex that I won’t even understand the boring details of how and why! I must need professional help! Thank goodness there is a professional there to save me!
Tactic #3–The Sales Pitch
The financial industry is always there to solve our problems. They can eliminate any risk. They always have the solution if you just… wait for it, wait for it, wait for it…..buy this very expensive insurance policy that coincidentally is highly profitable to the financial professional and the company he represents. This generally will mean (A) a whole life insurance policy or (B) a variable annuity. In this case, the author went with option B (with a side helping of long-term care insurance) as the solution to my problems.
Nothing Is Risk-Free
We all will have to go on our own financial journey, which due to the power of money in today’s society will have a massive impact on our life journey. The whole purpose of this post is not to pick a fight on the internet with Joe or anyone else in the financial industry. Rather it is to challenge each of you to think independently and to realize that nothing in life is risk free.
Every decision we make involves managing risk and every decision has costs (financial, time, and opportunity). We simply must decide what risks we are willing to accept and what price we are willing to pay for the decisions that we make.
A Lesson In Logic
In Joe’s post, he starts with the argument that assuming that you could support $40,000 spending on a $1,000,000 portfolio, based on the 4% rule, gives too great a risk of running out of money in retirement. I agree with this statement and this was the basis for developing “Our Ultra-Safe Early Retirement Plan” that he critiqued.
By the end of his post, Joe states that using his “risk-free” approach would “increase the total amount Chris needs to retire today to $1.32 million.” Well that’s kind of a big deal. If I had $1.32M and needed 40K, I would not be following the 4% rule that Joe is critiquing. Instead, $40k spending would represent only 3% of this larger portfolio. It is an apples and oranges comparison.
Even with today’s near record low interest rates and high stock valuations, it is pretty simple to put together a portfolio of low cost index funds that will yield 2%. Thus, you would need very little portfolio growth to support 3% withdrawals, making this far safer than a 4% withdrawal rate. While still not risk-free or guaranteed, historically a 3% withdrawal rate has never failed and in most cases would lead to substantial portfolio growth in retirement.
The other logical fault in this whole argument is the author’s idea that people spend more than they think they will in retirement, meaning their original assumptions are faulty. If this is the case, there is no logical way to the idea that an Asset Liability Matching (ALM) plan designed to safely produce that wrongly assumed amount solves this fundamental problem.
Joe manages to build a complex argument with plenty of technical jargon and an assortment of numbers that can make your head spin. However, the whole argument fails to meet these tests of basic logic.
The Cost of “Risk-Free”
There is no argument that a larger portfolio means less risk of running out of money. Whether simply following a 3% withdrawal rate or buying insurance products with an ALM approach, this whole argument assumes that running out of money is the primary problem that we face and are trying to address.
Saving 33% more money, or in real dollars in this example an extra $330,000, would mean both my wife and I working full-time for an extra 3-4 years despite our relatively high incomes and high savings rate. Therefore, while we would decrease the risk of one undesirable outcome, running out of money in retirement, we would guarantee another undesirable outcome, not beginning our transition to our early retirement on the timetable that we desire.
One of my biggest motivators behind carrying out our plans in the fashion that we are is to have the year prior to my daughter starting kindergarten to maximize this time with her. One of the reasons that I am so passionate about assisting others in their financial education is that following lousy advice from “financial professionals” in the first decade of our careers is the reason we have not already been retired. Bad financial advice has cost my family literally hundreds of thousands of dollars in excessive fees and taxes. Put into terms of what is really important, it has meant spending the majority of our time during our daughter’s formative years working rather than already having achieved financial independence.
Using the author’s ALM methods, which he claims “removes stock market risks because there is no market risk” also means that by definition it also eliminates potential stock market upside because there is no market upside. In the event that we experience anything but a worst case scenario, missing out on this powerful passive wealth building tool could come at a very steep financial price as well.
A Totally Different Approach
Joe’s stated motto is that “Every financial product has their purpose. If used correctly, you can maximize the benefit.” It is a logical approach to try to solve every problem with a financial product, if you relied on the sale of financial products to make a living. I am not questioning the integrity of Joe specifically or the financial industry in general. I am just stating a simple fact of life. If the only tool that you have is a hammer, everything starts to look like a nail.
Using strategies outside of traditional financial instruments allows us to achieve our goals and maintain potential investment upside while also managing risks in a way that we are comfortable. This requires creativity, flexibility, and utilizing our own unique skills, abilities, and interests, all of which a do-it-yourself planner can incorporate without being constrained by the need to rely strictly on financial products.
I do not think that I am smarter or more educated than Joe, who carries a CFA designation, on financial issues and products. In fact, I am certain I am not. The issue is, to quote Upton Sinclair, “It is difficult to get a man to understand something, when his salary depends on his not understanding it.”
How do you manage risks? How much potential upside and time are you willing to sacrifice for safety? What role do financial products like insurance and annuities play in your planning? Do these products really make us more safe and are they worth the associated costs? Let’s discuss it in the comments below.