There Is No “Risk-Free” Option

DSCN0259I 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… 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.

24 comments on There Is No “Risk-Free” Option

    1. We are also very risk averse and so we would be interested in options to decrease risk. However, there are various ways to modify risk outside of just buying more insurance which tends to be complex, expensive, limits upside, and doesn’t necessarily make your plan any less risky if not chosen and implemented correctly.

  1. If your insurance company can offer it to you they expect to come out ahead investing your money versus the product you bought. Since they have no different investment options then you do it should be obvious what you should do with these products.

    1. Agree with you 99% of the way. I do think there are times when it pays to pass the risk on to someone else, if you can not afford to take the loss. Some examples are homeowner’s insurance, umbrella liability insurance, and medical insurance to protect you against massive losses you can not afford to take. However, you are 100% correct that all insurance is a bet that is mathematically very likely that you will lose out on, and you hope to lose those bets! You should therefore minimize when and how you use it.

  2. Hey there, I’m not sure I’ve commented on your blog before, but I have been enjoying your content. Let’s start with this: I have an MBA and until last Friday (I early retired – woot woot!), I worked in the finance industry for 20 years. Even though I’m a financial professional and certainly capable of managing my own stuff, for many years, I bought into the hype, and thought I should turn over my finances to someone else. I also bought all the insurances (disability, term life, whole life), you know, just in case, because the financial planners told me it was the right thing to do. I like to trust folks I view as “experts” and I focused on my little world of finance and maximizing my income while maintaining my integrity at my job. I finally discovered this FIRE world a couple of years ago and realized that my intuition about a lot of the investments I had let my FP “manage” for me was on point. Note that I had fired my FP in 2008 when the markets imploded and took over managing my stuff because instead of index or plain old mutual funds, I was somehow invested in not very well diversified investments. My experience is that folks who really understand these more complex finance topics, can break them down for people in the FIRE community. They can even explain these concepts to folks who are less savvy about finances than FIRE people. You simply have to define the technical jargon first . I know several people with CFAs who willingly admit that not all the financial products available are appropriate.

    I’m conservative by nature, so I held out until I could follow the 3% rule (plus, theoretically I should last more than 30 years since I’m RE) and I have a mix of investments index equity funds, index bond funds, and some private equity. I discovered the EarlyRetirementNow blog a few months ago and if I’m going to trust what someone with a CFA has to say, likely I’ll go to his analysis first.

    I don’t like when folks assume that other people are “dumb beasts”. I’d think that the gentleman who wrote that piece would have a hard time understanding some of the conversations had by a room full of Physical Therapists as well, just as I would, because I don’t speak your language.

    On the insurance front, I carry homeowner’s insurance (I live in SoCal and fire and earthquakes happen regularly) and of course have health insurance but I dropped all the rest of my silly policies a few years ago which were pointless once I became FI. Even if I were to get hit by a bus tomorrow, my daughter would financially be taken care of.

    Keep up the good work, Mr. EE.

    1. Congrats on the ER!!! And thanks for stopping to read and comment. I appreciate your honesty and insights from the perspective of a financial professional. I think we need way more of that.

      I agree that like you, I am also VERY conservative. My reason for pulling the cord at 20X (or 5% WD rate) is not b/c I feel that this is safe or smart, but b/c I know that I do not desire traditional retirement and plan to make money over time and my wife doesn’t want to do anything differently than her current part-time work which can support us while continuing to save (though a much smaller amount than our current rate). While it would take 5% WD to cover our current expenses, our plan is to have a 0-1% WD rate, which sounds pretty safe to me! Therefore, I don’t need to work a job I am burnt out on and can pursue other things that I am more interested in while having time to spend with my daughter. These were the reasons we were pursuing FIRE to start with. I think it is very easy to get focused on the wrong things, in this case complete safety, and forget why we started down this road in the first place. If I desired traditional retirement, I would be much more in line with you at shooting for 3%.

      The only part of the comment that I disagree with at all is that you couldn’t have a conversation with a room full of PT’s b/c you don’t speak our language. I think that there are good and bad professionals in any field. It is the job of the professional to speak your language and communicate in a way that is effective to help serve you, rather than creating dependence and constantly selling. If your professional (PT, financial, MD, lawyer, etc) is not willing to help you understand things and get the best results for you, then leave and find a better professional. I think too many people sell themselves short and fail to ask the right questions. As bitter as I can be with the financial industry, I certainly know that ultimately I was responsible for my lack of due diligence which is what I ultimately want to teach others.

      Thanks again for a great comment and insight.

    2. Re homeowners insurance in California: it does NOT cover earthquake damage (at least the typical policy does not). You will need to get separate earthquake insurance to cover that risk.

      1. I have always carried an earthquake policy in conjunction with my insurance (since 2002). Cost has come down significantly though the past couple of years.

        1. Thanks for chiming in again. Living in PA my whole life, I have to bow out of this conversation and plea ignorance.

        2. Fair enough, just wanted to make sure you weren’t under insured for a risk you thought was covered. I just got earthquake insurance myself because I noticed that the prices were surprisingly reasonable. I had thought that they seemed too high to be worth it when I last looked into it a few years ago, so I guess if they have actually dropped recently that may explain it.

  3. I am Can, retired and 86. Have a 90 + protfolio in Blue chip Div paying stocks. At 4% per year withdrawl it will last for 25 Years.
    Also have Can pension, old age, Guaranteed Income plus small Company pension. Need 2Mill a bunch of BULL.

    1. I don’t know Bob, 25 years only gets you to 111 years old. Sounds risky! Better go get yourself an annuity!
      Just kidding. Thanks for reading and commenting. I think that it is awesome that at age 86 you have the curiosity and desire to learn to be reading early retirement blogs. Not sure how you found us, but certainly glad that you did. You’re a great role model and I hope you’ll stop back!

      1. Bob is right, for him $2mill is bull. He has two annuities, one through the Canadian pension and the other through his company…

  4. Your guest post described Asset Liability Matching (ALM) as growth in value to match the expense. Are we not just turning that around and matching out saving and investing for a future expense and keeping control of our money at the same time The only way I see a variable annuity would have worked for me is someone else buying it for me when I was a kid and not tapping into it no early that 59.5. Even then you would be changing possible qualifying dividends and capital gains from a mutual fund into income taxed as ordinary income from an annuity.

    1. Yes, except when investing ourselves if markets over-perform our expectations we maintain control. I didn’t honestly even think about tax issues and I cut out several other criticisms as well to keep it the post to a reasonable length. Just bad.

  5. I agree with just about everything you said. I’m fond of telling people that they need to monitor their own financial position because “no one cares about their money more than they do”. My experience with the professional financial planning world has not been great, and I have not done badly on my own – though had I just plowed money into broad funds and ETFs, I would have done just as well, without all the time and energy expended 🙂

    Risk is something that everyone has a different view on, usually based on their experiences, either lived through or witnessed. I applaud your striving to find a way to live within your risk tolerance. It does not obviate the legitimacy of someone who has a higher tolerance, but regardless of where your risk tolerance lies, having a plan to deal with the risk, and live with the results, is vital.

    I enjoy your posts and the clarity and passion with which you write. Keep those thoughts coming!


    1. Thanks. I appreciate your support and encouragement.

      Agree that we all have different views on risk. Unfortunately those views are often shaped by fear, and there is never a shortage of people out there to take advantage of that fear. I agree that there is no right or wrong answer on how much risk is acceptable and all are legitimate. What is not legitimate IMHO is preying on the fears of others for your own personal gain, which is where the passion comes from.

  6. Really good post questioning some of these assumptions. I really like the idea of pointing out that the suggested alternative is really just equivalent to a 3% withdrawal rate.

    1. It kind of invalidates the whole reason for the discussion as 3% is about as safe as it gets, assuming you have a good grasp on your spending and a plan for heathcare costs. And if you don’t have those things accounted for, his solutions don’t help you anyway

  7. Wow, you completely misunderstood the purpose of my article. There was no critique of your article just another way of thinking about it and there was nothing to debate. Also, your “rebuttal” assumes I’m trying to sale something instead of just giving a simple article without going into the mine fields of calculations. I am financially free and don’t sale any insurance products for a living. In fact, I probably dislike the industry more than you do which is why I actually created a company to do something about it. Another fact, the first conversation Jared and I had was discussing option trading strategies and stock investment strategies…far more advanced and a lot harder to understand than what most are accustomed to. Another thing, there was no scare tactic…simply pointing out how the finance industry uses a BS calculation. Good luck on your endeavors.

    1. Thanks for reading and replying. I apparently did/do misunderstand. Maybe you are over my head as well, and as I said in the article I am certain your CFA credentials mean you are smarter than me when it comes to financial analysis and products. I am extremely weary when I see promises of risk-free or no risk, combined with unnecessarily complex scenarios, and then mixing in insurance products to the solution, such as with variable annuities. I think all of my characterizations were accurate in this case. If I missed the point, maybe the point should be made more clearly?

      I did look at your website and admit that I do not understand what you actually offer. If you are genuinely helping people develop strategies to get out of massive student loan debt, then I tip my hat to you for your efforts as this is a massive problem and an under-served population. If it is promoting option trading strategies and stock investment strategies, I think it is probably doing more of a disservice than a service to the vast majority of people by creating dependency at best as most people do not have the temperament, interest, and time to be successful in these endeavors. At worst, it is selling a losing proposition and distracting people from simple strategies likely to be far less complex, less costly and more tax efficient and therefore likely to be successful.

      1. My company doesn’t talk to anyone about option strategies. I said I talked to Jared about them…I also never said no risk or risk free. I actually say, “Although there is risk in this modeling approach, such as predicting expenses and reinvestment risk, it removes many assumptions.”

        1. Fair enough. Again, this is not an attack on you personally. You know I offered to publish the post here as a contrast to our plans as a way to stimulate honest discussion, since the intro made it seem as though it was a lower risk option to our plans.

          So if you care to share, what does your company do? How are you paid if you don’t sell products? What is your business model? Do you advocate a conservative investing model that eliminates stock market risk for young investors as would read Jared’s blog or even early retirees like myself who have to support spending for 40, 50, or even 60 years? If not, what do you advocate? Do you really think tying any of your money up in a variable annuity, which on average cost 2+% of assets each year in fees and then are taxed as ordinary income upon withdraw rather than at capital gains rates, is really a good option for investing for any but a very select few individuals?

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