Afford Anything - Three Percent is the New Four Percent - with Larry Swedroe, Retirement Planning Expert

Episode Date: February 1, 2019

#175: Larry Swedroe is one of the most respected investment thinkers and writers of our time. He's published 8 books on investing, including one of the first books to explain the science of investing to a layperson audience. He recently wrote an ultra-comprehensive guide to retirement planning. He joins us on the show today to discuss the nuances of investing and retirement planning. We talk about the stock market (is it going to fall soon? Are we heading for a recession?), we talk about risk (including three dimensions of risk that all investors should consider), and we talk about what traditional retirees vs. early retirees should know. For more information, visit the show notes at https://affordanything.com/episode175  Learn more about your ad choices. Visit podcastchoices.com/adchoices

You can afford anything but not everything. Every decision that you make is a trade-off against something else. And that's true, not just for your money, but also your time, your energy, your focus, anything in your life that's a scarce or limited resource. So the questions then become twofold. Number one, what matters most to you? Not what does society say should matter most, but what actually is the most meaningful thing in your life?

And number two, how do you align your daily decisions in accordance? Answering these two questions requires a lifetime of daily practice, and that's what this podcast is here to explore. My name is Paula Pan. I'm the host of the Afford Anything podcast, and today, Larry Swedro joins us to talk about retirement planning. Larry was one of the first authors to publish a book that explained the science of investing in accessible layman's terms. That book is called The Only Guide to a Winning Investment Strategy You'll Ever Need. Since then, he has authored seven more books and co-authored eight others. He is also the Director of Research for Buckingham Strategic Wealth, and he has an MBA in Finance and Investment from New York University.

He's a well-respected, well-known name in the world of retirement planning, and he has recently come out with a new book that is extremely comprehensive, called Your Complete Guide to a Successful and Secure Retirement. He co-authored this with Kevin Grogan, who is the Director of Investment Strategy for Buckingham Strategic Wealth. In today's upcoming interview, Larry and I discuss everything ranging from planning for a meaningful retirement, filled with life-affirming activities, to the nuances of investing. How do you make decisions about risk and asset allocation? How do you react to changing market conditions?

Larry shares tremendous knowledge and insight. with us. Here he is Larry Swedro. Hi, Larry. Good afternoon, Paula. Larry, you've written a lot of books, and your most recent one is an extremely comprehensive guide to retirement planning. There are a lot of facets that a person needs to think about when it comes to retirement planning, everything from investments to insurance, to tax planning, to estate planning. What are some of the most overlooked or neglected aspects of retirement planning that people aren't paying enough attention to? Probably the one I would highlight is, while many people do focus on having a financial plan, I've yet to meet many people who actually have a plan for having a meaningful life in retirement.

And obviously, you don't want to retire from life when you retire from work, yet so many people find great meaning and value in their life from their work. They get it from their social connections by going to work and meeting people. their friends and connections are often at work, and they get their intellectual challenge from their work as well. And then when work ends, they have a serious problem if they haven't planned for a meaningful life in retirement. And the statistics show some really serious problems. Number one, the rate of depression goes way up. Number two, the fastest growing problem in terms of Suicides is not teenagers, as many of us would think. It's actually retired men. And the silver

divorce rate is rising rapidly. So these are problems that I think are all avoidable by people who spend the time to figure out what a meaningful life in retirement would be, having a reason to get up in the morning, if you will, stay connected socially. And to what extent can you plan it? I mean, to what extent are you able to accurately project yourself into the future and anticipate what that future might look like? Well, I think you can actually practice it. For example, I've had friends and family who have retired and become tax preparers for the elderly and the poorer peoples. And they do it as a charitable contribution, their way of giving back. I've had friends who have become candy stripers at hospitals, and they take the time to do that while

they're still working to see how it works, maybe do it while you're on a vacation. I've had friends be big brothers, so you can plan and practice that. One of the big mistakes I often hear is I'm going to go play golf every day, and, yeah, that works for about two or three months, and then it becomes like going to work, if you will, you lose the joy out of it unless you have other interests that, like I said, that stimulate you intellectually as well as getting you out social. Now, with regard to planning a meaningful life in retirement, there are a lot of people who listen to this podcast who are interested in extreme early retirement, the fire movement.

How do things change if a person is aiming to retire in their. mid-30s or mid-40s? Well, like I said, it's really important that, you know, you don't want to retire from life. So you may want to think about a whole series of careers, or it could be other things that you find meaningful, like I said, some way to give back to society so that you can feel good about yourself and the contributions you make. It could be being, like I said, a big brother. It could be working for habitat for human.

It could be fulfilling your desire to write and blog on a subject or write that great novel if that's what you're interested in. But those are the things you have to figure out. You have to have that, what I call, reason to get up in the morning. And you have to have a way to stay connected socially. And for most of us, we're a great part of our lives. That's through our work. Let's talk about that silver divorce rate. divorce is, of course, one of the most emotionally and financially devastating things that can

happen to a person. How do you plan for that and deal with that when it happens after retirement? Well, as you probably know, there's the old cliche that I married you for better or worse, but not for lunch. And that's the problem. People don't have a plan. So you really need for both spouses to sit down, create a workbook, and to go through laying out very specifically what a meaningful day and life and retirement is going to be, figure out how much you're going to travel and build that into your budgets, et cetera. And then also think about your, importantly, your intellectual happiness. That means feeling challenged and learning as well. So it could be, for example, taking classes at the local university.

It could be learning the language, could be learning to play bridge or whatever it might be that you're interested in. You need to find things that keep you, as I said, occupied and stimulated mentally. And by the way, a couple of other points. You want to make sure that you're exercising. It helps fight depression, number one, and keeps you healthy. but it also, they have found that it fights cognitive decline, which is a major problem because we're living much longer. And as you age, the increased risk of cognitive decline, Alzheimer's, dementia increases dramatically. And so you can help prevent or reduce that risk by two things.

Exercising and learning new things because learning creates new synapses in the brain. that helps reduce the risk of Alzheimer's. Those are fantastic tips for how to have a healthy life and a healthy relationship. But what if you are post-retirement and that divorce is inevitable? Let's say that you want to hold on to the relationship, but your spouse leaves and calls it quits and isn't willing to reconsider. How do you financially cope with something like that? Yeah, that's a real problem, and it's much more of a problem for women. and we cover that in our chapter on women's issues.

One of the problems for women is related to divorce is they tend to be remarried, much less frequently. One reason might be, of course, the pool of eligible women to men favors the men because the women tend to live longer, so they're more likely to outlive their spouse and also the pool of eligible men relative to women isn't as good. So they tend to have to live both longer and single more than men. Women have a much more difficult problem because once you're divorced, your costs of costs go up much more and you're only got half of the income. Two can live cheaper than one.

So that can be a real problem. And it can also be a problem for women who are depending on their spouses, Social Security, pensions, and other things. So how do you safeguard against that prior to retirement? That's a good one. If you think you're at risk of a divorce, then certainly you've got to be planning for that possibility and thinking about what that means for you financially. May mean that you should be going back into the workforce,

increasing your earnings and your own savings. That's a real difficult question. I don't have a great answer for you because obviously, you know, most people are going to not be prepared when that happens. Let's talk about investing. What are the major factors that a person should consider as they invest for retirement? And how does that differ depending on if they want a traditional retirement, which will define as, say, age 60 plus? versus an early retirement? Yeah, well, I think one of the biggest mistakes people make is say you retire at age 65. When I was growing up, I didn't know many people who were, say, above age 75. Very few people lived longer than that. Today, the second-to-die life expectancy of a 65-year-old couple is almost 25 years.

that means the family together has to plan or should be planning for at least 30 years because if you have 25 years on average, half the time someone's going to live longer. So you have to plan for your assets to last a very long time. And that means you can't get too conservative in your investments. And many people when they retire tend to become very conservative. They're worried, of course, that they'd no longer. have their labor capital, their income from their work to replace losses in the stock market. And yet you can't get too conservative.

Bonds tend to yield very little in the way of real returns. Stocks over the long term are the outperforms inflation. And then there obviously can continue to grow. But if you get very conservative, you could have a real problem in retirement. So you have to plan for a very long retirement. And also you have to make sure you're planning for the likelihood that you're going to need long-term care at some point for some period of time because the large majority of our senior citizens, they live to say age 85 are going to need long-term care at some point. So you need a fairly large pool of assets if you're going to.

to retire at 65, and that pool only increases significantly the earlier you retire. At what age should a person buy long-term care insurance and what factors go into the decision-making around how much coverage they need? Yeah, it's a good question. We have a chapter on that in the book, and unfortunately, the bad news is that, one, we are living longer and we need more long-term care. But the industry has had very bad experience in terms of losses with long-term care. They underestimated how much progress we have made in longevity. So people are living longer. The increases of cognitive decline and the high expense of care that goes with it has increased dramatically. So the cost of long-term care has increased dramatically. It's to the

point that most people who have under a million dollars, say, of net worth probably can't afford it. And those who have, say, at least five million probably don't need to buy it. They can pay out the expenses out of their assets. And so it's that middle group that needs to at least consider looking at it. We think the right way to take a look at long-term care is you have to run what's called the Monte Carlo program, putting in to that program the assumptions about what happens if I need long-term care for, say, three or five years, and I don't have insurance versus what happens if I do, and that takes the emotion out of the decision. It's just the math. And so if you can increase your odds of not running out of money by using long-term care insurance, then it becomes a

viable product. If it's not going to help you, then because it may be too expensive or you can't afford it, you may have to do without it. It's a very difficult issue, I'm afraid to say, and the industry has cut back dramatically. You mentioned running a Monte Carlo simulation. Other than talking to a financial advisor, how can the average individual who was listening to this podcast run a Monte Carlo? There are some money. call-up programs that are available on the internet. They, unfortunately, many of them have problems with errors and who would be very difficult for an individual to be able to spot them. So that's a risk I want to point out. But I'll give everybody a good rule of thumb that we use

today. If you keep at least a moderate amount of equity exposure, let's call it 40 or 50 percent equities at age 65. And if you don't withdraw more than 3% of your portfolio's value at age 65, so let's say you had a million dollars of financial assets, you want to withdraw $30,000 that year, the first year, and then every year increased that by the rate of inflation. So if inflation was 3%, you would add another $900. So next year, you would take out $30,900. If you do that, then your odds of not running out of money are very good. It's not a certainty. There are lots of issues that can happen.

Medical costs can be catastrophic. Could have need for long-term care. That's much more than expected. But that's about as good a rule of thumb as you can have. The rule used to be 4%. That's exactly what I was about to ask. The Trinity study said 4%. Yeah, the problem is bond yields then were 5 or 6%, and today we're,

two to three. And so with today's higher equity valuations, meaning higher price to earnings ratios, if you pay more for the same dollar of earnings, your expected returns are now lower. Most financial economists today think stocks are likely to return in the 4 to 5 percent, perhaps as a real rate of return. Historically, that number has been seven. And so since bond yields are lower, stock valuations are higher and we're living longer. So we need to have a bigger pot. 3% is the new 4%. Wow.

I think a lot of people listening to that are going to think that that's a little scary to think that 3% is the new 4%. Well, if that scares them and that's actually the introduction to the book, I'd rather people be scared and be realistic than living a pipe dream and then find they're eating cat food in retirement. right? So you want to be prepared properly. And so the beginning of the book is the, in the introduction, I talk about the four horsemen of the retirement apocalypse. It's one that equity valuations are higher and bond yields are lower. So you need a bigger pot of money because your expected returns are a lot lower. The typical 60-40 portfolio over the last 35 years has had big tail wins as stock valuations went way up and interest rates came way down.

It's returned 10 points, a little over 10% since 1982. Over the longer term, it's only returned about eight and a half, but we think it's much more likely, and most financial economists agree, to return more in the 5% range. So you got those two hurdles. Then you're living longer. Your risk of long-term care is going. up. Those are the four horsemen. And today, I think to be realistic, you need to think about a fifth, which is that Social Security in 14 years will no longer be able to meet its full obligations

if Congress doesn't do anything, and they don't seem like they want to. And so Social Security will only be able to pay out 75%. So it's not going bankrupt. It'll be there. But 75% is not a hundred So if you were planning on getting, say, 40,000, you may want to lower that number to 30,000 in your plan and to be conservative. So we really have these five horsemen that people need to be aware of in designing their plan. When you talk about equity valuations, is that a reference to the U.S. market? If so, to what degree can that risk be hedged by investing more globally? Yeah, well, let's, we'll define a few terms. Well, yes, U.S. valuations are quite a bit higher than they have been historically.

What's called the cyclically adjusted price earnings ratio created by Nobel Prize winning economist Robert Schiller. So it's the Schiller Cape 10 and you can find it on the internet. That's about as good a predictor as we have of future equity, real returns. What you do is you just invert it. So instead of a PE ratio, you get an earnings yield. Today, that number is about 28. So let's just even round it to 25. At 25, you would expect 4% real returns.

Historically, that number has been about 16. So you would be closer to 7. That's for the U.S. Now, the good news is because international and emerging markets have significantly underperformed the U.S. for the last 10 years. Their valuations are quite a bit lower. And so their expected returns are higher. And one of the mistakes that most people make around the world is they have a home country

bias. So U.S. investors typically have 10% or less in international investments. We think you should look like the market. That means you should have about half your equity in the U.S., half overseas. Today, our own estimate, based on this Schillard figures, are U.S. real return of about 3.6, about 5.8 or 2.2% higher for developed international markets, and closer to 7.5 for emerging markets. So by moving more assets to international assets, you can improve at least the expected, but of course, not guaranteed return. And you can also, as we point out on the book, improve the expected return by increasing your exposure to other risky assets such as small and value stocks,

which have over the long term have also outperformed the total market. So many investors only invest in U.S. large-cap growth stocks, something like the S&P 500. We recommend building portfolios that are more diversified, including more small and value stocks, more international, more emerging markets, as well in building portfolio. The book shows you how to build a more diversified portfolio. If you do put a larger allocation of your portfolio into international markets and emerging markets and frontier markets, to what extent do you need to be concerned about currency risk? That's a great question. First of all, I don't recommend investing in frontier markets. There, you don't have enough legal regulatory protections. So I would limit it to what are called the emerging markets, countries like Singapore and Taiwan and South Korea, those countries. So that's number one. Number two, it's interesting the way you frame that question is exactly the mistake that most people made.

currency risk is not a one-way street, meaning you worry about these currencies going down. Currency risk is a two-way street. If the U.S. dollar weakens, that's probably because of poor economic performance, bad geopolitical things happening. The economy is doing poorly. And by the way, if the dollar goes down, that has negative implications in terms of the costs of imports. do import costs increase, but that allows domestic producers who are now competing with more expensive imports. They have the ability to raise prices.

That can cause inflation and create problems. So you really have a currency risk is a two-way street, not a one-way street. And the fact of the matter is that nobody knows whether the U.S. will do better than other countries around the world. The best example I can think of is in 1990, Japanese investors thought Japan was at the top of the universe there. Japanese stocks had dramatically outperform U.S. stocks over the prior 20 years. Their land under the imperial palace in Japan was worth more than all the land in California. Japan was taking over the whole technology industry.

We had one semiconductor plant left in the U.S. Sony's chairman was on the cover of Fortune magazine saying that, you know, we're taking over. Japanese were buying up Rockefeller Center and Pebble Beach. And the last 20 years, or 28 years now, or Japanese stocks are half the value of what they were in 1990. So you were better off sitting in T-bills or the equivalent in Japan. And there's no guarantee that the U.S. can't be the next Japan.

So if you don't have a clear crystal ball, the only logical thing to do is diversify globally and don't make the mistake of this home country bias. we all believe no matter where we live that whatever country we were in is not only safer, but it's going to provide higher returns, which is an oxymoron. Literally, you should not logically believe both of those things at the same time, because if something is safer investment, it has to have lower expected returns, yet probably 90% of Americans believe that.

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and then there's also the amount of risk that you actually need within your portfolio. As you approach retirement, how do you adjust this thinking around risk levels? Yeah. Well, in the book, we focus on what I think are the three key levers that everyone needs to consider when developing their plan. One of them, of course, is your ability to take risk. That many people focus only on your investment horizon. And of course, obviously as you age, that horizon shrinks, but you also have to keep in mind, as we touched on earlier, that even at 65, you should be planning for 30 years. But the other thing that needs to be considered is what's called your labor or human capital, your earning skills, and how they relate to the risks of the stock market. So you can have two people of the very same age and the very same willingness to take risk.

Maybe they're both big risk takers. But one is a tenured professor at the local university, and the other is a construction worker. I teach people to ask the question on I a stock or a bond, and the tenured professor, his or her labor capital, is very bond-like, and therefore she could hold more equities in the portfolio. The construction worker, on the other hand, she is more likely to have her income disrupted by a recession. So her income is more equity-like, and she needs to hold more bonds. So that's the first thing that people need to think about. The second, as you pointed out, is this willingness to take risk. How much stomach acid can you absorb without panic selling?

And I think it goes beyond that because life's too short not to enjoy it. So even if you don't panic and sell and in 2008, when the market dropped 60%, if you lost sleep and you worried too much, then you should have learned that you were taking more equity risk. So I give people some tables to help them think about what the right maximum equity allocation is. Then the last one is this need to take risk, which declines the wealthier we get. So what you need to determine is, one, what are the things I really need to have in retirement in terms of spending? Separate them from your nice-to-haps. And once you have enough money to meet those needs, and that's the 3% test I gave you. So if you need, say, 60,000 a year and you're getting 30 from Social Security, you need 30,000 more.

Multiply that by 30. That's 900 grand. Once you're there, you don't want to be taking a lot of risk to try to grow that portfolio, say, to 2 million. Because while 2 million is better than 900,000, the problem is the value incremental benefit. to the quality of your life is marginally higher. Yet on the other hand, if we experience another 2008 and you lose 60% of your assets, that would be unthinkable. I'll try to make this a short story.

It is about a couple I met who was at the time 71. I met him in 2002, and they had $3 million. Three years earlier, they had had $13 million. and I knew the only way they could have gotten down to three, not only did they have to be all inequities, but because the market had only dropped 40%. That had to be mostly in high-tech flyers because they're the ones that got slaughtered.

And I said to them, imagine this alternate universe that showed up and you had doubled your money and you now are 26 million. Would it have changed your life in any meaningful way? And the answer was no. And I said to them, well, obviously it's been a very traumatic experience dropping to $3 million. You no longer can do many of the things you wanted to do, pay for your grandkids, college education, donate a lot of money to your church, which was important to them.

So I asked them, so why did you take the risk if you knew that risk could show up? And the wife turned to the husband and punched them hard in the arm and said, I told you so. The problem is you have to think about this utility of wealth curve, it's called. We show that in the book. And the point that there's little incremental benefit. More money, of course, is always better and less. But when you have enough that you're happy, the good things in life are either free or cheap. The best things for me are sitting down reading a book with my grandson, taking a walk with my wife in the park.

Those things don't cost anything. Right. I remember one of the saddest things about that story of the couple that went from 13 million down to 3 million is that their cost of living was only about 100,000 per year. So at 13 million, they were more than set. Yeah, that's exactly the point. And we had that discussion. I showed them that utility curve. And that's when I told them the story about the alternate universe.

I said, look, a utility curve starts in the bottom left-hand corner. It looks like an elephant's back if you're drawing the picture. So it goes straight up at a very steep angle, starts to flatten out. It never goes down, actually, because more money is always better and less. But once it flattens out, the incremental benefit just isn't worth the risk because it doesn't change the quality of your life in any meaningful way. So maybe you stay at a five-star hotel instead of a four-star hotel or drink a $50 bottle of wine instead of a $20, but 99% of people can't tell the difference between that

50 and a $20 bottle of wine. And it certainly doesn't change your life in any meaningful way. And you can walk on a public golf course and you enjoy the same walk, the same companionship, the same son as the person walking at Pebble Beach. Is it prettier there? sure, but in any meaningful way, it doesn't change your life. So that's what we try to teach people sitting down in conversations of what we call a discovery meeting. That's the second chapter in our book, helping them figure out what's important about money to them, separating desires from

must-haves, and then making sure you don't mix those because the more you convert desires into needs, the bigger the pot you have to have and the more risks you have to take, and you subject yourself to the stress of bare markets, and there's no guarantee that the markets will ever recover, as Japanese investors found out. The Niki was at 40,000 in 1990. It's just slightly over 20,000 today. So that's a really important role of a good financial advisor,

is helping you go through that discovery process, figuring out what's important about money, running Monte Carlo's to show you what the odds of success are, various spending rates, etc. What is the difference between risk and uncertainty? That's a great question. One of our top economist Frank Knight best described it this way. He said, risk is where either we know the odds, like at the crap, you can calculate exactly what the odds of throwing snake guys are or matching a seven, whatever the roll of the dice is, you know exactly what the odds are.

And actuarial sciences, we don't know exactly what the odds of somebody who's 65 living to age 90 because we don't know things like whether there'll be another flu pandemic or SARS viruses or wars. but we have pretty good data that allows insurance companies to make very good estimates of those odds. Uncertainty is like trying to estimate the odds of an event like 9-1-1 or a nuclear war or an earthquake in Japan unleashing a tsunami that sets off a nuclear chain reaction and their nuclear plant blows up and who knows what happens. We have no way to even estimate the odds of those things happening, let alone what the impact would be on the stock markets and bond markets around the world. Now, investors much prefer to make bets where they know or at least are comfortable estimating the odds than when they can't. We obviously would all feel more comfortable doing so.

What happens, though, is when things are rosy and everything's looking good, we tend to think about the stock market in terms of risk, where we can at least estimate the odds. When we get bare markets like we had in 08, it tends to become, we fear it's more like uncertainty. We hate that. Our stomach's royal. We end up panic selling. What investors have to understand is that investing in stocks is always, always about uncertainty and not risk. You mentioned also that once you panic and sell, it's much harder to get back into the market. Your whole psychology changes.

And you told another fairly sad story of somebody who sold in November of 2008, bought back in January, and then sold again. again in February or March of 2009, just eight loss after loss. Yeah, you know, the analogy I like to use is if you're a surfer, you go to the beach, it's easy to tell if it's safe. There's a green flag at the lifeguard stand. It's safe to go. If it's red, discretion is the better part of our. Just come back the next day or the following day.

You wait for the waves to calm down to an acceptable level. With the stock market, the problem is there literally is never, ever, ever, ever a green flag. Investors often think so, like in perhaps late 1999 or 2000, you know, after we have this long bull market run of the 80s and 90s, especially the latter part of the decade. But then something happens and they learn there really wasn't a green flag. So here's the problem. You get a bare market. Now you panic and sell because you're worried the market's down, say, 30, 40 percent, and you just can't take anymore. And you're worried it's going to the U.S. will be the next Japan and not recover.

That's what happened with one client I work with. And I said to him, okay, if you get out now, we know you can't reach your goals sitting in Treasury bills. You can't earn a high enough rate of return to reach those goals. so you're going to eventually have to get back in. How are you going to know? It's never safe. Just think back over the last decade when we had great returns. There was never a day where it looks like many gurus were forecasting,

horrible equity returns saying the market was vastly overvalued. We have concerns over the U.S. budget deficits, inflation, with all the easy monetary policy. We had the U.S. losing its AAA credit rating. We had government shutdowns. We had crises in the Middle East. We had Europe in crisis over Brexit. Before that, it was what called the Pigs Crisis, Portugal, Italy, Ireland, Greece, Spain,

or all maybe going bankrupt. Greece almost did. We have had one crisis after another. We had the worst economic recovery in history. We have trillion dollar debt. deficits now, it never looks safe. And so you would have missed out. And that's what I pointed out to this person. So he said, okay, I'm going to wait one month. I just wanted to make sure it's just not collapsing. I don't want to catch the proverbial dropping knife. And so I said, all right, if you wait until the end of the year and if the market's how you get back in, I'm not making a prediction, but it's certainly possible. The market will rally between now and the end of the year. and then you'll buy and then it could turn down and then what will you do? You'll never be able to buy again.

And sadly for him, the market rallied 20% from Thanksgiving to the end of the year. He came in and bought. The market then dropped 25% before March 9th low. And he got out just before that low. And I never heard from him again. I don't know how he ever could have bought back because he would feel. a repeat of what just happened. So I tell people it's absolutely key, never take more risk than you have the ability, willingness, or need to take, because the market is going to test you.

We get drops of 15% at least about every third year, and we get 20% or more with an average loss of almost 40% about once every six years. So if you're 35 years old, you should expect to live through 10 severe bare markets averaging losses of 40%. Your stomach's going to be tested. Don't take the test if you don't have to. Make sure your asset allocation reflects what I teach in those sections on ability, willingness, and need to take risk. Given that a 35-year-old might reasonably be expected to live through 10 bare markets, is it better to be contrary? and buy on the dip? Or is it better to ignore market timing completely? I would say without question, you want to have an investment plan. You'll create what's called

the rebalancing table. So for simplicity stakes, say you're 60% stocks, 40% bonds. That rebalancing would occur, say, if stocks went up and outperform bonds. So now you're above 65%. You sell your equities back down to 60, you should become conservative and take chips off the table when everyone else is getting greedy. And then when the markets are collapsing, it takes typically about a 20 percent move to trigger a 5 percent move down from 60 down to 55 percent for your equities. And that's when you want to buy when everyone else is panic selling. It's very difficult to do. It's easier to sell when everyone else is being euphoric, but it's much more difficult to do that. But that's exactly what Warren Buffett advises.

Here's one of the, perhaps I think it is the greatest anomaly in all of finance. Investors idolize Warren Buffett, yet they tend to not only ignore his advice, but to do exactly the opposite of what he recommends, which is why I wrote a book, think, act, and invests like Buffett. Buffett advises people to never, ever try to time the market. He hasn't even listened or read a market forecast in 25 years because he says it tells you nothing about the direction of the market, though it tells you a lot about the person making the forecast. But he says if you can't resist, you want to sell when others are greedy and buy when others are panicking. And so you do that. You get to.

act just like Warren Buffett if you simply adhere to your plan and your established rebalancing table. And that's what a good financial advisor does. He or she plays like Clint East with the cop enforcing the plan that you put in place. So it sounds like the solution is to keep your asset allocation intact. Yeah. However, I will say this. It is important to not consider a investment plan or asset allocation plan as a one and done, it should be reviewed. I would recommend at least on an annual basis. The important thing is to review it whenever any of the assumptions you made have changed. So it could be your ability to take risk.

You have an inheritance. You've got more ability to take risk, but your need to take risk just went down a lot, perhaps. So that needs to be considered. You got a promotion, you got a more stable job, you got married, you have kids. All these things can happen. Divorces, some things are good, some are bad. Whenever you have a life-changing event that causes your ability, willingness, and need to take risk to change, you should review your plan, go over the assumptions again, rerun a Monte Carlo simulation.

And it could even be that the stock market itself, its performance can cause the assumptions, change. Because if you get a big bull market and you already have lots of assets, you're going to be way ahead of where you thought you'd be. You should be able to take chips off the table. That's what many of our clients did from 2009 through 18. They were taking chips off the table because equities far outperformed our expectations. For others, it may be the reverse is true. So you have to review based upon current circumstances. Speaking of current circumstances, at the time that we're recording this, which is mid-January of 2019, there are some significant market fluctuations that are happening right now.

And one of the questions that I hear from people who listen to this podcast is the question, but this time it's different, how do I respond? Is it different this time? Or it? Is this more of the same? The only people who say this time is different are those that don't know their investment history. Sure, there's always something different causing markets to move. But what you have to understand, as I said earlier, market and equity investing is always about uncertainty. There are no clear crystal balls. You should never listen to gurus forecast because the track record of gurus is God awful.

there are simply no good forecasters, which again is why Warren Buffett tells you to ignore them. And as I said, he hasn't read or listened to an economic or market forecast in 25 years. So what you have to do is accept the fact that there's uncertainty. There will be volatility. There is nothing unusual about what happened last year in the fourth quarter, for example. You know, as I said, we get a drop like we experience about once every six years. So it clearly isn't anything that unusual. If you think it's unusual, then you're going to make some mistakes, and you'll panic and sell.

You need to build the certainty that bare markets are going to happen. You're going to have to live through all kinds of crises. when 2008 hit, I went back and wrote a speech to help people learn how to sit through them by teaching them financial history. And I looked back over the prior 35 years and I found that there were 16 major financial crises that occurred in that period. That's like one every two and a half years or so. So there's nothing unusual about that. I bet most people don't even remember, for example, in the late 1980s, we had the fifth largest bank in the U.S. failed.

I would bet, Paula, that you couldn't even name that bank. And yet imagine today what would have happened or in 2008 if the fifth largest bank had failed. We lived through crises. If you have faith in our capitalist system, democracy, then you should understand that you're going to live through them, likely but not certain will get through them. And that's why stocks have high expected returns. They were their price to deal with that kind of risk. If we didn't have that risk, equity valuations would be a lot higher and equity returns would not have been 10%.

They would be more bond like. By the way, do you happen to know the name of the fifth largest bank that failed? I have no idea. Right. It's a company called Continental Illinois. We'll come back to the show in just a second. But first, do you want to wear shoes that are environmentally friendly, sustainable, comfortable, and look good? Check out Rothies. They make great flats for women and girls that are made out of recycled plastic water bottles.

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So these are the shoes you've been waiting for. Head to rothies.com slash Paula today. Rothes.com slash Paula. If you're a small business owner, you're juggling a lot. And while some of these things that you're juggling are great, some things like filing taxes and running payroll, meh, kind of boring. that's where Gusto comes in. Gusto makes payroll taxes and HR easy for small businesses.

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Let Gusto make things easier on you. And as a bonus, listeners get three months free when they run their first payroll. Try a demo and see for yourself at gusto.com slash Paula. That's gusto.com slash Paula, g-u-t-t-o. You mentioned that these types of financial crises happen on average once every two and a half years. But we have had what seems to be an unprecedented bull run over the last decade. Does that change things at all? Absolutely not.

You hear this nonsense that this is the longest bull market. It's now gone 10 years. a lot, longest run for the economy, you know, and therefore, you know, it's going to reverse. Economies, recoveries, stock markets, full markets do not die of old age. That's just sheer nonsense. There is no reason for that to happen. They die either because there was a bubble and prices got too high because investors were euphoric, which is what happened in March of 2000.

Or they die because of some event. It could be an exogenous one like the events of 911 or a war. Or it could be that the Federal Reserve is stepping in to tighten monetary policy to fight inflation. And that would slow the economy. There is literally nothing on the horizon that anybody who's a financial economist is forecasting a recession, at least in the next year. If you want as good a forecast as I could think of for the markets, there's something called the Philadelphia Federal Reserve Survey of Professional Economists. That's sort of wisdom of crowds. They take the consensus of 50 of the leading economists from the top banks.

So it gives you this wisdom of crowds, which has been shown to be the best forecasts that we have, not any individual, but the collective wisdom of crowd. and they're forecasting economic growth in the 2.7% range just down slightly from what's projected for the final numbers for 2018. Now, of course, we could have this government shutdown last a long time, creating less economic growth. We could have the trade wars erupt into a full-scale battle. That could cause the recession. On the other hand, you could certainly make the case. It's more likely that the trade wars will get settled. China is facing difficulty.

Their economy is slowing. They need growth in their economy with their population. And obviously, their standard of livings are well below hours. They have far more incentive to get a deal done because much more of their economy is trade-related than hours, about three times, I think, as much as hours. We're less dependent on trade. So that's likely to happen. And Trump, of course, wants to get that deal done to make himself look good and to prevent the economy from going into a recession. So I think, you know, nobody knows what will happen.

But if you're a pessimist, you shouldn't be in the stock market in the first place because you're going to face crises like this. And that will likely cause you to sell. You're better off just simply either not investing in the market or having a low low. equity allocation. But it's not different this time. Those are the three most dangerous words in investing or four words. We all know that a person ideally should start saving for retirement in their 20s. But let's say that someone who's listening to this right now is in their 40s or 50s and has not begun saving for retirement yet. Is it appropriate to take on a larger element of risk in order to make up for lost time?

I would say the answer is better late than never, first of all, but it does mean you're going to have to save a dramatically higher percentage of your income. And that's just the fact of life. The power of compounding is the eighth wonder of the world. And so if you start early and save as much as you can, that's the best advice that anyone can give you. Skip a lot of the nice to haves. Not everything, of course. You want to enjoy your life, but make sure you're separating nice to have from needs. As you get older, the problem is if you take more risk, your investment horizon is now shorter, your stomach acid ability to absorb it,

maybe less able to take the risk that a 30-year-old can take. So I would say that you probably should not, but that's a personal decision you have to make. And as I teach people, whatever advice I give you, it's irrelevant. You're the one who's going to have to live with the consequences of your decision. And if you take more risk, you better be prepared to deal with the consequences if those risks show up. And don't be too optimistic about the outcomes. You want to be realistic. So it sounds as though focusing on contributions is the better approach. I would say focus on one, putting as much as you can away, two, put in place automatic triggers. So if you get a raise, your plan is you save, I don't know, 80% of that raise.

Don't raise your standard of living. That really will allow you to save more quickly. I would plan on working longer to reduce the risk of running out of money in two ways. One, you earn more income. You may increase your Social Security benefits as well. That will also allow you to delay taking Social Security longer, and that's one of the best things that you can do because Social Security increases 8% a year. That's the single best investment that anyone can make in general, delaying Social Security. Social Security as long as possible.

So if you enjoy working, or at least part-time working, I would urge people to do that and make sure you don't take more risks than your stomach can handle either, regardless of your need to take risk, because you will panic and sell or you certainly increase the likelihood. You won't be able to enjoy your life. You'll worry too much. you're better off having to work a little longer and save a little bit more. Final question.

Speaking of Social Security and given what we know about Social Security becoming underfunded soon, if you are currently in your 20s or 30s, how should you think about Social Security? Yeah, as I mentioned earlier, I think to be conservative, I would suggest planning on you're only receiving 75% of the benefits. Social Security is not in that greater danger, but the longer we delay, and Congress doesn't seem to have the stomach or the courage to deal with the problem. No one wants to admit it, which is nuts. So I think the bottom line is, you used to be conservative, I would plan on only 75% of the benefits. I think you'd be making a mistake on planning on zero.

Thank you so much, Larry. What are some of the key takeaways that we got from today's conversation? Here are seven. Number one, retire into something, not just away from your work. Larry discussed how retirement is risky business. In fact, retirement correlates with higher levels of depression, increased probability of divorce, and even increased probability of suicide. We're seeing those issues affect the senior

citizen community much more so than they have in the past. And so in addition to all of the logistical retirement planning that a person does, figuring out your finances, your taxes, your insurance, you also need to figure out what's important about your life. Because when you don't go to a nine to five every day, that question stares you in the face. You have to have that, what I call reason to get up in the morning, and you have to have a way to stay connected socially. And for most of us, we're a great part of our lives. That's through our work. And so that's key takeaway number one. Don't just retire away from your work. Retire into something that you're excited about that you find meaningful.

Key takeaway number two. Don't invest too conservatively even after retirement. And this is particularly applicable to people who plan on retiring early? So you have to plan for your assets to last a very long time, and that means you can't get too conservative in your investments, and many people when they retire tend to become very conservative. They're worried, of course, that they no longer have their labor capital, their income from their work to replace losses in the stock market, and yet you can't get to. conservative, bonds tend to yield very little in the way of real returns, stocks over the long term or the outperforms inflation, and then therefore obviously can continue to grow.

Remember, if you retire at the age of 65, you don't convert your entire portfolio to cash on your 65th birthday. You'll still have investments for the next 30 years. And if you plan on retiring early, like at the age of 55 or 45 or 35, the same lesson applies just even more so. You're going to have investments in your portfolio after retirement for many, many decades. So don't become too conservative upon retirement. I mean, conversely, don't become too risky either, but don't dial back so much that you create the very thing that you were trying to avoid, which is, you know, an inadequate, insufficient portfolio.

So that is key takeaway number two. Key takeaway number three. 3% is the new 4% at least according to Larry Svedro. Now I'm going to give the disclaimer that I find that to be stunning. I find that to be difficult to believe. I don't want to believe it. And I am not the expert. My job is to interview experts.

So my job is to interview people like Dr. Wade Fow, Dr. Larry Swedro, people who are very well respected as some of the most preeminent retirement thinkers in the nation and ask them what they believe. And we have heard now from Larry Svedro that he believes that 3% is the new 4%. And that is a frightening, fascinating concept. 3% is the new 4%. You heard it here first. So what does this mean? Well, from the perspective of somebody who has a goal of early retirement, you will be retiring at a young enough age that presumably, assuming that your health is in good condition, you can supplement your portfolio through some side hustle income, some freelance income, some consulting income. So if you plan on retiring early, or more accurately, retiring while you're healthy,

then perhaps one option is that you could draw down only 3% and then create an online business, have some side hustle income that supplements the rest of the expenses that you need to cover. Another option would be diversifying into rental properties because a rental property creates a stream of cash flow. And that cash flow, that rental income does not correlate to what the stock market is doing. So another strategy for your retirement could be drawing down at a 3% or 4% whatever you feel comfortable with, but for the sake of this example, at a 3% rate, and then supplementing that with rental property income. At any rate, the major takeaway is that you may need to think about retirement with a degree of flexibility and creativity. and the examples of side hustles or rental properties, those are tactical examples that fall under the broader umbrella of outside of the box thinking.

This is another way of saying that the conventional paradigm of planning for retirement with that three-legged stool, the three-legged stool being Social Security, a pension, and a market-based portfolio, a stock and bond portfolio, that conventional paradigm, may not be sufficient. It may need to get updated for the modern world. Maybe it's a five-legged stool or an eight-legged stool, or heck, maybe the whole stool is a floor cushion because you have so many multiple streams of income. And each one provides a bit of a hedge, a bit of diversification, in case something goes wrong with any of the others.

So it might be that in retirement you find that you have five or six different sources of income, and that will benefit you greatly if while you are in retirement, there's a pullback, there's a recession, and due to your multiple streams of income, you have the ability to weight it out and not convert paper losses into real losses during the times of pullback because you can spend or draw down at a 4% rate when the market is strong, but draw down at a 0% rate during pullbacks and recessions. That might be a way to approach your retirement portfolio.

So what I'm saying here is that there's a lot of flexibility and year-to-year adjusting that comes with the way that you think about your source of income and your source of funds during your retirement years. All right, that was key takeaway number three. Key takeaway number four. And this goes hand in hand with what we just talked about. Ask yourself if you are a stock or a bond. how much risk is present in your own life and in your own source of current income? So you could have two people of the very same age and the very same willingness to take risk. Maybe they're both big risk takers.

But one is a tenured professor at the local university and the other is a construction worker. I teach people to ask the question on Ayasstock or a bond. and the tenured professor, his or her labor capital, is very bond-like, and therefore she could hold more equities in the portfolio. The construction worker, on the other hand, she is more likely to have her income disrupted by recession, so her income is more equity-like, and she needs to hold more bonds. If you're in a cyclical industry,

if you have a job that you can easily lose, if you have only one source of income, which means that you have no income diversification, all of your paycheck eggs are in one basket, well, then you have a higher exposure to risk in your own life. We're not talking about stock market risk, we're talking about income risk that you're facing right now. If, on the other hand, you have a job that's extremely stable,

or if you have multiple sources of income, then you have a lower degree of income risk in your own life. And the income risk within your life will have an effect on what level of risk you are able and willing and need to take in your investments. If there's a lot of risk in your life, you might want to be more conservative within your investments. And conversely, if you have a very low risk stable

income situation, then maybe you can go bigger with your investments. You can take a few more risks. In my own life, this is precisely what I did. I knew that I wanted to be self-employed. I knew that I wanted at the time to be a freelancer and to run my own business, and I knew that that would have a lot of income volatility. There would be months of feast and months of famine. That's what the life of a freelancer is. And as a result, I decided to invest in rental properties so that I would have a more stable base of income coming in. When you think about rental properties, they're an income play. I'm not wildly speculating on some equity valuation.

It's an income play. I'm essentially optimizing for dividends, and that is a conservative approach to take in your investing life. And the reason that I took that more conservative approach is because I knew that the income from rental properties could provide a level of, of stability that would safeguard against the volatility that comes from self-employment. So my own life is a perfect example of what Larry was talking about. When you have volatility

or income instability in your work life, then you might decide to counterbalance that through more conservative income-producing investments within your investing life. And conversely, you know, if I'd been a tenured professor, who knows, maybe I wouldn't have been attracted to the income stability that comes from rental properties. That's a hypothetical question, but maybe I would have chosen something different. Maybe I would have put it all on Bitcoin. Who knows? I hope not. But the broader point is to think about risk in the context, not just of your investments, but of the relationship between your investments and your work life. So that is key takeaway number four. Key takeaway number five. There are three elements of risk management.

number one is your ability or capacity to take on risk. Number two is your psychological or emotional tolerance for risk. And number three is your need to take on risk. And there is a concept called the utility of wealth curve, which states that greater wealth has lower marginal utility, meaning that the wealthier you become, the less you need to take on risk. The problem is you have to think about this utility of wealth curve is called. We show that in the book.

And the point that there's little incremental benefit. More money, of course, is always better and less. But when you have enough that you're happy, the good things in life are either free or cheap. The best things for me are sitting down reading a book with my grandson, taking a walk with my wife in the park. Those things don't cost anything. What's fascinating about this concept is that it seems as though your ability or capacity to take on risk and your need to take on risk are inversely correlated. The wealthier you become, the more that you have the ability to withstand some drops, the more that you are able to safeguard against the risk of ruin. And yet, it is precisely when you have the capacity to take on additional risk that you are able to, you are able to safeguard against the risk of ruin.

to take on additional risk that you don't really need to. And I like the fact that Larry reminded us that if we don't need to take on risk, then don't do it. It's very common to think of the concept of risk tolerance as simply your emotional or psychological capacity to handle a market decline. But as Larry reminds us, risk tolerance is more than just how you feel. it's also whether or not you need to bother taking on additional risk in the first place. So that is key takeaway number five. Key takeaway number six, don't time the market.

Buffett advises people to never, ever try to time the market. He hasn't even listened or read a market forecast in 25 years because he says it tells you nothing about the direction of the market, though it tells you a lot about the person making the forecast. As I often like to say, projection is just a fancy word for yes. None of us know what the market is going to do in the future. What we do know is that contributions are the single biggest determinant of investment success. So focus on making contributions and let the market take care of itself.

Finally, key takeaway number seven. The fact that the market. market is rising is not, in and of itself, intrinsic causation for it to fall. In other words, markets don't fall because they rise. Economies, recoveries, stock markets, full markets do not die of old age. That's just sheer nonsense. There is no reason for that to happen. They die either because there was a bubble and prices got too high because investors were euphoric, which is what happened in March of 2000, or they died because of some event. It could be an exogenous one like the events of 911 or a war.

Or it could be that the Federal Reserve is stepping in to tighten monetary policy to fight inflation and that would slow the economy. Now, it is true that historically, the market moves cyclically. It rises, it falls, it rises, it falls. We've seen that pattern. And we correlate a long bull run with a corresponding decline. But a bull run does not cause a decline. Something has to cause the decline. The decline has to come from somewhere. And an existing bull run itself is not the cause. That's what Larry Swaydrow means. when he says markets do not die of old age. And so the lesson or takeaway that you should get from that is don't have a fear of heights. There are many reasons why a market may drop, but the reason will not be it went bad because it was good. Those are seven key takeaways that came from this conversation with Larry Svedro. If you enjoy today's episode, I want you to think of somebody who you know,

who's always been a little interested in investing, particularly stock investing or market investing. And I'd like you to send this episode to them. You can send them a link to the show notes, which are at afford anything.com slash episode 175. Or you could just share this episode with them directly. But think of someone you know who's been a little bit curious about the market and send them this episode and then have a conversation with them about what they thought of it. I've met plenty of people who say, oh, you know, I'd kind of like to invest, but I don't really know where to start. And this episode, while not a beginner's how-to guide, while not a tactical step-by-step instructional, it is an episode that introduces a lot of concepts that an investor would need to be aware of or would need to think about.

Concepts like risk and its many dimensions. So, please share this episode with somebody who you know. and also hit the subscribe button in your favorite podcast playing app so that you don't miss any of our upcoming episodes. My name is Paula Pant. This is the Afford Anything podcast. I'll catch you next week.