The Personal Finance Podcast - The Retirement Mistake 80% of Investors Make (with Vanguard's Lead Researcher)

Starting point is 00:00:00 A specific amount in your retirement account does not guarantee retirement success. So it's not about your balance, it's about how you're spending that down. Someone who has a half million dollar portfolio. Maybe they live pretty frugly, maybe they have a lot of guaranteed income. So they need $10,000 a year from their portfolio to meet their retirement goals. If you assume zero returns, that portfolio will last 50 years. But if you have a million dollars and you're withdrawing $100,000 a year, It only lasts 10 years.

Starting point is 00:00:31 So it's not how much you have because, you know, the smaller portfolio and the example I gave lasts five times as long as the million dollar portfolio, which is twice as large. Reducing your spending rate by just half a percent is one of those things. And the reason this works really comes down to compounding. Know what your numbers are, know where your money's coming from, know what you're going to do. Because if you can start early, these little changes can make a huge difference over a 30-year retirement. Longevity is actually the bigger risk. If you haven't planned to live a longer time,

Starting point is 00:01:05 you're going to run out of money. On this episode of the personal finance podcast, we talk about the most important metric when it comes to your retirement. What's up, everybody, and welcome to the personal finance podcast. I'm your host, Andrew, founder of mastermoney.com. And today on the personal finance podcast, we're going to talk about it. about the only number that matters in retirement. If you guys have any questions, make sure you join the Master Money newsletter by going to mastermoney.com slash newsletter. And don't forget to follow us on Apple Podcast, Spotify, YouTube,

Starting point is 00:01:52 or whatever your favorite podcast player is. And if you want to help out the show, consider leaving a five-star rating and review on Apple Podcast, Spotify, or your favorite podcast player. Now, most people think that the hardest part about retirement is saving money. It isn't. The hard part is what happens after. The day after the paycheck stop and the only thing standing between you and the rest of your life is the number in your account. And here's the big question that you might be asking yourself. Well, how much can I spend every single year before running out of money? If you get this wrong in one direction, you could die with a fortune that you were too scared to touch. And you may have spent 30 years saying no to the life that you actually worked for. You worked your tail off for this amazing life. and we're too scared to spend the money. Get it wrong in the other direction,

Starting point is 00:02:41 and you could end up running out of money. And so this is why we want to have this conversation today. My guest today has spent a career running numbers just like this. Garrett Harbron is the lead researcher and head of advised wealth management strategies at Vanguard. And he is the mind behind their brand new research, principles for retirement income, when some of the largest financial decisions in your life

Starting point is 00:03:04 come down to math and behavior. And this is the person who, actually modeled the outcomes. And what he told me genuinely changed how I think about this. A half a percent can change how much you can withdraw and add an entire five years to how long your money lasts. That the thing that most people should fear in retirement is not a market crash, but how long you live.

Starting point is 00:03:25 And that there's a window, a quiet window between when you first retire and when you should be doing raw conversions. We talk about Social Security. We talk about taxes. and there are a lot of six-figure nuggets in this episode that could really change the way that you think about money. If you are anywhere near retirement or you are planning out retirement 20 or even 30 years out, this is a conversation to you. This is a conversation that you need to hear.

Starting point is 00:03:53 So let's welcome Garrett to the Personal Finance Podcast. Awesome. Well, Garrett, welcome to the Personal Finance Podcast. Thanks, Andrew. Appreciate being here. I'm really excited to have you here because Vanguard just put out this, incredible research on retirement income and kind of the way that income impacts people's retirement. And I know our audience is really big on planning for retirement. All of them are, you know, thinking through this a ton when they are going to this process. So first, can you kind of tell us a little bit about yourself, the research that you do? And then we'll dive deeper into

Starting point is 00:04:25 some of the questions on this research that you guys have done. Sure, absolutely. So I worked for Vanguard and I lead our advised wealth management strategies team, which is a really fancy way of, I lead the team that does the financial planning research and thought leadership for Vanguard. And we decided to take this paper up a little over a year ago. We looked across the horizon of industry topics. And what we realized was that while there were a lot of pieces out there that talked about retirement income in very narrow sleeves, there wasn't anything out there that really kind of brought it all together in a way that would help investors make decisions. about how to generate income and retirement.

Starting point is 00:05:11 You know, we've got a lot out there on accumulation strategies and how to accumulate, even some guidelines on how much to accumulate. But there was this kind of blank spot for retirees. Like, once you've accumulated and you move into retirement, what should you be thinking about and what questions should you be asking? And those are really the topics we wanted to tackle with this paper. And this is what I love about this paper, because I always think about this all the time. the point in time where you're in this accumulation mode and you're trying to kind of build up your

Starting point is 00:05:39 portfolio and you're trying to build your wealth and all of a sudden you get to the point in time where you need to kind of enjoy this portfolio and kind of utilize it as income. Psychologically, that can be a difficult point in time to reach where then you kind of have to overcome, okay, now I have to draw this down and start spending this. So I love that you guys did this because I feel as though there's a lot of questions that have not been answered for a long period of time that you all have answered in this research paper. And for all those listeners right now, the the paper will be linked up down in the show notes below so that you can check that out as well. And everyone knows, I'm a huge Vanguard fan here and that everybody, you know, who listens to this show for a long time knows we love everything that that you all put out.

Starting point is 00:06:15 So up front, the paper makes a pretty bold claim, kind of talking about the most important factor to a successful retirement is not how much you have saved, but how much you withdraw every single year. Now, this has been something that has been a point of contention, I think, over the last couple of years. But why did you lead with that? And what does the average person get wrong when they fixate on the balance instead? Yeah. So the reason we decided to focus on this, and we really did bring it front and center in the paper, right? Like, this is one of the first things we say in the paper. And we felt it was really important to get it out there right away because I do think this is one of the biggest mistakes that retirees make, right?

Starting point is 00:06:55 As an accumulator, typically you hear a lot of things around, hey, you need a million dollars to retire, you need $2 million to retire, you need three months. million dollars to retire, right? But a specific amount in your retirement account does not guarantee retirement success because it's all about what you want to do in retirement and how much you need to spend in retirement, right? So like, take for example someone who has a half million dollar portfolio and maybe they live pretty frugly, maybe they have a lot of guaranteed income. So they need $10,000 a year from their portfolio to meet their retirement goals. Well, if you assume zero returns, right, that portfolio will last 50 years. But if you have a million dollars and you're withdrawing $100,000 a year, it only lasts 10 years.

Starting point is 00:07:46 So it's not how much you have because, you know, the smaller portfolio and the example I gave lasts five times as long as the million dollar portfolio, which is twice as large. So it's not about your balance. It's about how you're spending that down. And one of the things we say in the paper is, we lay out four principles for retirement income, right? And we start with goals. Their goals, cover the essentials, make your wealth last, and simplify. Goals are the most important because that helps you define what do I need my money to do, where is my money coming from, and how much do I need from my portfolio to support my retirement goals. And so setting those goals and defining what

Starting point is 00:08:31 your, what your portfolio withdrawal rate needs to be, that is going to determine whether your retirement plan is successful or not. And we wanted to get right out in front of that. That is one of the most important things that I think you get guys did up front is I think it's just really, really great where you put that and kind of how you're leading with that, because the misconception for many people is, you know, the amount that you have on hand is all that you need to focus on. But instead, you flip the script and showed, oh, there's a lot of different variables involved in this. We got to make sure that we are nailing those down first. Now, one of the things that you talk through as well is the landing on, you know, the withdrawal rate and kind of thinking through, okay, what would support a retiree over the course of 30 years or more and how much should they be withdrawing?

Starting point is 00:09:12 Now, this has been something that has been debated over the course of the last couple of decades, I feel as though, where we've seen, you know, Bill Bang and the founder of the creator of the 4% rule and we've seen people come in, like the Trinity study talking about the 4% rule. And then people now saying, oh, actually, you can withdraw a little more than 4%. But your paper has some interesting statistics and it has some interesting ideals when it comes to, you know, the withdrawal rate where you landed right around that three and a half to four percent rate. That is what can support somebody for 30 years or more. For someone who grew up hearing something like the 4 percent rule, what is actually new or different about how you got into that range? Look, the 4 percent rule, as you said, has been around for a long time. It's kind of classic. It's been debated on and off. But at the end of the day, it's a heuristic, right? And time has proven it to be a pretty good. heuristic, but we wanted to take a little bit different approach, and we wanted to either come up with our own sustainable withdrawal rate, or perhaps, which we kind of did in this case, reaffirm the 4% rule. So what we did when we were doing our research and analysis for this paper was we took a number of persona and ran them through a forward-looking life cycle analysis.

Starting point is 00:10:22 And some of the things that are a little bit different in what we did from the traditional 4% rule, the traditional 4% rule is backward looking. It looks at previous, it looks at historical returns and said, well, you know, for the last 30 years, a 4% withdrawal rate was acceptable. But we all know that, you know, past returns are no guarantee of future returns and all of that. So we wanted to take a forward-looking approach using Vanguard's capital markets model. our proprietary capital markets model. And we ran a number of personas through our capital markets model with different assumptions. And maybe most significantly, we used stochastic life expectancies when we were doing this, right?

Starting point is 00:11:08 So in contrast to a lot of these other studies that have done where they say, hey, we're going to assume that everyone dies at age 80, 85, 100, right? we used stochastic life expectancy out to age 110. And we looked at the results and looked to see like what is a withdrawal rate that is sustainable that takes into account life expectancy uncertainty. And where we landed was three and a half to four percent, right? And I'm familiar with some of the work you're talking about where they're saying, hey, maybe it's four and a half percent, maybe it's five percent. maybe the 4% rule is a little bit too conservative. And I think depending on your assumptions,

Starting point is 00:11:49 that may be true, right? But based on our analysis using stochastic returns and stochastic life expectancies, this is kind of where we found the sweet spot to be. And I love that you all stretch that out to give a little cushion on that 110 years, because I think that's very important as we have seen, you know, just things progress over the course of the last couple of years. We don't know how long we're going to live and having that additional cushion is very, very helpful. I'm Mr. Conservative when it comes to some of these models. And I definitely am for sure excited that you guys kind of did that because I think that's a very, very important metric to look into. Yeah. And that does help, you know, we'll get to longevity here in a minute, I believe. But,

Starting point is 00:12:28 you know, that also helps offset that longevity risk. Exactly. I think that's the big key because as we see, you know, medicine progressing and people are living a little bit longer and we don't know what AI is going to bring in terms of like some of the stuff that could have. happen in medicine. There are going to be a lot of shifts over the course the next couple of years, and many of us could be living longer, and I love that you have that in there as that cushion. If you've been listening to this show for a while, you know it's not just me anymore. It takes a great team behind the scenes to make everything happen. And if I had to hire someone tomorrow, I'd want someone who could jump right in and make an impact. That's why I'd use Indeed

Starting point is 00:13:05 sponsor jobs. When Workplace Chaos hits, IndeedSponsor Jobs helps you reach qualified candidates faster. Your job gets boosted in search results, so you're spending less time searching and more time interviewing the right people. Plus, you only pay for a result, which I absolutely love. Sponsored jobs posted directly on Indeed are 95%, more likely to report a higher than non-sponsored posts. That's a huge advantage when you're trying to grow your business. Spend less time searching and more time actually interviewing candidates who check all of your boxes. Less stress, less time, more results. when you need the right person to cut through the chaos, this is the job for Indeed

Starting point is 00:13:45 sponsored jobs. And listeners of this show will get a $75 sponsored job credit to help get your job the premium status it deserves at Indeed.com slash podcast. Just go to Indeed.com slash podcast right now and support our show by saying you heard about Indeed on this podcast. Indeed.com slash podcast. Terms and conditions apply. Need to hire? This is a job for Indeed sponsored jobs. One thing I've realized is that your home doesn't have to be expensive to feel like it's really yours. Sometimes it's just one or two pieces that completely change a space. For us, it was the big umbrella by the pool from Wayfair. Before that, we'd only stay out there for a little while before the Florida Sun sent everyone back inside.

Starting point is 00:14:28 Now we've actually got some shade. The space feels finished, and we spend a lot more time out there as a family. What really surprised me was the value. We found exactly what we wanted without spending nearly. nearly what I expected, and the reviews made it easy to feel confident before ordering, and everything showed up quickly. You got to check out Wayfair. They've got everything in one place, and with Wayfair verified, their team has already vetted products for quality, functionality, and ease of assembly. I ordered from Wayfair, and honestly, you should too.

Starting point is 00:14:57 Ready to upgrade your home for Wayless? Had to Wayfair.com right now to shop all things home and get your space ready for less. That's W-A-Y-F-A-I-R.com. style every home. There's another number that jumped out at me, which I thought was fascinating, was reducing your withdrawal rate by just a half a percent can add up to five years to how long your money last within your portfolio. Can you kind of walk listeners through why such a small change can have such a big impact on their money?

Starting point is 00:15:30 Yeah. So look, one of the things we wanted to really stress in this paper was we know there are some people out there who are going to reach retirement and feel like, wow, I've really dropped the ball. Like, I am not ready to retire. I haven't saved enough. Like, what is my retirement going to look like? And so one of the things we focused on in this paper was the fact that, look, if you're getting ready to retire, there are a lot of things you can do that can help improve your retirement outcomes that don't require a whole lot of sacrifice. And this reducing your spending rate by just half a percent is one of those things. And the reason this works really comes

Starting point is 00:16:09 down to compounding, right? We talk about compounding as being like, you know, one of the, one of the wonders of the investing world. And we usually think of that in terms of, hey, invest early and receive that compounding. Well, it ends up, it works in retirement too, right? So if I cut my spending in retirement, especially if I do it early in retirement, let's say I'm withdrawing $45,000 a year on a $1 million portfolio. And I cut my spending by half a percent. So I cut it down to $40,000, right? That's $5,000 a year that I am not spending, right? That is $5,000 a year that I am effectively saving, that I am earning returns on, and over a 30-year retirement, that really adds up. You know, you think about it, $5,000 a year for 30 years, that's $150,000 before we even take into

Starting point is 00:17:02 account any returns, right? That's almost four years of spending right there. You add returns on top of that over a 30-year time period, and you get to five years, maybe even a little beyond, depending on what your return assumptions are. So by starting early, and this is one of the reasons we really encourage people, go into retirement with a retirement plan, know what your numbers are, know where your money's coming from, know what you're going to do. Because if you can start early, these little changes can make a huge difference over a 30-year retirement. If you wait until you're already in crisis mode, then you're going to have to make a lot bigger cutbacks. It's such an important note because there are way too many people even now that just enter into

Starting point is 00:17:45 retirement without that plan in place. And you got to have that plan to understand what you're going to be doing and know some of the risks even early on in retirement that we'll be talking about in this episode too. Because I think it's just so incredibly important to have that plan in place. So I love that you guys are diving deeper into there. And the big thing that you guys were talking about is kind of looking at you make the case that longevity can be a bigger risk and it is going to be an increasingly bigger risk over the course of the next few decades. And for many people out there, if they don't plan for this longevity or if they don't plan that this is going to happen and they live longer than anticipated, this could be something that, you know,

Starting point is 00:18:20 is a bigger issue for your retirement plans. So how should someone think about this when it comes to the risk of simply living longer over time? Yeah. So like, look, let's let's be clear. longevity is a good thing, right? People are living longer, they're living healthier lives, they're getting more out of their life. These are all good things. But the problem it causes from a retirement planning standpoint is it means your retirement portfolio has to last for longer. And that's really where the longevity risk comes in, right? Like a good analogy is you're going on a car trip, you're going on a road trip, and you have one tank of gas.

Starting point is 00:18:58 That's all you're allowed, right? And so as you're going down the road, maybe you run into some construction, you run into traffic, it slows you down, you find out you've got to climb a lot of hills. Well, that impacts how much gas you use, how quickly your gas tank is used up, right? But if you're, if suddenly your trip gets extended by 50 or 100 miles, right, no matter how good the road is, no matter how smooth your trip. you're going to run out of gas before you reach your destination, right? And so in this, in this analogy, right, the road conditions are the market returns. So you can have good market returns, you can have bad market returns. And yes, that's a risk. And it impacts how long your money is going to last. But no matter how good the market conditions are, if you're not,

Starting point is 00:19:51 if you haven't planned to live a longer time, you're going to run out of money anyway. And that's why we say that longevity is actually the bigger risk, not only because even in good market conditions, longevity can create a failure of your retirement plan, but it's also one that people don't think about a whole lot. And when it comes to market conditions, I think this is a big thing that most people need to know. We just did an entire episode actually recently on this podcast, just talking about sequence of returns risk and how people just need to think about this and make sure they understand how this works and how to kind of plan for this. So can you kind of dive into Sequence of return risk and how it can kind of damage a retirement plan if you have some of these bad years

Starting point is 00:20:30 early on and you don't have a plan in place on how you're going to withdraw or how you're going to think about some of this stuff. Yeah, I actually listened to your episode on on Sequence of Returns Risk and I really enjoyed it. I think you and I agree on a lot of things there. Yeah, sequence of returns risk is just the risk that in the beginning, early years of your retirement, you hit a string of bad returns in the stock market, right? And some of the things we here for accumulators. And this is one of those places where the math works very different for accumulators than it does for retirees, right? If you're an accumulator, the order your returns come in doesn't make a whole lot of difference to you because you've got time for the market to

Starting point is 00:21:10 recover. And more importantly, you're not drawing down on your portfolio. When you retire and you hit a bad string of returns, you still have to make withdrawals from that portfolio. So you are reducing the balance even more quickly than the market is doing it for you. So like if the market's down 30%, and you have to withdraw 5% of your portfolio each year, you're down 35% that year, right? And when the market recovers, you're still withdrawing 5%. If the market goes up 20%, you're only up 15%, and on a smaller asset base than you started with. And especially if you get a string of bad years early on, this can really quickly erode your asset base and put your retirement plan in real danger. That can be really, really tough to recover from as a retiree.

Starting point is 00:22:04 You know, the best way people can offset that risk is by maintaining a reasonable asset allocation. At Vanguard, we are big proponents for retirement goals of glide paths that de-risk over time, right? So when you get to retirement, you have a balanced portfolio of equities and fixed income. And the fixed income acts as ballast in the portfolio. It helps offset the volatility of those equities. So if you're 50-50 and the equity market is down 20%, maybe your portfolio is only down 10. It really cushions that blow. And so I think one of the most effective mitigating actions you can take for sequence of returns risk is to make sure you have, a reasonable asset allocation. Absolutely. And I think that's one of the most important things that

Starting point is 00:22:57 people need to realize. If you do not have that asset allocation that fits your risk tolerance in place up front, it is one of those areas where we need to make sure that we are mitigating against some of those downturns, especially in those early years. Those early years are so incredibly important because you can see the impact on that portfolio. And especially when I look at people who, you know, we've talked about the retirement spending smile a couple of times in the past as well, where you can kind of see, okay, well, early on, people are spending a little more. maybe in their early years. They want to have some of those experiences. They're enjoying their time. They finally get to retirement age and they have the ability to kind of enjoy this. And in the middle,

Starting point is 00:23:30 you know, they're starting to spend a little less. You know, they've seen the sites. They've done some of the things that they wanted to do. And then as time goes on, well, health care is going to be kicking in. And so those costs are going to rise again. But you can see when you are spending or drawing down earlier on, many people have that risk in place. And so whatever the market conditions are, we just have to have a plan in place in order to make sure that we are looking at this the right way. Now, one of the big things that we think through, too, is, you know, the essentials. And covering the essentials is something that a topic that you guys cover a lot in this paper as well. And you frame Social Security as an annuity that people already own, which I love. I love that framing. I think that's the way I kind of think about Social Security. And so for someone trying to decide when to claim, we know kind of, you know, the later you claim, it's kind of like a guaranteed 8% rate of return when you kind of push off a few different years. What is the simplest way you think that people should consider? thinking about this and should they actually wait till 70, should they actually, you know, consider claiming earlier. How should they actually think about Social Security?

Starting point is 00:24:29 So, look, I think Social Security is one of these things. Like a lot of topics when it comes to retirement planning or financial planning in general, there's no one-size-fits-all answer, right? When you are making your Social Security claiming decision, the main trade-off you're making is less monthly income now, potentially for longer. or more monthly income later, potentially for a shorter period of time. And the real question becomes, how long am I going, do I think I'm going to live? Right. So if you think you're going to live beyond your kind of normal life expectancy, then delaying can be really powerful, right? Because once you claim that, once you get that bump for delayed claiming, that lasts for the

Starting point is 00:25:18 rest of your life, no matter how long you live, right? But the important thing to remember is that social security is about as actuarially fair as any kind of payout system gets, right? So what that means is if you live to your normal life expectancy, it doesn't matter whether you claim early or delay. Your lifetime benefits should be the same about, right? So there are a few things people should think about. Probably one of the most important is how long do you expect to live? What is your health like? What is your family history of longevity? Like, do you expect to live long enough to break even on your claiming decision? If you think you are, if you're in poor health or have reason to think that, you know, you may not make it to normal life expectancy, then you should probably think about claiming early. If you're healthy income from a lineage of long lived people, then it probably makes sense to delay claiming. The other factors that come into play here are do you need the money, right? Some people retire with minimal assets. Maybe they were forced into retirement because of health reasons or they just can't work anymore for whatever

Starting point is 00:26:28 reason. And they really need that money, that social security, to help them pay the bills early on in retirement. That's fine. That's a perfectly valid reason to claim early, right? Other people may not need that money as soon. They've got plenty of savings and they can afford to live off those savings until age 70. For them, it probably makes more sense to delay. So, you know, it really depends on what your financial and health situation is and what works best for you. And I will say, like, look, we tried to make the framework and the decision points within the paper as simple as possible. We really wanted people to be able to use this on their own. But Social Security claiming can get really complicated. And this would be a good place for people to go and consult with an advisor to look over their,

Starting point is 00:27:20 their options and decide which approach is best for them. Agreed. I think that's one of the most important areas to kind of make sure that you know, you know, where you are, where you stand and where you land. Because for each person, it is very personal in terms of how you want to think about this. And it can get more and more complicated. As you'll even see, you know, if you're married, that's another pain point where, you know, this can be a complicated scenario on who should claim first.

Starting point is 00:27:44 Should they start to take, you know, early? so somebody else start to take later, and then you start to get into this scenario of kind of how to think about this. And so even for married couples, you kind of describe a coordination of play where the spouses claim at different times. Can you explain kind of how that even works and why it can protect surviving spouses if you do this the right way? Absolutely. So one of the most powerful social security claiming decisions is coordination of spousal benefits, right? And the reason for this is when one spouse dies, the other spouse gets a spousal benefit. And that spousal benefit is either equivalent to their own benefit or the deceased spouse's benefit, whichever is greater. So if you have a situation, like many families do, where you have one spouse that is a high earner and another one that hasn't earned as much during the career, keeping in mind that social security benefits up to a point are directly tied to income during your working years, it can make a lot of sense for the higher earner to delay their. they're claiming to age 70 to maximize their benefit. And what happens then is when that higher earner passes, the higher benefit that they have accrued by waiting until age 70, the surviving spouse can claim that much, much higher benefit and end up having a much higher social security

Starting point is 00:29:07 benefit than they would if they had relied on their own earnings record and their own social security benefits or if the higher earner had claimed at age 67 or 62 or some younger age. So it's really about maximizing the survivor benefits. I love that. And I think for most people, just knowing how to do that the right way and knowing that this is the process, I think, is really, really important. So if you're thinking about this again, like we're talking about here, you know, it's really, it's really great to consult an advisor, especially when you're trying to think through, you know, finding, figuring out when to claim Social Security because I think it's a very important and a very needed solution to what most people are trying to think through there.

Starting point is 00:29:46 Completely agree. And social security claiming strategies tend to be one of the more complex retirement topics. So yeah, agree. This is another place where an advisor could add a lot of value. And I can tell you, like most of, you know, my, my, even my parents, for example, they're kind of in their late 60s now. And most of their friends are either just retiring or retired. That's the number one question they always ask me. They come up to me and say, hey, when should I claim Social Security? I'm like, listen, I can't look at your situation. You got a doctor and advisor about that, which is for sure a big, big question that comes up. Well, and it's complicated.

Starting point is 00:30:17 You know, I mean, I do this for a living and I look at some of the social security rules. And not only do I do this for a living, but I'm an attorney by education. And I look at some of these social security rules and I'm like, what? For sure. It is a whole different animal, for sure, which it's one of those things for like your individual situation is very important. So I love that. Absolutely. Most of us picked a bank years ago and never really thought about it again.

Starting point is 00:30:47 But when you stop and look at what you're actually getting, it makes you wonder if there's a better option. That's where Chime comes in, because Chime is changing the way people bank. They're not like traditional banks that pile on fees or gatekeep the best rewards. Chime offers the most rewarding fee-free banking with no overdraft fees, no monthly fees, and no minimum balance fees. You can earn up to 5% cashback on your Chime card in a category that you choose like gas or groceries, build credit through everyday spending with no credit check, grow your savings with a rate that's nine times the national average, and if you're ever in a pinch, Spot Me lets you overdraft up to $200 fee-free. So join the millions who are already

Starting point is 00:31:28 banking fee-free with America's number one choice for banking. Head to chime.com slash pfp. That's chime.com slash pfp. Sign up now. It only takes a few minutes. Chime is a fintech, not a bank. Banking services and CHIME card provided by CHIMS bank partners. Qualifying direct deposits require. Terms and limits apply. Go to chime.com slash disclosures for detail. It's kind of amazing how much can change in just a single year. Every summer, the kids are a little bigger, a little more independent, and life looks a little different than it did the year before. And it reminds me that while we can't predict the future, we can prepare for it. That's one of the reasons I like PolicyGenius. See, PolicyGenius isn't an insurance company. They're an online

Starting point is 00:32:09 marketplace that lets you compare life insurance quotes from some of America's top insurers side by side for free. And their licensed team helps you compare coverage, prices, and terms, answers your questions, and even handles the paperwork so you can get the right policy without the hassle. For me, having life insurance isn't about expecting something to happen. It's about knowing my family is protected so I can actually enjoy these moments together instead of worrying about what comes next. And with policy genius, you can find 20, year life insurance policies, starting at just $276 a year for $1 million of coverage. Head to PolicyGenius.com to compare life insurance quotes from top companies and see how much

Starting point is 00:32:51 you can save. That's policygenius.com. And so one of the things that that paper talks about as well is annuities. Now, annuities with some of my audience has a bad reputation. The reason why is because the fees. They kind of always talk about fees and what's going to come into play when they are thinking about annuities. But I have, you know, read a lot of work from a lot of different people. And there are some very smart people who kind of claim, okay, well, annuities actually can make sense for certain people. They can make sense in certain situation. So when does something like an income annuity genuinely makes sense? Or when is it something that's just kind of wasted time or just the wrong tool for someone? Yeah. So let's be clear. I mean, I completely agree with your

Starting point is 00:33:30 statement that there's a lot of skepticism around annuities out there, right? They can be very expensive in the past. There's no question that they have been miss sold. And they've just gotten a really bad reputation in the industry. That does not, however, mean that the right annuity for the right person cannot add a lot of value, right? And in our paper, we really focused specifically on fixed annuities. So we didn't talk about variable annuities. We didn't talk about indexed annuities, right? We focused very specifically on fixed annuities. And part of the reason we did that is, in some ways, fixed annuities are almost like the index fund of the annuity world, right? They tend to be fairly low fees.

Starting point is 00:34:14 They're kind of boring. They do one job, but they do it quite well, right? And so we decided to focus on fixed annuities because they really fit the need that we were focused on in our paper. In the section on our paper on covering the essentials, what we say is to the extent possible, you should really seek to cover your essential expenses. Those are your basic living expenses. Housing, food, transportation. health insurance premiums, right?

Starting point is 00:34:43 The things that if you can't afford them, they are going to significantly erode your standard of living. These things should as much as possible be covered by guaranteed income. So no matter how long you live, no matter what happens in the market, you know your basic living expenses are covered. So what are forms of guaranteed income? Well, we've talked about Socialist Security, pensions are another form of guaranteed income, right? But if you still have a gap between your guaranteed income and your essential expenses,

Starting point is 00:35:19 this is where an annuity can come in and be really handy, right? Fixed annuities tend to be fairly inexpensive from a fee standpoint, and they provide you a guaranteed income for the rest of your life. And what that does is, along with other forms of guaranteed income, it puts a floor under your spending, where you can say no matter what happens, I'm going to have at least this much income that I know I can count on and pay bills with. And I think that's where a fixed annuity is really, really valuable, right?

Starting point is 00:35:52 So who should perhaps consider a fixed annuity? Anyone who has meaningful longevity risk. So if you, for instance, you look at your, you do your retirement plan and you have kind of a marginal withdrawal rate, maybe it's 5% or so. you know, an annuity can come in really handy there because if you're unfortunate enough to run into bad markets and you have a slightly high withdrawal rate, you could end up exhausting your portfolio. And an annuity can provide you that floor of consumption. Also, if you're just worried about living a long time, an annuity might be appropriate for you, right? When they are not appropriate is when you have no meaningful longevity risk.

Starting point is 00:36:38 So either you have a really large portfolio and or your portfolio spending needs are really low, like 1 to 2% of your portfolio, where you can basically self-insure that longevity risk. An annuity might not make sense in that case because there's really no longevity risk to protect against there. Another place would be if you really prioritize flydemean, flexibility, right? One of the downsides of an annuity is once you pay that money to the annuity

Starting point is 00:37:08 company, it's gone. You're not getting it back, right? So if you really prioritize financial flexibility, then an annuity might not be right for you in that case either. So they're not for everyone. I think a couple of key things to remember is annuities are insurance products. They are not investment products. And I think they should be looked at that way. You don't buy homeowners insurance or auto insurance because you think you're going to get a big payout. off at the end of it, right? You buy it to protect you from catastrophe. And annuities are served the same purpose. They are insurance against running out of money. And I think viewed in that way, they make a lot more sense than trying to view, trying to view them as investment products. I love that reframe,

Starting point is 00:37:54 because that's exactly what I was going to say is, basically, you are just ensuring that your income is going to be there, you know, during the long term, if you are going to go this route. And again, there's pros and cons obviously to each side, but I think for some people, it can make sense, especially when you keep those fees low and you look at it in a way that, you know, if you are buying your income and making sure that your income stays level and you're covering your expenses, and that's what gives you peace of mind and that's what reduces your stress and anxiety around your retirement, that may be a good move because, you know, even just the psychology side of this, removing that stress and anxiety out of the equation could be very helpful for some people.

Starting point is 00:38:26 So looking into this or at least just kind of, you know, talking to your advisor and kind of understanding, the pros and cons of each of these options can be something that is great. But again, like Garrett said, I think this is something it has been oversold. The wrong annuities have been sold to the wrong people, which is why they get that bad rap. But in reality, it's going to depend on each and every single person. Yeah. And you said something that I just want to kind of reiterate here and expand on a little bit. You know, you were talking about like, hey, if you want that piece of mind that comes with having that insurance, right? I think that's a really important point because I think there are very few right and wrong decisions when it comes to financial planning, right? There are tradeoffs

Starting point is 00:39:07 involved with every decision. And that's really what we look at or what are the tradeoffs. And yes, we kind of say, hey, for the kind of average person, like this is probably the better tradeoff than this. But if buying that annuity, even if you don't really need it from like a strictly quantitative point of view, if buying that annuity gives you peace of mind and helps you sleep at night and you feel like, you know what, it was worth it because I feel so much better now that I've done this, then that's not a bad decision, right? That's a good decision. I think a lot of times when we talk about financial planning and we talk about personal finance, we get really caught up on the quantitative piece. Like from a financial standpoint, what's the right answer?

Starting point is 00:39:50 But we also have to keep in mind at the same time, money is emotional. And sometimes, not always, but sometimes the emotional answer actually is the right answer. But you've got to know what you're paying for that going into it. Exactly. I could not agree more because I believe, you know, money really comes down to kind of 90% your psychology or emotions how you behave. And that is really where, you know, if you can remove some of that stress and anxiety out of the equation, that is using money as a tool to enjoy it. And I think that is a huge piece of this whole equation that everybody should be considering as they start to think through some of this stuff. Now, you guys found that the order that you pull money from accounts, I love this stat, can cut lifetime tax bills by about 14%. So what is the default order that you recommend and why does it work? And is there a default order or is this something that it just depends on each person again?

Starting point is 00:40:42 So it does depend on each person. It depends on your goals. It depends on your account mix and how much money you have and a lot of other factors, right? But what we found was about 80% of the time, what we consider our default withdrawal order is the optimal withdrawal order for people. And that is take from your taxable accounts first, your tax deferred accounts next, and then leave your tax-free accounts until last, right? And essentially, the reason this works for most people is because that is the order from least tax-fired to most tax efficient, right? You take a taxable account and each year you have to pay taxes on dividends, interest, realized capital gains. If you're holding funds, you may pay capital gains taxes on gains you didn't even realize because they were realized within the funds, right? And all of these

Starting point is 00:41:46 taxes that you have to pay as you go, erode your after-tax return. And really what my team looks at and what withdrawal order is trying to do is maximize your after-tax returns. So all other things being equal, a taxable account is going to have the most tax drag and have the lowest after-tax return. So get that out of your portfolio first. Give your more tax-efficient accounts, more time to grow in a tax-deferred or tax-free way. The next least tax-efficient account is a tax-deferred account. Now, you don't get taxed as you go. All of your capital gains and interest and dividends, they're all reinvested. You don't get taxed until you withdraw them. But when you withdraw them, they're treated as ordinary income and you pay income tax on them. So more efficient

Starting point is 00:42:40 than a taxable account, less efficient than a tax-free account. a tax a free account, a Roth, you know, you put the money in, it grows tax free, you don't pay taxes along the way, and everything you take out is tax free. Not only that, but it passes to your heirs tax free if you have something left. And so just by spending your money, getting that tax drag moved out of your portfolio as quickly as possible can save you a lot of money over your lifetime in tax liabilities. And many people listening right now may be saying to themselves, okay, that's interesting. But I want them to just kind of paint a picture of exactly how much savings this is. So anybody who has

Starting point is 00:43:19 more than, say, a million dollars in their portfolio, this could be up to a six-figure differential or decision just by making sure you understand this. And this is why it's so important to go into retirement, like we're talking about here, with this financial plan in place, because once you have the plan in place, it is not just, you know, saving money up front and understanding, you know, where or when you're going to spend, but it's also just understanding the account order and understanding exactly what is going to happen here. It is a six-figure to even seven-figure decision, depending on how big that portfolio is. So in reality, this is a huge, huge deal for many of us to understand. And so I think that is wonderful information and the research is so compelling.

Starting point is 00:43:58 And I highly encourage everybody to read that section because I think it's just so incredibly powerful. And one of the cool things is you wrote that more than 80% of investors could benefit from Roth conversions. And I think this is something that I think is really, really interesting for a lot of people because sometimes people are like, well, I thought Roth conversions were just for people who were making too much to contribute to a Roth IRA, but there are so many different strategies that you can have available when it comes to Roth conversions. So is there a specific window in retirement when you think people should kind of think about this? Is it when they're coming up on RMDs? And is there a sweet spot to this on when they should look at those Roth conversions?

Starting point is 00:44:32 Yeah, so for the vast majority of people, there is definitely a sweet spot to do Roth conversions. And that is in between the year you retire and stop receiving employment income and the year you turn 75 and have to take RMDs, right? Those years tend to be the lowest income years in a retiree's life because, you know, you're not receiving employment income and getting taxed on that. RMDs, once you're forced to take those, those can be significant, especially if you've been a good saver and those are going to bump you up into higher tax. brackets, but that kind of middle area between those two things, for most people, they tend to be years where income is low and as a result, they're in lower tax brackets than they ever will be again in their life, right? And so it's important to remember that the way Roth conversions work is I take money out of my traditional account, I pay taxes on that withdrawal, and I put it

Starting point is 00:45:32 into my Roth account, right? And so this is why low income is, having low income is an important point is because the less income tax you can pay on that conversion, the more valuable that conversion is going to be. So do it during those years where you're in a low tax bracket and are paying low taxes and pay a lot of attention to how much you're converting and manage your tax brackets, right? If you can do it in the 12% tax bracket, that's a bargain. If you can do it in the 12% tax bracket, that's a bargain. you bumps it up to the 22% tax bracket, depending on your tax situation, that can still be really beneficial, right? If you're going up to the 37% tax bracket to do a Roth conversion, you're probably not getting a whole lot of benefit out of doing that, right? So there is some

Starting point is 00:46:20 planning that needs to be done there. We call it threshold planning. And again, this is one of those places where it can get really complicated and an advisor can really help with this. Absolutely, because if you do this in the wrong, timeframe of the wrong, you could end up with a big tax bill that you did not anticipate. And so for sure, that's a big deal, is knowing what years are optimal to make sure that you are doing this. The other thing that people need to keep in mind, and this is a little bit of a mind, this is a little bit of a psychology shift for a lot of retirees, right? Is that like with everything in investing in financial planning, there is a tradeoff with Roth conversions, right? And that is, I pay more taxes today, but I save on my lifetime taxes in the future.

Starting point is 00:47:06 And I think this is one of the hardest hurdles for people to get over, right? It's like, why should I have to pay $30,000 in additional tax today when I don't have to? And the answer is, well, because over the next 20, 25 years, it's going to save you $75,000 in taxes, right? It's not taxes today that retirees, when they're making their retirement, plan should really be focused on. It's how much am I going to have to pay in taxes over my lifetime? Because that's really what impacts your wealth, your long-term wealth. Exactly. Those are, those are some of the things even understanding that is just a huge, huge differential for a lot of folks is knowing when to take those. And I love that you guys are covering that in here.

Starting point is 00:47:52 My relationship with money has changed a lot over the years. Early on, I thought building wealth was about making more money. Now, I know it's really about having clarity. When you know exactly where your money is going and whether you're on track, you make better decisions. That's one of the reasons I love Monarch. It's the personal finance app that tracks everything from your accounts and investments to your savings goals and spending. So you can see your entire financial picture in one place. One habit that's made a huge difference for me is my five-minute drill every single morning. I open Monarch, check my spending, investments, cash flow, and net worth, and I'm done in just a few minutes. It gives me

Starting point is 00:48:30 confidence that nothing is slipping through the cracks. I also love the AI weekly recap because it'll flag spending changes, upcoming expenses, or shifts in my net worth before they become a problem. Instead of reacting after the fact, I can make adjustments early. It really feels like having a financial advisor in your pocket. Write your own money story with Monarch. Use code pfp at monarch.com to get your first year of Monarch core half off at just $50. That's 50% off your first off your first year at monarch.com with code PFP. One thing I've learned from running multiple businesses is there's usually a gap between how you think work is getting done and how it's actually getting done.

Starting point is 00:49:11 And we've had times where we thought we knew the bottleneck, only to realize later, the real issue was somewhere completely different. That's exactly what today's sponsor, Scribe, helps solve. Scribe is a workflow AI platform trusted by 94% of the Fortune 500. And Scribe Optimize turns real workflow data into decisions your AI strategy actually needs, automatically capturing how work happens across approved apps, surfacing inefficiency and opportunities with no interviews and no manual discovery and no extra work from your team, which is the key.

Starting point is 00:49:46 And the live dashboard shows where work is happening, how much time is taking, and where the biggest opportunities are right now. It automatically discovers workflows across multiple tools, then highlights your biggest in efficiencies and gives AI-powered recommendations with estimated time saving. You know I love saving time. It's also built with privacy in mind. It only runs across approved business applications, user level data is anonymous by default, and sensitive information is automatically redacted and never leaves your firewall. To see, optimize an action, head Describe.com, how, slash PFP, and mention PFP for a 30-day risk-free trial. That's S-C-R-I-B-E.H-O-W-W.

Starting point is 00:50:27 slash pfp. The next one is dynamic spending. Now, this is a concept I love. Dynamic spending is something that, you know, I grew up reading about the 4% rule and that was like the end all be all. We kind of started at that point in time. But now that dynamic spending is something

Starting point is 00:50:44 that has been, you know, a little more popularized. I think it's a very interesting concept and something I absolutely love. Can you kind of explain dynamic spending and how guardrails work and how that works maybe in practice even? Sure. So dynamic spending,

Starting point is 00:50:58 quite simply put is you adjust your spending based on market conditions. So when markets are doing well, you give yourself a little bit of a raise. You allow yourself to spend a little bit more that year. When markets are down, you cut back a little bit, right? And what this does is, it does a couple of things. We'll get to the guardrails in a second. But assuming you have your guardrails set correctly, what it does is it gives you a little bit more freedom to spend in good market years, but you cap the raise you give yourself to a fairly low level. So if the market has a really strong year, you're banking most of those returns for future years, right? And then on the downside, you create a floor where you say, in a bad year, I am going to cut my spending by two and a half percent.

Starting point is 00:51:52 And what that does is it takes some of the stress off of your portfolio in those bad years. You know, when we were talking about sequence of returns risk, we talked about the damage that can happen to your portfolio when you are taking withdrawals during a down market. And while that is most impactful in the early years of retirement, it can still have an impact later on as well, right? So the idea with lowering your spending in bad years is to take some of that stress off of your portfolio during those bad years and give it more, leave more assets in the portfolio to recover later on. So the way the guardrails would work, we typically recommend that 5% raise and 2.5% cut are good guardrails to start with. If the market is up, you give yourself a raise equal to the increase in the market up to your ceiling. So if it's a two, if the market's up 2%, you give yourself a 2% raise. If the market's up 10%, you give yourself a 5% raise and you bank that other 5% for the future, right?

Starting point is 00:53:02 If the market's down 1%, give yourself a 1%, cut your spending by 1%. If it's down 10%, cut your spending by 2.5. right now the reason we we say that you should be pretty conservative with that floor number of how much you cut your spending is because while while it's a good idea to cut spending during bad years you don't want to cut yourself too short right you want to make sure that you can cover all of your necessary expenses maybe not go out to dinner quite as often or go on that big european trip that you were planning to be planning to but, you know, still have some fun in your life. And so two and a half percent is a number by which most people can cut their spending and not really feel too badly about it, right? But it still helps preserve that portfolio value, especially if during the good years you're banking extra money. And what we've found is that by doing this, by being just a little bit flexible in your spending, it can significantly increase the long-jointed.

Starting point is 00:54:10 of a portfolio and is really effective at avoiding potential large cuts in your spending later on in your retirement. I think it's so important to note. And I think I love that you guys do have that kind of cap on the reduction of spending because human psychology, as we just know, it's just kind of harder to go backwards sometimes. And so making sure that we kind of have a balanced approach to that, I think is really important. I've just noticed every single person that we've coached or talked to is a lot of times they just have a difficult time kind of cutting back too far. And so when you have this balance approach like

Starting point is 00:54:44 that, I think that's much more helpful for most people. I completely agree, right? Like, if I came to you and I said, Andrew, the markets are bad this year, I need you to cut your spending next year by 15%. Your reaction to publicly like, how am I supposed to do that? Right. Like, I don't even know where to start. But if I came to you and I said, Andrew, you need to cut your spending by two and a half percent this year, you know, that's something that for most people, it could be, Oh, two and a half percent. Well, yeah, okay, I can probably do that, right? Like, that's not that much.

Starting point is 00:55:15 So, yeah. Exactly. It's, it's that one big thing that I think that is so helpful overall. That's where I think most people will worry about the guardrails is like, well, I've had to cut way, way back. But instead, you guys have this great parameter around that that I absolutely love. And this all comes down to human psychology. I mean, part of this is the human side of kind of what we've been talking about here.

Starting point is 00:55:34 And you all have a whole section in the paper about behavioral risk. And I think there's a lot of emotional mistakes that people can make when it comes to retirement. Is there any emotional mistake that you have seen many retirees make that could be either detrimental to their finances? And how do they kind of build a plan to make sure that they kind of separate some of their emotions from some of the things that they should be doing? Yeah. So, you know, like, look, I think taking, I think taking human emotion into account when you're doing financial planning is really, really important, right? Like I've said before that I can have quantitatively the perfect plan, right? And if I present those recommendations to an investor and they look at it and they're like, there's no way, then that plan adds absolutely no value for that client, right? So deviating from the quantitatively perfect to incorporate emotion and just investor psychology to get it to the point where it's like, well, maybe it's not absolutely perfect.

Starting point is 00:56:34 it's something they'll implement, there's a ton of value in doing that. And I think that's really important to keep in mind. As for your question about the biggest mistake that we see people make, I think it's really just abandoning their plan for whatever reason, right? Maybe it's that there's a big market drop and they got emotional and pulled their money out. Maybe it's that, you know, they decided that instead of staying in the home they had when they retired, they want to move across, they want to move to Florida or they want to move to Arizona

Starting point is 00:57:07 and kind of start over, right? Just abandoning their plan and moving forward without a plan, right? So they don't know how this is going to impact them. They don't know, they don't know what their, what their costs are. They don't know how this is going. They haven't reestablished their goals, like what is their purpose in doing this and what does that mean for them? And so they, they abandoned their plan and just kind of wing it. And that's not a plan. That's relying on luck. And a lot of times that doesn't work out real well for people. Now, that's not to say that plans don't and shouldn't change, right? One of the things that we talk about in the paper is like, hey, you need to have your goals. You need to set priorities. But be aware of those priorities. They will change over time.

Starting point is 00:57:57 If you are not going to have the same priorities 20 years from now that you have today. And that's okay, right? Like, we expect priorities and goals to change over time. You just need to adjust your plan with them, right? So the plan once you make it is not set in stone. It is a living, breathing document that you should update on a regular basis. And if your priorities change, change your plan and incorporate those changes into your plan to make sure that you remain on track. I think the biggest mistake that we see people make is not going through that process of updating and changing their plan to reflect their changing priorities, but just abandoning their plan altogether and proceeding without a plan at all. I love that. And I could not agree more. And even for folks

Starting point is 00:58:47 who are listening right now, if you're in your 30s or 40s, I'm even a big proponent of them starting to think about their plan now and making those adjustments even as life progresses in the early years is kind of like looking at your retirement number and looking at some of your plans that you have in place and just making those adjustments as you get closer and closer to retirement age. Because once you get five years out, you got to make sure that you have that plan secured and you have thought through some of that plan. And then it's dynamic. You have the ability to change it and make adjustments, but you just have to know what the implications are going to be if you do some of that. So, Garrett, if someone is, you know, five years out from retirement and only changes one thing

Starting point is 00:59:20 from this conversation, what should it be? Or is there just a slew of things that they should consider? And it just depends on each situation. No, look, I'm going to go back to the first thing we talked about, right? And that is stop focusing on your balance. Your balance is not what determines directly, is not what determines the success of your retirement plan. Start thinking about what do I want my retirement to look like. What are my other sources of income in retirement going to be? How much income do I need to live the kind of life I want to in retirement?

Starting point is 00:59:53 and really start to focus in on that portfolio withdrawal number and use that as a checkpoint to see if your retirement plan is realistic or not and if it's not what changes you can make to achieve the kind of retirement you really want. And what I love is that the paper talks about like what you just said is that it's about turning your savings the life that you actually want. It's about kind of figuring out, you know, what your dollars need to do and using money as a tool to get the life that you actually want. After doing all this modeling and after doing all this math,

Starting point is 01:00:28 is there anything that surprised you most about what people actually want or what makes them feel secure in retirement? You know, I think the biggest thing is the goals piece, right? You know, being able to sit down and say, like, this is my vision for retirement and this is what I need to bring that retirement into reality really simplifies the retirement planning process.

Starting point is 01:00:52 You know, people view retirement planning as being really, really complicated. And it is. Like, I don't want to give people the impression that, like, oh, this is really easy. Anyone can do it, right? Like, it's really complicated. But, you know, retirement planning is, is like taking a trip, right? If you don't know what your destination is, it's really difficult to plan for that trip. And your goal is really your destination.

Starting point is 01:01:20 So that's where you start. Like, this is where I want to get to. And if you, if you figure out what your destination is, then it's, it's not easy, but it's a lot easier to fit all the other pieces into place. The last thing you want to do is pack a bathing suit on your trip to Alaska. So I love that analogy. I think that's absolutely perfect. Unless you're going to join the polar bear club.

Starting point is 01:01:41 Exactly. Unless you go to a cold punch. Exactly. So that's, that's exactly right. Well, Garrett, thank you so much for coming on here. This has been absolutely phenomenal. Where can people learn more about you, what you have going on? everything else, all the Vanguard research you all are doing. Yeah, so go to vanguard.com and click on

Starting point is 01:01:57 the resources and education tab, and you can find all of our articles and thought leadership there. Wonderful. We will link that up down below in this show notes. Again, thank you so much for being on here. This was a wonderful conversation. Thanks, Andrew. I've really enjoyed it. If you want a $3,000 a month payday for life, what would you feel free to do? Maybe take a long weekend, every weekend, or try a bunch of new hobbies. Would you feel free to upgrade in the listen ad-free? Don't worry. We get it. Every $20 ticket could win you $3,000 a month for life and supports life-saving cancer research at the Princess Margaret. Feel free to buy your Payday for Life ticket today. Raffle number 155-2194. Please play responsibly.

The Personal Finance Podcast - The Retirement Mistake 80% of Investors Make (with Vanguard's Lead Researcher)

There aren't comments yet for this episode. Click on any sentence in the transcript to leave a comment.