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I might be hitting my head against a brick wall, but it’s a rather poor show that “RDQ” gets all the down arrow glory and doesn’t share. Maybe I need a few arrows with this doozy of a post.
Let me roll out my pre-retirement risk credentials. I quit a corporate job when I reached the level of director, with lots of stock purchase opportunities, a high salary, and a solid pension package. I left all that to start my own business—a very risky move, but one that was well within my risk envelope.
Before I retired, my portfolio was heavily invested in developed world funds and specialist China and Southeast Asian “special situations” funds. My wife Suzie’s advisor nearly lost his eyebrows when he first laid eyes on my portfolio’s risk level. I simply shrugged my shoulders; I was totally comfortable with my exposure.
In short, I’m no stranger to financial risk and have a very high tolerance and ability to take it. But here’s the thing: I’m now retired and have dialed down my risk level because I simply don’t need to stretch for significant growth to support my lifestyle.
A fixed-term annuity is now one of the main planks of my retirement. I still have a very high capacity for risk, but I’ve deliberately chosen a retirement income and cash flow strategy that gives me what I need at the lowest possible risk, outside of social security. I truly wonder why such a small portion of retirees opt for this choice.
In my mind, once your income goal can be easily met, or once the required growth to support your desired lifestyle is minimal, taking on additional risk becomes unneeded and, therefore, irrational. To reiterate, I still have the financial capacity to absorb losses but no longer need to take those risks to achieve my lifestyle goals. If you’re in that position, why would you still take the risk?
I guess it will be a combination of the normal behavioural biases: FOMO People see a rising stock market and worry they are leaving money on the table by locking in a lower, fixed return and Loss Aversion: The idea of giving up control of a lump sum of money in exchange for an income stream can feel like a “loss” to many, even if it’s financially sound risk mitigation tool.
When you couple this with a general negative perception of annuities due to complex products, high fees, and stories of unsuitable sales along with the fact many people don’t understand the different types (like a fixed-term vs. variable) it is understandable why the entire category might be dismissed out of hand. It must be said I’m not Captain Kirk’s sidekick Spock, full of logic and no emotion, when the market goes on an upwards rip, I feel the FOMO just like anyone else!
It’s not just behavioral biases at play; even established theory seems to be misunderstood. Modern portfolio theory (MPT) actually supports the use of fixed income products and bond ladders within a retirement portfolio but this seems to be overlooked in favour of other elements of MPT. Here’s what I find particularly puzzling: the investment community often portrays annuity purchases as unsophisticated, as if only financial novices would “give up” market upside. This seems backwards to me.
The sophisticated approach is optimizing for your actual situation, not maximizing for theoretical returns you don’t need. Once you’ve won the game and have a strong plan for inflation management, why keep playing with money you don’t need to risk? It seems to me to be the opposite of a smart strategy.
Of course, I recognize there are valid reasons some retirees might choose higher risk – perhaps they want to maximize bequests to family or charity, or they’re concerned about long-term inflation exceeding what fixed income can handle. These are rational choices for their specific situations.
If you’re retired and can meet your lifestyle goals with lower-risk strategies, taking additional risk isn’t bold—it’s somewhat counterintuitive. The goal isn’t to die with the most money possible; it’s to live comfortably without worrying about sequence-of-returns risk or market volatility derailing your plans.
Yep, I’ll suffer those down arrows gladly because sometimes I think it’s refreshing to challenge conventional wisdom just to keep our views flexible and not get stuck in a rut. Occasionally, the most contrarian position is possibly the most sensible one.
Are you also mitigating health and housing risks?
If by health risk you mean personal fitness, then yes, I definitely am. I’m very active; on an average week I play about 10 hours of different racket sports, cycle at least 30 miles, and jog 6 to 7 miles. I average 12,000 steps daily. If you mean health costs I live in the UK and nearly all treatment is free at point of use, although I also carry private medical insurance for treatments outside the scope of our health systems.
I also have funds dedicated for the future purchase, if needed, of an immediate needs annuity. This is a UK-specific, medically underwritten policy that is extremely tax efficient and not a rider on a normal annuity, which is the normal practice in the US.
Housing wise I don’t have a mortgage so have no interest rate exposure. I obviously carry comprehensive property insurance and regularly maintain the structure of my property . My house has two downstairs bedrooms and a full bathroom also on the ground floor, very little adaptation would be required to age in place.
I’m not 100% sure what you mean. Can you elaborate slightly?
There are some audio issues, but on Rob Berger’s YouTube channel there’s a good interview with Bill Bernstein.
I’m not so sure “giving up market upside” is the issue, I think it’s the fear that you pay 200, 500,800k etc for an annuity and drop dead the next day.
A TIAA advisor told me that most of their annuitants opted for a period certain, usually 10 years, even though the payout is somewhat less.
I suppose in that scenario the choice would literally be dead wrong!
Risk is one of those things that serves a purpose but should be managed.
As I approached true retirement I saved more than might be necessary and made allocation changes to my retirement accounts. One reason was “wealth defense” and another was to position for RMDs. And let’s not forget about that “sleep number”.
While my accounts are comprised of individual stocks and ETFs, I don’t have a S&P 500 index fund, per se. I did not have a desire for maximum possible returns, but I did want to beat inflation. In general, it has been shown that “long term” index funds can do that but do include certain risks.
For example, there have been periods of malaise. I don’t attempt to make predictions but I do think it is prudent to prepare for different outcomes. I chose a well-diversified portfolio which should do well under all circumstances. I do have concerns and the past performance of the market supports these concerns.
There have been two periods in the last 50 years in which stocks flatlined. A “lost decade” is a period of about 10 years when the stock market went nowhere. I have experienced two such periods. One was in the 2000s and it cost investors roughly 12 years. Similarly, through most of the 1970s and into the 1980s, stocks went nowhere; that was 10 years. One of these periods was because of the combination of the Dot-Com bust and the financial crisis. The other was because of an energy crisis and stagflation.
I’d only been investing for about 5 years when the Dot-Com bust occurred and most of my retirement savings were wiped out. For 9 years the S&P 500 returned -0.95% annually if we include dividends. If we don’t it was -2.72% annually. The S&P dropped 10.14% in 2000, another 13% in 2001 and 23.4% in 2002. Then in 2008 it dropped by 38.5%. This made a lasting impression. Imagine if I were taking withdrawals during that period!
Some, including Berkshire’s Charlie Munger have said we are approaching a third period. Who knows? But what we do know is that out of ten 10-year periods 70% of the time the S&P delivered positive returns, but for 30% the returns were dismal (lost).
I realized that had the Dot-Com bust occurred when I was on the cusp of retirement it would have had a terrible impact on that retirement. With that knowledge I made significant adjustments during the most recent 25 years of saving and investing.
I also think of the lost decades. In my case, I am in the privileged position of being able to hold a lot of cash-like instruments within my portfolio without affecting my retirement spending. For me it wouldn’t be an issue unless it stretched beyond a decade.
If the passive income (SS, Pension, Annuity) covers expenses with a cushion along with future inflation, then taking some risk with savings to get a higher return makes sense.
Your point is well taken. Retirement is an inflection point in life. What worked for 40 years, may not work for the remaining years. So make a change.
I think there are more than a few here who would agree with your point that if you’ve won the game, why keep playing?
The answer depends so much on the size of your savings vs amount of residual living expenses after dependable lifetime income from Social Security, pensions, or annuities.
Bill Bernstein is one of my heroes. People often misinterpret his well-known saying as implying that one should reduce all risk once they have won the game. However, he has always considered his advice to only apply to the money that you can’t afford to lose. He doesn’t have a problem with folks taking risks with their additional assets.
Bernstein prefers TIPS ladder over fixed annuities but acknowledges that some people may be more comfortable and/or find it easier to opt for an annuity.
He sounds interesting. I will have to check him out.
Mark, In addition to Bill Bernstein’s excellent books, I recently stumbled upon a trove of articles written (or co-written) by him. If you put the following address into a browser, it will bring up the articles:
https://www.advisorperspectives.com/search?author=William%20Bernstein
I too am a fan of Bill Bernstein. I’ve read all his published books, and what he has posted on http://www.efficient frontier.com and have learned a lot from him. Thanks for the link to these recent articles.
I spent a lovely couple of hours this morning reading through some of his articles. Unfortunately, life nudged my shoulder, and I had to continue with my day! I’m looking forward to reading the rest this evening. Thanks for the link.
Start with The Four Pillars of Investing, Second Edition
Love him, too. Wicked smart, deeply curious, quite caring, and a sly sense of humor.
In our plan, applying Bernstein’s philosophy to the money we can’t afford to lose let us take a bit more risk, for long-term growth, from the part which funds discretionary and legacy.
Some people simply enjoy the challenge and excitement of risk. That’s not me. Let them skydive. I’ll ride my trike.
To narrow, albeit not completely fill, the gap between my SS benefits and my CCRC-living expenses, I happily purchased a SPIA with 5% annual compound increase from a portion of the cash in my portfolio, along with a QLAC to start in 2034. So I need to withdraw only about 2% annually from my remaining all-index-funds portfolio. My priority for retirement was to simplify and reduce stress. Good so far. No down arrow from me.