 Welcome to Bogle Heads On Investing, podcast number 24. Today our special guest is Dr. Wade Fow, a professor of retirement income at the American College of Financial Services. Dr. Fow is the author of three books and over 60 articles on how you can get the most out of your retirement savings. My name is Rick Ferry and I'm the host of Bogle Heads On Investing. This episode, as with all episodes, is brought to you by the John C. Bogle Center for Financial Literacy, a 501C3 non-profit organization and can be found at BogleCenter.net. Today our special guest is Dr. Wade Fow. Dr. Fow is the program director of the Retirement Income Certified Professional designation and a professor of retirement income at the American College of Financial Services. He holds a doctorate degree and economics from Princeton University and has published more than 60 peer-reviewed research reports. He is an expert panelist for The Wall Street Journal. He has written three books in his latest book, Safety First Retirement, an intricate approach to a worry-free retirement, is the subject of our talk today. So with no further ado, let me introduce Dr. Wade Fow. Welcome, Dr. Thanks and feel free to call me Wade and it's great to be on the podcast. Well, thank you so much for joining us today. The Bogle Heads are extremely interested in the work that you're doing and I think it's fascinating. I've read all your books and we've got a lot to talk about, a lot to get through today. But before we get there, at least start by having you tell us a little bit of something about yourself. You decided to go into this field and what was your motivation? Sure. Going back to the early days and grew up in Michigan and Iowa, went to majored in economics, went to grad school for economics and then from there just slowly started stumbling into personal financial planning. My dissertation was about the Bush commission proposal to create personal retirement accounts by carving out part of Social Security. I was just exploring how that might work out in practice and that really became the foundation for what I'm doing today in terms of simulating retirement outcomes based on different strategies. I did spend 10 years in Japan as an economics professor. That was my first job out of grad school, focusing more on the pension systems and developing and emerging market countries. But in wanting to move to the US and find something more marketable here, started looking at was studying for the CFA curriculum and so forth. And I came across this 4% rule of thumb about how much you could spend from a retirement portfolio. So from that, I had another data set that the 4% rule is just based on US historical data, but I had the global returns data for 20 developed market countries. And I was curious, did the 4% rule work with other countries data? And that really became my introduction into the world of retirement income. When you started researching safe retirement rates using basically what you call the probability base system, which is a stock and bond and cash portfolio, you discovered that there was risks to that. And basically you came up with three risks, a longevity risk, a sequence of return risk, and also spending shocks. And those three things together gave you the idea that maybe that's not the most optimal way to build a portfolio for retirement. Could you explain those risks and why it may not be the most optimal way? Right. I mean, the 4% rule of this idea that if I had a million dollars, I could take out $40,000 in the first year. And then every year just spend that same amount with inflation adjustments. That's the fundamental way the investments world thinks about retirement income. Of course, there's a lot of variations on it, but that's a fundamental idea. And the way it seeks to manage these three types of retirement risks may not be the most efficient way. With longevity risk, this is the idea that you might live longer than anticipated. The 4% rule is meant to be conservative in the sense that it plans for longer than life expectancy. In 1994, the article is written, which now is 26 years ago. The idea was a 65-year-old couple. It's pretty unlikely that either of them would live past 95. So if you build a plan that worked for 30 years, you should be in good shape. Now, there's no protection there. You might live longer than 30 years, but at least you're trying to be conservative in that regard. And then it's the same sort of story with the market risk. The 4% rule, it introduced the idea of sequence of returns risk into financial planning because it accounted for how the market volatility impacted a sustainable spending rate. And it was based on the worst case 30-year period in terms of not necessarily the average return over 30 years, but the retirement that had the most negative experience early in the 30 years. And well, in this case, it was in the mid-1960s. Markets do great after about 1982, but it was still this worst-case scenario through the sequence of returns risk. But you try to spend conservatively that your plan will work in the worst-case 30-year period from history. And so people who are comfortable with it are comfortable with that being an appropriate way to manage the market risk in the sequence of returns risk based on a worst-case historical experience. And then the spending shocks. So these are, well, I've got my baseline retirement budget. I want to spend the $40,000 a year, but I may have surprises along the way with long-term care, big health care bills, different types of events that can happen. And the 4% rule, strictly speaking, doesn't help manage spending shocks because it does anticipate just spending your budget. You're going to end up with zero after 30 years. But that's only supposed to happen in the worst-case scenario. So if you're in any other sort of scenario, you don't necessarily end up at zero. And so you would have some excess funds available to provide a source of spending for spending shocks. And that's how the 4% rule manages those types of retirement risks. Now, it's not necessarily the most efficient way to manage these risks because it really just means I'm going to be extra conservative to try to not run out of money. I may not be conservative enough. There could be a new worst-case scenario. But most of the time, I would just end up underspending and then have a bigger legacy at the end than I otherwise had anticipated. But you also wrote in your latest book, Safety First Retirement Planning, which is a whole different way of doing this that, and I'll quote, there is no such thing as a safe withdrawal rate. A safe withdrawal rate is unknown and unknowable. So your research has shown that even if you said, well, let's make it a 3% rate instead of a 4% rate, even then it might not work. Yeah, that's just kind of the academic concept behind, well, if you are trying to spend a fixed amount from a volatile investment portfolio, that there really is no such thing as a quote unquote safe withdrawal rate, that anything could fail. It's the inherent issue of volatility with fixed spending. And so if you wanted to have fixed spending, you probably shouldn't have the volatility in the portfolio. Or if you want the volatility in the portfolio, your spending should also be flexible or volatile or adjust for the portfolio performance. The 4% rule of thumb does assume you use 50 to 75% stock-straw retirement. And that inherently creates the most sequence risk because it leaves you the most exposed to being forced to sell assets at a loss in a market downturn. Right now, if I wanted the 30 years of inflation adjusted spending with where kids' yields are, at this point, we're getting close to about a 3% safe withdrawal rate. And that would ensure you run out of money at the end of 30 years because you build a ladder of Treasury inflation protected securities. And if I'm trying to spend more than that, I'm investing more aggressively. I'm hoping and anticipating that the upside from the stock market will allow for a higher spending rate. But if I get a poor sequence of market returns early on, I end up having to sell principal and digging a hole for my portfolio. And so the portfolio may not recover with the overall market. And so that's really the risk created by that sort of probability-based approach in the purest form with how the 4% rule is structured. Then your solution to this is what's called the safety-first retirement approach, which would also feed in basically annuities and life insurance and perhaps reverse mortgages and other types of assets into the portfolio to try to mitigate the longevity risk. So in a broad sense, could you talk about the safety-first retirement planning approach? So and to just be clear, I know some Bogo heads take issue with which are can be expensive assets to use annuities. We know life insurance, reverse mortgages, all can have significant costs attached to them. But what really kind of the reason I find that these things can help in retirement is because of this sequence of returns risk and how small changes to this need to take distribution from a portfolio at a loss can really disrupt the retirement plan and how just being able to cut back a little bit on that can have such a huge positive net impact on the retirement plan that that's kind of the avenue where these different types of tools can help. It goes back to just looking at what's the efficient frontier for retirement income with an article I wrote now about eight years ago and just finding that stock bond allocations are really the least efficient way to try to meet a spending goal with downside market risk while also preserving an average like the highest average legacy at the end as well that if you basically shift from bonds to income annuities so that I mean an income annuity is effectively a bond portfolio held by the insurance company. But rather than paying coupons for a fixed number of years, they pay for the lifetime. They hedge your longevity risk. If you end up living to 110, they pay you until you're 110. Now if you end up only living the 70s, they don't pay you until you're 70. But by pulling that risk, you can have your retirement outcome be more on an average experience rather than if you have this worry about outliving your money and therefore spend less to try to stretch those assets out for longer. That's where the stock income annuity mix can work better for retirement than a stock bond mix. And that's a basic idea that safety first is. It's based on more academic type models going back at least to the 1920s which is if you have a basic spending floor where you really don't want your spending to have to drop below a particular level, the most efficient approach is you lock in that level with lifetime protections through risk pooling and then you can invest the rest more aggressively and spend more aggressively at a variable rate. So something like just following RMD rules on here's how much I'm going to spend from my discretionary investment portfolio. That increasing spending rate as I age from an aggressive portfolio mixed with an income floor, that that's a more efficient way to build a retirement income strategy than something like using the 4% rule from a total return like 60-40 style investment portfolio. This sounds an awful lot like a replacement almost for defined benefit plans which 50 years ago a lot of workers had defined benefit plans which were this annuity based on risk pooling, correct? And so people had this money coming in for the rest of their life. Now that defined benefit plans have gone away, it sounds like what you're advocating for at basic sense is to replace that. Yeah, yeah and Moshe Moleski even calls it like pensionize your nest egg. That's the idea with social security and with traditional defined benefit pensions we do get risk pooling and with a defined benefit pension the longevity risk is pooled. Some workers don't live as long as other and some live longer and also market risk is pooled because the insurer assuming they select the correct average they based outcomes on an average rate of return that some people would have been better off on their own with their own sequence of returns others would have been worse off but that market risk over time gets pooled and so a defined benefit pension it pays your pension based on an average market performance and based on it's a formula linked to your work history versus in a defined contribution pension where if you're investing that in a market portfolio you're now fully taking on the market risk of your specific sequence of returns and if you're going to do systematic distributions and not use any sort of annuity you're then also taking on that longevity risk. So indeed annuity is just provide a way to create that pension with that risk pooling that if you had a defined benefit pension you would have been getting that way before. We're not talking about everybody here. I think that the target market for what you're talking about are people who ordinarily would have had say a defined benefit plan. We're not talking about people who have 10 million dollars and only spend 150,000 dollars a year correct? Well I mean to some extent correct but at the end of the day it's still the same sort of idea that anyone now they they're not going to run out of money clearly but to the extent that you take some of your bonds or if somebody in that situation might have a big pile of cash sitting on the sidelines if you took some of that and put that into that lifetime income annuity and then you feel all the more comfortable investing what's left more aggressively you're still though you're not going to run out of money anyway you're creating a better foundation that you're at least if you live past life expectancy going to be able to leave behind a larger legacy than if you still just spent your 150,000 dollars a year from a 60-40 allocation on a 10 million dollar portfolio it's just a mathematical outcome that doesn't depend on the spending rate. Now if you are more constrained you can see a more noticeable increase in your probability of success it's not that you're going to see the success rate increase there it's if you've got 10 million dollars and you're spending 150,000 dollars a year your probability of success is probably 99% no matter what you do but still in terms of legacy it's what's the most efficient way to build the retirement strategy and in that regard using bonds to fund the retirement budget is really the least efficient way you can approach things. I did a little math to take a look at if my wife and I decided to take a million dollars and annuitize it at age 62 I am 62 and she's 60 went to the website that you recommended which is what's the website immediate annuities.com immediate annuities.com okay not a plug for immediate annuities we are non-commercial but I went there and I and I plug in some numbers and I see well what what could I get right now at 62 and my wife is 60 if we put a million dollars into this and it came out to 46,000 dollars a year I believe it was with 4.6 percent and then I said what if I never spent that money what if I just took that money and I invested in it in treasury bonds so as the money came in I invested in today's treasury bond rates you know at what point would I actually make more money than if I just took that million dollars and invested it in treasury bonds and quite frankly doing that gave me a much higher legacy rate of return as long as we one of us lived until we were I think was one of us had to live until our 80s and if one of us lived until our 80s by taking the higher return from the annuity and just taking the income from that and investing it in the same treasury bond that we would have bought we ended up having a higher legacy so the return if you live long enough the return from the annuity is higher and if you could explain why that is it's not just interest rates that drive the return on an annuity correct us the pool of investors that you're in right I mean the income annuity it's you really want to think about it as the cash flows because there is an underlying interest rate but it's not reported it's part of the payout rate that you get quoted and that's what you see it's the payout rate if I put in a million dollars how much will I get on a monthly and annual basis for the rest of my life and so naturally the longer you live the more cash flows you're getting back on your initial investment now it with a pure life only income annuity the the return is going to be negative until you get your full premium back as payments and then you'd have an internal rate of return of zero percent and then as you live beyond life expectancy your return gets higher and higher and if you live into your 90s yeah you're or even to beat bonds probably probably more like your mid to late 80s depending what the interest rate was on the bond it came out to 87 or so one of us had to live till we were 87 and then if I would have just invested 100% in a treasury bond versus investing in the annuity taking the money and put that into a treasury bond that's when I started making money in the annuity yeah and if you're both in average health at least not even bid health but just average health for the for a couple the joint longevity is going to be higher than 87 especially if you're non smokers that you're you'll have a 50% chance that at least one of you is still alive in the early 90s so the probabilities are in your favor of living long enough where you can beat out bonds with an income annuity you're right as far as a legacy asset and what I'm going to leave to my children even if I'm not going to be needing the income from an annuity it's actually a sometimes a good investment right if you're comparing just annuities versus bonds and not because then you can add in the stock market as well but with annuities versus bonds you're going to be lagging on the legacy for a while because bonds you still have the full liquidity for that but yeah once you're past life expectancy and then with the bonds eventually you're going to deplete that entirely and then you could talk about whether there's a reverse legacy like if I was just going to fund my retirement with bonds and I outlive the age that I anticipated I'll need someone to take care of me at that point but with the annuity though you may be given up legacy in the early years and we're talking about like a partial annuity strategy in reality no one's going to put all their money in the income annuity so legacies may lag for a while but if somebody ends up having a short retirement their errors are going to be getting a lot anyway it's really with the long term where you still can have a reasonable legacy with a partial annuity strategy versus with the bonds eventually they run out and you don't have any spending source at that point so it's changing the dynamics of what the legacy will be over time the annuity strategy will have a lower legacy before life expectancies but a bigger legacy after life expectancies and that's because of that risk pooling where as you live longer more and more of your spending is coming through the the subsidies of these mortality credits that investments just simply don't provide it's the premiums from the short lived helping to pay to the long lived raising that standard of living for everyone in that risk pool and that's what they call that they call mortality credits in other words I'm kind of making a bet that I'm going to live longer than you and we're all in the same pool together but I think my genes are better than your genes and my wife's genes are better than everybody else's genes in the pool too so if we get in this pool and if we actually win we only have to be on the top 50% as far as our longevity if you will we we come out ahead right and you can't think of it that way but often behaviorally it's not necessarily good to think about annuities as bets or investments because you can frame any sort of insurance that way like if I buy home road insurance I'm making a bet that my house will burn down and if it does I'll get this big payout and with the annuity it's a little bit different it's to protect a good outcome in this scenario where I live a long time and therefore my retirement becomes more expensive and I don't have the resources to fund that sort of longevity so it's insurance against outliving my assets more than it's a bet that will pay off if I beat the rest of the risk pool I mean you can think about it either way think about the insurance side as well when you're looking at your retirement plan you say there are basically four priorities and you start from the the bottom and work your way up and at the bottom is your basic needs in other words the how much you need to live on and this is where the annuities could help along with social security and then the next thing you have is called the contingency fund and a lot of people think of that as an emergency fund but you know I think the word contingency fund is actually probably a better word your house could need a new roof that's not an emergency but it is a a contingency the next level is discretionary and a legacy so I like the way that you prioritize that then you basically looked at this and said this is how you have to think about your retirement and you have to fill your basic needs bucket first with known income and then you have to have a contingency fund and then you could have your discretionary fund which might be filled more with equity and a legacy which might be filled with equity and fixed income or real estate or something am I getting that correct yeah yeah that's the idea in right the contingency fund it's really for any of these spending shots so in retirement there can be a lot more health related or long-term care and so forth so it yeah right it's more than an emergency fund but yeah that's that's the basic order of prioritizing and working your way up to your financial goals in your book and you talked about those liabilities of your basic needs and contingency and discretionary and legacy and you sort of married them up against your assets so you did liability matching these assets would be used to match up against these liabilities yeah and that's that important part of like the safety first approach it's an asset liability matching problem the liabilities are just the expenses associated with your goals which you are describing I use the term four L's as well the longevity lifestyle liquidity and legacy are your four L's the longevity about your core expenses lifestyle about discretionary liquidity for the contingencies and and then legacy for legacy of course as those are the liabilities associated with your goals and then positioning your assets to match to those goals with reliable income assets so things like social security individual bonds traditional pensions and then annuities as well potentially and the diversified portfolio and then reserve assets and so is it with this asset liability matching that's another thing where you can't double count assets so reserve assets are just what you have that's not already year mark for something else and that's important in the context of retirement income because if like if I believe in the four percent rule and I'm looking to spend $40,000 and I have a million dollars so I put it in a brokerage account and put it in like 50 50 stock bond mix do I have any liquidity uh technically the answer is yes my brokerage accounts liquid but in the meaningful sense of this retirement income problem the answer is no the entire million dollars is earmarked for that $40,000 spending goal and even though I could spend it on something else doing so directly jeopardizes that future spending goal and so the reserve assets are just what you still have available for contingencies that are not earmarked for one of your other three else your lifestyle longevity or legacy goals okay well now we're going to dig into all these different insurance products because they are they could be very simple again they can be very complicated and in your book you go through them all and some of them believe me could when I especially when I got to the variable annuity uh it got to be extremely complicated and I don't know how how anybody could keep this in their head difficult but let's go ahead and move on to the different types of annuities you talk about them all in the book and uh you know there's the basic immediate annuity deferred annuity uh getting into a whole life policy if you could go through the you know the pluses and minuses of each one of these types of annuities that would be great yeah so on the annuity side the spectrum would be the simple income annuity so single premium immediate annuity or deferred income annuity those would be uh those are fixed annuities they're on one side of the spectrum in terms of the most guaranteed income but the least or no liquidity and least or no doing no upside exposure and then as you move along the spectrum from that end towards the other end it's going to be the fixed index annuity and then the variable annuity so the fixed index annuity is in the middle where it is a fixed annuity but it's deferred you haven't locked up your money with it in the sense that you still have access to the funds and they're generally based on some sort of like a financial derivative strategy that's where you can read about how people can create their own fixed index annuity return structures they can't create the mortality credits if you have a guaranteed living withdrawal benefit but it's generally you have principal protection because the insurance company buys enough bonds to protect your principal and then with what's left over they buy some call options to give you some exposure to the upside it's like the very basic level of how they work so downside protection with some upside exposure and with a guaranteed living withdrawal benefit can provide that lifetime income and especially with the tax deferral they their returns could be competitive with the bond portfolio after taxes and then you've got moving along the the variable annuity at the other end which would generally then have the least downside protection that you can have the guaranteed lifetime income but it would generally be lower than what an income annuity or a fixed index annuity would provide but the most upside potential with the ability to invest in an underlying asset allocation and sub accounts that are not the same as mutual funds but they're the annuity equivalent of mutual funds and then also the liquidity as well were you because it's a deferred annuity you still can tap into and get access to those funds if you wanted to get them back and take them out of the annuity so that's the spectrum income annuity fixed index annuity variable annuity and where you end up on that spectrum really just depends on that tradeoff between the most the most income in the worst case scenario versus maybe less income in the worst case scenario but the most potential for a higher income if markets end up doing well you recommend that if people are going to buy a an immediate annuity that they should first not take social security delay social security oh yeah yeah that's an important point because step one of thinking about annuities is delay social security because delaying especially for the high earner in the couple the spouse might start sooner delaying social security age 70 that the delay credits that you get from doing that were based on the situation in 1983 when people were not living as long when the assumed real interest rate was 2.9 percent instead of the negative territory that it is now and so the implied benefit of delaying social security if you think of if I delay social security the benefits I give up become a premium for at least the difference in benefits the premium the benefit increase I get at 70 that's a really high assumed payout rate much higher than any commercial annuity could provide and so it'd be really inefficient to start social security at age 62 and then also buy an annuity first delay social security to 70 then figure out what's going to be your income gap at that point and then think about the annuity from there I kind of think of it in many ways as if you're going to go buy an immediate annuity that you are trying to beat the pool you know you're trying to be in the 50% that outlives the rest of the pool that you have other people in the pool who are thinking the same thing they're healthy and you know they think that longevity is going to beat the pool so everybody who's in that pool is you know I think probably more healthier than say the average person out there but that's not the case with social security I mean everybody's in the pool so if you're healthier delaying seems to me to be the best option oh yeah yeah absolutely right that with annuity is there's adverse selection that those who have a feeling they're more likely to live longer are more likely to buy the annuity but but right social security is based on the aggregate us population and so to the extent there's all these factors that are correlated with longevity some people because they have more of a long term focus and this is going to be a lot of bogelheads they just higher education higher income levels saving and accumulating more wealth that ultimately they're going to have a longer average lifetime than the average American so that's even speaking stronger to the idea of delaying social security because your likelihood of living beyond the break even ages is all the more greater than the average person and generally it's once you get past age 80 you benefit from delaying social security and 80 is well below life expectancies for well almost anyone who's going to be listening to a podcast about retirement income but I mean there's going to be accidents or illnesses that happen randomly on occasion but the average person listening to this type of podcast will live dramatically longer than the average American and that's even a stronger case for delaying social security and for annuities you also talk about another type of insurance which is called whole life normally you know out there in the world to stay away from whole life and but what you're saying and you're making the argument that this could actually be a good option for people yeah that that's what I found in doing my simulations and just to be clear so I'm still a little bit young to be buying the annuities I anticipate doing that but still in my early 40s but after doing this work on whole life insurance and I am at the right age so I found it so compelling I did get myself a big whole life policy I know Bola hedge generally don't like it but it's not about whole life versus the stock market this is about as a replacement for bonds the if you just think about the cash value as an alternative for taxable bond investments it can be competitive in that regard that the simulations I do they start at somebody who's still you know 35 or 40 years old and they decide they need life insurance pre-retirement then they think about do they buy term and invest the difference or do they buy whole life insurance which is going to have a much higher premium and it's going to reduce the amount they have in their investment accounts but then lays the foundation for then having different strategies for retirement income and comparing well what what sort of approach where I'm going to have a limited amount of savings each year and I can allocate that between investments term insurance and whole life insurance what can lay me the best foundation to get the most spending and legacy in retirement and finding there were a number of different ways that whole life insurance can fit into that puzzle to support more income and or more legacy in retirement and I found it compelling enough to actually kind of begin implementing this for myself it's we just had the discussion about the annuity that the simple income annuity often has the most downside income and that's true like a single life only single premium immediate annuity would have the highest payout rate and then if you have two spouses with annuities the way you protect the spouse would be you get a joint life or you get a cash refund or you keep the the liquidity for the underlying contract value and so forth and then that's your life insurance in that case you get a lower guaranteed payout rate because you're building in more protection through the annuity and I compare that to well what if I just have the death benefit to back up the annuity premium so in retirement you could get a single life life only income annuity backed by the life insurance and I found that that sort of approach could work much better than bi-term and invested difference and then doing systematic distributions or even bi-term and invested difference and then by a joint life income annuity at retirement and then the other approach it's really about the sequence of returns risk and it's this buffer asset which I first really learned about on the reverse mortgage side but cash value life insurance is the other major example of a buffer asset it's this idea you have something outside your investment portfolio that's not correlated with the portfolio that can be a temporary spending resource to help avoid having to sell assets when they're at a loss or in trouble or the rule that I found work best is whenever your remaining investment assets are less than the amount they were at the start of retirement in nominal terms draw from the buffer asset if you have it and that can really help manage sequence of returns risk and help to preserve the portfolio in a way that the gains in the portfolio can more than offset the fees associated with the buffer asset whether that's the expensive reverse mortgage or whether that's the life insurance that has of course the insurance fees but you're getting the death benefit for that but also just anything else related to the complexity of the contract and how that can lead to commissions or fees that are otherwise hard to tease out what exactly they are but looking at real policies finding that you can support more spending and or more legacy at the end of retirement as well with these more integrated strategies but it's the same idea again it's it's not that you're selling stocks to buy the insurance it's you're selling bonds to buy the insurance try to keep the same amount of stocks but you just position bonds so that they're not all held in bond bonds they're also held in income annuities or in in whole life insurance and I just found the results to be really compelling and tested many different variations on it I agree it's counterintuitive and surprising because I do come from the investments only world but I found it compelling enough to actually implement for myself so just a couple of clarifications when you're talking about your buffer assets you're talking about if you have a downturn in the market and you don't want to have to sell stock in order to take the money to live on that you go to one of these buffer assets like the cash value in a whole life policy or like a reverse mortgage and that's where you get the money from in the year or two in which the markets are down and then when the markets come back up then you can go back to selling stock then and this is the the concept of a buffer asset yeah yeah that's the idea and that because sequence of returns risk works in such odd ways the synergies of being able to avoid having to sell at a downturn or at a loss are really compelling and really then lead to a much better outcome for the portfolio in both cases with the reverse mortgage or the cash value you're treating it as a loan the reverse mortgage you're borrowing from the home equity and the cash value you structure it as a loan from the policy so there's going to be a loan balance that grows with interest but the the benefits to protecting the portfolio can more than offset the the costs of the growing loan balance associated with the buffer asset so yeah that's the idea we're going to talk about reverse mortgages but I think that before we do that we need to kind of clear up a couple of things and that is I live in a retirement community and an over 55 community and I get these invitations to go to dinners where they're put on by retirement specialists talking about giving me guaranteed retirement income for life so I went to one of these free chicken dinners you know I'll tell you it was the biggest farce I've ever been to in my life the guy used all kinds of emotional things to try to get particularly targeted the woman the woman in the audience to to say you're never going to see your grandchildren again if your husband dies unless you come and see me and I'm going to make sure you get the income that you get I mean like it was a real sleaze there's a sort of the impression that people get about you know insurance and insurance sales people so all of this stuff gets lumped under don't do it don't go there it's just high commission garbage yeah and I mean as a starting point default assumption that's probably a good rule to live by because as annuities get more complicated that they're not transparent so the that can allow costs to be internalized in ways that are not at all obvious I mean so the starting point is the simple income annuity and just the reason all these more complicated annuities developed was because the simple income annuity is you pay the premium and then that asset disappears from your balance sheet but you now have this protected monthly paycheck for the rest of your lifetime people were not comfortable giving up liquidity and then also they were not comfortable with giving up upside for that asset once you have the income annuity you can't strike it big in the stock market and so forth and so that's where these other types of annuities developed and these are deferred variable annuities or fixed index annuities and I think a lot of those chicken dinner type events are going to be for the fixed index annuities where they might even portray them as get the returns of the stock market without the risk and that to be clear is also not how they work but it's easy to get misled about that but at a basic level and so the idea is there can be good competitively priced versions of those that's not necessarily what you're getting at one of the chicken dinner events but it's a way to still have the liquidity you don't have to annuitize the contract so you can still get your money back now there could be surrender charges and things but you still have access to the funds and then you still have some degree of upside exposure and the variable annuity usually would provide more upside exposure than a fixed index annuity but you have the underlying contract value you have the upside exposure and then you have this optional rider that really was developed just in the 1990s initially this guaranteed living withdrawal benefit that will provide you that guaranteed lifetime income and you're spending your own money as long as there's money left in the contract but the idea is if the contract depletes that's when the rider kicks in and you'll continue to receive that guaranteed income for the rest of your life so it works as a source of guaranteed lifetime income but the companies have just made these things so complex and every company uses different terminology and then especially with the variable annuities they have the guaranteed roll-up rates that people misconfute misunderstand to mean a guaranteed rate of return and so the point of those two chapters in the safety first book was to just try to step back and describe how the annuities work so that if somebody's thinking about them they at least know the basic underlying structure and know what questions to ask and know what they need to understand to determine if that's the right type of product for their situation but yeah I mean otherwise the default is you do want to be quite cautious you know to me the transparency of say an index mutual fund here's the fee here's what you get here's the performance of the index here's the performance of the fund it's very clear even if you're doing you know treasury bond here's the interest this is what you're going to get you know here's the bond if you go to a bank and you buy a cd this is the annual percentage rate that you're going to get this is for how long if you turn it in early there's a penalty and it's all very simple and very clear and a lot of people can figure it out and on their own and they'll end up buying index funds and cds and you know keeping it simple but when it comes to insurance why things can get really messy I mean how do you know you're working with an agent who actually cares about you well but that's a good question and since I'm not actually involved in selling insurance these kinds of more practical issues it's a good question that I don't necessarily have a good answer for because you can't just go by on who has the nicest personality or who's a member of your church and so forth because those a lot of people can use these types of civic organizations to gain trust in inappropriate ways um so yeah I mean I don't have a good answer but I think you probably want to just do more especially like bogelheads who are more involved in this process do the research about the actual annuity products themselves figure out what annuity is right for you and then just as necessary use an agent to get what you want rather than having to rely on that agent to give you the proposals about what they want to sell you I guess would be the real starting point with that but do you see why there's a kind of an inversion to doing the whole concept of the safety first not that it wouldn't work it all sounds good and I'm sure that there are good companies out there to do it it's a question of how does a individual actually go out and decipher which are the good people to work with and whoever's out there selling chicken dinners trying to capture a 10 commission and on to the next person it makes it very difficult to say adopt your strategy which probably should be adopted by more people so the question is the process of how you actually ferret out all this stuff out there and actually come up with what is the way in which you do this yeah I'm probably like staying away from those chicken dinners is a another sound bit of advice but increasingly the annuities are now being offered on a like a fee only basis where they they don't pay commissions and so the traditional financial advisors who don't accept commissions and who just charge a fee from their clients to provide the advice are able to offer annuities to their clients as well and with the the fee only version since it doesn't bake in a commission it can have lower fees and and also even perhaps not have surrender charges or at least have dramatically lowered surrender charges as well but yeah your point's valid that it's hard to know who you can trust in the world of annuity purchasing let's talk about another buffer asset that you mentioned a few times now called the reverse mortgage which you wrote a book about in fact it was your first book you wrote it in 2016 some of the rules and regulations have changed since the book has come out so could you go over reverse mortgages and how reverse mortgages could work into this whole retirement plan right so it's it's another tool that you can have as part of the toolkit and indeed as people are starting to really figure out the value of reverse mortgages and it was possible to set one up for 125 dollars in some circumstances in august 2017 there was a rule change introduced that got implemented october 1st 2017 that effectively by increasing the initial mortgage insurance premiums raised the initial cost of setting up a reverse mortgage quite dramatically i wasn't planning to do it but i had to like write a second edition of my book to redo all the analysis under the new rules found the new rules did weaken the case for reverse mortgage but didn't completely overturn it so the the second edition of my book accounts for today's rules and it's the same idea if you can be strategic and you open the reverse mortgage and then use it strategically alongside the investment portfolio in any number of ways it can help lay a foundation for a better retirement outcome in terms of either supporting more spending and or the same spending but having more legacy at the end of retirement as well where legacy in that case would be what's left in your investments plus the value of your home minus the loan balance due on the reverse mortgage where it's the buffer asset same as we were just talking about with life insurance that you have the reverse mortgage line of credit and it's growing over time and it's it can't be canceled or frozen and then rather than having to sell from your portfolio at a loss in a troubling time you could tap into the reverse mortgage as a source of funds again it's proceeds from a loan so it's not taxable income doesn't show up as part of your adjusted gross income and it can provide that bridge for spending you could also just set it up as a contingency fund as a way to have liquid contingency assets for any sort of spending shock so there's a lot of ways reverse mortgages can be used wait a lot of these ideas seem to make sense what stops people from doing it in terms of annuities there's this whole academic literature about the annuity puzzle of just trying to explain why people are not comfortable with annuities and that we've talked already about the lack of liquidity and upside potential in a traditional income annuities another thing is just people they view it as the gamble like we discussed that if if I buy the annuity and then I die early the insurance company wins at my expense and people aren't always comfortable with that that's not strictly how the annuity works it's it's a long lived in the risk pool that that win at your expense rather than the insurance company but that that can certainly be an impediment and so there are things as well like charitable gift annuities where you can usually the payout rate would be less with a charitable gift annuity because it's trying to build in something for the charity but in that case you can frame it more as well the charity would win at my expense rather than the insurance company so that that can be a potential solution to that annuity puzzle could you explain what a charitable gift annuity is it's a way for charities to receive charitable contributions from individuals but to link that as well to a lifetime income now charities have different approaches the safest approach for the charity is they take your gift and they purchase from a commercial insurer an annuity for you to pay you but because they're offering a lower payout rate than a commercial annuity they're able to then keep part of that as a gift the riskier way for a charity to manage that would be to actually become an insurer themselves so to speak and to pay out the annuities through the the collections that they receive but either way is the idea is they're paying below market rates as annuities and therefore on average are able to receive a charitable contribution so that people can make that gift sooner but still receive a lifetime income connected to it so that they can also be thinking of it as it's like a way to mix their retirement spending and their charitable giving together into one overall strategy rather than keeping them separate how do the taxes work on that in other words do you give a gift to charity and they buy you an annuity I mean how much of a deduction do you get on the gift and how much of do you have to pay in taxes on the income that you get from the annuity well you're not going to necessarily get the full tax deduction right away you probably do want to indeed talk to a CPA to make sure that you're getting all those specifics right because indeed part of a charitable gift annuity payment can be taxable income and as we talk as well about this annuity puzzle and kind of why don't people seem to like annuities another idea that's been offered is it's been called the Scrooge McDuck effect yeah from the the old cartoons he loved to jump into his money bin and swim through his money and it was like people want to see their money they they may not have a money bin like Scrooge McDuck but when they look at their portfolio statement if they see a lot of funds they feel wealthier and if you purchase an income annuity you can lose that phenomenon the annuity has a present value of its lifetime future payments and that can be substantial but that's not usually reported anywhere and so people may feel poorer after purchasing an income annuity because instead of having this pot of assets to look at they do have a valuable asset if they just don't get to see it and they they don't appreciate it as much for that reason let's jump into one topic that you talk about a lot that is not insurance related and that is using tips in a portfolio well so interest rates are very low now but that's true across the board if you're going to hold individual or if you're going to hold bonds in retirement I think yeah the case for tips would be much stronger than for traditional treasuries but at the end of the day I don't just simply know how many different types of bond holdings a retiring needs it would lean more towards using that income annuity approach instead but yeah I mean it's if you want inflation protection tips and I bonds are the bonds that can provide that to you let's end with what you call the retirement research manifesto where you have eight points you put this in the beginning of all your books and I just want to go through them with you and comment quickly on each one the first one is play the long game uh-huh you occasionally hear somebody say oh I don't need a retirement plan I'm going to be dead by 70 and that's not really the way to think about retirement planning you've got to assume you're going to live a long time that the foundation of how we mostly think about retirement but it's just important to have that reminder on number two don't leave money on the table the idea there is to just be efficient with your planning and there's so many parts of retirement income where a small short-term expense can lead to a big long-term benefit and that's what I mean about not leaving money on the table in that regard use reasonable expectations for portfolio returns I think that one's really important a lot of financial planning software just plugging in historical averages for everything assuming bonds are going to average five or six percent returns when we see interest rates in the neighborhood of one percent you've got to be realistic and especially with sequence risk which leads into number four be careful about plans that only work with high market returns so much of the simple stuff you'll see online is assume an eight percent rate of return and this or that happens and sure it's easy to fund retirement with eight percent returns but the probability of getting those is not necessarily all that high you've got to make sure you have a plan that can work even if you don't get eight percent returns and that leads us to what we talked about today number five build an integrated strategy to manage various retirement risks bonds are a starting point and the way to try to spend more than just a simple bond portfolio you have the diversified stock portfolio aggressive portfolio and get risk premium from the stock market or you use an insurance approach and get risk pooling and either way you have the potential to spend more and they can manage these different risks the longevity the market risk and the spending shocks in different ways so integrating tools together is important and number six is the reason I want to do on the call today because of what's going on in the financial markets with very low historic low interest rates negative interest rates all over the world approach retirement income tools with an agnostic view yeah that's the important one because if you come from a particular area you think that's a solution for everything whether it's investments whether it's insurance even people who think that reverse mortgages are the solution for everything and and at the end of the day just keep an open mind about any sort of tool think about how it can contribute to your plan and and think about things that way don't just exclude things without a deeper investigation number seven start by assessing all retirement assets and liabilities the retirement balance sheet it's about asset liability matching and so you figure out your goals they lead to your liabilities or expenses and then you map your assets to those goals and you try to match up the risk characteristics so you don't want a lot of stock market investments for your basic expenses that sort of thing but you need to think about the whole picture about matching assets to liabilities and finally distinguish between technical liquidity and true liquidity an investment portfolio can be technically liquid but with asset liability matching if i believe in the four percent rule and i have a million dollars and i want to fund forty thousand dollars that money though technically liquid is not true liquidity it's earmarked to meet my future spending true liquidity is when you have assets that are not earmarked for something else and then they became the source of reserves that can fund your contingencies in retirement wait thank you so much for being on bogelheads on investing you gave us a lot to think about and i very much appreciate you being on the show today well thanks it's been a pleasure this concludes bogelheads on investing podcast number 24 i'm your host rig ferry join us each month to hear a new special guest in the meantime visit bogelheads.org and the bogelheads wiki participate in the forum and help others find the forum thanks for listening