Misleading Retirement Study

Ben Carlson says You Probably Need Less Money Than You Think for Retirement.  His “favorite research on this topic comes from an Employee Benefit Research Institute study in 2018 that analyzed the spending habits of retirees during their first two decades of retirement.”  Unfortunately, this study’s results aren’t what they appear to be.

The study results

Here are the main conclusions from this study:

• Individuals with less than $200,000 in non-housing assets immediately before retirement had spent down (at the median) about one-quarter of their assets.
• Those with between $200,000 and $500,000 immediately before retirement had spent down 27.2 percent.
• Retirees with at least $500,000 immediately before retirement had spent down only 11.8 percent within the first 20 years of retirement at the median.
• About one-third of all sampled retirees had increased their assets over the first 18 years of retirement.

The natural conclusion from these results is that retirees aren’t spending enough, or that they oversaved before retirement.  However, reading these results left me with some questions.  Fortunately, the study's author answered them clearly.

At what moment do we consider someone to be retired?

People’s lives are messy.  Couples don’t always retire at the same time, and some people continue to earn money after leaving their long-term careers.  This study measures retirement spending relative to the assets people have at the moment they retire.  Choosing this moment can make a big difference in measuring spending rates.

From the study:

Definition of Retirement: A primary worker is identified for each household. For couples, the spouse with higher Social Security earnings is the assigned primary worker as he/she has higher average lifetime earnings. Self-reported retirement (month and year) for the primary worker in 2014 (latest survey) is used as the retirement (month and year) for the household.

There is a lot to unpack here.  Let’s begin with the “self-reported retirement” date.  People who leave their long-term careers tend to think of themselves as retired, even if they continue to earn money in some way.  Depending on how much they continue to earn, it is reasonable for their retirement savings either to decline slowly or even increase until they stop earning money.  What first looks like underspending turns out to be reasonable in the sense of seeking smooth consumption over the years.

The next thing to look at is couples who retire at different times.  Consider the hypothetical couple Jim and Kate.  Jim is 6 years older than Kate, and he is deemed to be the “primary worker” according to this study’s definition.  Years ago, Jim left his insurance career and declared himself retired, but he built and repaired fences part time for 12 more years.  Kate worked for 8 years after Jim’s initial retirement.  

Their investments rose from $250,000 to $450,000 over those first 8 years of retirement, declined to $400,000 twelve years after retirement, and returned to $250,000 after 18 years.  Given the lifestyle Jim and Kate are living, this $250,000 amount is about right to cover their remaining years.  Although Jim and Kate have no problem spending their money sensibly, they and others like them skew the study’s results to make it seem like retirees don’t spend enough.

What is included in non-housing assets?

From the study:

Definition of Non-Housing Assets: Non-housing assets include any real estate other than primary residence; net value of vehicles owned; individual retirement accounts (IRAs), stocks and mutual funds, checking, savings and money market accounts, certificates of deposit (CDs), government savings bonds, Treasury bills, bonds and bond funds; and any other source of wealth minus all debt (such as consumer loans).

So cottages and winter homes count as non-housing assets.  This means that a large fraction of many people’s assets is a property that tends to appreciate in value.  Even if they spend down other assets, the rising property value will make it seem like they’re not spending enough.  It is perfectly reasonable for people to prefer to keep their cottages and winter homes rather than sell them and spend the money.  

Consider another hypothetical couple Ted and Mary who have generous pensions that cover their needs and wants.  Their only significant non-housing assets are a cash buffer of $25,000, and a nice trailer in Florida whose value rose from $40,000 when they retired to $200,000 18 years later.  By the methods used in this study, Ted and Mary appear to be continuing to save throughout retirement for no good reason.  In reality they’re not doing anything wrong.  Once again, people like Ted and Mary are skewing the study’s results.

What about an inheritance?

It’s not uncommon for retirees to receive an inheritance from a long-lived family member or close friend of the family.  When the amount of this inheritance is predictable, beneficiaries can account for it in their spending.  However, beneficiaries often don’t know much about when they will get money, how much they will get, or even if they will be named in the final will.  

It’s prudent for retirees to plan for the low end of a possible range.  When they finally get the inheritance, and it turns out to be more than they planned to receive, it might look like they’re underspending when we only compare their assets on retirement day to their assets two decades later.

Conclusion

It’s always possible for nitpickers to quibble with the methodology of any study.  However, it would make a material difference in this study’s results if we were to adjust its methodology to account for working income after retirement, cottages, winter homes, and inheritance.  The study’s conclusions don’t mean anything close to what they appear to mean.  They shed no light on whether retirees are spending reasonably.  We know that there are retirees who spend too much, others that spend well, and those who spend too little.  This study fails to tell us anything about the relative sizes of these three groups.

Party of One

We’ve heard for some time now that China’s rise as an economic superpower is inevitable, and that China will surely surpass the U.S.  Extrapolating from the past few decades, this appears certain.  However, changes made by China’s current leader, Xi Jinping, have cast doubt on China’s ascendancy.  Chun Han Wong has covered China for the Wall Street Journal since 2014 and has written the book Party of One: The Rise of Xi Jinping and China’s Superpower Future.  His descriptions of the massive changes Xi is making lead me to believe that China’s growth will at least slow, if not falter altogether.

My take on China is hardly original, and does not come from a deep understanding of China.  It comes down to the simple observation that for a society to become wealthier over the long term, its most brilliant and driven citizens must have the freedom to innovate.  We can’t know in advance which citizens will make a big impact, so this freedom must be available to most citizens to get the benefits from the few who will do big things.

Until recently, China’s rise has been impressive.  “Deng-era decentralization had unleashed dynamism that helped China boost its gross domestic product by more than fiftyfold from less than $150 billion in 1978 to $8.2 trillion by 2012, and bring more than 600 million people out of poverty.”  After decades of increasing freedoms under previous leaders, Xi has reversed course.  “Where pragmatic innovation once flourished, Xi imposed ‘top-level design.’”

Bureaucracy “has grown even more pervasive under Xi, whose top-down governance has driven officials toward foot-dragging, fraud, and other unproductive practices—so as to satisfy their leaders’ demands and avoid his wrath.”

Xi is using technology to exert greater control.  Citizens were assigned green, yellow, or red codes based on “their potential Covid exposure.”  “What began as a disease-control mechanism became a handy tool for social control, as some security agencies started using health-code data to flush out fugitives and block dissidents from traveling.”

“Xi’s insistence that entrepreneurs serve the party fostered what critics call a ‘hyper-politicized’ business environment, dampening enthusiasm to invest and innovate.”

Under Mao Zedong’s “totalitarian control,” “productivity frequently suffered, as factories were often overstaffed and workers generally content to meet minimum output quotas without concern for the quality or marketability of what they made.”  Although things aren’t this bad in modern-day China, Xi is heading down the same path.

In one example, police detained an entrepreneur, and his daughter stepped in to run the business.  But after more than 18 months, the daughter “made a dramatic plea: inviting the government to run the company and take over its assets.  ‘It’s too bitter and too tough being a Chinese private entrepreneur.’”

Although it has little bearing on China’s future growth, Xi’s sensitivity about his schooling is interesting.  According to “Hu Dehua, a son of former party chief Hu Yaobang,” Xi “attended school only until the first year of junior high.”  According to “one princeling who has known Xi for decades,” “Xi is not cultured.  He was basically an elementary schooler.”  “He’s very sensitive about that.”  Apparently, to compensate, Xi “started raving about his passion for books,” claiming to have read the works of dozens of famous writers.

In an extreme example of the suppression of human rights, “The United Nations human rights agency spent years reviewing” allegations of Beijing “committing cultural genocide against Uyghurs” and concluded that “Chinese authorities there may have committed ‘crimes against humanity.’”

According to “Wang Huning, a party theorist who joined the Politburo Standing Committee in 2017,” “American individualism, hedonism, and democracy would eventually blunt the country’s competitive edge.”  “Rival nations powered by superior values of collectivism, selflessness, and authoritarianism would rise to challenge American Supremacy.”  I think the opposite is true.  Rival nations can only catch up to the U.S. by freeing its people as China did to some degree in the decades leading up to Xi’s control.  Xi’s “top-down control suppressed initiative and flexibility, while encouraging rote compliance and red tape.”

“A decade into the Xi era, the party appears more in control than ever.  It embraces digital authoritarianism and maintains a high-tech security state.  It coerces and surveils its citizens with internet controls, big data, facial recognition, social-credit systems, and other state-of-the-art tools.  Civil society has been all but neutered; activists get imprisoned, muzzled, forced into exile, or coopted by the state.  Dissenting voices face police harassment, jail time, and a ravenous online ‘cancel culture’ fueled by party-backed patriotism.”

I’m not suggesting that China will collapse or that Xi will lose control of China.  China’s impressive economic rise to date could sustain it for decades even if its citizens are tightly controlled.  In a sense, the economy China has built is available to be spent by Xi in whatever way he sees fit.  He could also reverse course again and let capitalism grow its economy further.  As ever, the future is unclear.  What is clear from the evidence presented in this book is that Xi has made a hard break from the policies that fueled China’s rise.

The Intelligent Fund Investor

There are many mistakes we can make when investing in mutual funds or exchange-traded funds.  Joe Wiggins discusses these mistakes from a unique perspective in his book The Intelligent Fund Investor.  He covers some familiar territory, but in a way that is different from what I’ve seen before.  Although most of the examples in the book are from the UK, the points of discussion are relevant to investors from anywhere.

Each of the first nine chapters cover one topic area where fund investors often make poor choices.  Here I will discuss some of the points that stood out to me.

“Don’t invest in star fund managers.”  There are many reasons to avoid star fund managers, but I never thought of lack of oversight by the fund company being one of them.  “Individuals working in risk and compliance have little hope of exerting any control – they are likely to be relatively junior and considered expendable.  If they go into battle against a star fund manager, there is only one winner.”

Wiggins claims that index funds perform best during periods when large stocks perform well, but that active funds are better when large stocks falter.  This first appeared to be an attempt to support expensive stock-picking fund managers, but late in this chapter he explained that by “active” funds he means “alternative index funds” such as smart beta or “funds tracking equally weighted indices.”  As for the problem of knowing whether large stocks are going to perform well or not, the author suggests mild shifts in index fund allocation based on the valuations of large stocks.

Investors like steady predictable returns, but “smooth fund performance conceals risk.”  The reported price of most funds is “marked to market,” meaning that the fund price is based on the current trading price of its holdings.  However, for funds holding illiquid investments, we usually don’t know what the current price would be if the holdings were traded.  In this case, the holdings are often “marked to model,” meaning that there is some price model that the holdings are assumed to follow, and these models tend to give smooth results.  “Private equity is another asset class that enjoys the benefits of mark to model pricing.”  “Unfortunately, both the return and risk measures commonly used are illusory.”

Simple investment approaches tend to give better results than complex strategies, but that doesn’t stop investors from seeking complexity.  We like to feel sophisticated.  “We don’t just buy complex funds because we believe they might give us better outcomes; we buy them because they make us look better.  The asset management industry is a more than willing seller.”  Wiggins gives two examples of complex funds: XIV and LTCM.  While they are examples of complex funds that cratered, they seem more directly to be warnings about using excessive leverage.

“Great stories make for awful investments.”  At some point, “a certain narrow area of the market will generate strong performance.  This attracts the attention of investors and the media.”  Then fund managers “launch concentrated funds tapping directly into this area.”  Such “thematic funds are perfect for asset managers as they come with built-in marketing.”  Some thematic funds “will wither and die, while others will raise assets and continue to outperform for a time.  There is no need to worry too much about the investors left experiencing losses or stumbling from one story to the next.”

In a chapter where the author argues convincingly that “investment risk is not volatility,” but “is the chance that we will fail to meet our objectives,” he makes a strange assertion.  “Most of us will have to draw on our investments at some juncture.  We should aim to make withdrawals as small and as late as possible.”  Making withdrawals at some point is the purpose of investing.  The goal shouldn't be to die with the largest possible portfolio.  There is nothing wrong with living well, as long as it doesn’t force us to scrimp late in life.

A lesson I learned the hard way was that “past performance is a terrible way to select a fund.”  Sadly, this is exactly how a high proportion of investors choose their investments.

The interests of the asset management industry are very poorly aligned with the interests of investors.  Wiggins does an excellent job of explaining this problem in both the cases with and without performance fees.  He even takes a run at explaining the problems with having a fund manager invest his or her own money in the fund alongside investor assets.  I found this argument much less compelling than the discussion of the other conflicts of interest.

In a discussion about focusing on the long term and not abandoning funds too quickly, the advice seemed to be to be patient, but not too patient if it turns out that the fund is being poorly run.  I found the whole discussion to be a strong argument for using simple index funds and not worrying about other types of funds.

In the last chapter before the conclusion, Wiggins explains the good and bad of investing in ESG (Environmental, Social, and Governance) funds.  Investors who want to just buy ESG funds to feel good about themselves might not be happy with what they learn in this chapter.

Overall, this is a thoughtful book about investing in funds intelligently.  Investors who choose their own funds will likely find useful discussion here.

Short Takes: Paying Cash, Breaking up Telcos, and more

I’ve noticed an increase in the number of businesses offering discounts for paying in cash.  I’m happy to see this for two reasons.  One is that those who pay in cash (or some equivalent)  have been subsidizing credit card users who collect various perks at others’ expense.  The second is that I’m happy to have some of my purchases not contribute transaction fees to Canada’s banking oligopoly.

Here are some short takes and some weekend reading:

Teksavvy has some advice for the CRTC aimed at improving competition among internet providers.  The most interesting one is to “Examine functional or structural separation, where large providers are split into two distinct companies. Under such an arrangement, one company owns and operates a network and sells wholesale access to it to all comers on an equitable basis. The other purchases that access on the same terms and rates as every other competitor, and then offers it to customers as retail internet service. Canada's big telcos currently do not want wholesale-based ISPs to exist so they are intent on killing them off – splitting them in two would change that.”

Tom Bradley at Steadyhand makes the case for focusing on the fund returns that clients get (money-weighted returns) rather than funds’ time-weighted returns.  This puts the focus on helping clients improve their investing behaviour.

Robb Engen at Boomer and Echo explains the pitfalls in the ways people try to avoid probate fees.

Short Takes: Bank Accounts in the U.S., Investing in Retirement, and more

After only 10 short weeks, I’ve managed to open a checking account at a U.S. bank and move some money into it.  Some of the delay was due to misunderstandings on my part about what steps I was supposed to take next, and some of it was due to weird restrictions on the type of account in Canada that can be used to transfer money out of the country.  Mostly, though, it was the fact that there are many steps and each one seems to take a few business days.

I doubt that the specific details of my experience matter much.  The main takeaway is that if you’re considering opening a bank account in the U.S., consider starting the process long before you need the account to be in place.

Here are my posts for the past two weeks:

Bad Retirement Spending Plans

My Answer to ‘Can You Help Me With My Investments?’

Here are some short takes and some weekend reading:

Robb Engen at Boomer and Echo describes a smart two-fund solution for investing in retirement.

Tom Bradley at Steadyhand explains the risks of owning liquid versions of illiquid investments.  This adds to what I’ve read about illiquid investments that convinces me to stay away.  Your mileage may vary.