Friday, February 22, 2019

Your Complete Guide to a Successful and Secure Retirement

It’s not easy to figure out the best way to handle retirement accounts once you’re no longer collecting a regular paycheque. I’ve been working on the best way to handle my own retirement, so I was quite interested to read Larry Swedroe and Kevin Grogan’s book Your Complete Guide to a Successful and Secure Retirement. I’ve appreciated the academic rigour in Swedroe’s other books, and this one proved to be more of the same.

Unfortunately for Canadians, this book is for Americans. Most of the book is relevant to Canadians as well, but detailed discussion of retirement accounts and tax laws are for Americans only. Knowing the rough mappings (IRA, RRSP) and (Roth IRA, TFSA) helps in some cases.

This book leans toward giving advice to high net worth families. It isn’t entirely this way, but some parts are clearly intended to draw in rich clients for the authors’ advisory business. That said, it’s easy enough to ignore these parts and focus on solid advice relevant to people of more modest means.

The retirement topics covered are wide-ranging, beginning with a non-financial discussion of how to handle the big life transition of retirement. “One-third of all men over 65 become depressed within one year of retirement.” Such a sobering statistic should drive near-retirees to follow the authors’ advice on “helping you change the focus from retiring from something to retiring to something.”

One of the planning errors the authors describe is underestimating your needs. “The average person will need to replace 80 percent to 90 percent of their preretirement income.” I find it doubtful that the average person needs this much income to maintain a comparable lifestyle. This is far higher than most other recommendations I’ve seen that tend to range from 50-70%.

Another planning error is that “People often assume that their tax rate will be lower than actually proves to be the case.” I’ve found people tend to overestimate their retirement tax rates. Perhaps this is a Canada-U.S. difference, or maybe it’s a wealthy vs. not so wealthy difference.

The last retirement planning error the authors list is one I’ve seen many times in my own extended family: underestimating the build-up of inflation over time. It’s sad to see an older person trying to get by on a very modest income that used to be enough before the ravages of inflation.

An interesting chapter on “The Discovery Process” showed how talented advisors would draw relevant planning information out of their clients. I think this could be useful for my wife and me. You never know where you disagree with someone before you get them to say what they think.

“As Bill Bachrach says in his book Values Based Financial Planning: not having to worry ‘about your finances is critical to having a life that excites you, nurtures those you love, and fulfills your highest aspirations.’” Having watched how financial worries shrunk the lives of some of my older family members, I agree.

“The investor should consider tailoring the portfolio to gain specific exposure to the currency in which the expenses are incurred.” This is the reason I am somewhat overweight in Canadian and U.S. stocks.

One interesting aspect of retirement planning the authors advocate is making a “Plan B.” This is pre-planning what actions you’ll take to reduce expenses if your investment returns disappoint. It was this type of planning that kept me working longer. I worked extra time at high wage instead of waiting until I’ve been retired a decade and need to find a job likely paying one-quarter my previous wage.

The authors place a lot of emphasis on Monte Carlo simulations to look at a range of different retirement outcomes you could have. This is good to a point, but these simulators usually bake in the assumptions that returns follow lognormal distributions and that annual returns are independent. “Although stock returns do not fit exactly into a normal distribution ..., a normal distribution is a close approximation.” Actual data show that normal approximations aren’t good at the extremes, and that annual return independence breaks down over decades. It’s not clear that you’re really helping yourself by seeking 95% certainty that your plan will succeed. Long-term stock returns don’t tend to be as wild as simulators assume.

The authors are more conservative with withdrawal percentages than many others are: “we recommend that at age 65 you consider withdrawing just 3 percent a year from your portfolio, adjusting that each year by the inflation rate. You could increase that to 4 percent if you have options that you would be willing and able to exercise that would cut expenses should the portfolio be severely damaged by a bear market. If you are older than 65, the safe withdrawal rate increases as the portfolio does not have to support as many years of spending. At age 70, you can increase the safe withdrawal rate to 3.5 percent; at age 75 to 4.5 percent, and at age 80 to 6 percent.”

The failure of active management is well known, and the example portfolios worked out in the book are based on passive index investing with a heavy dose of factor-based investing. After starting with a portfolio A and optimizing it into a factor-based portfolio B using historical factor returns, the authors admit that “there is no way that, in 1982, we could have predicted the allocation for Portfolio B would have produced returns so similar to the allocation for Portfolio A. We might have guessed at a similar allocation, but we cannot predict the future with anything close to that kind of accuracy. This is an admission that the optimization method used future information. Actual portfolio construction must be based on guesses. I’m skeptical that heavy use of factors in Dimensional Fund Advisors (DFA) funds offers much advantage over simpler factor tilts available with Vanguard funds at lower cost.

There are four alternative funds where the math says returns are weakly correlated with other factors. In theory, these funds offer a way to get a safer, high-yielding portfolio. In practice, they scare me: alternative lending, re-insurance, variance risk premium, and alternative risk premium.

On the subject of tax-advantaged accounts (RRSPs in Canada), take the example of Mary who is in a 25% tax bracket: “The right way to think about it is that Mary never owned 100 percent of her $1,000 investment. She owned 75 percent of it; the government owned the other 25 percent. The government let Mary invest its share of the money until she withdrew her share.” Many people have a hard time understanding that their RRSPs are not entirely their own. Consistent with this way of understanding RRSP taxes, the authors advocate focusing on after-tax asset allocation.

I had never heard this term before, but I’m currently in the “black-out” phase of investing. This means I’m retired, but not collecting any government pensions, and have no required withdrawals from RRSPs or RRIFs. It’s in this phase that it’s important for many retirees to make some RRSP withdrawals to take advantage of low tax rates on low income.

On the subject of filing for Social Security benefits (CPP and OAS in Canada), “Being alive without sufficient assets to support an acceptable lifestyle is almost unthinkable for most people. Protecting for longevity always weighs the decision towards filing as late as possible.” I agree.

On the subject of reverse mortgages, “The lender can begin the foreclosure process if you fail to pay real estate taxes or homeowner’s insurance, or allow the house to deteriorate.” Of course, it’s very common for old people to have problems maintaining a house properly. Once a lender is owed nearly as much as the house is worth, the incentive for foreclose becomes strong.

There is a very interesting section later in the book on elder abuse. “According to The True Link Report on Elder Financial Abuse 2015, the amount stolen from elders each year in the U.S. is more than $36 billion.” The authors demonstrate that preventing abuse by family members and others is challenging.

An appendix tries to scare wealthy readers into seeking an advisory firm. To go it on your own, “You need advanced knowledge of probability theory and statistics, such as correlations and the various moments of distribution (such as skewness and kurtosis).” I have knowledge of these things, but I seriously doubt I’ll ever use them in planning my own retirement.

Other questions the authors ask about your ability to plan your own retirement are far more relevant: “Do I have a strong knowledge of financial history?” “Do I have the temperament and the emotional discipline needed to adhere to a plan in the face of the many crises I will almost certainly face?”

Although I’ve tended to focus on aspects I the book I disagreed with, most of the contents are excellent. Swedroe’s opinions on any subject are always well thought out and have significant academic backing. Deviate from his recommendations at your peril.


  1. The points of the book are interesting, but more so, your counter points (for which I agree with).

    Side question, if I may? Prior to your retirement, I believe you were very heavily tilted towards equity vs fixed income in your personal accounts. Did that allocation change when you decided to retire, or thereafter?

    1. @Lance: My rule has always been that I only have money in stocks if I think I won't need to spend it in the next 5 years. Prior to retirement, that meant my savings were 100% in stocks. Once I retired, I started maintaining 5 years' worth of my family's spending in fixed income. The rest is in stocks. I spend from this fixed income and replenish it as necessary by selling some stocks.

  2. “we recommend that at age 65 you consider withdrawing just 3 percent a year from your portfolio" vs. “The average person will need to replace 80 percent to 90 percent of their preretirement income.”

    These two lines are difficult to reconcile.

    1. @Larry C: I agree. You'd have to save a lot of money to satisfy both pieces of advice. I tend to focus on how much I spend now as a guide to future spending needs rather than using my income as a guide.

    2. Also your savings rate will disappear. If your savings rate was 20% pre-retirement, that means your lifestyle can be maintained at 80% of your pre-retirement income.

      As for the withdrawal rate (3%, 4% or whatever) my experience (10 years retired) is that I have only made lump sum withdrawals for special purchases (new truck). My wife on the other hand periodically withdraws the income generated by her investments. Never any capital.

      I realize that this may not work for everyone, but it is another perspective you may want to look at.

    3. @John Russell: The idea of spending only returns and leaving principal intact is widely used. However, the definition of "principal" can be quite tricky. I had a relative who only spent interest on Canada Savings Bonds back in the high-inflation days of up to 19% interest. Obviously, this was far too high a spending rate despite not touching principal. Today you can buy income funds that use return of capital to make part of the high payments. But this seems like leaving the principal alone because the investor maintains the same number of fund units. At the other extreme, if you only spend dividends from index funds, you're underspending because the principal is growing faster than inflation.

  3. Thanks for telling me about the "blackout phase." I hadn't thought of that opportunity for, as I see it, income smoothing.

    1. @always_learning: I've heard early retirees talk about how great it is to pay no taxes, but income-smoothing, as you say, is often the better long-term choice. This is especially true if you're destined to be subject to OAS clawback after mandatory RRIF withdrawals kick in.

  4. Looking back, I fault our former fiduciary adviser (CFP, fee-only) for not discussing "the blackout phase" with us when I stopped working involuntarily at age 63. We had significant assets in tax-deferred accounts we could have drawn on, plus significant inheritance on the near horizon. He tried to discourage us from taking CPP/OAS early but didn't offer alternatives. I'm confident wellw be fine long-term, but we'll probably pay more tax than we needed to.

    1. @Deborah: I've found this area to be complex; the right way to handle drawing down RRSPs is sensitive to many variables. I haven't been able to break it down to rules of thumb.