Should You Plan to Spend More in your 60s and 70s than in your 80s and 90s?

Episode: 171
Guest: P.J. DiNuzzo, CPA, PFS®, AEP®, MBA, MSTx

The Lange Money Hour - Where Smart Money Talks

The Lange Money Hour: Where Smart Money Talks
James Lange, CPA/Attorney
Listen every other Wed. on KQV 1410 AM or at our radio show archives. Note: Some events referenced in our archives have already passed.

 

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TOPICS COVERED:

  1. Guest Introduction: P.J. DiNuzzo
  2. The Safe Withdrawal Rate
  3. A Change in the Safe Withdrawal Rate?
  4. How Long Can You Expect Your Money to Last?
  5. Lump Sum of Annuity
  6. The Best Asset Allocation
  7. Diversification

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Welcome to The Lange Money Hour: Where Smart Money Talks with expert advice from Jim Lange, Pittsburgh-based CPA, attorney, and retirement and estate planning expert. Jim is also the author of Retire Secure! Pay Taxes Later. To find out more about his book, his practice, Lange Financial Group, and how to secure Jim as a speaker for your next event, visit his website at paytaxeslater.com. Now get ready to talk smart money.


1. Guest Introduction: P.J. DiNuzzo, CPA, PFS®, AEP®, MBA, MSTx

Dan Weinberg:  Welcome to The Lange Money Hour.  I’m Dan Weinberg, along with CPA and attorney Jim Lange, and tonight, we welcome back to the program P.J. DiNuzzo.  P.J.’s a nationally-recognized expert in investment management and was approved as one of the first one hundred Dimensional Fund Advisors.  His Pittsburgh-area firm, DiNuzzo Index Advisors, Inc. was founded in 1989 as one of the first few hundred fiduciary, or fee only, advisors in the United States, and it consistently ranks among the country’s top five hundred investment companies.  Now tonight, Jim and P.J. will be talking about how to spend your retirement savings as you age.  Should you plan to spend more in your sixties and seventies with the idea that you’ll likely spend less in your eighties and nineties?  Well, new research indicates there may be reason to question our traditional thinking.  So, with that research as the backdrop, Jim and P.J. will answer questions like: how long will my retirement savings last?  Should I take a lump sum or annuitize?  And what is the best asset allocation to take you through your retirement?  Now, feel free to give us a call with your specific questions.  The studio line is (412) 333-9385.  And now, let’s say good evening to Jim Lange and P.J. DiNuzzo.

Jim Lange:  Good evening, P.J.

P.J. DiNuzzo:  Good evening.

Jim Lange:  So, before we even get into the meat of tonight’s show, I do feel honor bound to have full disclosure.  Usually when I have guests, whether it be John Bogle or Ed Slott or Roger Ibbotson, I have no financial interest whatsoever in any of these guests.  Do I usually plug their book?  If I think it’s a good book, yeah.  And do they hopefully enjoy some book sales?  Yes.  But with P.J. DiNuzzo, it is different.  I actually do have a financial interest, and I just thought, by way of full disclosure, I would explain that.  P.J. and I have an arrangement where if a prospect comes to our office and meets with either somebody on our team or me, and they are a prospect for a combination of the services that we provide, which tends to be more in the strategic area, how much Roth IRA conversion should you make, what should you do for Social Security, what does your estate plan look like, and those types of things, and that’s really our area of expertise, then, the client also uses P.J. DiNuzzo and his firm, DiNuzzo Index Advisors, for the actual investments.  But rather than paying us a fee and P.J. a fee, they pay one fee, which is a very reasonable fee (the highest fee being one percent and the lowest fee being closer to fifty basis points or one-half of one percent), and then P.J. and I split that.  So, we do share, I think, close to about two hundred clients with a total of about $225 million together.  So, I clearly am not independent with P.J., and it is possible that if you are interested in the combination of our services that you should know that I am not independent with P.J.

All right.  So that said, why don’t we get to the meat of today’s program, and it was partly motivated by the ever-present question of how much money can I safely withdraw and never run out of money during my lifetime?  And we’ve had multiple radio shows on that, and one of them was with a guy named Bill Bengen, who’s probably the most cited expert in the world on the safe withdrawal rate, and he was kind of sticking up for the four percent for a thirty-year retirement.  So now, there’s some new research that says well, maybe if you’re in the early part of your retirement, maybe you can spend a little bit more on the theory that younger retirees spend more than older retirees.  So, I do want to get into that and related questions, but first, I thought I would ask you, P.J., if you could kind of explain to our listeners what the safe withdrawal rate is, just in case we are not communicating with everybody, and we want to be crystal clear about what the safe withdrawal rate is.


2. The Safe Withdrawal Rate

P.J. DiNuzzo:  Yeah, historically, it was not known really the safe withdrawal rate would be the number that we’re targeting that you could withdraw out of your retirement portfolio.  Again, you think typically that you’ve worked for, let’s say, an average of thirty plus years, you’re going to be retired for thirty plus years, so all of that corn that you put in the silo, all the money that you saved, what is a safe rate that you can draw out of that silo over the next thirty to thirty-five years of your retirement?  And as you said, you’ve had Bill Bengen on, one of the foremost national experts on this topic, and he historically has used a flat fee of four percent, and there’s been some recent research, which is interesting in light vis-à-vis at the historical four percent.

Jim Lange:  Okay.  Why don’t we just deal for one more minute what that four percent is?  And I’d like to give an example.  So, to make the math easy, let’s say you have a million dollar portfolio and it’s year one of retirement, and let’s say you and your spouse, you expect the longer of the two of you to live for thirty years.  So, the four percent safe withdrawal rate technically, or the way Bill Bengen explained it, says in year one, you take four percent times your million dollars, or $40,000.  That’s how much you can withdraw from the portfolio.  Then in year two, you can take $40,000 plus inflation.  But here’s an interesting facet: you don’t even have to look at the balance.  So, even if your investments went down, you could take four percent plus inflation times the full million.  And year three, $40,000 plus two year’s inflation, etc.  Now, I’ve never been quite that aggressive.  I like to look at it on a year-by-year basis, but that is the classic safe withdrawal rate.  So, when we say four percent, it really is four percent.

Now, if you are willing to maybe spend less if the market goes down, there’s arguments that you can take out more than four percent.  But P.J., what about this new research?  So, a lot of people, and I’ve had this discussion many times with people, have said, “Hey Jim, you know, I look at my parents, and when they’re in their eighties and nineties, you know, there are certain physical ailments that come, it’s harder to travel, and frankly, they lose interest in some of the things that cost a lot of money, and the house is typically paid off by then, and they don’t really need as much money as we might, let’s say, between sixty and seventy or sixty-five and seventy-five.  Could I take out more money now, in the early part of my retirement, on the theory that I’ll spend less later?”  Well, I posed that exact question to Bill Bengen, who, again, is the most cited safe withdrawal rate expert in the world, and he said, “No, no, no, Jim.”  He said, “Yes, people might spend more for travelling and they might, you know, get around a little bit better when they are in the early phases of their retirement, but in the later phases of their retirement, they have to think about medical cost, and the additional medical cost would be roughly equal to the additional travel cost, so you really can’t spend more now on the theory that you’re going to spend less later because it’s just too risky.”  Now, P.J., I understand that there’s some research that’s questioning what Bill Bengen said, and maybe you could tell our listeners a little bit about that, and what, if anything, you are doing about that research in your own practice?

P.J. DiNuzzo:  Yeah, Jim.  One of the top research analysts that we follow across the country, the head of retirement research for MorningStar, David Blanchett, recently penned an article estimating the true cost of retirement, and we’ve talked at our practice for years, or decades rather, about the three phases of retirement.  We refer to the first third, the second third and the final third.  The first third, we called “go, go,” the second third, “slow, go,” and the final third, “no, go,” and really it does echo what you had stated earlier, that individuals, when they get to the final third of their retirement, there’s health situations that would preclude them from being able to travel.  A lot of times, they’ll say, “Hey, been there, done that.  What am I going to see?  I’ve seen everything that I want to see,” etc.  And what Mr. Blanchett and his research came up with is that in that final third of retirement, that there is some statistical rigor that there is less spending.  So, what Mr. Bengen was referring to, the medical costs growing at a high rate, as far as the inflation, those medical costs don’t more than make up for that smaller spending in the final third of retirement.  The key would really be, I think, the question that you asked, Jim, what are we doing?

When I first started in this business, you mentioned in the late 1980s, the best practices at that time were we worked for months and months on a plan, we handed you a plan the size of a New York City phone book, and we said, “There goes your plan.  Hallelujah!  You’re in great shape for the rest of your life.”  But really, it’s turned into what we refer, we mention to clients, as an ongoing financial checkup, and the best analogy is the same thing as an ongoing physical checkup, and it really is customized from household to household.  We’ve joked around referring to a snowflake approach, but literally, every single household’s completely different.  And on some of these keys, it all depends.  As you said, there are different reactions.  A lot of people, how they made it through the ’07, ’08, ’09 meltdown, the great recession, was to tighten their belts.  So, they did cut back on their expenses, and that intuitively, the listeners in the audience can appreciate that does help your plan, but what about us as advisors?  Some folks want to spend the same or increase it.  Some want to maintain exactly the same.  Some are willing to cut it.  So, it’s really a customized relationship, and that gets back to the overall relationship that we have with clients with you and your team, with your estate planning law firm, with your CPA firm, with what we’re doing on our side from financial planning, retirement planning, and on the investment management side, we’ve talked before on the shows of customizing for this retirement plan with three separate portfolios.  And again, the customization that you do on an ongoing basis at your practice and that we’re doing in our practice is really this Cleveland Clinic-type financial checkup that we’re doing on a regular basis.  Again, we prefer to do it every six months.  It’s under the old adage of if you take care of the small things, the big things will take care of themselves, and it’s really this ongoing process.

The exciting part when I think about retirement planning is that in the joint effort that we offer between your two firms and our one firm, you know, with that. The value that we’re able to add is quite pronounced.  I’m just thinking of two recent cases that we had, and one national firm, which I won’t mention, but is considered now the largest robo-advisor in the country, big mutual fund company, and we had talked to an individual and given them sort of a little laundry list as far as what they needed to do to get their house in order and to prepare for retirement, and they called me back and they were questioning the list because they said they had gotten an opinion and got basically an A+ on their retirement plan from this national firm, again, who doesn’t meet you face to face, talking over the phone, you don’t know who your advisor is, etc.  Well here, the firm had underestimated their retirement expenses by $60,000 a year.  So, that’ll give you a lot better grade!  And once I pointed it out to them, you know, the painstaking detail we go through with all the personal financial statements, with the assets and liabilities and income and expenses, etc, and that, no, they were in fact off by $60,000, that was enough to basically seal the deal, that they appreciate that.

So, it’s all this attention to detail, and if I could just do a little segue, Jim, going into the future, I just spent time working, with our back office, our suite of technology, so to speak, for our entire practice, on what the future’s going to look like.  It is going to be almost…what we’re working on right now at our practice is a day-by-day upgrade on your portfolio, so to speak.  There may be a number of listeners in the audience who’ve heard of client portals, and the robo-advisors had made this big breakthrough, so to speak, with the portals, and all the firms across the country were thinking, “Holy mackerel, these robo-advisors are going to take over the world,” but then it’s really the way that they’re delivering the technology.  It’s almost, if you think of it, Uber vs. Yellow Cab.  It seems nuanced, but it’s really a major breakthrough.  So, what we’re working on at our practice right now is incorporating this deep and broad data gathering that we do at the beginning of every relationship with the personal balance sheet, assets and liabilities.  I just worked on two of our joint cases today.  We had initially five cash flow statements, five iterations for them, retire now, retire in one or two years when they wanted to, a couple age differences between the husband and the wife, one not getting Medicare, the other getting the Medicare, Social Security maximization (which you’re an expert at), etc.  So, there was literally five major financial points of inflection until basically all the dust settles until the second spouse reaches age seventy…actually, the sixth iteration is going to be working with your CPA firm on great Roth candidates retiring early, a lot of money in the bank, not earning much interest, they’re going to have zero income for a few years, and it’s really these customizations that make the difference.  So, with us taking that into the new financial planning software that we’re onboarding, we’ll be able to upgrade your plan on a daily basis.  So, we’re looking to roll that out later this year.  The real big breakthrough for us has been all of the software…and I’m sure you have the same challenge in the office, Jim.  You’ve got great software A and B and C, but they don’t talk to each other.  So, that’s really been the big breakthrough here that we’ll be able to present our clients with a daily update on their retirement plan for their needs bucket, their wants bucket, and the dreams and wishes bucket by aggregating all their personal finances together.

Jim Lange:  Well, let me make a comment on software, but I do still want to get back to the safe withdrawal rate.  Now, we have a different function.  Ours is more strategic: how much of a Roth IRA conversion should you make?  What year should you make it?  What is the best Social Security strategy?  What’s the best estate planning strategy?  How much you could spend?  And this is what we found, for whatever it’s worth.  We actually have multiple software programs, but none of the programs, and I would imagine it’s the same in your world, none of the programs are sophisticated enough that you could just put in a bunch of variables and hit ‘maximize.’  It’s much more like the concept in math of interpolation.  Well, let’s try this and see how this works.  Let’s try that and see how that works.  Let’s try this and see how this works.  So, it’s partly art and partly science to come up with the appropriate strategy.  But getting back to the safe withdrawal rate.  So, very frankly, I will be honest with you.  If you were following my newsletters within the last several months, I actually included a newsletter talking about the old four percent, and some people are actually saying less than four percent, and then David comes along and writes this article, and, of course, it’s hard to summarize the article because he has a hundred pre-conditions.

P.J. DiNuzzo:  Yeah.


3. A Change in the Safe Withdrawal Rate?

Jim Lange:  But is it fair to say that at least he says that under certain assumptions (and we can get to those), that for a thirty-year retirement, rather than starting with four percent on year one, or even years one to five or even one to ten, that you could even consider going to four-and-a-half or even five percent.  Is that a fair reading?  Now, he does have some conditions, so this isn’t just, “Okay guys, you can use five percent, don’t have to think about it.”  But that was the end of his article.  Now, there was a lot of gobbledygook to get there, but was that your reading, or are you so focused on what I would call the gobbledygook that really is individualization?  And I’ve heard the snowflake analogy a hundred times, and now I use it too because it’s certainly that way with Roth conversion, Social Security, how much you could spend, estate planning, spendthrift child, no-good son-in-law, you know, people do come in different shapes and flavors.  So, what, if anything, are you doing about the safe withdrawal rate, or is it the kind of thing where you’re saying, “Well, that’s nice, but our clients are probably a little bit more comfortable at four percent?”

P.J. DiNuzzo:  Yeah, it literally is customized on a case-by-case basis, and that’s what I was referring to, Jim.  We’re able now…this is the first time, and, again, it’s a big deal for us because it’s the first time in twenty-seven years that we’ve got a software at the next level that we can tie into and do all these customizations.  Like you said, a piece of software is only as good as the input it’s given, and we are providing the advice, obviously, as wealth advisors, but to give us a tool to do extrapolations on a daily basis, well, we’re taking our assets and liabilities, income and expenses, all of our different iterations from an Excel spreadsheet or a point in time, but to able to place these in and update these on the data aggregation where we’re pulling in the balance from your mortgage on a daily basis, your checking account, your 401(k) at work, and we have a living, breathing balance sheet, that’s really what we’re most comfortable with is that customized format.  Now, customized for certain households, as you said, there’s an art as well as a science, we do have households that we do understand what those caveats are and what the specific levers and switches are, and they are around a five percent rate of withdrawal.  And again, you have to understand the caveats and other clients were at four, but, I mean, really, the key is updating this on a regular basis, staying on top of it, customizing it for each household, but we are very excited.  I mean, this rollout of our client portal, I’m not prone to hyperbole, but it is going to be…

Jim Lange:  No, you’re not, by the way!  I’ve known you a long time.

P.J. DiNuzzo:  Yeah, I’m not.

Jim Lange:  And you’re one of these understated guys.

P.J. DiNuzzo:  Yeah, but this is arguably, at least, in a tie and maybe a standalone, the largest forward movement improvement that we’re going to be able to deliver value to clients in the twenty-seven years we’ve been in the practice by pulling everything together and providing them with a very succinct, extraordinarily high level where we’re leveraging up all this hard work that we do and your firm does that we’re jointly putting in together, and we do have those key toggles that you mentioned, the top five to even ten, what if inflation is higher, what if it’s lower, what if one of the spouses were to have a shorter life expectancy.  I mean, it’s everything across the board.  What if my pension got cut back through a downturn?  So really, the top ten variables that individuals are sensitive to, and we call that area the ‘play zone,’ where they’re actually able to go in themselves and use those toggles back and forth to see how it affects their plan, but it’s really going to bring our plan to the next level, and again, it’s exactly what we’re doing with our team and you’re doing with your team, but again, my overall macro concept here is tying it into that safe rate of withdrawal.  It’s customizing that and managing that as close as humanly possible on a household by household basis.

Jim Lange:  So, is it possible that…and by the way, I appreciate you announcing this, because I follow all of your literature and I have not seen this.

P.J. DiNuzzo:  This is hot off the press from last week.

Jim Lange:  All right, so we have an official hot announcement, a first for The Lange Money Hour, although we actually did have a presidential announcement.  Remember when Larry Kotlikoff announced for his candidacy for president?  By the way, he’s not such a nut.  He wrote the bestselling book on Social Security in the country.  Mine’s number two.  I just thought I’d put that in there a little bit!  But his was number one, and he gave us some great information.

So, let’s say that you have this software that, and let me tell you how I am interpreting this.  When I read the article and it had all these preconditions before you could go to five percent, it was mainly watching things after you’re making this decision, and perhaps the combination of the idea that no, we don’t tend to spend anywhere near as much, let’s say, between eighty and ninety as sixty and seventy, that we actually can take out more money, we can enjoy a higher lifestyle, or even if we don’t, we can feel more confident.  And, I think, Jonathan Clements talked about part of the joys of not spending money, that a lot of people just genuinely enjoy having money that they’re not going to spend, and it makes them feel better.  Is it possible that the combination of Blanchett’s research and the tools that you’re talking about would enable someone to a) either spend more money than the four percent, maybe up to five percent, and b) if they choose not to, at least feel better that they’re being very conservative?  Is that a fair summary?

P.J. DiNuzzo:  Yeah, that’s very accurate, Jim.  You know, I just think of a case that comes to me at the top of my mind.  You know, we talk about the bucket approach for the needs, the wants and then the dreams or wishes.  I’ve had a couple of our joint cases I just met with in the last couple of weeks that are very heavily overfunded in the dreams and wishes bucket, the extra money, so to speak, and they’ve got sensitivity as to the children, but they are spending more in this first third, maybe even into the second third of retirement, understanding that “Yes, I have an ideal range I’d like to leave the next generation, my children, but, you know, for us to travel and do what we want to do, if it’s a little bit less, that’s okay.”  In that case, again, we’re looking at around a five percent rate of withdrawal because, worst case scenario, it may dig into their dreams and wishes, but they still have a significant cushion to be able to get them through their entire retirement plan.

Jim Lange:  And I hate to repeat myself on anything, but I do feel honor bound by full disclosure to mention that P.J. and I are not independent financially.  Usually, when I have a guest, I might plug a book if I think that they have a good book, or I might talk about what service they might have, but I don’t have any personal financial interest in whether you do any business with them.  On the other hand, P.J. and I have an arrangement that if you come to our office first, that our office does what we would call ‘the strategies’: the Roth IRA conversions, there’s certainly some overlap in how much money you could spend, estate planning, Social Security strategy, what you should be doing about your children, your no-good son-in-law that you don’t trust, these types of things.  His firm actually does the money management.  They do a lot of planning, and that’s what we’re talking about today.  But anyway, you actually get the benefit of both of our firms, and instead of paying each of us a fee, you pay one fee, which, depending on how much money is invested, is anywhere between fifty basis points or half of one percent on the low side and one percent on the high side, which he and I split, and we could think of it as a win-win-win because he gets to do what he’s really good at, which is the actual money management side in the planning; we get to do what we’re good at, which is the strategic part and the estate planning, and the client gets what we think is the real win, which is the best of both for one fee, and with that, we have roughly two hundred clients, maybe $225 million total, and we have a 98% retainage rate.  So, people have stuck with the program.

But anyway, so, P.J., we were talking about safe withdrawal rates, and one of the questions that people have all the time is, “Well gee, how long can I expect my money to last?”  And again, you’re probably going to tell me, “Oh, it’s a snowflake situation!”  But why don’t I let you determine that?  So, how would you answer somebody’s question if they said, “Well gee, how long can I expect my money to last, and do you ever take other assets into account?”  Such as, maybe they have a paid up house?


4. How Long Can You Expect Your Money to Last?

P.J. DiNuzzo:  Yeah, certainly.  On how long it would last regarding the retirement savings, you know, we would prefer for that to be under the topic of longevity risk.  There’s a risk that may sound sort of counterintuitive to the audience, to the listeners, but if you think you’re going to live to, let’s say, for example, if a male thinks he’s going to live to age eighty-three, and he lives longer than age eighty-three (he lives to eighty-seven to ninety), well, that’s a huge risk to the retirement plan if the longevity is longer than what the estimate was.  What we do is, whenever we’re talking to individuals, you know, you get the good old-fashioned IRS actuarial tables, the average male at a certain age lives so long, etc.  But we like to ask three additional questions to, let’s say, the typical household, to each spouse or each partner, and that would be a question…the first one, obviously, that has the largest impact on life expectancy is are you a smoker or not, the next question would be regarding your personal health, would you grade your personal health at above average, average, or below average, and then the last one is the family genes, so to speak, has the longevity in your family been above average, average, or below average?  And that really gives us a highly customized number, which is very difficult to argue with, so to speak, and we really don’t have this challenge with women.  I can’t really think of a single case we’ve ever had it.  We have it with men an awful lot.  They swear up and down they’re not going to live past a certain age.  “I don’t want to spend all my money.  I’m going to be disturbed if I pass away and there’s anything left in the bank account, etc.”  So, that’s a real challenge in managing expectations.

One thing that we see a lot when folks come in from other firms is they’ve talked to an advisor who’s using a longevity expectation, and it’s just at the fiftieth percentile.  And again, I’ll remind folks that, you know, if you’re using that, that fifty percent of the time, you’re going to live longer than that expectation that someone else has given you.  So, we go down to the thirtieth percentile, again assuming that for safety that they’re going to live a little bit longer, but when you get that customized, you know, we try to start off…I’m getting in the weeds, but if we start off with the real big picture, if you think of it, you know, one of the challenges is if folks have under-saved and overspent.  If you want to think about retirement, some rules of thumb for how many years you’re going to draw money off the portfolio you saved, you’re going to have to save for at least that many years.  So, take a look at your portfolio, and even divide it by a shorter time horizon, divide it by twenty, how much money you’re going to withdraw out of that portfolio per year.  Divide it by twenty-five, divide it by thirty.  So, a lot of folks are surprised.  You know, just a recent case, again, I was going through, that they’re talking about retirement within a decade or so, and, you know, the income in the household’s well over $200,000, the total investments would provide around $30,000.  So, there’s a lot of expectations that need managed.  So, you know, regarding under-saving, again, the big thing is managing expectations, you know, the same thing the audience has heard before, but get started as early as you can and save as much as you can, and even remember that if you don’t save as much as you can younger, the national averages are, again, the typical individual preparing for retirement is a procrastinator, and really, there is a significant amount of money socked away (for lack of a better word) that final decade coming into retirement.  So, if you are behind, if you are unable to really ramp it up and increase your saving significantly for that last decade, something’s going to have to give.  You’re going to lead a diminished retirement regarding spending, or you’re going to have to work an extra number of years to be able to provide.

Jim Lange:  Well, one of the challenges that we have, and we’re talking about maybe potentially increasing the safe withdrawal rate, is we’ve actually done a study in our own practice.  So, as you know, we have recently taken new space.  In fact, we’re sharing it with you because we have an ever-growing number of common clients, and we see these clients and review these clients and we just ran out of conference room and rooms to house everybody.  So, we were trying to figure out how much work we’re going to have in the future, and one of the things is we, as we also have a law firm, and we have, I believe it is somewhere around 2,250 wills, so we have the birthdates of when these people were born, so we know how old they are.  My daughter, she is a math whiz and she’s very good at actuarial tables and she made a calculation that we should have a seven percent mortality every year, meaning that seven percent of our clients should die every year, and that that could be a reasonable estimate of how much estate administration that we should have, and then we could plan personnel and space accordingly.  Well, it turns out our actual rate is closer to three or four percent.  So, why would our clients live so much longer than the national average?  And it’s hard to say, and I don’t think it’s a cause and effect relationship, that is, you know, it’s not like if you use our services, that you’ll live longer, but maybe a little bit!  But the theory is that we tend to attract smart people and the two marshmallow people.  Now, the two marshmallow people that I’m talking about as studied down in Stanford, where they gave all these five-year olds one marshmallow, and they said to the five-year olds, “You can eat the marshmallow now and you can enjoy it now, or if you wait fifteen minutes before you eat the marshmallow, we’ll give you another marshmallow.”  Well, of course, most of the kids ate the marshmallow.  But a whole bunch of the kids didn’t eat the marshmallow.  They waited the fifteen minutes.  They had cameras on these kids.  They were squirming.  They were going nuts.  But a bunch of them did wait.  Then they tracked these kids for forty years, and most of those kids actually did really well in life.  Their marriages lasted longer, they did better at work, and I think that you and I, P.J., tend to attract the two marshmallow kids.  And the other thing is, we tend to attract people who are smart.  Just the nature of our marketing tends to be more attractive than, you know, come get a rubber chicken dinner and then I’ll sell you a crappy annuity, which is…well, I better watch myself, but I’ll just say that we’re at a higher level.  So, we get smart, two marshmallow people who live longer, and maybe that’s something that needs to be taken into account on how much money they can spend, and if you’re having guys who are saying, “Oh no, I’m only going to make it until eighty-three, therefore I can spend a lot of money now,” some of your caution might be very well advised.

P.J. DiNuzzo:  Yes.

Jim Lange:  So anyway, that also goes into the question: should I take a lump sum, or should I annuitize?  And I guess I’ll just start off with a scenario.  So let’s say that you have some money, either in a 401(k) or a retirement plan, or even a pension plan, and sometimes, you have the option at retirement of saying, “Okay, I just want the money.”  Boom!  And you get a chunk of money, usually rolled into an IRA.  Or two, you can give the pension company, the insurance company, all or a portion of your money.  In return, they will give you a certain amount per month, perhaps if you’re willing to take a little less, a certain amount per month for the rest of your life and the rest of your spouse’s life, or what a lot of people do is some of each.  Do you have a position on lump sum or annuitizing?


5. Lump Sum of Annuity

P.J. DiNuzzo:  Yeah, Jim, on the annuitization, I think starting from the ground up, you know, we have a lot of joint clients, professors at major universities around town, and there’s the TIAA traditional annuity, and we’ve loved that for the security.  The professors are typically in love with it as well.  They like the stability, the fact that it’s paying, on average, a higher than market rate of interest, and from our approach, we love to use that to fill our needs bucket.  Members of the audience may have heard me talk before about our needs bucket.  Each household has a unique food, clothing, shelter, healthcare and transportation need, and typically, three out of four times, your Social Security is not large enough to satisfy that need.  So, that is sort of a low hanging fruit that we use an awful lot, maintaining the TIAA traditional annuity to solve that solution.  The next one is, as you said, you were talking about the rubber chicken circuit, there’s an awful lot of people that you meet that come in and have annuities!  And fortunately, a reasonable number have…

Jim Lange:  Now, to be fair, let’s distinguish.  You’re talking about commercial annuities that tend to have very high internal costs, high fee for the advisors.

P.J. DiNuzzo:  Yeah.  Our position is that…again, just our personal position, we would defend that there’s no reason to just put your money into a variable annuity, for example, because we feel there’s other ways of doing that with a couple of percent less per year in expenses.  But again, these are people that have met with other people in the marketplace.  They’ve already purchased this.  There’s surrender charges, etc.  But if there is a living benefit rider on a variable annuity, and there are solid insurance companies out there who’ve provided these, that again, the knowledge of being able to incorporate that into the portfolio and helping the client use that to the best of their interest for that needs bucket is a huge help.  You know, one area we’ve been able to help a lot of people, when you come down to the black versus white question you asked earlier, Jim, the lump sum versus annuitization, we run into a lot of clients, and again, joint clients who are thinking that they’re ready to almost over-annuitize, or annuitize too much.  So again, once we show folks the clear line between fulfilling that needs bucket versus the wants bucket, I can say as a pretty much hard, fast rule of thumb, at least nine individuals out of ten do not want to overfund that with something that’s higher expenses and higher fees and is more restrictive.  A lot of those individuals are very happy to have that guarantee with their Social Security and that annuitization covering their needs bucket, but in a lot of cases, we’re saving them hundreds of thousands of dollars not being tied up in higher fees and higher expenses.

Jim Lange:  Well, the other thing that I have noticed, you know, working with you through the years, is you use the example TIAA, which both you and I are a fan of.  To my knowledge, you have not displaced one dollar in TIAA, even though probably nine out of ten advisors would recommend a change in your TIAA because you don’t make any money on that, but you are a fiduciary duty advisor, meaning that you have the, not only the moral, but the legal obligation to do what is in the client’s best interest, which is one of the great things about what you do.

P.J. DiNuzzo:  I can’t remember one case in twenty-seven years, so yeah, we love that.  It’s a perfect fit.  It’s low fee, low expense, and again, we’re making less money, so to speak, by not bifurcating that or taking some of that and placing it under management, but as you said, we’re not trying to sound too altruistic, but, you know, we do honestly have our client’s best interests at heart, and that is a perfect fit for that needs bucket in the portfolio.

Jim Lange:  First the answer, then the question.  The answer is, “Gee Jim, everybody’s a snowflake and every situation is different.”  Now, the question.  “What’s the best asset allocation to take me through retirement?”


6. The Best Asset Allocation

P.J. DiNuzzo:  Yes, that’s the million dollar question.  As we go through our process, we do have a target aggregate asset allocation.  Again, for the audience, for the listeners, that’s one part I dislike about our business, is we got all these fancy words for some things we try to make as down to earth and common sense as possible, but asset allocation is simply the percentage of stocks in your portfolio versus the percentage of bonds, and, of course, money market would be included on the bond side.  The stock side of the portfolio, U.S. stocks, international stocks, etc.  They could be individual stocks or mutual funds, it doesn’t matter.  But that’s really going to be the key driver and the key determinant for how much money you’ll make over your lifetime, in plain English, and also the risk that you’ll bear on your portfolio.  So, the best allocation in the portfolio, what we’re doing is, typically for our retirees, we come up with three individual strategies.  One for the needs bucket, which would be conservative.  We don’t want that portfolio targeting, most times, down more than ten percent over a calendar year.  A balance strategy for the wants bucket.  We’re targeting, we really don’t want that to go down more than twenty percent over a typical calendar year, and then the dreams and wishes.  That could be anywhere from seventy percent in stocks up to a hundred, but what we’re really focusing on, again, is what is that aggregate allocation when we add those three together again for stress testing the entire portfolio, and what we see whenever we’re meeting with clients is, and at the risk of oversimplifying this, but if you’re overly aggressive, we refer to that as decades that we’ve told clients that you’re getting ready to win the race, you’re getting ready to step over the finish line, get the wreath, the gold, the medals and everything else, and you decide, “Oh, I’m going to turn around and go back out and jog around a little bit and let other people catch up to me and make it interesting.”  That will be the case where you may just need an overall allocation, and again, it’s customized, but it may be fifty percent overall, or sixty percent overall, or sixty-five, maybe forty-five, and you may be a hundred percent in stocks, which we see a surprising amount of time, and really, you’re putting your entire retirement plan at risk if you were to go through a severe bear market, or even a moderate bear market, taking withdrawals off of that portfolio, you’re putting your portfolio at risk.  So, the ideal asset allocation in that case, of course, would be less than a lot of clients who come to us.

On the other side, we see the flip side of the coin where people are putting their retirement plan in jeopardy to the tune of ten to twenty percent, or even twenty-five percent more risky, or a higher failure rate is a better way I could explain it, by being under-allocated.  And unfortunately, since the super recession in ’07 and ’08 and ’09, we see a lot of individuals surprisingly that we’re still meeting who exited the market and still have not reentered the market.  I just had a preliminary meeting with an individual that we’re going to have an initial discovery consultation with and they are fourteen percent in stock in their overall portfolio, and eighty-six percent in bonds, fixed income money market.  That’s just not going to be enough.  One thing that the audience needs to remember is you won’t notice it in a year or two, but it will show up in a short period of time, the effects of inflation and the withdrawals that you will take on your portfolio.  So, you have to have enough growth in your portfolio.  There’s only one asset class that we know of, and that is equities investing in our economy and the worldwide economy growing through GDP and the companies that are involved in that GDP.  So, you’re going to have to have enough growth in your portfolio to be able to take withdrawals over time and offset the effects of inflation.  The number of people who meet with Jim initially who are taking a four percent withdrawal out of a portfolio, even some people who are conservative with three percent withdrawal, well, if you’re earning one percent on your money, you’re taking a three percent withdrawal, and inflation’s two percent (we’re being conservative here), you’ve got a negative five and a positive one for the one percent interest.  I mean, we’ve referred to that, you know, for decades, as losing money safely or losing money slowly, and you won’t notice in a couple years, but given five years or even, unfortunately, it takes the average person close to ten years until it gets their attention.  At that point in time, the ship has taken on so much water, you’re not going to be able to bail yourself out.


7. Diversification

Jim Lange:  Yeah.  Jane Bryant Quinn calls that the Harvey the Rabbit risk because you don’t really see Harvey, but he’s there chipping away at your purchasing power.

Well, we only have a few minutes, and one of the areas certainly related to asset allocation, but I would say that we see an even bigger, or, perhaps more important, or more egregious problem with, is the diversification.  And one of the things that we do, in fact, we usually do it even before somebody gets to see you because, very frankly, one of the reasons we have a 98% retainage rate is that we get to be selective, and there’s quite a few clients that, if you’re going to be a general pain in the you-know-what, we ask you to go somewhere else.  But if that isn’t the case, people come in and we actually run their portfolios through MorningStar, and we tend to find most clients (one today an extreme case) have poor diversification even just within the stock sector itself.  So, let’s even say they have the appropriate percentage of stocks or equities, but they tend to have a lot of U.S., they tend to have a lot of large companies, and they tend to have a lot of growth.  So, can you talk about, say, an alternative to U.S., alternative to large, and alternative to value and growth?

P.J. DiNuzzo:  Yeah, that’s one thing, Jim.  What we always see in the portfolios is, and this may sound as overstating this to the audience, but what we see consistently, and we’ve seen this for twenty-seven years, is what shows up in individual’s portfolios when we meet with them for the first time and we start to do the analysis, as you notice in your office, is they own a lot of what’s done well recently.  And unfortunately, they didn’t own it before it made the big move five years ago, or three years ago.  I always refer to it as they’re buying the past numbers.  They say, “Oh, it’s done twelve percent a year for the last five or ten years.  I want some of that.”  Well, you just bought it right now, and typically, you take a look after everything makes a run.  I mean, typically, you’re buying the bad end of that.  You look at the history of Bill Miller Legg Mason value trust fund, the majority of individuals who own that fund, I believe, didn’t make any money because they came in late to the party.  So, you’re not going to make money in the market.  I mean, if you want to think about someone along the lines of Warren Buffett.  I mean, you have to let the market come to you.  You want to be diversified.  You have to have an investment philosophy.  We have a historic philosophy.  We know what our asset classes have done for eighty-eight years.  You have to have a strategy based around that philosophy.  So, a disciplined strategy around that regarding the asset allocation, it’s always the toughest trade to make.  It’s the most profitable trade.  Everybody always talks about and jokes around about, “Well, I want to buy low and sell high,” and that’s what we’re doing consistently in our portfolios.  We’re selling high whenever that area in the market has gone on a run, and we’re buying low on the area that hasn’t.  So, and then again, this isn’t unique to DiNuzzo Index Advisors, this is what you would see across the country in the largest, best and brightest run firms in the country is buying low and selling high, having a philosophy, having a plan, having a strategy, sticking to it, and all we know is, again, you’ve had Mr. Jack Bogle on a number of times.  It works like a charm over time.  You don’t know, is it going to take one or two or three years, but when things are in cycle or out of cycle, they’re typically on a roll for a few years.  You’re not going to notice that uptrend today or tomorrow.  Typically, the average individual notices it after two to three years.  So, you’ve already missed the first big two or three years of the run regarding that asset class.  You may catch a good six months or twelve months and then it’s down for a couple years and you’re cursing it again, you’re selling out and you’re on to the next shiny object.  So, again, you want to have a philosophy.  You want to have a strategy.  Two-thirds U.S., one-third international.  As I say, no one rings a bell when international’s been soft for a few years, but no one rings a bell at the bottom whenever it’s time and it comes up off that bottom, believe me, it’ll make a twenty or thirty percent move, or even higher, before the average individual knows, and you’ll underperform the rest of your life by chasing returns.

Jim Lange:  And I guess you could say the same thing about value investing and the size.  That is, most people tend to overinvest in large companies, overinvest in growth companies, underinvest in, let’s say, international, as you mentioned, and underinvest in value and small.

P.J. DiNuzzo:  Yes, since U.S. large and U.S. large growth has done better, again, you’ve seen everybody clustering into that space, they’re crowding into that space, but again, value’s done better historically.  We have all the confidence in the world that that will continue over our lifetimes.  Again, you have to always be disciplined.  You want to have a representative share of small stocks, not as much as U.S. large, but we say two-thirds large and one-third small.  You want to own themw in your portfolio, as well.

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