Unveiling the Retirement Myth

But you are missing the point. There is no need to plan anything in order to save. There is no need to plan anything in order to invest. There is no need to plan anything in order to draw down funds.

E.g Everyday you make trade offs between spending money now (instant gratification) and retiring early (or going back to school, or buying that big boat LATER). The decision is not make according to some 'plan'. It is made according to which you think is more important at that specific time. You ask yourself "will spending this money make my happier?'. Or "will traveling in retirement make me happier?"

In other word you just do your best, knowing only the generality that you will need savings for retirement (etc).

Learning basic math does not constitute a 'plan'. You do not 'run the numbers' through that math everytime you make a purchase (or decide not to). Nor do you do not need to run the numbers every year-end, because you already know that you did your best.

I expanded on the math angle only because you showed you did not know what it was all about.

Along with the concept of financial planning, we find that some individuals 'budget'. No, they don't sit down every time they are about to go to the store and make a purchase, but at various times they (presumably) determine a budget to see whether they can afford a major purchase... can I buy a new car every three years? what should I plan to spend on a monthly scale such that I will be able to buy that new car, and still make it out to some reasonable age without sucking air.

Budgeting means striking a balance between spending and saving. If you choose to blindly plow ahead without any foreknowledge, fine... maybe you are blessed with scads of money... I'm not.

Using a calculator or a set of tables might suit some, however the world is much more complicated when you include the effect of income tax, bridging, inflation, partial retirement,... unfortunately, "common sense" doesn't always cut it. The mere fact that you are sitting at a computer and participating in this forum says you have access to more computational power than your parents could even dream about. Why not harness it in some small measure?

Leslie above said: Instead ask yourself "how did people save, invest, and retire for the hundred's of years BEFORE the terms 'financial planning' was invented.

Up until the late 1980's people saved using Savings Bonds & GICs and retired using life annuities or a Defined Benefit Pension Plan (aka: a Life Annuity). Investing as we know it today simply was not available to the masses until very recently.

In fact I don't know of anyone and who has sucessfuly proven you can accumulated assets using a diversified portfolio and retire with a inflation adjusted 4% income for 30 or 35 years.

Leslie, do you know even a single person you can hold up as an example that proves it would be sucessful startegy?

In the distribution phase any amount of loss might become a permanent loss.
The efficient frontier, asset allocation, frequent rebalancing, asset dedication, diversification, the concept of "long-term" and Monte Carlo don't and can't work in a distribution portfolio as you might want to believe.

In a distribution portfolio you will be Lucky or Unlucky in the early years of retirement. The sequence of those returns is what matters and will determine the longevity of the portfolio. People need to hedge the risk of being Unlucky.


http://www.yourwealthadvisor.ca/zonestrategy.htm

Below are two a clips from pages 454 & 456 of Jim's new book.

Quote:

"The zone strategy tells you exactly whether your portfolio will be accumulating or decumulating during the distribution stage.

• If you are in the green zone, your portfolio will be accumulating. If you are lucky, it will accumulate at a steeper rate, otherwise it will accumulate at a slower rate.
• If you are in the red zone, your portfolio will be decumulating. If you are lucky, it will last a little longer, otherwise it will deplete sooner.
• If you are in the gray zone, your portfolio may be accumulating or decumulating, depending on your luck.


Export or Retain the Risk:

There are three financial risks of retirement: longevity risk, market risk, and inflation risk. When you buy a life annuity with payments indexed to CPI, you are in effect exporting these risks to the insurance company. Keep in mind that the insurance company is a for–profit organization; transferring risk to them costs you money. For example, if you are buying a life annuity, you have to part with your capital permanently.
By definition, if you are in the green zone, then your portfolio has sufficient reserves to cover the longevity, market and inflation risks. For you, the volatility of returns is the deciding factor, which can be handled with proper asset allocation and diversification. You do not need to export these risks to an insurance company. Only if you want to feel extra safe, you can export risks partially or fully, and you will still have money left to invest.

However, in the gray and red zones you have no choice. Your investment portfolio does not have sufficient reserves to cover longevity, market and inflation risks. For you, the sequence of returns is the deciding factor and that cannot be fixed within the investment portfolio. In the gray zone, you need to allot part of your assets to annuities. In the red zone, your entire assets are used to purchase annuities"

End Quote

The belief that "planning is necessary ... to be mortgage/debt free" is wrong. Common sense everyone is born with, and does not require any advisor, tells you to save up FIRST to pay for what you want. Therefore you do not go into debt in the first place.

The offshoot of this error is thinking that you can 'afford' to make certain purchases NOW, because your budget says you will have saved the money by some LATER date. In effect budgets PROMOTE spending before the cash has been saved.

There is no motivation to save 'because of a budget' commitment. There is no emotional gratification from budgeting. You save because you really, really WANT that new car. The more you want it, the more expenses you are willing to cut.
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Regarding whether you are "lucky or unlucky in the early years of retirement ... will determine the longevity of the portfolio". There is an assumption behind that position - that withdrawals are a set dollar value (or inflation adjusted set $). As a result you get the same, but reversed, effect as Dollar-Cost-Averaging. A set $$ taken from a portfolio after it has lost value hurts more (as a percent of it) than the same $$ withdrawn when its value was higher.

But that assumption is not true in the common sense behavior I exampled above (that does not need any planning or advisor or modelling). Your withdrawal is relative to the portfolio's gains - it reduces the net % return.

Look back and you will see I stipulated you have to set aside (say) 2% (as well as reinvesting inflation) in anticipation of the bad years. In those bad years you live off the accumulated immergency fund. E.g. I average a loss year in every five. So after putting aside 4 years of 2% I have 8% to live off for (say) 2 years until the market recovers. So again this mechanism reduces the net % return you plug into simple math.

The reverse dollar-cost-averaging effect does not play out. Not from the draws for living expenses nor the funding for years of investment losses.

Another way to draw funds that does not result in the reverse-dollar-cost-averaging effect is to again draw relative to what was earned. But calculate the year's maximum draw as the average of the past (say) 5 years returns (after inflation reinvestment). Again, no plan, no advisor, simple.
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If the OP of this thread really wanted to help people, he would tell them about another time-value-of-money calculation that is NOT on any calculators I know of --- the PRESENT VALUE OF A GROWING ANNUITY. This calculates the nest egg you require to fund an annuity of retirement payments that grow with inflation. Put it into an Excel spreadsheet so that you can solve for any of its variables:

expected after tax investment returns % (less what you reserve for loss years)
the portfolio balance at the start
the inflation rate you expect
the starting value of the draw for living expenses (not including taxes).

I can remember many, many years ago... I think it was 1st or second year algebra. It was a module on finite series. We went through all the time value of money derivations to the point we could derive them on our own (PV, Sinking fund, FV, annuity...). It was rigorous, but once you understood it, it was pretty trivial.

At the end of the module, our prof showed us how to derive the formula for an indexed annuity. That was pretty hairy, but the punchline he delivered went along these lines...." All the math we have just slogged through is pretty much useless... none of these formulae relate to the real world. For instance... why should we derive a financial plan and assume that the interest rate is going to be constant? (as we get older, we grow more risk averse and our rate expectation goes down) or why should pmt levels stay constant? Might it not be better to design an annuity which has a higher pmt (adjusted for inflation) in the first 10 years to account for the fact that our lifestyle requirements may take a dip in our latter years? or surely these investment cash flows don't exist in a vacuum. You will need more income in the years prior to 60/65 before your CPP/OAS kick in, or before your loan is paid off... fixed payment (inflation adjusted) annuities don't allow for that. Or how about a planned-for sale of your cottage 10 years out?"

The time value of money algebra is fine for teaching someone compound interest... the general implications of saving for retirement and subsequently living off the proceeds, but as practical, real life tools, they just don't cut it.

Now for the coupe de grace... Income Tax. The only element which has meaning (to me anyway) is the amount of cash (after tax) available to purchase beer, groceries and gas (as well as the occasional car every 5 years say)

The above-mentioned math will not solve that problem for the principal reason that the income tax formula is not linear... it is a complex calculation involving discrete tax brackets (indexed to inflation) age credits, loan interest deductibility, dividend tax credits.... it is a nightmare.

Why is it a nightmare, given that many of us still do our T1 by hand, you ask? Simple... the tax formula was designed to work from the top down, whereas for the purpose of financial planning, we need to start at the bottom (net income) and drive the T1 backwards. The simple question... "how much should I draw from my RRSP such that I net (after tax) exactly $30,000?"... sounds easy, but it isn't. Now throw in the reality that tax on our RRSP withdrawal doesn't live in a vacuum... we are taxed on investment growth on capital outside of our RRSP, maybe even at the dividend rate. We are receiving additional taxable income from CPP, a pension, an annuity. This is absolutely impossible to solve with even the most convoluted set of time-value-of-money formulae.

Thankfully, there is a way to solve these kinds of problems... recursion math. The way you would solve that simple 'how much to draw from my RRSP to return $30K after tax?' question can be done by hand. You simply continually shovel RRSP withdrawals into a T1 program until you get close to the answer. It can be time consuming... trial and erroring 10 , 20, 100 times until the exact $30K drops out, but it is do-able.

Before the modern day computer arrived, this would have been the way to solve the 'reverse tax' problem, but now, the computer allows us to solve the 'needs-based' (after tax driven) tax accurate financial planning problem quickly and easily. The bad news, is that spreadsheets are not sufficiently fast or flexible, however using a procedural language (C++, Basic, Fortran, ...) will solve the problem and allow it to converge in a reasonable (several seconds) period of time.

Sorry to ramble on like this, but is is kind of my life's (well the last 15 years anyway) work. I get sort of passionate about it.

leslie replied: "Regarding whether you are "lucky or unlucky in the early years of retirement ... will determine the longevity of the portfolio". There is an assumption behind that position - that withdrawals are a set dollar value (or inflation adjusted set $). As a result you get the same, but reversed, effect as Dollar-Cost-Averaging. A set $$ taken from a portfolio after it has lost value hurts more (as a percent of it) than the same $$ withdrawn when its value was higher.

But that assumption is not true in the common sense behavior I exampled above (that does not need any planning or advisor or modelling). Your withdrawal is relative to the portfolio's gains - it reduces the net % return."

end quote.

Nonsense. Withdrawals during retirement are based on actual need, not market returns.
If you depend on that income to pay bills you can't defer withdrawals until you get better returns or decrease withdrawals to some arbitrary amount in keeping with the returns of the past year. What do you do if the market falls by 40 or 50% all at once, or goes sideways for 10 years?

Distribution income planning is about planning & designing a safe and reliable inflaton adjusted income for life. If you are in the Red or Grey Zones you cannot afford to finance the time-value of fluctuations. Your only relaible and safe option is to export risk to an insurance company.

http://www.yourwealthadvisor.ca/app...772426-offloading-risk-to-insurance-companies

http://www.yourwealthadvisor.ca/apps/links/

The conclusion of my comments that you quoted provide the answer to your objection.

leslie said:

Look back and you will see I stipulated you have to set aside (say) 2% (as well as reinvesting inflation) in anticipation of the bad years. In those bad years you live off the accumulated immergency fund. E.g. I average a loss year in every five. So after putting aside 4 years of 2% I have 8% to live off for (say) 2 years until the market recovers. So again this mechanism reduces the net % return you plug into simple math.

The reverse dollar-cost-averaging effect does not play out. Not from the draws for living expenses nor the funding for years of investment losses.

Another way to draw funds that does not result in the reverse-dollar-cost-averaging effect is to again draw relative to what was earned. But calculate the year's maximum draw as the average of the past (say) 5 years returns (after inflation reinvestment). Again, no plan, no advisor, simple.

Click to expand...

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Maybe you remember that there was a big market crash last year. I survived just fine by doing the above - living off what I had put aside for loss years. I cut back all my discretionary expenses - no big deal. My portfolio has now recovered to the Jan08 level, and it is above the inflation adjusted balance I started retirement with.

No need for planning. No need for advisors. Just common sense - doing the best I can each and every year.
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Regarding annuities, you assume my position is 'against them'. Not at all. Once you reach the age where your cohort is dying at a good clip, they start to offer good value because you capitalize on the value left behind by those who die --- and I expect to long longer than the average. I think they are of value to everyone, no matter the size of your portfolio, to cover your necessary costs. The only people I would exempt would be home-owners with a revenue suite. Because RE works much the same way as an annuity.

But there is no value to annuities when you retire early (me). Not enough people are dying for them to give you a better rate than bonds.

steve41 said:

OK I could have changed my guy from two different loan strategies to two different CPP timing strategies... taking at 60 and taking at 65. The point is... here is someone with exactly the same age, financial assets, etc... except his "A2W number" can vary all over the map. The above example showed A2W values in one case 8, and the other case 20.

My number (the ATI/BQ) varied hardly at all. That's my point.... what is the significance of the A2W?

And more importantly... can a person get dangerously mislead by not understanding it correctly?

Click to expand...

I've been busy so I am just catching up now. Thanks for posting the outputs for your two examples.

I don't get what point you are trying to make... take 2 cases which are identical except in one significant area and point out that the A2W's aren't going to be the same during that period. I don't need a tool to tell me that - it should be obvious.

What would be perhaps more telling is like one of the other papers mentioned - determining "safe" A2W's based on the investment mix and forecasted growth rates.

One thing that the paper did not try to simulate was what would happen if one drastically changed the mix during the drawdown phase based on the stock market performance. Specifically, if the market has run up very high (greater than normal P/E ratios) and one expects it to return to the norm, what happens when one liquidates a healthy portion of assets and buy the inverse. And, the opposite like earlier this year - when the market is in an historically low evaluation period, liquidate fixed income portion to go overweight the equities. (Don't do this in a non-registered account otherwise the capital gains triggered could be extremely detrimental.)

Or, when interest rates are quite high, purchase annuities at that point in order to lock-in a higher income stream as opposed to living with a variable based one. Perhaps another paper has done that research.

leslie said:

Instead ask yourself "how did people save, invest, and retire for the hundred's of years BEFORE the terms 'financial planning' was invented.

The answer is in my post above. No one needs to be told how. Common sense is all you need. Your assumption that we would be "sucking air at age 70" with "rottn kids" without them is preposterous. My parents weren't. Nor were their parents. Nor will I be.

This industry has created a need for its own services, a need that does not exist. You have been sold a bill of goods and your defense of your own need for it proves my point.

Click to expand...

steve41 said:

Garbage.... My folks had a set of tables (they were very common from what my Mom told me) These tables had three sections...

-mortgage/annuity
-sinking fund
-future value

Using these 3 tables, you could, based on what you had saved already and what you planned to continue to save until retirement... what you could look forward to in retirement. They were arranged by rate and length of term.

They taught the use of these tables in high school home economics!

Well before the computer even existed.

Click to expand...

Common knowledge and common sense are sometimes oxymorons. One of the items I decry about our educational system today is that kids are taught about all manner of things like Canadian history and to not dangle participles - but, heaven forbid they should be educated on personal financial management.

And, even if people have been taught, does that mean that they only need that one lesson before they make it part of their day-to-day routine? When I was young, I used to exercise to look good for the summer season - now, I exercise as a lifestyle change because I need to and it is hopefully going to make my life healthier and better in the long run.

You might think that this subject, which appeals to one of people's most basic drivers (GREED), would be of keen interest to everyone. There certainly are enough avenues to learn more and get the help necessary. But, people have different passions at different phases in their lives. I believe that it is typical to find personal finance books in the bestsellers' lists of non-fiction works. Television is a hit and a lot of misses - for every show dedicated to it (whether it is Suze Orman or "'Till Debt Do Us Part") there are 5 or 10 "infomercials" about how you can get rich quickly and easily.

It is encouraging that they are sites like this, with people like yourselves, which are providing support to others not so well versed, or not as keen.

Personally, I try to help others so that they can improve their financial state of affairs. The biggest problem I have is finding how to ignite the passion within them. I know that once this becomes their priority then they will be more receptive to the positive changes necessary to reach their goals.

Judging or criticizing people because they haven't achieved what we think they should is not the best way to start. Patient guidance without condescension would be more appropriate.

I once tried to construct a book which could be of general use and was comprised of several hundred tables. I used my program to generate the tables. I soon discovered after observing many disparate financial plans, that hardly any of these tables would be of the slightest use. Everyone is in their own complex financial universe.... retired/not, pensions (various types), savings (reg/nonreg/equity), loans (of various complexions) expectation of a future capital gain (downsizing home, selling cottage, inheritance), different income targets (buying a new car every five years...), estate goals (die broke, specifying an estate level on death).... it goes on.

Trying to make even the most remotely useful set of tables was a complete non-starter. I am afraid that the only way (other than using the good old "common sense" dartboard) is a single inclusive program which allows you to specify all the above variables in one integrated number crunch. (rather than running separate disconnected spreadsheet illustrators)

The point I was trying to make about the A2W ratio was exactly the same as my experience... I determined that two identical situations (paying off a loan in 3 rather than 10 years) gave two completely disparate A2Ws... 8 and 20.