Better get a spending strategy

I’m consistently amused by the disconnect between what people outside of the financial planning industry think we do versus what the substance of our work actually is.

Television people think financial advice is about guessing the future prices of stocks and bonds and then allocating assets accordingly.

Twitter people think it’s about picking eight index ETFs and then babysitting this portfolio (and its holder) until the next rebalance.

The reality couldn’t be more starkly different.

In truth, talk to a typical advisor circa 2021 and they’ll tell you that the hard part is actually convincing clients to spend their money. To use these savings, accumulated over decades and decades of working, to do the things they want to do. These things – sailing, traveling, vacation home-ing, RVing, gifting, sports car driving, etc – do not become more fun in your late 70’s or early 80’s. They would be fun now, in your 60’s. Easier said than done – when you’ve been programmed over the course of forty years to save, save, save, save, it’s hard to just flip the switch and start spending. Spending on the necessities, sure, but did you just trade forty years of labor for only the necessities? Certainly not. The rewards should be bigger, otherwise you’ve made a bad trade.

A change in mentality becomes necessary in order for all of this to have had a point. Getting comfortable with making this change requires an advisor who can show you the numbers. You need to see it to trust it. I know I do. A concrete spending plan must also be in place. Otherwise, it’s tough to have the faith necessary to pull the trigger.

Financial planners cannot alter the opportunity set in bonds, stocks, alts, etc to produce growth and income for a portfolio. It is what it is, and no amount of alpha within any mainstream asset class is going to meaningfully change that. An asset allocator can make improvements at the margins of a portfolio, but he or she cannot reinvent the prospective return dynamics in the prevailing environment. We can minimize certain types of risks in order to increase potential returns by adopting different kinds of risk, but these are all tradeoffs – and tradeoffs will always bear consequences. We have to choose the consequences we’re willing to live with. They will often be different for different people.

And with this inescapable truth as backdrop, the rate at which we plan to withdraw capital from a portfolio over time has got to be part of the construction of that portfolio from the beginning. The timing of these withdrawals too. It’s got to be hardcoded into the allocation and the rules by which the portfolio will be managed. This is why we will not build a portfolio without first having an agreed upon investment policy statement from each household or organization we work with. If the objectives are unclear, you’re building on a foundation of mud. The storm will eventually come and you won’t be able to withstand it.

Getting the asset allocation right means getting the spending strategy right. Or, at least, right enough for the time being and durable enough for future revisions. There are elements of this that are out of our control (market prices and income streams) and elements that very much are (lifestyle and living costs, tax efficiency). With the return of sustained inflation, these spending strategies become more critical. Much has been written of the 4% Rule, which sort of became a thing by accident and then just caught on. It’s not actually a rule, more like a rule of thumb, and a hopelessly out of date one at that.

My friend Allison Schrager has spent a big chunk of her career thinking and writing about this problem. This is from her latest Known Unknowns substack letter, which you should subscribe to immediately:

This should be the end of the 4% rule, which dictates that you invest in a 50-50 stock bond split and take out 4% of your portfolio’s initial value (on what day—who knows???) each year to spend. I get it: people want something simple. But spending in retirement is a difficult, complex problem. There are many unknowns that are very hard to hedge. Just because you have a simple solution to a hard problem doesn’t mean that it’s necessarily the right solution—in fact, that’s usually a sign that it’s actually the wrong solution.

I don’t like the 4% rule because it doesn’t manage risk. It was created in the early 1990s when rates were 8%. Then it had to be revisited because rates went low and stayed there. And that’s what happens when you don’t have a risk strategy. Now, Morningstar (concerned about equity valuations, not inflation) says that retirees should cut consumption to 3.3% of their portfolio instead of 4%. That’s a big cut in income, especially when prices are up! Morningstar also advocates for varying the drawdown percentage with asset performance.

This is all crazy. First, how can we expect senior citizens to solve one of the most difficult and complex financial problems each year? And how can we expect them to tolerate huge swings in their incomes that no worker would willingly endure?

The problem with spenddown rules is that they assume that the objective of spending in retirement is simply not running out of money. Actually, the objective is… well, spending—and having some predictability around one’s income. Not running out of money is the constraint, not the objective.

 Allison nails it. This is the hard thing. Picking ETFs is not the challenge. It’s a means to an end. The “end” being a sound strategy for enjoying the final third (or quarter) of our lives without fear, without guilt or hesitation.

Jim O’Shaughnessy was on the podcast this weekend and he said “My timeline is infinite.” He’s referring to the idea that most of his money will eventually be used by his kids, grandkids, their grandkids. From that perspective, our timelines are infinite. But our natural lives are not. In this context, obsessing over the individual components of a portfolio while neglecting the purpose of the money is the height of frivolity. “What are we even doing this for?” has to be the starting point, not “What should I invest in?”

Advisors exist in order to help clients with precisely this question. It’s urgent. There’s not a moment to lose. You want to give gifts to your children and grandchildren now, while you are alive to watch them enjoy it, not after you’re gone. You want to have the experiences today, because your health and wellness tomorrow is never promised. As every parent knows all too well, the days are long but the years are short. Get going.

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As always, you can talk to one of our Certified Financial Planners here. The answers exist. We can help. 

 

 

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