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Podcast 25

025: Retirement Planning for the Unwealthy and the Power (and Danger) of Data with Dirk Cotton *

Dirk Cotton was a senior executive at a Fortune 500 company. However, after retiring in 2005, he’s found himself busier than ever. He loves to do research, specifically retirement research, and publishes often on his blog, The Retirement Café. He’s also a Thought Leader at APViewpoint, Advisor Perspectives’ online community of investment advisors and financial planners, and provides retirement coaching services in exchange for pizza, craft beer, and charitable donations, among other gifts.

As Dirk sees it, a lot of the best financial advice is only available to people who have lots of money – and that’s why the Retirement Café focuses on retirement planning for the unwealthy – or those with less than $100,000 in savings.

Dirk came highly recommended by Wade Pfau, and his work has proven highly valuable for his readers and his clients alike. Today, Dirk joins the podcast to talk about how his second act as a retirement coach and researcher began, the dangers in trying to predict the future, and the many factors that people often don’t understand or think about as they prepare to retire.

In this podcast interview, you’ll learn:

  • How having achieved financial independence changed the advice that Dirk gives – and why he refuses to be paid for his retirement coaching services.
  • Why so many people get into financial planning and retirement planning when they themselves retire.
  • How the Great Recession taught Dirk that he vastly underestimated the risks in retirement – and why so many retirees don’t prepare for the worst.
  • The impactful questions Dirk asks to get at the heart of what people really want out of retirement.
  • Why children and grandchildren are a potential financial risk in your retirement.
  • Why planners and advisors need to have strong understandings of statistics and probabilities – and the reasons so many people in the financial services industry end up massively misinformed.
  • How to plan your retirement for a variety of different scenarios simultaneously.

Inspiring Quotes

“When you deal with uncertainty, the rationale approach to it is statistics and probabilities.” – Dirk Cotton

“I think people need to back away from their certainty of the future because there’s really not a lot of evidence that says you should be certain about your future.” – Dirk Cotton

Interview Resources

The Retirement Café
Mean Reversion of Equity Returns and Retirement Planning
What is Monte Carlo simulation?
The Black Swan: The Impact of the Highly Improbable (Incerto)

Investment Advisory Services may be offered through Howard Bailey Securities, LLC, a registered investment advisor. Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™ and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements. The CLU® mark is the property of The American College, which reserves sole rights to its use, and is used by permission. Howard Bailey Financial is a registered trademark of Howard Bailey Financial. All rights reserved. Howard Bailey does not offer legal or tax advice. Please consult the appropriate professional regarding your individual circumstance. Not associated with or endorsed by the Social Security Administration or any other government agency.

Read Full Transcript


Casey: Welcome to the Retire With Purpose Podcast. This is your host, as always, Casey Weade and today we have a special guest. We have Dirk Cotton joining us. Dirk, welcome to the podcast.

Dirk: Thank you, Casey. Glad to be here.

Casey: Hey, we’re so glad to have you and especially as you have become highly recommended. You have come highly recommended from Dr. Wade Pfau, one of our previous podcast guests and you're actually the second guest that we've had on that has been a referral from Dr. Pfau, and he never disappoints. So, I'm sure you're going to be able to share plenty of great information as a retirement researcher yourself much like Dr. Pfau, so thank you for coming on. And you know, one of the interesting things about yourself along with I think some interesting things that the guests that we've had on the podcast it's kind of strange because a lot of these individuals are retired and now, they're getting in the financial advisor, getting into coaching others on their own retirement, sharing their struggles. We had Nancy Collamer on not that long ago, Todd Tresidder on not that long ago, and they've all covered a lot of these topics and they’ve transitioned out of maybe a traditional career into providing financial advice. Some do it for money. Some do it for a second income and as we get started here, you said you do it for pizza.

Dirk: I do. So, when I first started doing retirement planning early in my retirement before I switched my focus primarily to doing research, I did a lot of plans for people but I later again moved into the research and so I was doing retirement plan for a UNC professor. I lived near the University and we share a coffee shop, for which my blog, Retirement Café, was named by the way. So, I did a retirement plan for her and then I found out that she, like a lot of other people, absolutely refused to let me do the work for free even though I explained, “Look, this is my hobby.” So, she finally insisted on taking me out to a pizza dinner to pay me for a retirement plan. I also got paid with a six pack of a microbrewery beer once. And another time a gentleman finally agreed to just make a donation in my name. But, yeah, I basically work for pizza.

Casey: Well, and then there's a reason you can do that and that is because you've achieved financial independence and I wonder how that has changed things for you. You said as we got started, some of these things like the Retirement Café, the blog, and initially taking over your life, and took a lot of your time and that enabled you, I know one of your posts that I read on your blog said how being able to be in a position where you didn't need the money really changed things for you and changed the game and change the advice that you're able to give and the time that you're able to bless people with.

Dirk: Well, I think I didn't intend to do this as a retirement hobby when I thought about retiring back in 2005. My idea was that I’d spend a lot of time fly-fishing and shooting sporting clays with my son, and all those kinds of things that you read about retirees doing and I went to a lot of college baseball games which I loved, and I still do all those things. And I’m very, very busy so I was a senior executive at a Fortune 500 company before I retired, and I had a huge department to manage and I'm actually busier now than I was then. People who are still working hate to hear me say that but it's true. My wife tells me I never really retired, that I just changed careers and refuse to be paid for the new one, which to some extent is correct. People asked a lot. I don't do a lot of nonfinancial retirement coaching, but people say, "What am I going to do when I retire?” or “I'm already retired and I'm bored. How do you manage your day?” And I think the great thing about being able to retire whether you retire early or you retire to a typical age at maybe around 65, one of the great things is you get to do the job that you always wanted to do for your whole life but for which you could never make a living.

So, once you retire, you can work for pizza and do what you really love doing. Now, what I really love doing it turns out is writing research which is probably not going to be on the top of everybody's list, but I found that I love it and that I don't need to get paid for it. I love writing my blog. So, I really think the key to me finding purpose in retirement was recognizing that I could do what I really love, even if it was paid for in pizza.

Casey: Why do you think so many retirees make this transition? And from my experience, not necessarily obviously the ones that are coming in that I visit with regularly, some have actually taken the leap and kind of gone along the lines of what you're doing, doing retirement research or doing financial coaching, helping others with this process. Why do you think that I have interviewed so many people that are getting into financial planning, financial advice, retirement planning when they retire?

Dirk: Well, I think it's one of the scariest and most important things you can do when you retire because retirement finance is far, far riskier than virtually anybody understands until you started to study it. So, when you retire, I actually started this like started doing the research about in the late 90s. So, by the time I retired, I had already been doing it for a long time. Most people don't. But then they retire, and they worry. They think I’m never going to get a paycheck again. So, it becomes an important thing for you to do to maintain your sanity, but you also have an interest in it because it's vital to you and then you start to read about it. So, I think that's why people get into it. You mentioned that a lot of retired people are getting insured. I wish more would because there is a paradigm shift once you retire and once you recognize that, "Hey, I'm never going to get another paycheck.” And going through that change gives you a completely different perspective than you would have as a younger middle-aged academic where the outcomes are purely academic. So, I think that's the reason you see it. I wish there was a lot more of it.

Casey: Absolutely. I do too. I think that, I mean, I've got one couple that just comes to my mind immediately when we think about this concept of really spending time and doing research about retirement and this is a couple that I probably had eight or nine different visits with before we actually implemented their financial plan. We probably had a good 20 hours just in visiting time before we implemented any plan and they probably had another 30 or 40 hours of research on their own, and dozens of emails back and forth, and they're constantly asking questions and I think for some advisors or the one they’re not really willing to put in that amount of time in their relationship to make sure somebody has that level of confidence they need. Now, granted this was two aerospace engineers and so they were kind of built for this research and this technical view of retirement planning.

But I just got an email from them this week and they said, "Everything that we've done, all this research, and the patience you've had, and the information you've been able to give us from the podcast, TV, radio, periodicals, just telling us which books to read have gotten us to a point where we don't have to worry about this stuff anymore because we've done the research, we put together a plan, and we don't have to have concern.” And I think it's just so huge for people to spend that time, as you said, and do some of the things that you've done because I’m sure doing and this journey for you has probably added a tremendous amount of confidence that you're going to be okay at retirement.

Dirk: Actually, the most important thing I've learned in the two decades that I've spent setting retirement is how little I know for certain. When I retired, and I suspect this is the case of a lot of people when they're retiring, particularly if they're retiring early, I really thought I understood the financial risk of retirement, but I vastly underestimated them. Then I have some tremendous bad luck. I retired in 2005 and you know what happened in 2007, which you read your retirement books you're like, "Well, as long as you don't have a really bad bear market early in your retirement, you’ll probably be fine.” Well, this was two years into my retirement. So, despite all that bad luck, I'd actually structured things such that the great recession didn't hurt me that much, but it did drive home the fact that I had underestimated the risk in retirement. And again, I think that happens to a lot of people. It's interesting that the story just told is about the engineers. I have similar experiences with engineers. By the way, they want to treat everything like an airfoil but they’re very thorough and they take a lot of time, but all retirees do, which is kind of a problem with the business model for retirement planning.

To do it right, you have to spend a lot of time talking to people and not just about what their holdings in the stock market are currently but how they feel about retirement. I spent hours and hours and hours with a couple about what their goals for retirement should be. And this went over a period of two years. My point being that it's hard to make money when you're planning especially if you're doing fee-only planning. It's hard to make money when you spend 1,000 hours with a client, but when you’re retired, you can do that. It's okay. They just send you an extra pizza. So, I spent tons of time with this couple and I referred them to another planner which I typically do know because they wanted a formal plan and they came back to me and said, "Great news. You know, according to this plan, I'm going to die with $6 million.” I said, “Well, that’s an awfully specific projection, but more basically, you've been telling me for three years now that you have no bequest motive. You have some nieces who you would leave the money to, but you don’t have a charity in mind, and you're worried about your spending over time. So, why do you think it is a good idea to die with $6 million? I mean, wouldn’t you be happier, if you don't have a bequest motive, wouldn’t you be happier to spend more money and live a nicer lifestyle?”

So, we had that discussion back and forth for months and he finally came to the conclusion that he didn't have a high paying career and he had saved a few million dollars and he was very proud of that and he finally came to the realization that it was very important to him for his own personal feelings about it to die with a lot of money. He knew it didn’t make sense, he knew it was illogical and stuck with that plan, but it takes those kinds of discussions to really get what people want out of retirement because at first glance, you look at it from a logical perspective and you say, "Why in the world would you want to live a frugal retirement and die with $6 million, and you have nobody to leave the money to?” But to him it was important, so he recognized that, and I suspect he’ll come down somewhere between spending a little more and dying with a lot of money. Of course, again, the $6 million was an incredibly specific projection and probably not a likely one. And that that was another issue.

My point being that retirement planning takes a lot of discussion over a lot of time and unless the retirement planner is maybe managing assets or that sort of thing, just developing a retirement plan is not a particularly lucrative business to be in. I do it all pro bono and I got to tell you that’s a really terrible business model. I wouldn’t recommend it to anyone else, but it just works for me.

Casey: Well, those discussions and I guess one of our advisors mentioned having a discussion like this with the family just the other day that seeing in front of a couple, and there was a gentleman there that he was not feeling the discussion. He wanted to get down to the brass tacks. He wants to talk about the numbers. He wants to talk about finances. He wants to talk about stocks and bonds, mutual funds, what's going on in the stock market. And our advisor was sitting there asking questions about what money was like growing up. And the gentleman stops him, "What's this have to do with our money? Why aren’t we talking about our money?” And I think you just pointed out there how important it is to have these ethereal discussions that don't have to do specifically with the research that you spent so much time on and you say that you spend most your time in retirement research and not really on the coaching aspect of things, but it sounds to me like you put a lot of time into the coaching aspect of working with these individuals and asking the right questions, the really important questions, the ones that really matter before they start planning. So, what do you think are some of the most impactful questions that you tend to ask individuals when you sit down with them and start talking about their retirement?

Dirk: Well, first of all, some of those clients including one that I just mentioned I call them clients. I don't charge them anything so they’re technically not clients. In fact, they kind of become friends over time because some of them I’ve talked to for five years and they'll still call out of the blue to talk about the stock market or to talk about if they got any cat, whatever. Seriously, people will call me with a finance question and we’ll talk for an hour and maybe five minutes of it is devoted to finance. I think the important things to understand are the major objectives that they have for retirement. I think that is the first thing that you have to discern and that is what do you expect from retirement? What do you want from retirement? Do you want to leave money to children? Do you have no bequest motive? How do you sleep at night? So, what is your risk tolerance? If I told you that 60% equities was a really good balance for you, but that in a bear market, you could lose 25% of your investment, would you be comfortable with that?

So, it’s very important to understand their risk tolerance and understand the fact that most people don't know what their risk tolerance is and in bad times their risk tolerance tends to disappear. But I think probably having a conversation with people upfront and asking five or six questions in different areas is the way to start before you talk about any of the money. Another important question to ask, particularly if it's a married couple is are the two in-sync? So, one couple I talked to, I said, "What do you want?” and the wife described an annuity. She said, "Look, all I want is a check every month and I don't want stock market risk. I just want to know that for the rest my life I'm going to get a check,” and I said, "Okay. Well, you know, we ought to consider an annuity,” and the husband said, “No, no, no. I don't want annuity. I want to invest in the stock market.” If you can't resolve that issue early on, at least come to some compromise and you're not going to come up with a plan with which they're both happy. And so, those are the issues that I tried to resolve upfront.

The easiest couple of actually friends, again, they’re not technically clients but the easiest to work with was a couple I’ve known for a long time where the wife would say, "This is what I want,” and I’d say, "Okay. Husband, what do you want?” and he’d say, “I want to make her happy.” “Okay.” So, every question I asked her she had an idea of what she wanted to do and when I asked him, he said, “I want to make her happy,” and that's a really easy couple but it's a rare one. So, I think those are the kinds of basic questions that you have to ask before you start looking at the money issues. I also think that retirees, people approaching retirement, and advisors have way too much overconfidence in their ability to predict those financial numbers. So, I'm kind of a top-down guy. I try to figure out what the couple wants for retirement and then I look at their finances and try to give them general answers and come to conclusions on what they might be willing to do. I also look at the numbers in great detail. I’m a big fan of Monte Carlo simulation so I look at tens of thousands of scenarios for people but again those tools for most people just create overconfidence in their ability to predict the future.

Casey: When you were retiring, did your wife retire when you retired? Was she working at the time?

Dirk: We were a two-income couple for decades. We were married for quite a while before we decided to have children and we both had pretty high-powered careers and there came a point, I think it was our third child, when we said, "Okay. This is not going to work. We can't play man-to-man anymore. It’s just not worth it.” My wife said, "Okay. I’ll retire,” and she did about maybe 10 years before I retired. She had a professional career as a computer analyst and she retired earlier.

Casey: Now, when you had actually retired, she had already retired. Did you two have any discussions that might have resulted in some conflict or disagreement that you had to overcome?

Dirk: That's a really good question. We didn't for a couple of reasons. One is we had a well-financed retirement, so she wasn't worried about money and I wasn't worried about money and we both have MBAs, so she understands finance. It’s just that she has absolutely no interest in retirement finance whatsoever. So, she was like, "You come up with a plan. We’ll do whatever you want. I trust you,” and I’m like, “Well, there's going to come a day when you might be on your own. You might need to understand this. You might make your own decisions.” She goes, “I’ll deal with that when the time comes.” So, no, we really didn't have conflicts, but I think financially we were in an unusual situation and also as I say, we’re both MBAs so we kind of talk about finance on a people level.

Casey: Well, I recently interviewed David Bach and what you said about a spouse that was uninterested in the financial side of things, I mean, I see it all the time and it typically is that the female in the relationship and David Bach said, “Men will never know if the retirement plan actually works out because 80% of men will die married and 80% of women will die widowed,” so I really truly believe we better get on the same page and make sure you understand everything because I know sooner or later my wife is going to outlive me.

Dirk: You know, I think that's a vital thing to understand. Interestingly, my experience is not so much that men are interested and women aren’t. I think it’s about 50-50 in my own limited anecdotal experience, but in a lot of the cases, the men are like, “Well, make her happy,” or they’re like she understands finance better than I do. So, it's probably kind of equal. I don't actually get a lot of cases where the wife just sits back and listens. It happens occasionally but they're usually pretty involved.

Casey: Well, I see more of that today I think than in the past. Over the last couple of years, I see more and more women that are coming in and really getting engaged in the financial planning process and I think it's absolutely vital. You mentioned financial risk that you didn't understand when you retired in 2005 and that you said you fared fairly well during the 2007, 2008, 2009, the whole financial crisis period of time. So, what specifically were the financial risks that you didn't understand? Was that your risk tolerance you didn't understand? The amount of risk that you're taking or is it something else?

Dirk: No. I understood my risk tolerance. In fact, I had about 40% equities in 2007. So, my portfolio only declined 50% while the market went down 50%, over 50%. And I’ve talked to people, by the way, who said their portfolio went down 50% during the great recession which means they were pretty much 100% invested in equities which is a bad idea. Now, I understood all that part. I understood the market risk. However, I didn't expect, I thought there's a really good chance I’d run into a recession early in retirement or I should say a market crash early in retirement because the recessions and market crashes are not 100% correlated. I knew there was a chance that there would be of a large market decline, but I had no idea it would be over 50%. That was unprecedented since the Great Depression. I just didn't expect that to happen and I think people misunderstand the difference between improbable and impossible.

So, a 51%, 52% loss in the market was highly improbable, it’s certainly possible, and it was something I needed to have a looked out for. And I did. I had an asset allocation that allowed me to live through a very heavy market crash. It's not just market risk that we underestimate. Although I think a lot of people do. For example, I had no idea when I retired, and my son was a senior in high school that he would want to go to med school.

Casey: How old were you at the time by the way?

Dirk: Fifty-two. I retired when I was 52. So, my son was a senior in high school at the time or I guess he had just graduated and then he just decided he wanted to be a doctor. And so, paying for his med school and, by the way, then he took off a year to get a master’s degree in epidemiology, which means he's basically a much better statistician than I am now and a handy resource, but I have no idea at the time and never considered the possibility that we'd be paying off med school. There are all kinds of problems. There are medical problems. There are, if you have children that are not financially established or pretty well off, actually, when you retire or grandchildren or if you have grandchildren, that’s the risk people need to consider. Now, a client told me, well, actually he’s a reader of my blog commented years ago that he would never consider his children or his grandchildren a liability which is a nice kind of emotional thing to say but the fact is a family with no children and grandchildren has less risk than a family that has children and grandchildren because if your grandchild gets sick or if your grandchild gets into Harvard and they can’t afford it, you’re going to pay for that. You’re a grandparent and trust me if your kids or your grandchildren need help, you're going to help them. So, that is a financial risk.

And I had three children that I retired from. I think the youngest was in the eighth grade and the oldest had just graduated from high school and we’ve run into some large expenses for them. Could've been a whole lot worse. Well, maybe not worse than med school but, yeah, so there are those types of risks that people tend not to understand. They don't understand that they could have - you don't only have really large medical expenses that ended your life and might get very ill early in retirement. There are just all kinds of things that might happen, and you have to plan for those things. So, those are the kinds of risks people tend not to consider. The market risk thing is a totally different kind of thing. You either have people you think the market’s going to solve all their problems or you have people that are scared to death to invest anything in the market and in between but that's just how people feel. It's not really a valid assessment of market risk, but that’s an important part of retirement planning. But, yeah, those are the types of risks that I think I underestimated before I retired, and I think a lot of other people do as well.

Casey: Once you had a better understanding of those financial risk, once you start to wrap your head around the real risk that you're going to face, were there any changes that you made. Did you have any evolution in your retirement plan or just your way of thinking once that you really wrap your head around those things?

Dirk: Not much because I have prepared well for it. As I said, I started setting retirement in about 1997 or so and I did retire early 2005. So, I was pretty well prepared, much better prepared I'm sure than the vast majority of people in retirement. I had a good plan in place. So, not bad. The one thing that really changed my mind is that I had a large mortgage when I moved here and during the financial crisis of 2005, The Great Recession, I was losing money as other people were, and as I said, it’s only 15%, but it occurred to me that I was borrowing money against my house to give me the opportunity to lose it in the stock market. So, about that time, I wrote a check and paid off my mortgage. So, that is something I changed. I still got about 40% equities. My portfolio despite The Great Recession is now bullheaded where it was when I retired, but I haven't made a lot of changes again because I think I was pretty well prepared.

Casey: Well, let's switch gears a little bit here, Dirk, and turn on over to the Retirement Café and learn a little bit more about your blog there. And your subtitle for the blog is Retirement Planning for the Unwealthy and I'm curious, who are these unwealthy and how do you define them?

Dirk: Well, they’re mostly everyone if you look at the numbers, if you look at the large number of people who enter retirement with little or no savings, for example. So, here's the problem from my perspective. If you have a lot of money, people beat down your door to give you retirement advice. They’ll give it to you for free if you let it, they can manage your money, and you’ll get good advice and you’ll get access to really high-quality people, but you have to have a lot of money to do that. Most people don't have a lot of money. Most people don't have any savings. A lot of them have $100,000 less which is a good emergency reserve fund but it’s not something you invest to increase your retirement income. So, when I started the blog, the reason I use that subtitle is that I found two things. One was that there's a vast market out there of baby boomers especially, but everyone really, approaching retirement that cannot get good retirement advice because they don't know where to look, because there aren’t a lot of really good retirement planners out there, or because they just don't have enough money to attract a good retirement planner. So, I wanted to build that market as best I could with a blog to give these people some advice on what they can do without them having to go find an expensive retirement planner.

Now, a secondary problem with this is that if you read the research, most of the research is written for wealthy people if you look at retirement research. For example, there's been a big interest over the last few years, well, up until the laws changed in 2017 in reverse mortgages, but the fact of the matter is they’re expensive. A lot of people look at him and come back to me and say, “Can’t really borrow all that much.” So, the target market for them is relatively small and these people have a lot of home equity and buy a lot of home equity, I mean, certainly more than the $200,000 that most people have. So, hard to find a retirement planner. Then describing the unwealthy now. This is a person that has trouble finding a retirement planner, has trouble affording a retirement planner and is not seeing a lot of really high-quality retirement research that's aimed at people who don't have a lot of money.

Casey: Well, I think this is a perfect time for a question from one of our fans and this question comes from Jeffrey Kenny. He said, “Well, how do families who live paycheck to paycheck plan and save for retirement?”

Dirk: Well, they may not be able to. I mean, I think of anything that the last since the 80s when we came up with IRAs and 401(k)s and all those sorts of things. One thing that has become obvious is that it's really, really hard for most people to save enough money for retirement. It’s just a really hard thing to do. So, saving is tough for a lot of people. Some people have been able to save really large retirement savings accounts. That’s a great thing, but not many of them. So, I'm not sure there's a great answer to that. One of my favorite sayings is from William Bernstein regarding saving for retirement. He said when asked, "How much should I save for retirement?” he said, "You should save as much as you can for as long as you can and never stop.” And that's a pretty good guideline. That doesn't mean it will be enough. It just means that what you basically have to do is save as much as you possibly can and use that amount for retirement understanding that it might not be a lot of money and in some cases, it might be nothing because people just don't have the ability to maintain a decent standard of living and save for retirement at the same time.

Casey: Well, Jeff goes on to ask, he said, "Are there financial planners?” He said, "There's not a lot of places they can go.” I mean, there's no place that they can go for financial advice or to actually get started on the right path, but he says, "Are there financial planners willing to work with these types of clients?”

Dirk: I haven't found…

Casey: Well, you worked for pizza, so I guess they can work with you.

Dirk: Yeah. Boy, I may have opened up a Pandora's box there. Who knew it was a pizza box, right? So, in my experience, there aren't any or there are very few. If someone came to me and said, "Hey, I don't really have any money. Who besides you would help me with my plan?” I couldn't come up with a name. However, there is a group and I don't recall all the names right now but they're working out of a Stanford who wrote a paper not long ago and I believe Wade Pfau was involved in that as well. They’re trying to come up with an approach that people could use for people that either can't get retirement help or who don't want to do much work. And essentially, the plan is to, as I recall, to postpone Social Security benefits for as long as you can. Of course, in this bracket they were talking about most people can't afford to postpone Social Security benefits unless they just keep working but to work as long as you can, to postpone Social Security benefits as long as you are able to, and to spend based on the required minimum distribution rules to the IRS. So, those are called RMDs and it's a set of rules that determines how much you have to spend from your retirement accounts at age 70.5 beginning at no later than age 70.5.

It's an amount that you have to withdraw from your retirement account to pay taxes on that and reinvest it. You do spend it or reinvest it in a taxable account. So, what they're trying to do is come up with a set of rules for people, a reasonable set of rules for people who don't have a lot of money. That's the kind of help you'll see for people who are unwealthy because there's no profit to be made in that market, frankly. Sad but true. So, I would say that you probably will not find financial help if you don't have a lot of money beyond these sort of kind of general rules but as far as, as I said, if you asked me to name someone other than me who will do a financial plan for pizza, I don't know who that person is and my time is I spend 40 hours a week doing research. So, I only do a few of those a year. It's not that I can't make money from it. It’s just that I don't have time to do it, so you run into that problem as well.

Casey: Well, in my opinion, I think all of us wherever we start, I mean, unless we were blessed with a trust fund or we came from a really wealthy family, we all kind of started in a difficult position. We didn't have a whole lot of money and the ones that ultimately made it to retirement either they were just very diligent about saving an X percentage of their savings every single year, say to their 401(k) or they started actually doing their own research. They started doing their own financial education and maybe had a good foundation in education from their parents and I would say that these individuals should go to their parent’s financial advisor in some instances because I know given our firm, if we have a parent that we work with and they say, "Hey, can you help out our son or daughter?” then, well, absolutely. We’ll treat it as one family household and he might be able to accomplish that. But you said that there's not a lot of good affordable financial advisors out there and I think most people are going, “Well, it seems like everybody's a financial advisor. Every corner that I turn around, there's a financial advisor.”

I hesitate to tell when people ask me what I do, the last thing I’m going to say is I’m a financial advisor. I’ll come up with something else because that's going like telling somebody you’re an insurance salesman that the conversation stops immediately, right? It seems like there’s financial advisors everywhere, but you say that specifically, there's not a lot of really good retirement planners. So, how do we recognize, if we’re working with a financial advisor, if we’re looking for retirement planner, how do we know if we find a good one, or where we look for a good one? How do we recognize the good ones if there's so many?

Dirk: So, it's really hard to do. You can start with the fact that most of the people who do research and involved in these areas and meet lots of people will agree that most retirement planners aren’t particularly good. There's some really, really good ones. Don't get me wrong, but the way the retirement industry works is that most retirement - it’s hard to make money writing retirement plans. So, if someone is willing to develop a retirement plan for you, there’s a good chance that they also sell stocks or like they manage assets or they sell insurance or they sell annuities or whatever. So, retirement planning tends to be an arrow people add to an existing quiver. It's not their main line of work. It’s something they do to generate more clients for their main line of work or something they do to sell other products. That's not always the case. Actually, I was told recently by someone who should know that there are a lot of people who are only doing retirement plans that are making a decent living. That doesn't say that they're good at it but it's a good thing to hear, but that's a problem for the most part.

So, I would say if you're talking to a stockbroker who wants to give you a retirement plan, don't be shocked if he recommends stocks. If you're talking to an annuity salesman, don't be shocked if he suggests insurance. So, you kind of have to look at I think, first of all, what is the retiree’s main business? They’re a lot. I know some really good retirement planners who will only work on an assets-under-management basis. So, unless you have a large portfolio for them to manage, their retirement finance advice is going to be quite expensive so that kind of rules people out. You have to kind of look at what is this person’s motivation for developing a retirement plan for me? There are designations like certified financial planner, which I think is kind of a minimum. It doesn't mean it's a good planner but at least you know that they've been tested, and their background looked into, to some extent, they had some experience. Unfortunately, you can't say, "This guy’s a CFP so I can believe anything he says. He must be good.” But you can look at it and say, "Well, he doesn't have any of those designations. Maybe I should look for someone who does.”

It's a really difficult thing to do to find a retirement planner that you should have lots of trust in and just because you have lots of trust in him, doesn't mean they're doing a good job for you. I talk to people who absolutely love their retirement planner and I look at their retirement plan. It’s not a very good one.

Casey: So, you say that you don't actually implement financial plans and you refer some of this. You refer people to other financial advisors. So, how do you select these people that you might refer out to? Is there a set criteria?

Dirk: There are people that I personally know. I've met a lot of retirement planners through organizations like RIA. I’ve met a lot through academic circles. I communicate with them frequently. I trust them. Normally, when someone comes to me, I will try to do as much work for them for free as I have time to do. And then at some point, we decide that either they have a need for a formal retirement plan or the informal form of retirement plan we have developed for them is good enough, and if they want the detailed retirement plan, I refer them to someone who actually develops retirement plans that they will pay. And these are people that I personally know I've heard speak, I've communicated with, and honestly, there are very few that I have on my referral list. And as I said, some of them you have to have substantial assets to get their good expertise and I recommend them but frequently, the people just don’t qualify for their help.

Casey: Well, we've been asking a lot of these high-level questions and I know your background and what you really enjoy is research and statistics. You’ve got a computer science background. I want to make sure that we get into these things that you write about all the time and the things that you really focus on. And earlier, you talked about statistical analysis and that you’ve often written that financial advice, retirement advice is often based on questionable statistical analysis. And so, I’m wondering what do you mean by that?

Dirk: Well, it's kind of a self-created problem. So, what we’re doing when we build a retirement plan is to some extent, we’re predicting the future or at least trying to get our arms around what the future might look like and that is a very, very difficult thing to do. So, when you deal with uncertainty like that, the rational approach to it is statistics and probabilities. So, statistics and probabilities can only do so much. We have relatively limited market data. We have 200 years of market data, but we only have about 60 years of unique sequences of returns. So, the beta is fairly limited and what that means to a statistician is that the confidence interval or the amount of confidence we can have in the statistical projection is quite broad. There's one study by a researcher named Gordon Irlam whom I greatly admire, and, in his analysis, he was looking at optimal asset allocations, and he found that the 95th percentile confidence interval for the optimal asset allocation was somewhere between I think it was like 15% equities and 80% equities and that's not very helpful, right?

So, it touched a couple of things. One, if you have a 40% equity allocation and your equity allocation grows with stock market and also you find out you have 45%, the right answer 95% of the time is between 15% and 80%. Adjusting 45% down to 40 is not a worthwhile thing to do. So, the statistics that we have, the research we have is based on some huge assumptions. One is that the future market returns will look like past market returns. There are lots of reasons to think that the United States won the 20th century and that our market returns are not going to be as high in the 21st century for example. There is a statistical assumption in most cases that market returns are normally distributed, but we don't know that. So, Nassim Taleb, for example, for The Black Swan thinks it's ridiculous to assume that these returns are normally distributed because of large tail risk. So, we don't know what the expected market return is going to be in the future unless we pretend that it's been embedded in a mere 200 years of market return data. Not only do we not know the expected return, we don't even know the distribution and we pretend that it's a normal distribution.

And when you look at the limited sample size, the potential error in expected returns, and the fact that we don't understand the tail risk or even know what the distribution market return is, that's a lot of uncertainty. Now, it’s better than nothing, because it does kind of narrow down what might happen in the future, and it rules out some extreme cases is pretty unlikely, but it is not something we can have a great deal of confidence in, yet people do have a great deal of confidence in it. That's the overconfidence that I keep referring to. So, I think the statistics and the probabilities themselves are rational, but the underlying assumptions are somewhat questionable. Unfortunately, people don't have a basic understanding of statistics are far more competent in those projections than they should be. So, we have researchers who are statisticians or econometricians and they build this data and they know what your confidence level should be in that data and then they publish it, and an analyst read it. I'm sorry. Advisors read it, but most advisors are not steeped in statistics. So, when they read it, they probably don't understand the level of confidence they should have, and they probably don't interpret it correctly and then they talk to clients and explain those statistics when the clients have even less understanding of statistics than the advisor.

So, as you go down this chain, if we’re going to base retirement planning on statistics, we need to understand how confident we can be in those statistics and so we’ve turned this into a world where a retirement advisor or a do-it-yourselfer retiree really needs a pretty strong understanding of probabilities in order to interpret the research, and the vast majority of them don't have that. So, that's kind of the issue I have and it's an overall level of overconfidence when people will say things like, “Oh, stocks mean revert. They get safer the longer you hold them.” Well, a lot of people say that to me with great confidence, but the fact is there is no consensus among economists whether or not stock returns mean revert or whether that means that stocks get safer over time. And this is not something that a typical planner, let alone a retiree can understand so we’re going to build this whole thing on statistical analysis.

Unfortunately, we’re delivering that knowledge through people and to people who probably in many, many cases don't have the statistical background to understand what they’re saying so they develop an overconfidence and it's like, “You know, I got it from a computer,” or this guy is a statistician. He’s shown me the probabilities, so it must be right.” And I think it’s actually getting a little worse now that we’re computerizing these things because I had someone…

Casey: I found it strange coming from a guy with a computer science degree not appreciating computers.

Dirk: Yeah. Well, no, I greatly appreciate computers but here's the thing. There are too many people that think, you know, people that read stuff on Internet say, “Hey, it must be right. It’s written on the internet,” or they say, "Well, you know, this plan came from a computer. It must be right.” So, I wrote about that not long ago and the reader said, “Oh, wait a minute. I would absolutely trust a robo advisor if it used artificial intelligence, machine learning, and evidence-based strategies.” And I’m like, "Well, you know, I might too but they don't do that.” But if you tell someone, "Hey, this came out of an application or this came from a computer somewhere,” it’s like the statistics thing. With statistics, they'll say, “Oh, well, this guy is a great statistician, so he must be right.” Well, he may well be right, but you may be misinterpreting what he’s saying, and it gets worse with computers because it’s like, "Oh well, it came out of the computer, so it must be right.” So, I think that's the issue I have with retirement planning in general right now. I think people need to back away from their certainty of the future because there’s really not a lot of evidence that says you should be certain about your future.

Casey: Well, I think that's what I appreciate most about you, Dirk, is this openness to ideas, openness to an idea that you might be wrong, that you might not know everything, and that was something that my dad instilled in me from a very young age. It was always, well, this is what we do, but look at all these other people that are doing this. Maybe this is the right way to do things. Let's explore that or let's explore this idea. Maybe we should be looking further into the stock market or looking into annuities. Looking into life insurance, looking into mutual funds, instead of ETFs. Actually, keeping your mind open to these different concepts and realizing that we don't know everything, and we need to keep an open mind to the reality that we might be wrong. And I think your article that you have on your blog, I think that was your most recent post which was titled The Mean Reversion of Equity Returns.

I really enjoyed that article and we’re going to make sure we put a link to that in the show notes because I do hear all the time you've got advisors that go, “Well, why would you want a guarantee that the market averages 7% a year or the market’s done 10% a year over the last few years?” You made 20% last year or it averages 7% to 10% a year. You hear all these averages that are used and they say, “Well, why would you do anything else?” and I think your discussion about statistics and also the mean reversion of equity returns really explains why we shouldn't just accept those things and say, “Oh, they make 7% a year,” because 95% probability which you mentioned a couple times here in our discussion is 95%. Well, there was that 5% chance of not getting the 95% was the 2008 financial crisis. That was a Black Swan event. It wasn't supposed to happen, but these things do happen and really, the odds are zero or one. It actually happens or it doesn't. And you said, "Well, there's two things I want to get to here,” and one is that you said that averages are fairly useless, and I'd like to have you further explain what you mean by averages are fairly useless because people always say, “Well, I want 7%,” because that's what market does.

Dirk: Well, and that's a very good example so you can look at the market and say the return has been 7% in the past. Well, will it be 7% in the future? I don’t know. A lot of good reasons why it might not be, but you can also go back and look at if you do that probability of ruin thing that comes up with a 5% probability to ruin. You see that while they have been 7% on average, there have been periods, there are two things. First of all, the average is not nearly as important as the sequence of returns and there have been periods during that 7% average return when you would’ve gone broke fairly, fairly quickly because the sequence returns, not because the averages themselves. You look at the average and, you know, more often than not, if you're looking an average, there's a 50% chance that you’re going to fail. So, what you really need to look at is the worst case and make sure you avoid that or at least that's what I think.

So, there are two kinds of schools of retirement planning that you read about. One is the probabilistic school and the other is the lifecycle school of planning. And the difference is in probabilities. So, a probabilist would say, "Hey, you know what, 7% almost always works,” and a lifecycle guy, an economist in particular, because probabilist tend to be equity plans, but if you talk to economists they’ll say, “Yeah, but do you really want a one chance in 20 of going broke in your old age?” So, that's the major decision you have to make with your retirement plan. Are you one of these people that has so much faith in probabilities in the stock market that you're willing to bet your future on it or do you want to say, "You know what, there's a 1:20 chance that things could turn out really bad for me. So, the first thing I want to do is build my plan around making sure that that doesn't happen and then if I have money left over after I do that, I’ll invest that in the stock market.” That's the difference between the two schools.

But, yeah, if you delve into the statistics, a lot of the things that we think we know become questionable right away and planning on an average market return, you're planning on two things really. You're planning on an average market return of 7% and you're planning on that because that's what happened in the past so you're also guessing that the past will be repeated in the future. And then beyond that, even if the past is repeated in the future, remember that a lot of people in the past would've fallen into that one in 5% failure rate.

Casey: If I understand you correctly, it sounds like you're saying you have this appreciation for statistics. You like to know that we have a 90%, 70%, 95% 98% chance probability, but the important part isn't that success rate, that 70% or 90% portion, it's the 5% or 10% chance of failure. And the way that we get around just hoping that everything works out and that we don't hit that 5% chance of failure is to actually solve for that 5% chance of failure. Maybe that 5% chance of failure is having major long-term care risk, we’ll put a long-term care strategy in place. And maybe that's outliving your assets, maybe that’s living to 105 instead of passing away at 80 so let's put it into position maybe some guaranteed income. And then if we have assets left over, then we can play with that 95% or that 90% probability side of the equation. Did I interpret that correctly?

Dirk: Yes, you did. So, there are a couple kind of financial models. There are deterministic models which we often refer to as Excel spreadsheet models and there’s the caustic models, probabilistic models that frequently Monte Carlo analysis is used for. And the main difference to me is with Monte Carlo analysis, it will generate lots of scenarios that you can look at and you can say, "Wow. This is unlikely, but this could happen to me.” So, I'm not a big fan of saying, “Oh well.” In the long-term, if I just put everything in the stock market, everything will work out. I think you need to do scenario analysis. I need you to say, "In this scenario, things would be really, really bad so is there a way for me to ensure against that?” And there isn’t always because you can’t always buy long-term care insurance. I applied for it. Couldn’t get it. Most people can’t afford long-term care insurance. It’s very expensive. So, there are some of those things that you might have to look at and say, "Well, I’ll mitigate this the best I can, but I really can't avoid it.” One way people mitigate it, by the way, is that a large number of homeowners plan to use their home equity as sort of a long-term care insurance according to some research that was done by an economist named Warshawsky. So, I'm a big fan of scenario analysis and just to give you an example, I used to do business planning for corporations and when I started, we had Excel spreadsheets. We didn’t have powerful computers so doing Monte Carlo Monte Carlo analysis of 10,000 scenarios wasn’t available to us, but we did three scenarios.

We would look at the best possible case, the most expected outcome, and the worst case. Now, that's only three scenarios instead of 10,000 or so but if you look at those three, it gives you the big picture and it forces you to say, “Well, wait a minute. This is what could happen in the worst case. So, is there some plan I can come up with that does a good job in the other scenarios and doesn't kill me in the worst-case scenario?” And I think that's a way that you could plan retirement. You could say if you didn't want to use, if you don't understand statistics and you don't understand machine learning, then build three scenarios. One says, "Things turn out much better than I had planned,” and then ignore that because, A, it’s not going to happen and, B, if it does, you have too much money and you can solve that problem. The second scenario is things don’t work out kind of the way I expect. And the third scenario is I live to 105 so is my spouse, the market does poorly, all these sorts of things. And then ask yourself, if you found yourself in that situation, what would you wish you had done when you retired? So, I think you can come up with a pretty good retirement plan without computers or without complex statistics.

Casey: And now as we wrap things up here, I want to ask you about a heated discussion you had here recently on Twitter and that was involving early retirement. You retired relatively early at 52 but there's this new movement called the FIRE movement, financial independence, retire early. What are your thoughts on early retirement and the FIRE movement?

Dirk: I think they’re two totally separate things so let me address them individually. Let’s address early retirement. I retired early. As I mentioned, I didn't understand the risks. Would I have retired that early, had I understood the risks? Maybe, but for non-financial reasons. Would I recommend that other people retire early? If you have a lot of money, then, yeah, you can retire early, and you can look at retiring early. Normally, though, you got to think, "Well, I'm giving up potential Social Security benefits because I'm earning less over the past 30 years. My savings are going to be lower, etcetera. You have to think about all those things. But if you're comfortable with that and realize that it’s really hard to go back to a career after a few years. So, for the first three years, I was retired, my coworkers used to email me and say, "Are you bored with this? Are you ready to come back to work?” and I’m like, "Are you insane?” but it's hard to do after about two or three years because you lose contacts and you lose some of the skills. So, there's the retire early issue. Should you? It's really risky. If you have a lot of money, if you have $10 million, yeah, you can probably retire early. If you have less than that, you all at least consider the possibility that you don't have enough money.

The other part of this discussion was that you are referring to on Twitter was actually quite interesting because I explained, this guy said, "Yeah, I retired. I am really happy, blah, blah, but I work.” I'm like, "Well, wait a minute. You’re either retired or you work. Which is it?” “Well, you know, I work some.” “Okay. Well, that doesn't sound like retired to me. It sounds to me like you have made a life choice to be very frugal and in doing so, not too so aggressively move toward a career that you’re not happy in. I get that.” Frugality is a life choice. Nothing wrong with it. If you personally choose frugality because you don't want to do a certain kind of work and the kind of work you do want to do gets you less money, I think that's a fantastic idea. I just don't think it's retirement. So, his response to me was, "Well, fist of all, I love your blog and I read it all the time and I think most people that do this, this FIRE thing, I think most people that do this, do enter it with the idea that they’ll retire with a big kind of - most of them quickly realize they need some kind income.”

So, my argument with him wasn't anything about whether or not that is a good thing to do. My argument with him was whether or not that is retirement. In my opinion, it's not. It's just a choice for a frugal lifestyle which he’s perfectly entitled to make. You need to consider I think the fact that he's minimizing Social Security benefits he’ll get later in life by reducing his earnings and he’s also losing the savings that he might have. But if you make all those choices and you understand what impact it might have on retirement then I think that's fine. Someone asked me to answer a question on Quora regarding this the other day and my answer to them was their question was, "What do you think about the idea of living a frugal lifestyle and retiring early?” and I said, “I don't think it's a question I can answer because I don't think they’re the same thing. Being frugal and retiring, especially if you continue to work isn't really a valid question.”

Casey: Well, I appreciate that and thank you so much for answering so many awesome questions, but I've got one more awesome question to ask you here and it's one that I've asked virtually everybody I've ever met when they start to talk about retirement and it's interesting the answers you get when it comes to everybody's definition of retirement because everybody has a different idea of what it means. If you could use one word to describe retirement, what would that be and why?

Dirk: Well, it's not an easy question to answer. I'm doing some research right now where we’re gathering data on households that have retired and I can tell you that looking at the data, it's really difficult to know who you would say is retired and who you would say is not. Now, fortunately, this data they ask people, do you consider yourself retired? So, if they say yes, then we assume they’re retired at least by their definition. But it's not easy even if you're looking at tens of thousands of data records who is retired and who is not retired. Tough question. To me, when you retire, you leave your primary career and you substantially decrease your earned income with the intention of not working full time. That's what I consider retired. There's also a question about which households are retired. If you got a two-person household, is the household retired when the first person retired? Or is the household retired after they both retire?

We came to the conclusion in our research that we would use the retirement date for the household as the first person who retired because even if it's the lower earning spouse, it’ll probably still have a significant impact on the household's finances. So, it's a hard question to ask. Again, my idea is you got a career. You're making a lot of money. You decide, “I don't want to work this hard. I don't want to work all these hours. I'm going to cut way back,” and I don't mean you're going to work part time just because you're not working 40 hours a week, but you significantly cut back on your income to the extent that it impacts your household finances. That's retirement to me.

Casey: I'm curious, what is the goal of this research that you’re working on right now?

Dirk: We are, well, I can tell you one part of it. So, it's not published yet, but kind of the important part we’re doing is developing a database of the finances of US households at the time someone retires. So, it's a quite complex project, and hoping to finish it by the end of the year. I started it in February, thinking I'd be done by June and now we’re trying to finish up the first draft by the end of December maybe but that's what this research is based on. And the other nice thing about it is which I have that data, there are lots of other research projects you can do with it so at least half of it is reusable.

Casey: Well, I look forward to congratulating you in your first Nobel Prize as soon as you get that published. Thank you so much for joining us here on the Retire With Purpose Podcast and I look forward to catching up again soon.

Dirk: It was my pleasure, Casey. Thanks.

Casey: Thank you.