Generalized Retirement Advice is Often Bad
Bad Retirement Advice is common! The reason: The Goldilocks Effect.
Think about what you hear on TV or read in the popular press. What passes for generalized retirement advice is often inaccurate or worse. Why is that the case?
Well, remember: specific facts and circumstances. There is always a disclaimer that the information may not fit your specific facts and circumstances. Ask yourself: Is the retirement advice just right for you?
Generalized retirement advice can be too hot, too cold, or—like the porridge in the Goldilocks fable—just right. What factors must be “just right” to prevent Bad Retirement Advice?
Overview of the Goldilocks Effect and Bad Retirement Advice
At a bear minimum, good retirement advice must account for income level and risk tolerance.
Look at figure 1 to understand the Goldilocks effect. On the left is income level (or total asset amount) and on top risk level (or risk tolerance).
Regarding income, when you hear general retirement advice, it may not apply to you because of your level of income.
For instance, let’s think about the advice “always use your 401k.” Deferring income into a 401k is wrong if you are making less income than the standard deduction. On the flip side, for those making many millions of dollars a year, a 401k won’t even move the needle. Only when your income is “just right” is the advice appropriate. Too much or too little income and the retirement advice is wrong.
As for risk level, a “100% equity asset allocation” might be fine advice for a youngster willing to take on short term market risk. Conversely, if that advice causes someone to panic and sell low, even once in their life, it is horrible advice. Only when the appropriate level of risk tolerance is baked in is the advice correct. Too much or too little tolerance for risk and the recommendation is wrong.
Next, let’s explore what happens when you combine standard advice with income and risk at the same time.
Low Income and Bad Retirement Advice
Let’s think about low income folks for a moment. Most standard advice you read or see on TV is for those with better than average income. This is because one assumes those are the folks consuming the retirement advice.
Standard advice for better than average income folks, however, has little application to those with lower incomes.
Specifically, let’s think about social security planning. If you have low income, it is often best to spend down early in order to delay social security as long as possible.
Social security, as a safety net, rewards low income folks more than high income retirees (via the bend points) and provides a life-long, cost-of-life adjusted, government-backed stream of income that will not run out. Social security is the largest source of retirement income for low income folks and must be optimized.
Low income also, by definition, increases risks. In fact, risk means something entirely different to those with low income. When the next bump in the road means a devastating set back with ongoing credit card debt and paycheck lenders, investing in a 401k may not be suitable for low-income folks without an adequate emergency fund.
I doubt this discussion resonates well with my audience. so, let’s move on to high incomes and bad generalized retirement advice.
Very High Income and Bad Retirement Advice
What about bad retirement advice for someone with a very high income?
For instance, personally, I like to ponder retirement issues faced by physicians. By most standards, physicians make great incomes. The typical physician income of $200-500k a year, however, pales to comparison to the actual 1%ers out there in the world with multi-million dollar income.
There is no way I can give reasonable retirement advice to someone making $200k and $20M a year. Every aspect of the advice required is different.
Risks are also different in the rarified stratospheres of income.
If a wealthy widow wants zero risk, she can live off 3-month treasury bills with a 0.05% withdrawal rate and never lose a penny.
On the flip side of risk, centamillionaires and the “family offices” that manage their money have access to hedge funds, private equity, and worse. “Come for the high fees and stay for the underperformance.” They can take on fabulous amounts of risk and it doesn’t matter because of built-in reserves. And if they go broke, there is always another scheme to make all that money back again. See, I told you I give bad advice to the very rich…
Even if Income Level is Right, Risk is Still Wrong
Assume now you are getting advice from someone who is preaching to your choir. The advice is appropriate for your income level.
Well, with the wrong risk level, bad retirement advice is likely!
Moreover, this depends on advisor type.
For instance, if you have an insurance salesman as a financial planner, you might get put into investments that are too conservative regardless of your risk tolerance. That’s right, for everything bad said about the insurance salesman, whole life insurance is generally a very safe investment! Even Indexed Universal Life Insurance has downside protection. These complex policies may be appropriate for someone who has a need for permanent life insurance, but are often sold (for high commissions) as equity-equivalents. They are not. They are bond alternatives.
Conversely, if you go with a Fee-only or Fee-based advisor preaching Assets Under Management, you are sold “risk with a side of fees.” Fees matter, and even 1% can decimate your returns over the long term. You can lose 1/3 of retirement over time with 1% yearly fees!
And to compensate for these high fees, asset managers goose your risk level beyond what you are comfortable with. You may wind up with MORE risk than you think with fiduciary financial planners!
Even if retirement advice is concordant to your income, it can be wrong due to “advisor type” and inappropriate risk levels. You are a square peg and will be pounded into the round hole of that “holistic” advisor who views the world as insurance or investments.
A Specific Example of Bad Retirement Advice
Let’s look at a specific example—a common conundrum—and see why bad retirement advice in action.
What about the pervasive pension question: take the lump sum or the life-long annuity payments?
If you get advice appropriate for your income level and risk tolerance, the correct answer is: it depends! It depends on the IRR (how well the annuity pays over the years—the internal rate of return) and what other assets you own. Well, “it depends” is not very satisfying!
Aside from the “Just Right” advice of “it depends,” what are some other possible answers to the pension dilemma?
Let’s look at folks with too much money and a Pension first.
If you are high income and high risk, you should take the lump sum and invest it for your heirs. Medium risk tolerance: the right answer depends on the internal rate of return—is it a good investment at face value? Finally, if you have low risk tolerance yet more money than you need, take the annuity option. Find something else to do with the rest of the money.
Next, average income.
For those who have an average levels of income (for the advice given): if you are high risk you are apt to take the lump sum and use asset allocation and the Safe Withdrawal Rate approach. This approach provides the best odds of a successful yet bountiful retirement. If income and risk are just right, you might get good advice from the generalized retirement advice. Finally, if you have low risk appetite, you might try a scheme like Pension Max.
Finally, low income.
For those with low income levels, it is all about social security planning. If the annuity causes the tax torpedo, it is best to take the lump sum to use as a bridge to delay social security. (Of course, you need to take health and longevity into account as well… facts and circumstances.)
In Summary: How can generalized retirement advice provide you with all those answers when they don’t know your income or risk tolerance? This is why you get bad retirement advice!
The Goldilocks Effect: Or, Why Generalized Retirement Advice is Often Wrong
Generalized Retirement Advice is often wrong because it is intended for a person with a specific income and risk level. You are not that person. Remember: specific facts and circumstances.
The Goldilocks Effect reminds us: you are not the target audience for the advice. It is bad retirement advice unless it is “Just Right” for your income and risk level.
Remember the anthropic principle of retirement advice. I just made it up but it goes something like: advice exists because advisors benefit from giving it.
Like the universe not existing if we aren’t here to observe it, bad advice wouldn’t exist if we didn’t pay for it.
The more you learn, the more you learn that simple is complex enough. And truly complex products and services do more for the advisor than the advised. Make sure the retirement advice you get is Just Right.