I was recently part of a presentation for financial advisors, put on by someone whose work I respect (and who I imagine probably would not have said this if he had had more time to think about it). Just before the end, this came out of his mouth:
Words I just heard! “If clients want to retire early & can’t lower spending, then allocate their portfolio to earn a higher rate of return”
— Sandi Martin (@SandiMartinSPF) August 20, 2015
(Of course I tweeted it!)
What’s going on here and why is it so outrageously wrong?
Let’s unpack that a little bit, because – as crazy as this sounds – it isn’t uncommon advice. Financial advisors all over the country look at people who don’t quite have enough to retire early and give this advice with a straight face (most because they don’t actually know any better, some of them because…well…)
First, someone who wants to retire early is going to spend more from their investments than they would if they retired later.
Second, someone who wants to retire early and is going to be spending more from their investments will be doing that spending sooner than they would if they waited.
Third, someone who wants to retire early is going to have reduced CPP and defined benefit pension payments because they either a) applied for the benefit early and are subject to the age adjustment factor, or b) have extra years of $0 income between their early retirement date and their “normal” retirement date.
Fourth, someone who wants to retire early is going to have to wait longer to be eligible for pension benefits like OAS (or CPP if this someone is hoping to retire before age 60).
Taken together, our poor client needs:
- His investment portfolio to last longer
- His withdrawals from that portfolio to be higher (to make up for the lower CPP and DB pension, and
- His withdrawals from that portfolio to start earlier
Sounds like a perfect recipe for over-exposure to sequence of return risk to me, and – to put it into the plainest language I know: this client probably shouldn’t retire early.
So why is “be more aggressive” such distressingly common investment advice?
Most financial advisors depend on selling you a product in order to get paid or make their employers happy. Employers generally want their advisors to be efficient with their time, and therefore structure advisor compensation and training to both discourage complex (and time-consuming) retirement income planning and encourage the sale of new, more valuable products. Product sales are rewarded. Investment advice is not.
Most humans are reluctant to give other humans bad news, and sometimes – for instance, when the first human’s income and/or job depends on keeping the second human happy (and lucrative) – advisors would rather promise higher returns through more aggressive investing, especially since the advisor and his or her employer is comfortably protected a familiar disclosure that says “past performance is no guarantee of future performance.”
If you find yourself across the table from someone who is telling you to take on more risk so you can retire earlier, there’s a small chance that you’re getting good advice, but there’s a much, much bigger chance that you’re holding hands with a blind man and walking toward a cliff.
Here’s some outstanding additional reading on how dangerous this kind of thinking is: What does retirement actually cost | Think Advisor
Image: Evelyn Simak [CC BY-SA 2.0 (http://creativecommons.org/licenses/by-sa/2.0)], via Wikimedia Commons