Focus on what clients need to support their lifestyles.
Bob Veres, in a recent e-column, wrote about the paradox of safe withdrawal rates. He used two hypothetical clients who each have $1 million at the end of a year (let's say 2007). Client A retires that year and Client B the following year. Unfortunately, the market loses 20% in 2007 and Client B is left with $800,000. If we follow the studies and recommend to each client that the safe withdrawal rate (improved by inflation) is 4%, Client A gets to withdraw $40,000 (increased each year by the rate of inflation) and Client B only $32,000. Of course, if we run the numbers for 30 years, we discover that Client A has a much more enjoyable retirement (my calculator tells me that he gets to spend an additional $400,000, if inflation is 3% per year).
There is one problem with this analysis. I don't know any planners who manage their client relationships like this. We certainly don't in our firm. There is much more art to what we do than science and, while I certainly applaud and appreciate the need for these quantitative studies, they are meant to provide us with guidelines and not hard and fast rules on how to micromanage our clients lives.
At our firm, we don't tell our clients how much to withdraw from their portfolios. We determine how much they need to support their lifestyles. If we believe it is reasonable (and we do long-term projections with different scenarios and Monte Carlo projections to test the withdrawal amounts that are anticipated), we have little to do but closely monitor the returns, withdrawals, etc., and make course changes when necessary. If we believe their spending may not be sustainable we recommend changes, perhaps phased in over several years. Moreover, when we do settle on withdrawal amounts clients do not ask for these amounts to be increased by the inflation rate each year. Adjustments are made periodically as needed. Isn't that what all of us who practice financial planning do?
Bob's article started an e-mail chat among some colleagues whom I greatly respect. Jon Guyton, who authored an award-winning paper on the subject, wrote, "We (and our clients) seem to approach this paradox entirely planted on the ground of scarcity and fear. It seems we (and our clients) can only ask, 'What if we take out too much and then run out of money?' How might that matter to our clients' lives? Here's what we do NOT seem to be asking: 'What if we take out too little and find that out too late?' How might that matter to our clients' lives? We give a premium to the possibility of negative surprises while severely discounting the chance of positive ones. Hmmm. Can we imagine turning this paradox over and over until we see it from a place of abundance?"
That is an interesting observation, because I seem to be convincing many of our clients that they have more than they will ever need and they should try to enjoy their retirements. It occurs to me that another paradox exists. Many of our clients have accumulated as much as they have because they were savers and not spenders most of their lives, and the habit of deprivation is hard to break. The New York Times (January 27, 2007) published a cover story, "Contrarian View: Save Less And Still Retire." While I certainly don't agree with some of their conclusions, they point to a group of economists who claim, "... the financial industry... overstates how much money someone will need in retirement." That may be true, to some extent, but it is clear to me that those who buy into depriving themselves today for a wonderful retirement find themselves unable to turn from savers to spenders just because they stopped working. How many of us observe clients with millions who spend $40,000 or $50,000 a year? Jon is right. What do we do to improve the lives of these clients, or do we just ignore them because they are withdrawing less than 4%?
In my opinion, many planners are searching for the "magic bullet," and they turn to these quantitative analyses for the answer. Life is full of unexpected events and course corrections need to be made. What do we do if the safe withdrawal rate for a client is $40,000 this year and a new roof is needed or an unforeseen emergency occurs? None of us would advise our client to forgo the necessary expense. We would work with her to make some changes, but would any of us say, "I'm sorry, but your plan will destruct if you replace your roof"? Helping our clients through good and bad surprises is what we do. It's called planning! Marcee Yager, who practices in the San Francisco area, wrote, "It's easier to have a rule to follow than to put effort into examining each case individually. My concern is that universal acceptance of 'bottom line' rules (those relying on single numbers, such as a 4% safe withdrawal rate) can "dumb down" the profession. It's one thing if we as a community are aware that using such rules can be beneficial in providing lower-cost help to those who can't afford to get a well-thought-through perspective on their specific situation. It's another thing altogether if we are relying on rules to give us legitimacy. It's too easy to 'hide' behind a rule and therefore not offer a client what they really need, which is help in identifying what aspects of their lives will be affected by the outcome of a particular decision, and prioritizing them, so they can get a sense of the trade-offs available from different approaches to an issue. It's too easy to use rules to shore up our own insecurity about the value of the advice we give. The most valuable thing we have to offer is our ears (to listen) and our hearts (to care), NOT our formulae."
Ross Levin added his opinion to our discussion: "None of us ever create a plan and accept its permanence. We are constantly adapting to the myriad of things both within and outside our control. I don't believe that even the abundance question is the right one. I think our 'solve-for' is continual and encompassing. It is as much about personal values as it is about portfolio values. We all need to remember that these tools are merely vehicles to promote discussion, not prescriptions for success." Elissa Buie agreed, and wrote, "The safe withdrawal rate is not a panacea and the planners who would like it to be need to brush up on their skill set-interior AND exterior. Safe withdrawal rate is about policies, not hard and fast decisions. And our profession seems to keep looking for hard and fast decisions ... What's that about?"
In my opinion, this issue is no different than most in our profession. Too much attention is given to the quantitative (exterior) solutions and far too little to the qualitative (interior) or life issues. Our clients have lives to live, and part of our job is to help them enjoy those lives and not agonize about money.
Several years ago one of my clients, a successful physician, retired. He had built a substantial portfolio over his lifetime and plenty of money to support his lifestyle and more. He called me to suggest his idea of how to withdraw money from his portfolio, which he saw as a guaranteed plan to never run out of money. He would withdraw, he said, whatever the portfolio earned the previous year, so that his principal would remain intact. I reminded him that there would be years when the portfolio would actually lose money and asked what he would do when that occurred. He asked if I had a better idea. "Yes," I told him, "why don't I just send you a check every month and let me worry about portfolio fluctuations?" I can't imagine telling a client that the amount of money he has to spend in retirement is subject to how well the market does. Wouldn't that create exactly what we want our clients to avoid: agonizing over every dip in the market? My retired physician started his withdrawal from his portfolio about ten years ago, and he lived through the longest bear market of our generation (2000-2002), and survived it very well with no reductions in his withdrawals. A small percentage of our clients needed to make some adjustments, but we didn't alarm them years in advance that this would be necessary in the event of a sustained market downturn. While many may offer the opinion that there is no "Magic Bullet," I believe that one does, in fact, exist. It's called Financial Planning!
Roy Diliberto is chairman of RTD Financial Advisors Inc. in Philadelphia.