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Surprising Research: Retirees Can Spend More Money in Retirement

So today I want to talk about a
topic that doesn't get nearly enough discussion and that sets many retirees
actually should be spending more money than they're spending, or at least
they could be spending significantly more money than they're spending. I started thinking about this topic
because I had a client who has more than enough money to live incredibly
comfortably for the rest of her life. And she called wondering whether she could
spend a thousand dollars on a retreat. And at first I was kind of taken aback
because I thought you could spend a hundred times that and not blink, but
the more I began to kind of think about it, I realized I actually see this in
a lot of clients that they're afraid to spend money because they don't want
to outlast the retirement savings. And so I started doing some
digging and I ran across a really interesting article called guaranteed
income, a license to spend. And it's written by a couple of
academics who are doing research into why retirees don't spend more money. And so I thought I'd take that
articles kind of a jumping off point to discuss the problem.

And hopefully, maybe encourage
some of you that you should be spending more money, not less. That's always a fun problem to have. Hi, my name's Kevin Lum. I'm a certified financial
planner based in Los Angeles. And this channel is dedicated to helping
a million people retire without worry. So why do some retiree spend
less money than they could? In fact, in many cases they spend
significantly less money than they could. Partially the problem is financial
advisors, which I am one. But . Financial advisors for
years use Monte Carlo projections. It's this process that was
created after world war two.

And essentially it allows advisors
to give a probability number, the probability of success. It's highly likely that if you talk
to a financial advisor, you've been given the probability of success. So there's an 80% chance or a 90% chance
of your retirement plan being successful. And if it's 70%, you know, then
they begin to freak out and tell you need to save more money. The problem is, is that it's
a very imperfect solution. It does give you some idea of whether
you are on track for retirement or not, but it has a lot of challenges. And one of the challenges is the
assumption that it makes is that you'll have static spending plus inflation
for there for your entire retirement. But that's simply not the
way that people spend money.

When you research, how retirees actually
spend money, it looks more like a smile. So early in retirement, when
you're in your best shape. And you're most active, you spend
way more money and then as you age, you begin, it begins to dip. And then for some retirees, it will
spike back up at the end of retirement. With long-term care or health care
expenses, but for many retirees, it's just a constant decline. But when the Monte Carlo simulation
is created, advisors are assuming that you're going to spend the
same amount of money throughout the rest of your retirement. And in addition to that, they're going to
continue to increase it by inflation, but that's simply not how people spend money. So, let me break it
down a little bit more. One of the problems with Monte
Carlo simulations is they're binary. It's either pass or fail. So let me give you an example
of why that doesn't really work.

So we have just a very simplistic
Monte Carlo simulation here. You need a hundred dollars each year
over a 10-year period and we're going to run 10 different variables, right? So typically in a Monte Carlo
simulation, they'll run a thousand different variations. One with market goes up, one with market
goes down, we're inflation takes off or flight inflation, collapses, all
these different possible universes. And then it says, did it pat,
did you pass or did you fail? Did you reach your goal or
did you not reach your goal? And then it provides you an
average of whether what's the probability of success of your.

Plan. So for example, in this scenario,
in the first simulation, the first run-through and you're 10, you only have
$90 or eight only, you would pull out $90 of income as opposed to a hundred. Now, in reality, if that were to happen
in retirement, all you would end up doing is just pull back, maybe some of
your discretionary spending, but when the Monte Carlo simulation sees this,
it asks, is this a pass or is it a fail? It's a fail. Now in reality, you re you achieved
99% of your retirement goal. I would consider that a pass. But the computer says no it's yes or no. It's a zero or one it's binary.

It failed. And the second simulation. Year nine and year 10. You're only able to plot $80 in the
ninth year in $80 in the 10th year. Once again, you're at 96%
of your retirement goal. You could just pull back your
discretionary spending, but the computer just says, is
this a pass or is this a fail? If your advisor was to look at this,
they would say you have a 50% chance of achieving your retirement goals, but in
reality, you achieved 96% of your goal. But in a Monte Carlo
simulation it's pass fail. It's just not dynamic enough. And the problem is, is that it
scares a lot of people into being way more conservative with their
money than they really need to be. Now, some people do need to be
conservative with their money. They need to be spending less,
but many retirees could be spending more money on trips and on their grandkids and all the
things in life that they enjoy. But because an advisor is so consumed
with what's the probability of success using a very outdated model,
they end up being entirely too conservative in the retirement years. The second challenge to retirement
spending is the 4% rule.

So many advisors talk about the 4% rule. You know, you can pull out
probably 3.7 to 4% of your income. And the reason is, is because as
you age, there's the glide path. So advisors begin moving more
money of your money from equities. Into bonds. So you have more security and
retirement, but in an attempt to reduce volatility in a portfolio advisors
are reducing greatly the longterm expected return of the portfolio. And there's all kinds of
problems with the 4% rule. First of all, it's not a rule. The guy who created the rule recently
said, you could probably pull out 4.7% if you had a more diversified portfolio. And then it turns out the guy who
created it also has almost all of his money in CDs and a bank. It's very, it's very
odd, but that's not the. We can do a nother video at
some point about the 4% rule. But the problem is, is that
what you see is that people have their money in equities.

Tend to be more fearful, partially because
advisors tell them they can only pull out three and a half to 4% of their portfolio. And the other challenge is, is because
there's real volatility in the market. So even if you have a 60, 40, or 50 50
portfolio, As you've seen over the past year or two, you can end up having a
25% draw down in a very safe portfolio. So if you have a million dollars
in that portfolio and you watch $250,000 of that evaporate, Two years in your retirement, you're
going to be scared to spend money. And so one of the things that researchers
found is that people who have guaranteed income streams tend to spend significantly
more money throughout their life than people have their money in , stocks,
bonds, alternatives, whatever it might be. So the researchers did is
they took two groups of people. They both had essentially
a hundred thousand dollars. Except the one person had a guaranteed
income stream and the other one just had their money in a portfolio and they
found that the people had their money.

Coming from a guaranteed income
stream, ended up spending almost twice as much money in retirement. Not at the end of the day, they
both are probably going to end up having very similar returns. In fact, the person whose money is
in the portfolio will probably have way more money at the end of their
life, but they're more fearful to spend that money on in retirement
because there's so much uncertainty. And so people have fixed income coming
in are just willing to spend more money because they feel less anxious. In fact, one of the other
videos we made, we talked. About the regrets of retirees. And one of the regrets of
retirees was essentially not having more fixed income coming. In fact, two of the top five regrets
were not waiting until later to take social security, which would create a
higher amount of expected, fixed income from their social security payment. And the other was not having an annuity. There's really three main types of fixed
income that most retirees can have the first fixed income, the most popular,
the one that almost everyone will have is going to be social security.

When you retire, you're going to
receive some amount of money from the social security administration. If you take it at age 62, you're
going to receive a smaller amount. If you wait till age 70, you're
going to receive significantly more. And so the longer you wait to draw
on social security, the higher your income amount is going to be. The second type of guaranteed
income is a pension. So, if you have worked for a
legacy company or the government, there's a good chance that you're
going to get a percentage of your. Salary into perpetuity during retirement. So it might be 70% or for some people
up to a hundred percent of their salary. That they're going to receive
through the retirement. So they're going to
receive social security. Plus they're going to receive a pension the third type of guaranteed
income comes from an annuity.

So annuities are really controversial
topic among financial advisors. Now, I'm gonna talk about some
of the problems of annuities in a minute, but let's just talk for a
minute about how annuities work. There's really two basic types of
annuities that honestly you could, there's a hundred different rabbit holes. I can go down. So I'm simplifying this greatly,
but the first type of annuity is an immediate annuity. So you take a hundred thousand dollars. You put in an annuity and then you
get a guaranteed amount of money paid out to you for the rest of your life. The other type of annuity
is a deferred annuity. So you have to wait at least a year. Can be significantly longer before you
start receiving your annuitized payment. So you have an immediate annuity and
then you have a deferred annuity. Some people will use deferred annuities
that won't kick in until age 80, because they're most concerned about
guaranteed income later in life. Other people want
annuities to start earlier. So they'll use an immediate annuity.

So you have immediate annuities and
then you have deferred annuities. And then the other variable within
annuities is you have a single annuity or a single annuity. Where you have a joint life annuity. So a single annuity basically
covered you for your life. When you pass the nudity goes away. A joint life annuity will cover two
people through the end of their life. Sometimes there can be a
step down and benefits. You can structure it in different
ways, but essentially it is annuity for you and your spouse. And then you can also structure
the payout of the annuity. So you can have a life only
annuity that typically provides you the largest payment. But that means that if you annuitize say
a million dollars and you're going to get, you know, $50,000 a year for the
rest of your retirement, and then one year after annuitizing that money you pass.

All that million dollars goes
back to the insurance company. There are all these
other variables, right? A 10-year certain annuity. So that means that, you know, if you
annuitize a chunk of money and then you pass right away, your family will
still receive payments for 10 years. There can be a cash refund annuity. So there's all these different variables. And then you can also have a riders. For like cost of living
adjustments for inflation. And so you can play with and
mix and max annuities, but the most basic type of annuity is an
immediate payout fixed life annuity. Where you give a million dollars to the
insurance company, and then they guarantee for the rest of your life or the rest of
your life and your spouse's life, a fixed sum of money that you're going to receive
often those annuities are called a SPIA, a single premium, immediate annuity, right? You give them money to the insurance
company and then you get an immediate payment for a certain amount of
money for the rest of your life.

So let's talk a bit about
the problems of annuities. Because we, the research shows that they
can be really helpful to retirees because they can allow them to spend more money
because you're less concerned about market volatility, market fluctuation. The problem with annuities and
the reason that financial advisors are so divided over annuities
is they've been greatly abused. Anytime you have a commission
attached to a product. There's a lot of room for abuse because
pers the person selling the annuity has an incentive not to provide you with the
best annuity possible, but to provide themselves with the highest commission
possible and particularly the United States, we have what's called a variable
annuity, which pays out incredibly large commissions to the, the advisor
and opens the customer up to a lot of risks because it can be invested
in the market and just doesn't provide the protection that it's supposed to.

But there's also been a lot of
changes in the annuity market. Historically an insurance agent was paid a
commission when they sold you an annuity. So let's say they sold a million dollar
single life premium annuity to you. They might make 10% commission. And so they're going to make
a hundred thousand dollars or whatever the case might be. Now you can get no commission annuities.

And typically the no commission annuities
or no fee annuities have a much higher. Payout to the client. Now the problem is, is that the
advisors who sell these are often at fee only financial advisory firms
and they'll charge a management fee 1% AUM or whatever it is. So both sides historically have had
some ulterior motives and particularly it's problematic in the field. Only community. Because fee only financial advisors often
claim to be the ones who are working in your best interests, their fiduciaries. But they still have, if they're
working on the AUM model, they still have an ulterior motive to keep your
money invested in the market, as opposed to putting it in a new city. Now, with some of the fee only
annuities or the no fee annuities that is beginning to change a little bit, so finally, let's talk about
the practical implications.

In reality. If you leave your money in an equity,
heavy portfolio, you most likely are going to end up with a much larger chunk
of money at the end of your retirement to pass on to your friends and your
family or your favorite charity. Then you will, if you use an annuity On the other hand, if you have guaranteed
income, you're likely according to the research to spend way more money in
retirement on things that you enjoy than you are, if you have your money in the
market, because while you will probably end up with a larger chunk at the end
of your retirement, if you leave your money invested, you're always going
to have way more volatility, right? You can have times in your portfolio
can be down 20, 30, 40%, which is going to make you worry to actually
pull money out of your portfolio. Whereas if you put your money. Into an annuity, you have a fixed
income stream coming in and you know that no matter what happens,
you're going to have, you know, $10,000 a month in income coming in.

And so you feel comfortable spending that
money on things that you enjoy in life. And so part of the decision that
you need to make is like, what do you actually value and prioritize? Do you value having less
worry, having less volatility? And you're not as concerned with leaving
a chunk of money at the end of your life, then maybe you should create
some more guaranteed income through. An annuity or through maximizing social
security or through choosing a job that has a pension, if you're still working.

Right.
So you might want to lean that way. On the other hand, if you're like, I
want to leave as much money to future generations as possible, and I can
withstand the volatility, then you might want to go into a more equity, heavy
portfolio and just ride the equity wave. Now for a lot of people facing
retirement, it might not be an either or. Maybe you put some money into an
annuity that hopefully between the guaranteed income that you're going
to receive from social security, plus some of the guaranteed income you're
going to receive from your annuity. You can basically make sure that all your
fixed expenses are covered and then you can leave the rest of your money in an
equity heavy portfolio that hopefully will grow significantly over time. You can pull some of that money out
to do things you really enjoy doing. Buy a second home, take the whole family to Disneyland
or whatever the case might be. Or leave a large chunk of
money at the end of retirement. And so really it's one of these
decisions that can't be completely answered by an Excel spreadsheet.

If we're just going to look in an Excel
spreadsheet, the best thing you could do probably is just put all your money in
the market and just ride the volatility. But that also might keep
you from sleeping at night. On the other hand, if you want to
sleep at night and have guaranteed income, the best thing is probably
to put everything you have into an annuity, and you just have guaranteed
income for the rest of your life.

And you're able to spend
your heart's desire. But you have nothing to
leave for future generations. Probably neither of those
options are perfect. And so maybe finding a middle
ground of that, that blended option is best for you, whatever you do. I would highly recommend that you find
a financial advisor that's fiduciary. And honestly, it might be helpful to find
a fiduciary that has an AUM or a flat fee model, and also offers a annuities
either through no fee annuities or no commission annuities, or maybe has an
insurance license and can write annuities. And that way, if you have a fiduciary that
can also write an insurance policy, maybe there's a little bit more balanced. The other thing you could do is just
find someone that will advise you for a fixed fee, do a one-time plan and
that their money is made simply from writing the plan and not from selling
you an annuity or managing your money.

Um, lots of different options. As always, if you liked this content
and if you can ding that bell,.

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