Tuesday, April 1, 2014

The Chicken and the Pig

In the mid-nineties, I began an intensive study of retirement finances. I wanted to retire early. The Tech Bubble was just getting into full swing and dollar signs were flashing before me, none so brightly as the largest "terminal portfolio values" generated by Monte Carlo simulations of safe withdrawal rate strategies.
You know those best of the best-case scenarios where you retire with a million bucks, fund 30 years of retirement, spend $45,000 a year and then leave your kids a portfolio worth nearly eight mil? Never mind that those numbers are inflated dollars 30 years in the future or that they happen once in a blue moon. In the late nineties, everyone with a sock puppet was going to be rich.

I couldn't figure out exactly how that was going to work, so I built my own Monte Carlo simulator to learn the details. (I started my career as a software developer.) Then I really couldn't understand how that was going to work. Constant dollar withdrawals just made no sense to me but, hey, Money magazine was on board so there had to be something there.

(I think today, particularly after the Great Recession, most people have abandoned the constant dollar withdrawal folly and realize that they can spend more when their stock portfolio grows, but they will have to spend less if it shrinks.)

I was a big fan of systematic withdrawal (SW) strategies back then.

Then something happened in my life that caused the financial equivalent of a paradigm shift. You know "paradigm shifts" in science, right? Like when Copernicus explained that the earth revolves around the sun and not the opposite and everyone was like, "Whoa, Dude! This changes everything!"

I had one of those.

I retired.

When my mother-in-law retired from teaching she had said, "You can't imagine what it feels like to realize that you will never receive another paycheck."

I finally understood. Then I looked at my retirement savings and realized that I would also no longer contribute more earnings to that pile of money and, in fact, I would be spending from it every year. In effect, I would be swimming against the portfolio growth tide. When the market gave me 8%, I would be spending half of that, not contributing another 4% of my paycheck.

I had to make that money last an awfully long time to support my family. Three decades, maybe.

Suddenly, "There's a 90% to 95% chance that your portfolio will last 30 years" started to sound more like "there's a 5% to 10% chance that you'll go broke before you die".

Bam! Paradigm shift.

I could stop the story here with ". . . and that's how I became a safety-first guy", except that isn't the end of the story and I'm not a diehard safety-first guy. (But, I'm close.)

The sudden scarcity of paychecks after retiring wasn't the only shock. In 2000, a friend who was heavily invested in tech stocks lost his entire $4M nest egg just a few years before retiring. Literally dozens of my coworkers who held on to their company stock too long lost millions in paper profits that year and likely will never be even paper millionaires again. And those were just the people I knew. At just one of the tech companies.

Having a secure source of money to at least meet my non-discretionary spending needs began to sound pretty important.

Retirement funding is far more complex than systematic withdrawals versus floor-and-upside. Many factors come into play in selecting a strategy. Like, how much wealth you have.

A few of my former colleagues and Tech Bubble survivors escaped the carnage with tens or even hundreds of millions of dollars. They don't much need retirement plans. They can build a diversified portfolio and be pretty sure that even their grandchildren won't need a plan.

More than 90% of Americans, though, have not been able to save nearly enough for retirement. They probably shouldn't be risking anything in the stock market. Other factors that play into strategy selection include whether or not you are married and whether you have heirs. Your health is a factor. It isn't simply a matter of your risk tolerance.

I view retirement strategies as a continuous spectrum from life annuities and certificates of deposit (my mother-in-law's preferred investment) on the conservative end of the spectrum to systematic withdrawals on the riskier end. You can choose fairly precisely how much safety you want at the appropriate point along that spectrum. As a financial planner, I think my job is to place clients at the right point along that spectrum depending on their unique, current financial situations.

Sometimes, things will happen as we age to suggest moving that point along the spectrum in one direction or the other. Pulling the trigger on retirement may be one of those times. It may, as my mother-in-law tried to explain, significantly change how you view the world.

There's a fable about a chicken, a pig and a plate of ham and eggs. The chicken is involved but the pig is committed.

Most people seem like chickens to me before they retire. I was. Same goes for retirement planners who are still working. Chickens think more about spending than risk. When we retire, risk takes center stage.

Retirees are committed.


  1. Dirk, I love your sense of humor. It really makes your articles as entertaining as informative. The sock puppet was great as was the chicken and pig reference. I recently retired (though my wife still works so we are still adding savings to our portfolio, but at a greatly reduced rate) so I have begun the transition from saving to withdrawing. Until the last few years risk was something I really didn't worry much about because I was in the portfolio growth mode as I had always been, but recently with your help I have had my paradigm shift getting a better handle on not only the upside of investing in stocks, but the downside. I am much more in touch with my risk tolerance, and it is much more visceral than before. I have one of Wm Bernstein's I think (who you told me about) quotes in a visible place by my computer 'take no more risk than you have the ability, willingness or need to take,' I have a lot to learn yet about investing and retirement income, but thanks to you I am in a much better place than just a few years ago. Thanks, Brad.

  2. I'm fortunate, in that my SSR, my defined-benefits pension and that of my wife (we're both ex-Feds) covers our monthly expenses. As I've mentioned previously, though, and you addressed in your LTC post, there remain worries. But, that seems to part of the human condition. To put that a bit more scientifically, neurologically and envolutionarily we are built to continually scan the environment for risk.

    I'm curious, though. You said you retired, but I take it you're now working again. I assume what you do is not all pro bono. Although you certainly are under no obligation to explain or justify, what is it that caused you to return to work--money, boredom, opportunity, risk reduction?

  3. I got this back following a post. What does it mean?

    "Your email comment subscription (address [my email address]) has been cancelled for this post."

    1. Sorry, no idea. I got both posts, though. Maybe re-subscribe the e-mail?

  4. I'm trying my original post again. Sorry if there's duplication.

    I'm fortunate in that my SSR, my defined-benefit pension and the d-b pension of my wife (were both former Feds) covers our expenses. Still, as you addressed in your LTC post, there are things that we worry about. I think that such worry is a part of the human condition. Or, to put that more scientifically, we are neurologically and evolutionarily built to scan for threat up to the day we die.

    I am curious, though, about why you decided to leave retirement for what I assume to be something other than exclusively pro bono work. Money, opportunity, boredom, risk-reduction? You certainly are under absolutely no obligation to answer just to satisfy my curiosity.

  5. I think we are programmed to "scan for threat", but my experience is that the vast majority of us scan for financial threat very poorly. How else do we explain the mortgage melt-down, Bernie Madoff, the Tech Bubble, etc., etc.

    At first, I thought you were asking why I retired early, but re-reading your question, you're asking why I "left retirement".

    I certainly haven't left retirement, I'm having a blast. Studying retirement finance is a hobby that just happens to come in handy almost every day when you're retired. Retirement planning competes for my time with other activities like fly fishing, shooting sporting clays, college baseball (40 games a year), raising three young adult kids, writing southern humor (at LocallyGroan.com), writing my baseball blog, and reading detective novels.

    I spend most afternoons at a local coffee shop reading novels or writing about finance and chatting with UNC profs about statistics, finance or the best restaurants and museums for an upcoming trip abroad. If it's spring, I spend the evening at a ballgame.

    I'm not interested in earning a profit from this. Just interested in maybe helping a few people out. So, not money or opportunity, maybe reducing the risk of boredom? Thanks for asking.

    1. Dirk said, "I think we are programmed to 'scan for threat', but my experience is that the vast majority of us scan for financial threat very poorly. How else do we explain the mortgage melt-down, Bernie Madoff, the Tech Bubble, etc., etc."

      We scan for threat in our finances, but in addition to being simply ignorant or misinformed we have other psychological blind-spots that cause us to misconstrue legitimately threatening situations as non-threatening, or irrelevant. One of the leading causes of such misperceptions is confirmation bias; i.e., we look for and find confirming evidence for our beliefs, ignoring or rationalizing away all disconfirming evidence. Climate-change deniers, creationists, believers in alien abduction or spontaneous bodily combustion, and GMO-phobics all think of themselves as heroes whose missions are a crusade for the truth. For some examples that are even more egregious than Madoff, the dot.com bubble, mortgage bubble, etc., see "The Unpersuadables: Adventures with the Enemies of Science" by Will Storr, Overlook Press, 2014. You'll have even more to chat about with those UNC profs when you read Storr's book. :-)

      Thanks for the story of what you're doing in retirement. Similar to my story, but I do mine in a rural environment.

      Best regards,


  6. Really nice post - the psychology of the retiree and this stage of life - separate from risk tolerance - is critical to providing guidance that can help real people get through their mature years.

  7. Thank you for pointing out that how much money you have makes a difference. Once I figured out I have "enough," I realized I should ignore most of the advice out there. Most writers don't point out that one's strategy will differ depending on how much savings one has.

    1. It's actually the single most important factor in determining a strategy.

      And the one piece of "advice out there" that I would recommend you not ignore is William Bernstein's: "After you win the game, stop playing."

  8. Great post!

    Not only is it good advice but, it really resonated with me. I'm just on the Copernicus side of the paradigm shift (retiring this year) and, Whoa Dude, this DOES change everything. Your article, Wade Pfau, Guyton, others, and a lot of E-R.org have moved me along the spectrum toward safety I'm a VWR, safety first for essential expense with a back-up plan kind of guy. In the last few years I've moved along the spectrum toward my grandmother. In my financial life, she was the equivalent of your mother-in-law. She was a wonderful woman, lucid and witty until she died at 95, and always lovingly blunt, emphasis on both loving and blunt. I remember about 20 yrs ago, right after reading and beginning to follow Ken Lee's "Trouncing the Dow", that I had a financial conversation with her. She would have been about 80 at the time. She had been widowed for two decades, lived a simple life, and had all she needed. All her money was in CDs, bonds, and a bit of real estate (the kind she could drive to and touch.) Being so smart, I was sure I could help her get a better return. So, one day I asked her, "Grandma, you're invested very conservatively and getting small returns. Can I give you some suggestions on how to invest in stocks, because I'd like to see you earn more?" Her answer, and it's delivery, said all that needed saying. "No honey." Then we went for afternoon coffee, she paid of course, because she had more money than she needed and loved to treat her grand kids. I think Grandma understood Bernstein without even reading his book.

  9. Mr. Cotton,

    I love reading your posts...I finally got it! I was sitting doing nothing but listening to some soft music as dinner cooked, the dog at my side the cats in and out in and out the door to the deck and it hit me.


    I have just started reading some of Phau's posts at his site and I still did not get it. But what I was reading had a lot to do with Social Security.

    Now, I am one of those females that took time out from work to care for parents, work in my former husband's business, did not really have a high paying career although I am well educated, paid for by yours truly so my SS benefit will be meager. Especially if I start taking it at 62.

    I have run the numbers and run the numbers and run the numbers again and I still did not see the light. Why NOT take it at 62 if I am one of the females that will die around 85. I figured that only gives me a few years where I make less (the year 82 is when the benefit from SS becomes less if taken at 62) so the experts say.

    But WAIT! It came to me. Quietly. Sitting on the couch with the dog. The money I have now (thank you Lord) will be the same price point going forward. No one is going to give me an inflation hedge

    (all I have to do is go to the store for something and yeah we are in inflation I do not give a you know what to see I am paying more for everything)

    on the money I have going forward unless

    1. my investments go up
    2. I do an annuity and TIPS
    3. I win the lottery

    All of which I kinda think is not going to happen. Maybe #2

    But if I hold off on SS until say 64-65 and use some of my investments to keep me going if I still cannot find adequate work, I see now that SS is an inflation fighter by the simple fact that it is hedged for inflation.

    My retirement savings are not.

    So I will be using up some of my savings so that I can put off SS so that I can get a better pay out going forward.

    So simple once the apple falls in your lap, but so difficult to understand until the apple falls in your lap.

    Thanks Mr. Cotton, you now have a bonafide believer in the power of inflation to wreck a retirement.

    I now have a 50/50 split in stocks and bonds at $259000, $25,000 in Treasuries, $90,000 in cash and $30,000 in an emergency fund.
    Vanguard thinks I am too conservative...but what did Bernstein say...when you have enough take it off the table. As would any really good poker player. Know when to fold em.

    Also, I just had a cancer scare when my mammogram came back with the WARNING WARNING WARNING. This is the second time this has happened, but I am older, am not special and know from listening to my now former spouse (he is a cancer doc) that cancer can hit anyone. That being said, I don't have cancer, it is a lump, just a lump.

    Puts life in perspective. I have been happier today for my life (good and not so good) than I have been in quite awhile. Blessings come in many different packages.

    Even inflation. And lumps.


  10. Teresa, over the long term, your stock investments will probably outpace inflation, too. The problem is that stocks don't provide those compensating returns at the same time inflation is occurring, so you have to wait for it.

    Also, I would encourage you to frame your Social Security claiming decision as insurance and not as a bet. If you frame it as a bet, you're betting that you won't live a long time, so you're better off taking less money sooner. Unless you have a convincing reason to believe you won't live a long life, there is no basis for making that bet.

    I've never understood that mindset. Are people thinking "I'll claim early and hope I don't live long?"

    Frame it as an insurance problem, instead, and consider that by postponing your claims you are buying longevity insurance to protect you if you DO live a long time.

    Thanks for reading!