If you are a financial advisor, does the advice you give your clients depend on how you are paid? If you are a retiree and work with a financial advisor, does his or her advice depend on how your advisor is compensated? In another fine blog post, Michael Kitces discusses the possible impact of financial advisor compensation on the partiality of advice given. He states, “the fact that financial planning remains rooted primarily in product sales [insurance products] and asset gathering [Assets under management or AUM] has influenced – perhaps more than most advisors realized – the way that our financial planning software is built.” In his post, Michael focuses on development of financial software, but his ultimate goal is to encourage advisors to provide impartial, “real” advice. Thank you for bringing up this unsavory subject, Michael.
Full Disclosure: As noted in my Biography, I’m a retired pension actuary with no expertise in financial planning or investments. I receive no direct or indirect compensation from visits to this website or from any activity associated with this blog. I will not try to sell you insurance products, try to manage your investments or give you advice regarding how to reduce your taxes. My mission is simply to encourage you to use basic actuarial principles to manage your spending in retirement. Sorry, I won’t be providing you with any sexy software for this purpose. Just the basics: 1) Using the Actuarial Approach to develop a reasonable spending budget (usually annually), 2) Monitoring actual spending vs. the budget developed using the Actuarial Approach and 3) making necessary adjustments to keep spending on track. To use an old football metaphor, I focus on the “blocking and tackling” of spending in retirement.
What follows are admittedly generalizations that don’t apply to all financial advisors, and particularly do not apply to financial advisors who charge an hourly rate for their advice.
Interestingly, Michael Kitces is a staunch proponent of the 4% Rule. This rule and other static (“safe) withdrawal rate approaches were generally developed by financial advisors who also encouraged their clients to invest significant portions of their retirement assets in equities. Many of these advisors down-played the benefits of insurance products as purchase of these products would reduce AUM, and therefore their potential compensation. Those who used these static approaches develop a spending budget by adding income expected to be received from other sources during the year to this static percentage withdrawn from accumulated savings (typically increased by inflation from year without regard to actual investment performance). Other than this addition, there was no coordination with other sources of income. So, the recommended amount to be withdrawn from accumulated savings during the year didn’t change if the client did or didn’t have a fixed dollar pension or immediate annuity or a deferred annuity.
On the other hand, those in the insurance industry tended to tout the risk pooling and guarantee benefits of buying insurance (generally lifetime income products and long-term care insurance) and begrudgingly acknowledged that there might be benefits of investing in stocks, bonds and other investments (but they took great care to emphasize the non-guaranteed nature of such investments). Since they generally looked down on such investments, they were somewhat of an afterthought when it came time to develop a client’s spending budget. Thus, those employed by the insurance industry tended to point to the various static approaches advocated by the financial advisors (if they addressed the issue at all) as possible approaches to be considered for those retirees who had some money left after buying insurance.
More and more academics and retirement experts are discovering that the optimal investment of retirement assets may involve some combination of pooled risk lifetime insurance products and investments. The Actuarial Approach advocated in this website develops an actuarial spending budget that coordinates the two types of assets to meet retiree objectives by matching a retiree’s total assets with her total liabilities. It doesn’t just “tap” the retiree’s savings by using a static withdrawal percentage. It also tells the retiree whether his or her spending is on track from year to year and reflects changes in investments and actual spending. The 5-year projection tab in the “Excluding Social Security v 3.1 spreadsheet also allows retirees and their financial advisors to plan future actions should actual future investment returns and actual spending force the retiree off the track.
The Actuarial Approach is not designed to help you choose investments or avoid taxes. But it does “tick a lot of the boxes” advocated in Michael’s Manifesto. While it is not as comprehensive as Michael would like, it does provide “real” impartial advice for managing spending in retirement.