- She implies that you can’t plan for a stock market crash
- She confuses assessment of investment risk with mitigation of investment risk using investment risk management
- She focuses on withdrawals from investible assets rather than spending from all retirement sources and
- She gratuitously denigrates the use of Deterministic models (like ours) for developing robust personal retirement plans
We will discuss these articles and will conclude with a recommendation that if your current financial advisor doesn’t suggest some form of effective downside investment risk management to deal with future stock market crashes, you may wish to:
- retain a new financial advisor who does,
- try our Recommended Financial Planning Process, or
- suggest that your financial advisor incorporate our Recommended Financial Planning Process (or something similar) into his or her plan for you.
Of course, you can plan for a stock market crash
In our posts of:
- April 23, 2018 OK Retirees, What’s Your Plan for Dealing with the Upcoming Bear Stock Market?
- September 16, 2018, What’s the Plan Betty and Stan?
- July 9, 2019, OK Retirees, Now May be a Good Time to Shore Up Your Floor Portfolio
Risk assessment vs. risk management
It is one thing to assess your risks (risk assessment) and it is another thing to take steps to try to manage your risks in retirement (risk management). Monte Carlo simulations (Stochastic modeling) is one of several tools that may be used to assess risks. According to Actuarial Standard of Practice No. 51 (a standard of practice applicable to pension actuaries) risk assessment tools include:
- “What if” stress testing
- Sensitivity testing
- Stochastic modeling
- Scenario testing, and
- Comparison of a present value (or sustainable spending budget) developed assuming a discount rate derived from minimal risk investments to a present value or sustainable spending budget developed assuming expected investment returns (Stochastic or Deterministic)
Monte Carlo models used by many financial advisors tend to underestimate the risk associated with investment in risky assets. It is important to acknowledge that stocks are risky investments, and most financial academics and experts like Nobel Laureate William Sharpe will tell you that, “Supporting a constant spending plan using a volatile investment policy is fundamentally flawed.” Therefore, retirees need to make sure they are not over invested in stocks relative to their fixed (essential) spending goals.
Focus on withdrawals from investible assets
Unfortunately, many financial advisors focus entirely on withdrawals from investible assets under their management when developing a spending budget, if they help you develop a budget at all. For example, Ms. McKenna says, “during retirement, the focus should be maintaining a reasonable and flexible withdrawal rate relative to your investable assets.” We disagree. We believe that a sustainable spending budget should be developed based on a comparison of all retirement assets and spending liabilities, and withdrawals from investible assets should be determined by subtracting income from other sources from the sustainable spending budget.
Monte Carlo models vs. Deterministic models
As discussed in many of our prior posts (most recently in our post of March 28, 2020), we disagree with the possibly self-serving comments made by Ms. McKenna regarding the supposed superiority of Monte Carlo models. Deterministic models like ours can also be very easily used to assess risks. We encourage modeling deviations in assumed experience using what if analysis. And, because our default assumptions are consistent with the concept of assessing risk through the use of a discount rate derived from minimal risk investments, it is easy to measure whether other proposed spending approaches assume more investment risk by simply comparing their results. If another approach indicates that you can spend more than our approach, it likely is based on an assumption that assumes more investment risk and higher assumed expected returns.
By encouraging annual valuations, our approach is designed to keep spending budgets on track when experience inevitably deviates from assumptions. Monte Carlo models don’t generally do this and imply a more “set-it-and-forget it” safe strategy.
In addition to being able to assess risks, our Deterministic model and Recommended Financial Planning Process can also be used to actually manage investment risk with respect to Essential Expenses via establishment of a Floor Portfolio of low-risk investments.
Kitces post suggesting financial advisors practice “rational overconfidence” to reassure clients
With respect to financial advisor client communications regarding possible decreases in spending resulting from the recent market decline (including discussions with hypothetical recent retirees who were told they had sufficient assets to retire), Messrs. Michael Kitces and Richards note in their post of April 9, 2020:
“Ultimately, the key point is that financial advisors can best support their clients by proactively guiding them through the adjustments needed to keep their financial plans successful, and clarifying that these adjustments are not only normal, but also that they are not an indication that the plan has ‘failed’ and instead simply that course-corrections are a part of the process in the first place. And by practicing rational overconfidence to reassure clients [emphasis added], advisors can communicate that the financial plan is a tool to help them figure out what adjustments to make to stay on course, navigating the unexpected-yet-inevitable roadblocks and obstacles that arise from time to time.”
And while we want our financial advisors to be confident and reassuring, we also want their proposed strategies to keep us out of trouble and keep us safe. We believe client discussions taking place at this time would certainly be much easier (and not require financial advisors to exhibit “rational overconfidence”) if the clients were told that:
- The risk management steps that had been previously implemented to establish a sufficient Floor Portfolio of low-risk investments to cover their essential expenses is working just fine, but
- they may need to reduce some Discretionary Expenses payable from their Upside Portfolio.
In her article, Ms. Grillo says,
“Moreover, while I love reading articles about how the profession is moving to being planning-based, I don’t see it as reality in the foreseeable future. Look, AUM fees are not going away anytime soon because there is just too much money involved for that to happen. Point blank, period.”
“What’s so wrong with having investment management be the focus right now? The highest value an advisor provides in a market like this is talking people down from the ledge and preventing them from selling down their positions locking in 35% capital losses. At a time when there is no cash flow, is financial planning more useful than investment management?”
Ms. Grillo bluntly points out the obvious conflict of interest that many financial advisors have when it comes to advising their clients and helping them develop their financial plans. Their fee income is based on assets under management (AUM), not financial planning and implementing risk-management strategies, and that fee income has been reduced as a result of the recent stock market drop. We caution retirees to keep this conflict of interest in mind when discussing Monte Carlo model results, investment strategies and risk mitigation approaches with their financial advisors.
In his comment to Michael Finke’s Advisor Perspectives article How Financial Plans Must Adapt to Market Crashes, financial advisor Michael Lorenzen said
“For our clients age 50 and up with retirement assets we strongly suggest they have active downside risk management. This is the third major bear market in the last twenty years. In my opinion there is no excuse for someone losing big. If you are an advisor, get a risk management strategy in place for your clients or get them to a money manager that has one that works. It’s a whole different ball game for a 30 something with time to recover as opposed to clients who do not have that kind of time to recover.”
We agree with Mr. Lorenzen.