Episode 143 – Retirement [7/7 Series Pt. 2] with David Macchia

Announcer:
This is The WealthAbility® Show with Tom Wheelwright. Way more money, way less taxes.

Tom Wheelwright:

Welcome to the WealthAbility Show, where we're always discovering how to make way more money and pay way less tax. Hi, this is Tom Wheelwright, your host, Founder and CEO of WealthAbility.

So you're nearing retirement or you're thinking about retirement and you're wondering, how will I make that nest egg last? Whatever it is, whether it's a small amount, a big amount, this is something everybody's concerned about. And particularly I think I want to focus a little bit on women, because we have an expert today in this field. Because in the end, as we know, most assets end up with women. They don't end up with men because women outlive men.

So today we have an expert in the field. This is David Macchia. David has written the book Constrained Investor, and his website is wealth2k.com. And David, if you would, just give us a little of your background and why you got into this whole idea of how to make money last.

David Macchia:

Well, I think there's nothing more important, Tom, for a retiree. I've been involved with the sort of specialty of turning cash into income at retirement since 2004 when I learned about the baby boomer phenomenon. Right now we have 10,000 Americans turning age 65 each day. Next year, we reach what's called Peak 65, which means that there will be 12,000 Americans turning age 65 each day.

The challenge of using your accumulated assets, your 401K plan, your private savings, in turning that into income that lasts life and inflation adjusts, is very important. I call it the most consequential financial decision you'll ever make because no retiree stops needing income. Therefore, you better have a strategy that makes your income last because that's how your standard of living is created.

Prior to this, I was involved with insurance and wealth management for over 30 years. I've been kicking around for a long time, to say the least.

Tom Wheelwright:

So of course one of the challenges is none of us know how long we're going to live, right? So I do think… So okay, in full disclosure, I'm one of those who turned 65 last year, and I have my Medicare card, very proud of it. And it is something you think about. I mean, everybody does think about that is, okay, no matter how wealthy you are, how do you make that income last? Because you don't know how long you're going to live.

So let's start with some of the basic principles. I mean, because we have people that have very little, they may have 100,000, 200,000, $300,000 and we have other people who have 10 million, 20 million. What are some of the basic principles that we have to start looking at right from the beginning?

David Macchia:

I would say the first thing is to determine what kind of investor you are and find out if you're a constrained investor, and let me explain what that means. In the financial industry, the industry tends to segment people according to how much money they have, and they put you into these neat categories. And that's okay while you're accumulating. When you retire, that system falls short because it doesn't make room for the things that are most important when you plan income.

So I developed a framework called the Constrained Investor. What does that mean? That means when you turn 65 or when you retire, every one of us can be put into one of three categories of investor. There are underfunded investors, overfunded investor, and constrained investors. Let me define them for you.

Underfunded investors mean just what it sounds, they have very little money at retirement, they're going to rely on social security.

The other end of the spectrum are overfunded investors. These are people who have lots of liquid assets, they have more money than they need to produce the income they require to live on. They're a lucky minority.

But in the middle, there's millions of people, millions of America's constrained investors, which means you get to retirement with savings, which is great, but the amount that you have is not high relative to the monthly income that has to be created to sustain a minimally acceptable lifestyle. When you are in that situation, which describes most people who've saved, you have to be very careful to protect against risks that can reduce or even wipe out your ability to create retirement income. And let me explain the first of two risks that are very important.

First one is timing risk. What timing risk means is that if you have unlucky timing of your retirement, if you are going to retire at a time when the stock market turns downward, you can very easily get into a downward spiral where you're having to sell more and more of your portfolio each month to reach a certain level of income you need, and you can easily run out of money.

And I'll show you how dramatic this is. If you can imagine two people who are financially identical, they're both going to retire. They have the same amount of money, the same investment portfolio, they're going to take out the same amount of income in retirement. The only thing is different is timing. Let's say one retires January 1st and the second retires April 1st. There's three months separation there. That three month separation could cost one of them a million or $2 million in lost income. So when you're a constrained investor, you have to protect against that risk.

And the second risk you have to protect against is longevity risk, because that goes right back to what you said, none of us knows how long we're going to live. So we need an element in our strategies, typically something that's going to pay guaranteed lifetime income. And that brings up the annuity word, which some people recoil when they hear, but in fact there are tremendously quality annuities that everybody should have a little element allocated to that if you're a constrained investor.

Tom Wheelwright:

Okay, so let's talk about those. So how do you deal with that timing risk?

David Macchia:

So here's the key. What you want to avoid is what financial advisors classically recommend. Now, this is a very interesting dynamic that people don't quite understand well enough. There are different types of financial advisors and a lot of financial advisors are considered registered investment advisors. And typically, Tom, as you may know, they're very, very talented at helping you grow your money, but their expertise is not in how you spend your money. So the tendency is to say, okay, we'll treat both phases of life the same. You systematically invest going into the market, then you turn 65, you retire. Let's take out three or 4% a year systematically. That is the one thing that you want to avoid at all costs because it offers no protection against timing risk.

And timing risk is very easy to guard against. All you have to do is that in the early phase of retirement, in the first 10 years is critical, make certain that you're withdrawing your money to live on from investments that are not subject to market risk. So safer investments, short-term bond funds, cash accounts, CDs, immediate annuities. Things that are safe, not subject to principle risk, because that's how you avoid the danger of timing risk. And right now, that's a prominent danger because the market is very choppy, as you know.

Tom Wheelwright:

So when you look at typical financial advisors, looking at asset allocation and you look at, okay, how much do I have in those what we would call safe assets, that are not subject to those market ambiguities versus those that are more subject to the market ambiguities, what kind of a ratio do you like to see when somebody retires?

David Macchia:

For a constrained investor, what I find after [inaudible 00:08:15] of studying this nearly 20 years now, roughly a 50/50 mix between safety risk in the ideal, it takes most people to the greatest extent. But again, it's the sequencing of how you take money out and from what you're taking it from. That's very, very important. Maybe the most important factor actually.

Tom Wheelwright:

No, I like that. That makes a whole lot of sense. So when you look at those safe assets, can you describe what are those safe assets? Because people are wondering, well, does that mean I have to have all this cash that's subject to inflation risk? Or what does it mean? Or am I in a CD that's paying 1 or 2% or where what am I doing with my money?

David Macchia:

Sure. So it's a great question. So I always ask people to think about the entire strategy, not just one element of it. What I write about in the book is a hybrid strategy that won't work, too complicated here. But there are different ways, different methodologies of creating income.

One is called bucketing, or segmenting assets. Let's say we wanted to divide income over 25 years, just to pick a number. We might set up five discrete accounts, each designated provide income over a five-year period. Then we would invest the money according to how long we're going to hold those segments. So in that first five years, we're going to invest very conservatively, it's going to be a cash-like account, because we want to make certain for those first 60 months of retirement there's no risk.

In that second branch or bucket where we're going to hold it for five years, we also want to be safe, but we're going to earn some interest. It's not going to be just pure cash, it might be a short-term bond fund, a structured CD, something like that. And so in that second phase, we're going to use that to provide safe income in year six through 10. So there's no risk at this point.

Now we go to that third phase, which has been held for 10 years, that's going to have some risk to it. And as we have these others that are held for longer periods of time, like 15 years and 20 years, those have equity risk. We want that because you have to have both because you have to worry about inflation. So typically with these kinds of strategies, we're looking to keep pace with inflation at say a 3% rate. That's a target.

Tom Wheelwright:

Well, we're inflation at a 6 to 7% rate right now, so how do we deal with… I mean people are, right now, they're concerned about how do I deal with that? I mean, I can deal with 3%. How do I deal with 6 to 7%?

David Macchia:

It's horrible. It's horrible. And it's funny you say this because people think interest rates have gone up. They really haven't gone up because if you have a 5% inflation rate and a 5% interest rate, you're still at zero. It could work for years. So it's really important. Your point is very important.

So you have to hope that the assets that are invested in your plan, equities, things that are subject to risk, market risk, will grow enough to keep pace with inflation. There's no perfect way to do it. You could use a strategy based on Treasury Inflation-Protected Securities or TIPS, but that's an expensive way to do it. The way that I'm describing is less expensive. And as long as investments perform… When there is inflation, investments tend to go up. And that's what we can hope for as we look forward.

Tom Wheelwright:

So you're not worried about… Basically when you're talking about that, you're talking about going up because you've got 10 years. So you're talking about 10 years away on that kind of 11 to end of life, basically period. And those are the assets you're talking about protecting against inflation risk the most. So those you're saying, well, it doesn't matter really what happens today, it's what's going to happen over the next 10 years? That fair?

David Macchia:

Yeah, really over the next probably 15 to 20 years, because we're going to try to create an income period of total of 25 to 30 years at least.

And then we're going to have a little bit of money allocated to that annuity because we want to make certain that if you live to 102, 105, which theoretically is possible with the medical technologies that are being created today, you want to make certain that you have income that lasts. Like I said, no retiree stops needing income. If you're 96 or 104, you still have bills to pay.

Tom Wheelwright:

And in fact, you probably have more bills to pay.

David Macchia:

That's right. Including healthcare bills.

Tom Wheelwright:

We have those healthcare bills, which are the biggest bills that we ever have in our entire life, are those healthcare bills the last few years of our life. And nobody wants to be put in a public institution for that. People would like to have something more private and available.

David Macchia:

That's right, it takes planning. I'm dealing with it in my own life right now. My wife's parents are 90 and 91, and they're both quite sick. And we're dealing with the financial aspects and the caregiver aspects of that.

And you mentioned women, that's maybe a segue to talk about something here that's important. Women are often charged with the caregiver responsibilities of parents. And that's an extra measure or layer of challenge that women face in planning for retirement security vis-a-vis men. That's one of many actually.

Tom Wheelwright:

So let's turn before we get… I would like to get to women because we do know that they outlive us, and that is every, frankly I think it's every husband's concern. And then of course we have single women have the same issues.

But let's talk about longevity risk first, because you covered the timing risk I think very well. How do you deal with the longevity risk?

David Macchia:

This is where annuities come in because there is only one financial vehicle in existence that will guarantee to pay someone monthly income for as long as they live, and that is an annuity. And so in the strategies that we recommend, and I write about this in my book, I show how the inclusion of an annuity does two things.

Firstly, it protects if you live to a very old age. Again, we can't determine when that will be, but if it's an old, old age, you're going to have income that lasts.

Now, if the economy turns [inaudible 00:14:51], and I remember vividly 1989, because I was traveling around the country and I was consulting for a big brokerage called PaineWebber, do you remember that firm?

Tom Wheelwright:

I do.

David Macchia:

Yeah. And I was traveling around the country doing seminars on retirement planning, and I was talking about Japan. And in 1987 and '88, people in this country were worried about Japan overtaking us, because the Japanese were buying a lot of big American assets, the Rockefeller Center, the Pebble Beach Golf Club, it was very high profile stuff. And it seemed like their economy was ascending. Toyota came in here and Honda and Nissan and all those cars that they were selling, people really worried about Japan. And the real estate in Japan was the highest price in the world, they had the highest personal savings rate, they had the highest stock market. And think about what happened, in December of 1989, the Nikkei, the equivalent of theirs S&P 500, reached its all time high, 39,300. It's never been there since.

Now I'm not predicting that happens here. What I'm saying is when you have an income strategy that's well-designed, it has to contemplate, what if stocks don't perform? And this is where the annuity serves a dual purpose, because that's a guaranteed income that one will always have when we can't necessarily assume that stocks will deliver enough money to produce income we want. You have to think about both sides of the equation.

Tom Wheelwright:

Hey, if you like financial education the way I do, you're going to love Buck Joffrey's podcast. Buck's a friend of mine, he's a client of mine, he's a former board certified surgeon, and he's turned into a real estate professional. So he has this podcast that is geared towards high paid professionals. That's who he's geared towards. So if you're a high paid professional, you're going, look, I'd like to do something different with my money than what I'm doing, I'd like to get financially educated, I'd like to take control of my money and my life and my taxes, I would love to recommend Buck Joffrey's podcast, which is called Wealth Formula Podcast with Buck Joffrey. I hope you join Buck on this adventure of a lifetime.

So are you suggesting… So we talked about that allocation between short term, 10 year and less, and 5 year, 6 to 10, 11 and beyond, but we didn't talk about that allocation to annuity. And at what point you're going, okay, I'm going to acquire annuity and when do I want it to start paying out? People even ask the same question, I mean, basically social security's an annuity, right?

David Macchia:

Correct.

Tom Wheelwright:

So the question is, at what point do you start social security? Because of course the later you start it, the more you have down the road. So do you start that earlier, later, what do you do?

David Macchia:

Yeah, so in terms of the annuity, what we typically recommend is the 11th year. Because as I said, when you front load the strategy with safe investments, you're creating paychecks that are certain. There's functionally no risk in the strategy. But in that 11th year, there is some risk because you have a segment there that's going to produce income, say in years 11 through 15. Maybe it was a 50/50 portfolio, it had some risk to it, what happens if it doesn't perform well? That's possible. That annuity takes risk away.

Remember I said constrained investors, one of their primary objectives is to reduce risk. Because we can't know what's going to happen, and then constrained investors don't have the margin of error. I tell people, constrained investors have enough money to retire, they don't have enough money to make mistakes. So you have to have a strategy that anticipates things that can go wrong and guards against them.

Tom Wheelwright:

So basically, if you've got some money in market, et cetera, what you're protecting against with the annuity is that market risk. And then how do you determine how much to… Because if we've got some that are again, 5, 6 to 10, 11 and beyond, what portion needs to go into that annuity?

David Macchia:

Yeah, good question. There's software that helps with this, and financial advisors use software to build a strategy. I would say typically it ends up being between 20 and 30%.

Tom Wheelwright:

Got it. Got it. And then where do other investments fall into this whole play? Because the standard is, we're talking about things like the stock market, et cetera, which we don't have control over, but there are investments you do have some control over, including real estate, business, et cetera.

David Macchia:

Yep. Good question. So I think about it in time. If we have a segment that's going to be held for 20 years, we should invest that rather aggressively. If we have another one that's going to be held for 25 years, we should invest that very aggressively. So advisors may use emerging markets and small cap stocks and those positions are going to be held for a long period of time.

But you also need, I'll introduce another word here called the floor, floor of a strategy, which means that what part of your income do you know is going to be secure? Social security is going to be secure. If you have an annuity, it's going to be secure. Maybe that some people will use a reverse mortgage at some point to get income equity out of their house that they can turn into monthly income, that's going to be secure. Those kinds of things are very important. People should always think about, can I get enough income from my floor to cover my most essential expenses? That takes a lot of risk out of retirement. And then use your more risky assets to create that extra lifestyle from those gains and those investments.

Tom Wheelwright:

Got it. Thank you. So let's turn to women in particular, because you've mentioned before we started recording that you feel like women are very poorly served, and in fact most of them actually fire their financial advisor within the first couple of years after they inherit whatever assets they're inheriting. So would you just address that. We have a huge female audience. I think that women are at risk and need to pay attention.

David Macchia:

It's a complicated issue. And let me start with some of the endemic disadvantages that women have in terms of creating retirement security. Firstly, regrettably, we have a gender gap in this country still, women earn about 85 to 90% of what men earn for the same work. It's not fair, but it's a reality. Women disproportionately shoulder the burden of rearing children, which may take them out of the workforce, and caregiver responsibility, sometimes both happening at the same time. If you're leaving the workforce, what are you doing? You're depriving yourself of income, but ultimately you're lowering your social security benefit, which has lifetime implications. So that's important. Women live longer than men, as we've said, which means their income's going to have to last longer. So you're starting with a smaller base, smaller savings amount, yet your charged with having to have income last a longer time. And so these are really difficult issues that require planning.

Now, there's another issue which you've said, which is that the male dominated financial services industry doesn't relate very well to women generally, especially boomer women, which is why that when the boomer husband passes, in 7 out of 10 cases, 70% of the time, the widow fires the male financial advisor. And you might say, well, why does that happen? Well, here's why it happens. Stereotyping, making false assumptions about the woman, assuming that she is less knowledgeable than her husband, the advisor playing to the male and ignoring the wife, assuming that when she nods it means agreement when oftentimes it doesn't. Maybe she's reluctant to speak up about it.

But over time what happens, Tom, is there's an alienation process that builds up. And when she finally does get in control of that money, she's going to terminate that male financial advisor and it's a big problem. And it's a problem for a couple of reasons, including, I work with lots of financial advisors, when I asked them about this, I say, are you worried about this? They all say the same thing to me. Oh no, that won't happen to me. I have a great relationship. Yet 70% of them get terminated, which shows you that there's a lot of false confidence about the future.

The other thing that's very important to understand is, and this is born out by quality research from McKinsey and Merrill Lynch and UBS and ECG and many others, the Boomer age group, women and men look at money differently. Men are very focused on historical performance, dot picking the charts and graphs, and women, not so much. Women are concerned about three things, their goals being understood, reducing risk, and having confidence about the future. That doesn't describe a man.

And so there's this, what I call a great mismatch, because what the male dominant industry serves up is not what women want. And that's going to be a problem that we have to wrestle with because there's going to have to be alignment and it has to come pretty quickly because within about five or six years, women will control virtually all of the assets.

Tom Wheelwright:

So I'm curious, so if the 7 out of 10 women are firing the financial advisor that their husband hired, let's say, are they hiring another male financial advisor or are they hiring a female financial advisor?

David Macchia:

Could be either, and here's the reason. It's not that women do not want to work with men. That's not the issue. The issue is that women want to have an authentic relationship with the financial advisor and they want to be felt that they're heard. Throughout those years when the husband was alive, the wife typically felt that she wasn't being heard. And so there can be another relationship with a male, which is good news for the male population, assuming they learn how to create authentic relationships with women. They need coaching, put it that way.

Tom Wheelwright:

So let's talk, for the women right now, before they inherit, what can they do so that they have a better handle on things, so that they're more involved, so that they have the say that they want to have?

David Macchia:

Get their husbands… I don't mean to say this out of convenience, but in my book I talk about this a great deal. It would be good if men and women, husbands and wives, can begin to have a discussion about what really matters to the woman. She is concerned about security, he's concerned about building the pile of cash, she's concerned about protecting what they have. So I think she needs to make her views understood, and maybe to some extent demand that they're listened to.

It's really hard when there's an ongoing relationship between the husband and the financial advisor, especially if it's been going on for 10 or 15 years, and especially if the account values have been going up. Because as you know, we had almost 14 years of stock market growth and everyone looked like an investment genius during that period of time. So it was hard to interrupt that process.

But it's really important that women express what matters to them, because it's just as important. And arguably it's more important because they're the ones who are going to have the burden and responsibility of maintaining and investing the money.

Tom Wheelwright:

Other recommendations for women?

David Macchia:

Educate, read, become knowledgeable. Not that you… Some women are extremely knowledgeable already. And I think feel confident. Feel confident. There's a dynamic, not among all women, but there's a dynamic, Fidelity found this in a survey about a year and a half ago, only one out of five women felt confident in choosing investments that align with their goals. So that tells us that there needs to be an effort at education. And the information is out there, women can find it, they have to make it a priority to educate themselves about these issues. Because it's going to be a tremendous revolution, if you will, because we're talking about $30 trillion that's going to wind up under women's control.

Tom Wheelwright:

It's interesting. So this is so interesting to me because my mother was way better at the finances and understood it way better than my father did, and my wife's a CPA and she's terrific at understanding this stuff. But my first wife did not understand anything, didn't want to understand it.

So there is a group of people, and they're not just female by the way, they're male too, you and I both run into them all the time, that really are not interested. They're not interested in finance, they're not interested in investing. This is something they go, it's like, it confuses them, they're uncomfortable with it. What do you say to that group of people? Because frankly I think that's the majority of people.

David Macchia:

Well, either become educated or find an advisor that you can trust, that you can believe in. One of the things that perturbs me is that we do such a terrible job with financial education. We ignore it in school.

Tom Wheelwright:

Yes we do.

David Macchia:

It's crazy to ignore it. And even basic financial education. And there's no education about what we talked about in the beginning of how to turn your savings into income. So it's either becoming educated or finding a financial advisor that you can trust and rely on.

Tom Wheelwright:

Yeah. And hopefully there's some combination of two, because how many times do we find people who find financial advisors they think they trust and they don't know what they're doing. Like you said, they may be good at accumulating and a good financial advisor at accumulating, but they may be terrible at distributing.

David Macchia:

Yeah. It's regrettably all too common. It's a separate science, the art and science of spending money in retirement is really complicated. I mean, I can simplify it like I did in the very beginning with the explanation I think, but it's not something that's intuitive. We're not trained how to do it, so we have to become educated or reliant on an advisor who's expert in that area.

Tom Wheelwright:

So do you find that men might also want to consider changing their advisor when they get ready to retire? That maybe the person who accumulated things isn't the right person for distributing?

David Macchia:

I would hope that man watching this podcast who was not prior to this, cognizant of the complications of turning savings into income, would think about that and say, is my advisor the right one to help me with that challenge? Because once I move from earning money to spending what I've accumulated, I'm in a different situation. My advisor better be in harmony with that situation, and if he isn't, then I'm going to need another advisor.

Tom Wheelwright:

So let's wrap up with this. Give us, if you can, two or three tips to finding that right advisor.

David Macchia:

One thing to look for is a professional designation that shows that that person was trained in how to do this. And there are two or three that you can look for. One is the RMA, retirement management analyst. Another is a CRPC, certified retirement planning, I can't remember what the C stands for. And the other one is RICP. These are bonafide, real designations that if you earn them, you have demonstrated competency in this specialty of retirement income planning.

If you see CFP, certified financial planner, that generally means that that person is very skilled at financial planning, growing money, but it does not hold that he or she is an expert in planning income. They may be, but oftentimes they're not.

So those other designations, CRPC, RMA and RICP, look for those because those are good markers.

Tom Wheelwright:

Interesting. That's great. And if you missed those, listen or watch this again and make sure you get those. Okay, that's one. What's another?

David Macchia:

Another is to realize that, this is very important, in retirement it's your income, not your wealth, not your savings, that creates your standard of living. You could have a whole bunch of savings and a poor standard of living.

I'll give you a quick example. In 2001, think of someone with $500,000, what they could have earned [inaudible 00:33:18] interest, 3 or 4,000 a month. Advance that 20 years and they would have virtually nothing. Even though they had the same $500,000, if they were putting it in a bank say, the interest rate went from 7% to 0.0009, something like that.

So it's not necessarily about the money, it's about how you create income. Income is the only thing that creates your standard of living in retirement. So you have to think about income, prioritize income, because it really is all about income.

Tom Wheelwright:

I like that. Another term we use a lot is cash flow. How's that cash flowing? It is cash flowing in and cash flowing out, right?

David Macchia:

Yeah.

Tom Wheelwright:

But it's that cash flow. Can you give us a third tip for finding that right financial advisor?

David Macchia:

Yeah. Oh, for finding the financial advisor, apart from… When you talk to people, ask them them how they manage risk for a retiree.

Tom Wheelwright:

I like it.

David Macchia:

Are they talking about timing risk? Are they talking about longevity risk? If you're a constrained investor first of all, and you meet a financial advisor who says to you, I'll never sell an annuity, you run away. Just run away. Because that's the wrong advisor. You can't be that dogmatic about anything when you're a constrained investor, because you need safety and uncertainty and you need exposure to investments. You must have both, because you have to worry about inflation, but you have to worry about mitigating risks.

Tom Wheelwright:

Awesome. So thank you. Any final words for our audience?

David Macchia:

Oh, I just want to say become educated, learn, and keep listening to shows like this. I think you'll do well.

Tom Wheelwright:

Well, thank you, David. The website is wealth2k.com and the constrained investor is, I think that's a terrific way to put it, really appreciate it, David.

And just remember that when we're looking at this, and don't forget that one of your expenses, even when you retire, is taxes, and remember as you're building that wealth don't forget that, what is your tax expense when you retire and when you combine these things, and I love the distinction between building wealth and then actually distributing wealth and having the income at the end. I love that. Really good practical advice.

And when we get this kind of financial education, one thing David and I think agree on absolutely the most is, we need better financial education. We need to continually get that financial education. I'm sure, David, you spend a lot of time getting your own financial education. I know I do. I'm constantly watching videos, talking to people, working with mentors, and so forth, because what happens is when we get that financial education, we're always going to make way more money and pay way less tax.

David Macchia:

Amen.

Tom Wheelwright:

We'll see everyone next time. Thank you.

Announcer:

You've been listening to the WealthAbility Show with Tom Wheelwright. Way more money. Way less taxes. To learn more, go to wealthability.com.