The pension fallacy (Part 4)

By Slow Dad - March 28, 2017

Beware who you seek financial advice from. Always "trust, by verify" anything you are told, and understand how the advisor is making their money.
Recently I’ve been writing about some of the commonly held fallacies associated with pensions, retiring and generally getting old.

So far I’ve talked about how the government aged pension began as a longevity trophy received by only the most out there of statistical outliers. Over time successive generations of cowardly governments chickened out from indexing or raising the pension eligibility age, creating a demographic time bomb.

Next I discussed some of the potential traps that pension age restrictions set for the unwary, and also the not insignificant regulatory risks associated with the inevitability of those age restrictions becoming moving goal posts.

Most recently I talked about the potential funding gap many potential early retirees will experience between leaving the workforce and reaching pension eligibility age.

I had promised to talk about how I constructed my passive income generating machine. However before I do that I wanted to write a very important post about critically assessing any advice or guidance you are receiving, from any source... including this one!

Be very careful who you listen to

Ms Our Next Life recently wrote a fantastic post about the potential for hypocrisy in the Financial Independence / Early Retirement blogosphere. She very astutely observed that many of the respected elder statesmen (people?) in this community derive income, often significant income, from sources more related to their fame and audience reach than their dutiful adherence to the so called “4% safe withdrawal rate”.

I think developing a diversified set of income streams (hopefully many of them passive) is something we should all strive for. It spreads the risk associated with stock market downturns, or property cycles, or changes to tax regimes.

Rich people generate wealth from businesses, not low cost index tracker funds

The authors of the Millionaire Next Door reported that most of the millionaires they had studied had generated their wealth as business owners.

To put that another way the majority of millionaires did not generate their wealth diligently saving into pension funds invested in low cost index tracker funds!

So I am all for owning and running a business, which is hardly surprising given that is how I earn my own living. However I can’t stand hypocrisy, and as such I applaud Ms Our Next Life calling bullshit on the many Financial Independence / Early Retirement bloggers who preach the clichéd Frugality / Vanguard / 4% Rule holy trinity, yet don’t live by their own advice.

The moral of story is choose very carefully where you seek out financial advice.

Choose carefully where you seek out financial advice

Be careful where you seek advice

Always ensure that those providing it are preaching from proven experience, rather than from zealous ideology or lazy conformity.

If you invest in buy-to-let real estate then make sure you seek out an accountant who also successfully does so.

If someone is telling you where to invest, check their investment track record and ensure they are backing their advice with their own money.

If you seek out financial planning advice, check that the person advising you actually has their shit together and that the path they are steering you down has provably worked for them.

In all cases if they haven’t been there, bought the t-shirt, and returned to show others the way then why the hell would you waste your time (and potentially money) listening to them?

Always understand what is in it for the the person providing you with advice.

Where does their income come from?

Honest, independent, paid by the hour advice is almost always better than commission led advice.
Paid by results advice is even better, though unsurprisingly is much harder to come by.

Here there be dragons

I despair at some of the extremely naïve finance questions people post on forums like Reddit or Bogleheads or LemonFool or Rockstar Finance. Not so much because the questions aren’t valid, but because the questioner has absolutely no way of assessing whether the sharks, shysters or well intentioned people of the internet offering guidance and advice knows what they are talking about. And for the avoidance of any doubt the vast majority of them do not.

Sharks, shysters or well intentioned people of the internet

I equally despair at the plight of people seeking guidance and advice via the Personal Finance blogosphere.

Blog posts are unsubstantiated opinion pieces. Some of them are amazing, insightful, and offering a genuinely unique piece of knowledge. Most of them unfortunately are not.

Sometimes they are written out of good intentions, in the hope of educating the masses.

Unfortunately just as often they are designed to herd those same masses into some form of commission generating behaviour, like signing up for expensive personal finance software subscriptions or unneeded web hosting deals.

Is always blindly locking away money in an age restricted pension fund the right answer?

No, of course not.

Is buying low cost index tracker funds or buy-to-let real estate always the right answer?

No, of course not.

Everyone has differing risk tolerances, priorities, and time scales.

There are no "one size fits all" easy answers to financial planning, regardless of what the self appointed experts of the internet will tell you.

A brief history of the 4% rule...

As a case in point take the much cited, much maligned, much misunderstood “4% rule”.

The much cited, much maligned, much misunderstood “4% rule”.

In October 1993 William Bengen writes a heavily caveated academic article in the Journal of Financial Planning. It outlines a rough rule of thumb that basically based on 20th century US stock and bond market historical data starting in 1926.

That rule of thumb hypothesises that if a retiree were to withdraw 4% of their capital + reinvested dividends then all things being equal (which they seldom are!) they shouldn’t run out of money within the first 30 years of retirement.

Bengen readily acknowledged this rule ignored the impact of brokerage fees and taxes. He also readily conceded that "not running out of money" is not the same as having enough to support yourself in year 31.

In 1998 three professors named Cooley, Hubbard and Walz from Trinity University back tested Bengen’s rule of thumb using a bunch of different stock/bond weightings. They concluded that a withdrawal rate of between 3% and 4% should represent a reasonably safe withdrawal rate, again ignoring brokerage and taxes, and again assuming a very US centric investment portfolio.

In 2010 Wade Pfau applied the 4% safe withdrawal rate to international markets. The results were grim. He followed that up with some intelligent analysis around the infamous "sequence of returns" risk.

In 2014 Todd Tresidder wrote a comprehensive post highlighting the many and varied risks associated with blindly following a simple (and limited) rule of thumb. His conclusion wasn’t that the 4% rule is complete bollocks, but rather that blindly following some oversimplified generalisation is dangerous in all manner of financially painful ways.

To summarise we started with a rough yet insightful rule of thumb about which the author acknowledges significant limitations.

Various big brain academics tested, validated, and disproved various aspects of that rule of thumb.

All of them cited the source data they used to allow interested parties to critically assess and potentially disprove their findings.

All good so far? I agree.

Personally I don't believe in the 4% safe withdrawal rate. However if I met Bengen or Pfau or Tresidder in person I’d buy them a beer, they’ve all done fine work adding to the collective wisdom surrounding the existence and limitations of safe withdrawal rates. In fact it is in part because of their work that I developed my healthy scepticism.

Unfortunately things aren’t all unicorns and rainbows.

... and some woefully incorrect advice about it

Just this past week I’ve read personal finance bloggers who should know better refer to the 4% rule as a “risk free safe withdrawal rate”. That is complete and utter bollocks, there is no such thing as “risk free” when it comes to investing.

I’ve read posts where people who are struggling to make ends meet while working for mediocre wages selling the dream of early retirement via the 4% rule… when they couldn’t possibly be saving enough from their earned income to fund the retirement nest egg necessary to support a 4% rule “safe” withdrawal rate.

That too is bollocks because either the blogger is being dishonest when telling their story, or (more likely) they are ably demonstrating their ignorance of the subject they are writing about.

Anyone following the misguided advice of these unqualified and ill-informed bloggers would be putting their financial futures unnecessarily at risk.

So what?

Be mindful that most of what you read is bollocks.

Many of the authors behind sites you visit know less about their chosen content areas than you do.
Many authors of books and textbooks are self appointed experts, who don’t necessarily understand their subject matter either.

That isn’t to say there aren’t good authors worth reading out there, because there are. Unfortunately there are also many who are not. Always maintain a healthy scepticism about what you are being told... including from me... and especially when that advice earns the provider a commission.

Next time out I’ll outline how I created a passive income generating machine.

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  1. Yep, that Our Next Life post is a great one.

    One of the worst (though some may say 'best') places for 'advice' is the MSE forum. For generic questions to point you in the right direction to do more/your own research, I think it's great but some people do go on there for actual financial advice and I'm not sure they do any further reading.

    I sometimes wince at the questions asked by newbies and the 'advice' given by 'experts' on there.

    I hope no one reads my blog and considers anything I say to be advice - I'm just talking about what I'm doing personally, not telling or expecting anyone to follow suite!

  2. Thanks weenie.

    I think a good rule to live by is to beware the self described gurus and experts, invariably they are trying to sell something!