May 21, 2013

Dr. Michael Finke: The 2013 IA 25 Extended Profile

Professor of Personal Financial Planning, Texas Tech University

'The supposedly safe methodology isn’t as safe as it was in the past,' says Finke. 'The supposedly safe methodology isn’t as safe as it was in the past,' says Finke.

This is Michael Finke’s first appearance on the IA 25. Click here to view the complete list and Special Report schedule for extended profiles for each of the 2013 IA 25 honorees.

The traditional 4% withdrawal rule is fine in a static world, but when was the last time the world was static?

For this reason, Dr. Michael Finke, professor of personal financial planning at Texas Tech and frequent contributor to our sister publication, Research magazine, called the success of the traditional 4% rule a “historical anomaly” in a working paper published in mid-January.

“The 4% rule was based on the historical asset return in a market environment that doesn’t look like the one that exists today,” Finke told Investment Advisor in March.

It’s caused something of a stir.

“Our intention with the paper was to acknowledge the reality of lower returns moving forward,” Finke recently explained, which in and of itself isn’t controversial (see PIMCO’s New Normal). But the methodology used and the conclusions he and his co-authors arrived at started a healthy debate over the best way to ensure clients’ money lasts.

“Asset returns are a random walk. No one knows what bond returns will be in the future, but the market believes they will be negative,” he said. “TIPS for instance are already negative. Nominal returns might go up, but real returns will be negative. It will either be a situation where they will be 0% for 20 years or slightly negative for 10 years.”

So how did he arrive at such a bleak outlook? Not how one would think.

“We used the same methodology as others, but we did it to prove a point,” Finke added. “The point was that we don’t think the traditional withdrawal rates will address retirement income shortfalls; the supposedly safe methodology isn’t as safe as it was in the past. Withdrawal rates will need to be modified and more dynamic to coincide with expected longevity and provide protection and income should retirees live for longer than 30 years.”

With P/E ratios currently around 23, he argued, most people expect 2% real returns in equities.

“We believe it will be twice as high, which might be seen as optimistic, but it’s actually pessimistic had you used traditional stock and bond returns. We used bonds in our calculations and even then, if you used stocks, the results would be even more pessimistic.”

So after shaking up the advisory world, what’s next? Shake it up again, apparently.

Finke and his colleagues’ latest study, which they plan to release this summer, takes a close look at retiree behavior during, and in the immediate aftermath of, the 2008 economic crisis. Specifically, it seeks to identify the type of retirees that went to cash as a result of the turmoil.

“What we found was that at an advanced age, there was almost a direct correlation between the amount of decline in cognitive ability a person was experiencing, and the amount of money they withdrew from the market.”

What it reveals, he concluded, is that relying on financial advisors for guidance might be even more important to prevent investors, especially older investors, from making this type of mistake as they age.

Reprints Discuss this story
This is where the comments go.