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The Big Retirement Risk Michael Finke Is Seeing Now

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As professor and Frank M. Engle chair of Economic Security Research at The American College of Financial Services, Michael Finke’s knowledge covers a lot of territory. Yet he has an especially keen expertise in all things retirement and what advisors need to know to not only grow their client portfolios, but protect them as well.

Via email, we asked a series of questions that touched on not only his professional knowledge but what he does off the clock as well.

1. What market indicator, industry statistic, regulatory change or advisor trend are you watching most closely right now and why?

Michael Finke: The Shiller price/earnings ratio, also know as the cyclically adjusted price to earnings ratio, recently reached 40 for the first time since 1999. I ran an analysis last year showing that the P/E ratio has done an amazing job of predicting returns on the S&P over the next 10 years.

Since 1970, the P/E predicted 74% of the variation in future 10-year U.S. stock return, and it has been 90% since 1995. When the P/E crosses 40, the predicted 10-year stock return is negative. It will be slightly higher or slightly lower, but the chances that returns will be 10% or even 5% are very low.

I worry that the recent bull market has lulled retirees into projecting returns that likely won’t materialize. I fear that many chose to retire early because they met a retirement number that won’t sustain the lifestyle they expect.

2. How has this statistic/indicator been changing recently (2021) and how do you expect it to change (2022)?

Since the March 2020 dip, the Shiller PE has gone up 60%. But the S&P was still 45% higher than the historical average even after the pandemic crash. Stocks are so expensive that the dividend yield on the S&P is lower than 10-year Treasuries.

If bond yields rise, stocks are highly vulnerable to a correction. It’s hard to imagine a scenario where valuations rise, and easy to imagine a scenario where they fall.

3. What would you suggest advisors do now or consider doing in the future about it?

Think about the implications of near zero equity returns for a client who is five years from retirement. Somewhere between zero and, say, 2% returns are about what we can expect.

If I run a Monte Carlo with 2% expected stock returns, about 46% of 5-year outcomes leave you with less money than you have right now. At the 10th percentile, you’d have 60% of what you have right now.

That is the tradeoff investors need to accept today when they take U.S. stock market risk. Is the modest upside worth the potential downside? If it isn’t there are ways to protect against the downside.

4. Who or what critical source of information do you track, or follow online, to keep up with this or other trends?

I’m a complete data nerd and closely follow government databases such as FRED data [Federal Reserve Bank of St. Louis] and data from the U.S. Treasury. I check real, inflation-protected rates using Fed TIPS [Treasury inflation-protected securities] quotes weekly. These rates are terrifying today.

The most popular target-date fund invests 20% of retiree assets in TIPS at age 72, and this will give retirees a certain $913 in spending power in five years for every $1,000 they invest today.

And I don’t think TIPS are necessarily a bad deal — in fact you can make the argument that they are cheap inflation insurance given the even lower after-inflation yields on safe bonds. And if interest rates rise, bonds with any duration will fall even further.

More on this topic

5. Are you changing any of your work habits at this stage of the pandemic? Why/why not?  

I’ve cut back significantly on travel for presentations, which has given me a lot more time to work on research and updating our new wealth management certified professional program at the College.

In many ways, travel is a treadmill and it can be difficult to step off. The pandemic has led me to question how much I want to get back on, although the recent Morningstar investment conference was a good reminder that I get a huge kick out of speaking in front of a crowd.

6. What’s your biggest hobby and what was the last event/activity you did related to it?

I spend most of my time in front of the computer, so I need to schedule regular time to decompress by going hiking in West Texas where I live or fly fishing in nearby New Mexico. In fact, I just got back from a camping trip last night.

7. What book are you reading now and why?

I just finished reading “In Pursuit of the Perfect Portfolio” by Andrew Lo. It’s a must-read about the history of modern finance and a deep dive into how academics think about investing.

The new research in culture and human evolution is perhaps the most important new field of science today — books like “The Secret of Our Success” by Joseph Henrich will completely change your perspective on human behavior.

8. Any special holiday plan, activity or focus you’d like to share as we near year-end? Or a New Year’s resolution that you’ve decided on?

That reminds me that another great new book is Katy Milkman’s “How to Change.” Her research into the importance of taking advantage of important dates to establish new habits provides a convincing argument that we should take advantage of New Year’s resolutions or an important birthday to establish a new habit.

At the beginning of the new year, I’m convening a group of industry leaders in wealth management for an in-depth discussion of the future of investment education funded by the Granum Center at the American College.

As we see advisor technology mature and a growing use of standardized portfolios, investment education will need to move beyond security selection and toward developing a goal-based investing process that includes a range of skills from understanding myriad tax rules and strategies to building trust and empathy. As the industry evolves, education needs to evolve with it.

9. Any other update/fact about you or piece of advice/wisdom you’d like to share with our advisor audience?

I spent the first 10 years of my career as a food consumption researcher, and ended up getting a Ph.D. in finance when I wanted to understand why healthy eating was so closely related to wealth and income.

The relationship has gotten even stronger over the last 15 years to the point that men in the top 10th percentile of income are now outliving lower income men by over a decade.

Whenever you see average U.S. longevity statistics, they aren’t relevant for your client. For most clients today, we need to get used to planning to fund a lifestyle beyond age 95.