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Kotlikoff: Conventional Investment Advice Is 'Bait and Switch'

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“Conventional investment advisory is dangerous to your financial health. The whole exercise is bait and switch. These people are selling snake oil,” argues Laurence Kotlikoff, the Boston University economics professor who served on President Ronald Reagan’s Council of Economic Advisors, in an interview with ThinkAdvisor.

Kotlikoff blames firms that “force” financial planners to sell products, which, when coupled with giving advice, is “a major conflict of interest,” he holds. 

Nor does the professor spare criticism of the Federal Reserve, which is spouting “largely cheap talk” about inflation — “and the market, by and large, is drinking the Kool-Aid,” he maintains.

As for the Fed’s said intent to sell back into the marketplace the assets it purchased, Kotlikoff asserts: “The Fed is very clever in disguising what they’re doing. It’s trying to keep [us from] understanding what it’s up to” about printing money and selling those assets.

He continues: “I’m not totally sure what’s really associated with printing money to pay [our] government’s bills and how much is dedicated to portfolio transactions.”

The bestselling author’s new book is “Money Magic: An Economist’s Secrets to More Money, Less Risk, and a Better Life” (Little Brown Spark, Jan. 4, 2022). It contains what the professor calls “tricks” and “shockers” to help investors to a rosier financial future and life.

One of his many provocative secrets: “How to Make Divorce a Win-Win.” In contrast to conventional financial planning, Kotlikoff’s advice pivots on economics-based planning, which focuses on consumption smoothing.

The professor, named by The Economist one of the world’s 25 most influential economists, is director of the Fiscal Analysis Center and has been a consultant to the International Monetary Fund.

In the interview, the Social Security expert, co-author of the bestseller “Get What’s Yours: The Secrets to Maxing Out Your Social Security,” argues that the U.S. is “bankrupt on a fiscal basis” owing to its excessively high debt. He then outlines a proposal for getting the country’s “fiscal house in order.”

The former consultant to Merrill Lynch and Fidelity Investments, among other firms, noted that conventional financial planning’s emphasis on the probability of retirees’ running out of money is “ridiculous.”

“The magnitude of the downside,” he says, is what “people really care about.” 

Here are highlights of our Dec. 21 conversation:

THINKADVISOR: In your new book, “Money Magic,” you say: “Conventional investment advisory is dangerous to your financial health. It recommends patently absurd financial behavior.” Please elaborate.

LAURENCE KOTLIKOFF: Conventional advice is based on a Monte Carlo simulation that assumes four things that no intelligent person would do:

No.1: Put savings before retirement on autopilot.

No. 2: You’ll be able to set a target for how much you spend in retirement that’s exactly correct. If you can’t come up with a spending projection, you’re given this replacement rule that’s correct for nobody and generally far too high for most.

No. 3: The methodology assumes you’ll keep spending exactly the same amount no matter what happens to your assets and to the demographics of your household. 

No. 4: The focus is on the probability of success; [that is,] not running out of money. But it isn’t focused on the impact of any of this on your actual living standard — the downside — and that’s what people really care about.

No. 5: People never adjust their portfolio even if their stocks go down the tubes.

All this is simulating crazy behavior.

Why did it become conventional advice, then?

The value of the whole exercise is just [for FAs] to convince people: “Hey, invest with me. You’re going to do better.” 

That’s a bait and switch. It’s baiting people by getting them to go along with a set of assumptions that are wacky and inappropriate and then saying, “If you do it my way — invest with me in my high-yield investments — yes, you’ll have a higher load, but it’s going to pay for itself.” 

That’s the switch — the product sell. These are people selling snake oil.

What are the implications?

The advice that Wall Street is conveying is not independent of their vested interest in selling product. They’re conflicted, and that’s a major problem. 

They shouldn’t be giving advice if they’re selling product; they shouldn’t sell product if they’re giving advice.

Are you referring to financial advisors across the board?

It’s not that I have a gripe with financial planners, per se. They, in general, are being forced to use tools in product sales from the company they’re associated with. They don’t have any choice.

Where does FAs’ knowledge and savvy about investing enter the picture?

They apply their common sense to what these tools [indicate] and give the best financial advice they can, given the crappy tools they’re taught to use. 

So my beef isn’t with them. It’s with TIAA and other major companies that are using this methodology. 

I’ve spoken to the TIAA board and [a past] president about the problems within that methodology and made it crystal-clear that it’s very dangerous for people — that it’s all connected with selling products.

There’s no response, except: “It’s working for us. Let’s keep at it.”

Moving on to the problem of rising inflation: What are your thoughts?

It’s partly the bottlenecks, the supply chain issues. But it’s also that there’s no tethering of information to any particular policy of the Fed.

It’s largely cheap talk: It’s good just till it isn’t good.

The Fed is telling people, “Hey, we’re going to be able to keep the inflation rate low through time.” And the market, by and large, is drinking the Kool-Aid.

More on this topic

But we’re seeing that things can go from people’s believing the central bank to not believing it overnight.

The Fed doesn’t have control over inflation apart from a kind of nuclear option, which is trying to put the economy into a deep recession. 

The Fed has increased the base money supply by a factor of six since 2008. [That is], the money it has printed is six times more than it printed up to 2008.

A lot of that printing was to buy financial assets, which it could sell back into the market.

But the Fed is very clever in disguising what they’re doing. It’s trying to keep [us from] understanding what it’s really up to. Its books are very hard to read on this issue. 

I’m not totally sure what’s really associated with printing money to pay [our] government’s bills and how much is dedicated to portfolio transactions.

What’s your underlying concern about inflation?

The country’s fiscal position is dramatically, grossly unsustainable. The country is insolvent; it’s bankrupt on a fiscal basis because: Look at all the obligations we have — we’re incredibly indebted.

When other countries are in terrible fiscal shape the way our country is, the easiest thing for them to do is print money to pay for government spending.

Turning to individuals’ investing, you write, “stock returns are unpredictable, but you should still time the market.” Please explain.

Time the market for risk, not for return. If the stock market is going down, you can’t count on its coming back up. It’s just as likely to go down again tomorrow.

If the economy is being shut down, as it was in March 2020, the environment becomes a whole lot riskier. So we naturally want to adjust our portfolio to get to a safer place.

[In that case], we don’t want to be investing to the same degree in those risky assets. And that means you want to time for risk, not for returns.

So you think the concept of “stay the course” — don’t adjust your portfolio; don’t exit the market — isn’t a good strategy?

That’s predicated on something the financial industry has concocted that’s based on the [idea] that stocks are safe in the long run, that intermediate bonds are safe in the middle run and that short-term bonds are safe in the short run. 

It’s this idea of setting up a bucketed portfolio. But there’s no evidence whatsoever that stocks are safe in the long run.

Stock prices move as a random walk. They’re not predictable. We don’t know whether a stock is going to go up or down. 

That’s why we can’t say that stocks are safe in the long run.

Broadly, retirees are worried about outliving their money. How should advisors address this?

The magnitude of the downside is what we really [need to] care about. It’s not the probability of running out of money. 

It’s a question of how little money you end up with when you’re 85.

This whole idea of focusing on the probability of running out of money is ridiculous.

“In retirement, hold an increasing share of your investment in stocks and other risky assets with each year passing,” you write. 

That’s the opposite of traditional advice, which says, hold a decreasing share of stocks as you age. Please explain.

As we get older in retirement, our Social Security [payments] become a bigger and bigger factor in our financial life because we’re spending down our financial assets.

So Social Security is continuing to maintain its value because it’s becoming a real annuity. It will remain fixed. 

Therefore, trying to maintain a constant ratio of risky-to-safe assets involves holding an ever-larger share of your ever-shrinking assets in stocks. You should invest more of what’s left in stocks.

“The rich should invest in bonds, and the poor should invest in stocks. All else being equal, invest relatively less in stocks the richer you are,” you write. Why?

If you have $10 million and you put half your money in stocks, and the market [plummets], you could lose a quarter of your resources in a couple of days.

Whereas, if you’re poor and have only 10 bucks in assets and $15,000 a year in Social Security payments, if you invest that $10 in the riskiest securities, you have downside protection. 

So the best you can do is to take your $10 and put it into very risky stocks. There’s essentially nothing to lose.

Getting back to the Federal Reserve, do you have a solution for the country’s economic woes? 

We need to get our fiscal house in order.

What would that involve?

The government would have to engage in major overhauls of the health care system, Social Security system, tax system, educational system and, to make sure we don’t have another bank crisis, the banking system.

That’s a long list, but actually there are more things on it.

There are ways to save this country so we don’t become the Weimar Republic with running hyperinflation.