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David Blanchett: If You're Retiring Now, You're in a Pretty Rough Spot

Morningstar's lead retirement researcher on retiree spending patterns, asset allocation, and mitigating the risks in a plan.

Our guest this week is David Blanchett, head of retirement research for Morningstar Investment Management. In his role at Morningstar, Blanchett works to enhance the Investment Management group's consulting and investment services and conducts research primarily in the areas of financial planning, tax planning, annuities, and retirement. He's also adjunct professor of wealth management at The American College of Financial Services.

Blanchett's research has been published in a variety of academic and industry journals, such as the Financial Analysts Journal, the Journal of Financial Planning, The Journal of Portfolio Management, The Journal of Retirement, and The Journal of Wealth Management. His research won the Journal of Financial Planning's 2007 Financial Frontiers Award, the Retirement Income Industry Association's 2012 Thought Leadership Award, the Journal of Financial Planning's 2014 and 2015 Montgomery-Warschauer Awards, and the Financial Analysts Journal's 2015 Graham & Dodd Scroll Award.

Background
David Blanchett's bio 

David Blanchett's research archive 

Quantifying the Value of Advice
Alpha, Beta, and Now ... Gamma 

The Value of a Gamma-Efficient Portfolio

Vanguard Advisor's Alpha 

Quantifying Advisor's Alpha

Capital Sigma: The Advisor Advantage 

Reducing Wealth Volatility: The Value of Financial Advice as Measured by Zeta

Retirement
Annuities are Likely Coming to Your 401(k). Should You Use Them?

A Safe Harbor for Annuities Could Help Retirement Savers

Save More Today: Improving Retirement Savings Rates With Carrots, Advice, and Nudges

Nudge, by Richard Thaler and Cass Sunstein

Behavioral Nudges for Goals-Based Financial Planning

You Can't Fix What You Can't Measure, Aron Szapiro on The Long View podcast 

I Don't Think the System Needs Nudges. I Think the System Needs Dynamite, William Bernstein on The Long View podcast

Man Bites Dog! Congress Is Writing Retirement Legislation!

Retiree Survey: Nearly All Say They Are Happy Though Many Are Financially Insecure

Estimating the True Cost of Retirement

Exploring the Retirement Consumption Puzzle

75 Must-Know Statistics About Long-Term Care: 2018 Edition

The 4% Rule Is Not Safe in a Low-Yield World

Simple Formulas to Implement Complex Withdrawal Strategies

Reducing Retirement Risk With a Rising Equity Glide-Path

Revisiting the Optimal Distribution Glide Path

Annuitized Income and Optimal Asset Allocation

Should Annuities Be Purchased From Tax-Sheltered Assets?

The Home as a Risky Asset

Careful With That Company Stock


Transcript

Jeffrey Ptak: Hi, and welcome to The Long View. I'm Jeff Ptak, global director of manager research for Morningstar Research Services.

Christine Benz: And I'm Christine Benz, director of personal finance for Morningstar, Inc.

Ptak: Our guest on the podcast today is Dr. David Blanchett, head of retirement research for Morningstar Investment Management. In his role at Morningstar Investment Management, David works to enhance the Investment Management group's consulting and investment services and conducts research primarily in the areas of financial planning, tax planning, annuities, and retirement. He's also adjunct professor of wealth management at The American College of Financial Services.

David's research has been published in a variety of academic and industry journals, such as the Financial Analysts Journal, the Journal of Financial Planning, The Journal of Portfolio Management, The Journal of Retirement, and The Journal of Wealth Management. His research won the Journal of Financial Planning's 2007 Financial Frontiers Award, the Retirement Income Industry Association's 2012 Thought Leadership Award, the Journal of Financial Planning's 2014 and 2015 Montgomery-Warschauer Awards, and the Financial Analysts Journal 2015 Graham & Dodd Scroll Award.

David, welcome to The Long View.

David Blanchett: Thanks for having me.

Ptak: So, maybe a good place to start is with Gamma, which is a concept that you've helped to popularize. You've done some research where you've attempted to quantify the value that an advisor can add to clients' returns with recommendations other than investment selection. Maybe you could walk us through that framework? What are the so-called Gamma factors? And what would you consider to be the most important factors where an advisor can have the most value for clients?

Blanchett: Sure. So, there's lots of fun names today to talk about the value of advice. There's Advisor's Alpha, there's Capital Sigma, there's zeta. Gamma a long time ago was a financial planner, my and Paul Kaplan's first kind of interpretation at "What do advisors do beyond just building great portfolios?" And I didn't like the fact that my value is often defined as performance when you're helping someone accomplish a goal.

And so, in the research that came out, I don't know, five or six years ago, we kind of asked the question, "If you can quantify certain things that you do to help someone retire, what are they?" And that includes things like creating a dynamic withdrawal strategy, possibly allocating more to guaranteed income, utilizing total wealth to build portfolios. And when I talk about it, I say we found that doing these five things adds 2%-ish in, what we call, Gamma-equivalent alpha for advisors. But in reality, you can do hundreds of things to help someone retire successfully, accomplish a goal. This research is geared on that, helping quantify or bring to light the other things that matter than just building great portfolios.

Benz: So, what are some of the other things that were not included in the Gamma research, some things that you think can be really impactful?

Blanchett: I mean, I think if you look not only at--there was a follow-up piece we did focused more on portfolio decisions, but also other research. I think it's really the behavioral piece, which is helping investors make good decisions over long periods of time. That includes savings advice, that includes staying in the market. Other things just vary by investor. I mean, it's tax strategies. It's estate plan. It's really just helping someone accomplish a goal.

And the part of it that's most important is that it's just really hard to quantify. And if you focus just on portfolios, I think you kind of devalue what a financial planner does for their clients.

Ptak: So, one of the things that we do hear in the financial advisor community is advisors invoking, call it Gamma, call it Advisor's Alpha or whatever your term is, to justify their fee. And so there's, obviously, a kernel of truth to that, in the sense that they provide valuable advice, and they deserve to be paid for it. But do you think that in some quarters, perhaps, advisors are maybe misrepresenting the value that they can add to clients just because they're oversimplifying it, distilling it down to a single number that perhaps has been published?

Blanchett: Right. And that's why I hate to focus too much on the precision. I think it goes like 1.59% in the first piece, that's just way too precise, right? And there's this kind of implicit assumption that they're actually doing the things that it talks about. I mean, it requires ongoing planning/advising on a regular follow-up basis. And in my experience, planners provide a spectrum of services. Some of them just build portfolios. They want to perceive themselves as advisors, but they're not doing financial plans. They're not doing all that hard work that comes with planning. So, I think that in reality that the true value of each planner varies, but people like numbers, and it's just hard to quantify.

Ptak: We've spoken to a number of advisors on this podcast, and a number of different business models that they work under, some of them are on the traditional sort of basis-points-on-assets model, others are hourly planners. So, when you think about the spectrum of value that planners/advisors can add, do you have a view on what an appropriate fee model is based on some of the research that you've conducted and the sorts of components of value that you've seen planners and advisors add?

Blanchett: So, I'm less concerned about the fee model, as I am them being fiduciaries and providing holistic services. I think that normally that's more conducive to do in a fee-based environment. But I think that in theory, you could provide someone with a financial plan and get paid a commission and still do a great job.

So, I think that, again, fees make more sense to me. But then again, we talk about fees, like what is the right fee structure. I mean, I think that our industry is predominantly based upon basis points, and I think if we are all really honest with ourselves, an hourly model makes more sense, because other professionals don't charge on basis points. In theory, if you're managing risk via portfolio, part of that could be basis points, but financial planning is kind of like being an accountant or an attorney, and they charge typically, primarily by the hour. And so, I think that I'd like to see the industry evolve. But when you do the math, usually compensation is quite a bit lower hourly versus basis points.

Benz: Shifting gears a little bit, you help contribute to Morningstar's retirement advice business. Let's talk about some of the key trends that you see in that marketplace. How have things shifted in your years working within that space, the defined-contribution space?

Blanchett: Right. So, the group that I'm a part of here at Morningstar is the Workplace team, and they offer a suite of solutions for DC plans. And I think that where our group has grown is just this desire for kind of independent advice and information, whether it be kind of helping plan sponsors build menus for plans or just having general advice. There has been an obvious growth in robo advice. There's the ones that we know about in the retail space, like Wealthfront and Betterment, but where I spend most of my time is actually a robo solution for defined-contribution plans. It's called managed accounts. And I think that increasingly, plan sponsors have realized that people need help. There's different ways they can get it. But one way they can get unconflicted advice and information is via a robo-investing solution inside defined-contribution plan. So, it's been growing. The assets are still very small as are the participants' total DC assets. But I think we're going to see greater adoption over time.

Benz: So, let's just talk about what a managed account is. And if my plan offers one, how that's different from the target-date funds that are defaults in many 401(k) plans?

Blanchett: Sure. So, managed accounts is kind of a terrible name, because it's used in lots of different domains for different things. But for better or for worse, we call it managed accounts, inside of defined-contribution plans. And it's not normally the default. Most defaults are target-date funds. And I think target-date funds are a really good first approximation of how someone should invest. If we go back over a decade, people were building portfolios themselves, that was just a terrible idea. Most people should not be building portfolios. But the idea that everyone that's in a five-year age band should have a same portfolio is really kind of an oversimplification.

And so, I think that things like managed accounts, again think robo advice, can help someone figure out not only what is the right portfolio for me, but also, for example, how much should I save, when can I retire, et cetera. And I think one area that's just so attractive is, the best kind of solution, ignoring cost for participants, would be to meet with a certified financial planner every year for two hours. That is not cost-effective, right?

If the average balance is $35,000, there's no way you can get someone to work with everyone to give them a great plan. I think managed accounts is a way to get guidance and advice on savings and investing from a fiduciary in a low-cost way. So, I really see it as kind of a complement today to target-date funds where it's helping someone figure out what they should be doing at a personalized level. They are being utilized more as the default, but again, we really see TDFs as the primary default in DC plans.

Benz: Target-date funds.

Blanchett: Yeah.

Benz: So, give me an example of how the allocation in the managed-account setting might differ for the same person versus what the target-date option based on that person's age would be?

Blanchett: Sure. So, most target-date funds aren't personalized to the plan almost at all. I think a plan sponsor will select a fund because it's an index or they like their performance. What managed accounts might say, for example, is let's say you've got an old-school employer that has, for example, a very large generous pension plan for employees. So, we would say, well, pension income is very much like a bond, and so we're going to have a more aggressive portfolio for the participant.

Other things could affect the allocation, too; things like human capital riskiness. The key is thinking about not only plan demographics, but also participant demographics. Along those same lines, someone who has very low compensation will get the vast majority of their income retirement via Social Security, they can be more aggressive. There's also the reverse to that. So, it's thinking about what makes the plan different and the participant different to result in a more appropriate asset allocation for each investor.

Benz: So, those are good examples of the pension plan plus salary. And those are things that would automatically be at your disposal as someone running these accounts. But it seems like in order for you to really get that holistic view of what the person has going on, they need to give you some information, right?

Blanchett: That's right.

Benz: They need to tell you what their spouse has in their 401(k) plan, what their total savings are elsewhere, and so forth. So, let's talk about that piece of it. How do you get people to give you what you need to help make really good choices?

Blanchett: Yes. So, I call that the known-unknown when building solutions in a DC plan. And to be honest, it's really hard. We distribute our managed-account solution kind of in two different ways. One is, where we're behind the scenes, where our partner utilizes their user interface as their experience; other approach is where it's our user interface, our experience. And we're doing things to make it easier, but it's just a really hard time to get someone to go in and engage consistently and give us all that information. So, we're trying to make it better, but it's tough.

Ptak: What has your research suggested as an appropriate price for a managed-account solution? And we should disclose here that this is a business in which Morningstar's engaged and so we're not totally sort of independent and objective on this. But all the same, I would imagine that you've done some research that looks into the trade-off between fee and the benefits that one accrues from increasing personalization through a managed account. So, what has that told us?

Blanchett: So, I mean, to me, it's when I think about managed accounts, I think about what is the value of a robo-advisor. I don't kind of just segment it to the 401(k) domain. It's what is the value of working with a Betterment or Wealthfront versus a kind of a true-on advisor. And I don't believe it's the same thing. I think that robos, by definition, aren't going to be as personalized on average, they possibly can be. But I would say, as long as it's less than 50 basis points and you're fully utilizing the service, it's probably worth the cost. Obviously, if it costs more than that, there's just this question of, well, what else could you be getting or doing if you weren't working with the robo-advisor.

Benz: One thing that nags at me is--and I know you've spent a lot of time on this issue, David--is the decumulation stage of retirement. So, when someone gets close to retirement, how the plan goes about helping them determine how much they can take out, where they should take the money out, and so forth? Do you think that there's more work to be done in that space? And sort of what's your vision of the evolution of decumulation solutions?

Blanchett: I mean, obviously, the research on decumulation is kind of somewhat new. Bill Bengen's piece on the 4% rule came out about 25 years ago. We've seen more since then. And I think that what's so concrete about decumulation is that it's so personalized. Everyone is so different. And there's this kind of combination of irrevocable choices you have to make when you claim Social Security, are you going to buy an annuity. And I think that what we need is, you need to have rules of thumb, but also personalization.

So, I think that, what I'd like to see is more of an intersection of the future of research on optimal strategies, combining the behavioral aspect of things. I've written a lot of research on annuities, for example--no one buys annuities. And so, it's how do you kind of take this idea that certain strategies or solutions are better but actually get folks to go down that path and enjoy it. So, I think there's still a lot of work to do to really help people retire more successfully.

Ptak: So, there's legislation that's wending its way through Congress that perhaps would make annuities more readily available in retirement plans. And so, do you think that's a positive development?

Blanchett: I do. So, you know that it's the SECURE Act. And here's my thing about annuities in DC plans. There's been a whole kind of mixture of perspectives. And let's say that there's kind of, like, seven reasons that a plan sponsor wants to add an annuity. This might eliminate one of those seven reasons.

And so, I don't think what you're going to see if the SECURE Act passes is every plan add in annuities. I think what you'll see is on the margin, some plan sponsors who thought, "You know,  we're getting rid of our pension plan, I want to offer my participants a way to access guaranteed income in a safe, high-quality environment." They might kind of pull the trigger. So, I don't think much will change. And it's not going to probably be part of the default. It's just going to be an option that's there should someone use it. And I like it. I like giving someone choice. I like plan sponsors having access to it and not being afraid to add it for fear of being sued.

Benz: Going back to retirement accumulators as opposed to people who are getting ready to pull money from their plans. Let's talk about the nudges that have been put into place over the past couple of decades, like automatic enrollment. Do they go far enough in your view? Are there more steps that should be taken? Because I think there's some agreement that they really have been working, right? But should we take things even a little further still on the nudge front?

Blanchett: Yeah. I think that like, with the Pension Protection Act, you had automatic enrollment, and that really did have a pronounced increase in participation. Went up from, say, 75% to 95%. I think the shortfall of it was that as an industry, we selected a default rate that's too low; 3% was without a doubt, the predominant default used in DC plans. Now it's going up to 6%, which is better, but it's still too low. And so, we really haven't seen this significant increase in savings rates.

There's two key drivers of getting that nest egg in retirement, there's investing and saving. And I think that most folks that are professional investors don't expect returns to be all that high in the near future. That means saving is even more important than it's ever been in the past. And I don't know that we can actually ever get to a really good place in terms of default investing, because lots of folks aren't covered by DC plans. Those that are in them can opt out. They cash out. I think it's getting better. But we're just not where we need to be to have kind of a better retirement for most Americans.

Benz: So, one thing we covered with our colleague, Aron Szapiro, was the idea of whether there should be some--you and I have talked about this too, David, the idea of like a thrift savings plan, some very cheap plan that is available to anyone, regardless of what their employer is offering up. Is that something that you would favor? Do you think that's a good idea?

Blanchett: So, I mean, I think we might see that. There's a provision in the SECURE Act that has open MEPs, that's kind of similar to offering a TSP.

Benz: So, the MEPs are the multiple employer plans?

Blanchett: That's right. I mean, here's my thing is that, let's say that I'm a small-business owner. I wear 20 different hats, and I've got 30 things to worry about. I don't know that because the plan is cheap, it's going to make me add it to the plan. I think that cheap is relative because I'm not paying for it, my participants do. And so, will it improve things? Maybe. But will it get us again to kind of like this national level of savings? I don't think so. I mean, I think that my best idea isn't palatable, it's mandatory savings, probably employers' base savings like they do in Australia, because I think that's what it really takes to get people to move the needle is to force them or their employer to safer retirement.

Benz: So, which mandatory contribution would you favor? The one on the part of the employee or the employer?

Blanchett: So, solely behavioral would say the employer because it doesn't feel the same. We're already telling someone that they have to save their Social Security and their employer, but making the employer do what I just think would be slightly more acceptable among Americans. But I don't really perceive either one of those passing in the near future.

Ptak: We've been alluding to it, but there's sort of the general topic of retirement readiness. We talked to Aron Szapiro, who we mentioned before, about that. We also spoke to William Bernstein, a number of our guests, and it has been surprising the diversity of views on how retirement ready the populace at large is. So, we'd like to get your perspective, given the fact that you live in that world, are we where we need to be?

Blanchett: So, one thing that gets tossed around a lot is this idea of a retirement crisis. And I don't think we have a retirement crisis. I think we have maybe a retirement-savings crisis. If we didn't have Social Security, we'd have a retirement crisis, because you'd have people that are destitute in retirement. That's why the system was created. It ensures some minimum income level when you retire.

But if you look at where savings rates are today and where they've been, they're lower than where they were 40 years ago. And we've seen a significant decline in pension plans. And so, as a country, we are not saving enough for retirement to live the same lifestyle when you finally retire. Now, here's the thing, though, retirees are very happy on average. About 90% of retirees are either satisfied or very satisfied with retirement. If you ask Americans, do we have a retirement crisis, about half of America thinks we do, but only about 10% of pre-retirees and 5% of actual retirees described their situation as a crisis. And so, what all the data suggests to me about the surveys is that we aren't saving enough on average, but people tend to make it work. Could retirement be more enjoyable if you save more? Yes, but it's the hard part of getting folks to save more for retirement to get them there.

Benz: So, how about by generation? Is there a risk that the baby boomers, who are entering retirement and people below them in age who have not had the benefit of pensions, by and large, that things could get worse because of that? Can you look at this by age band?

Blanchett: I think that as the need to fund retirement is increasingly placed on individual shoulders, normally younger Americans, there's going to be a wider gap. And so, I think that there's other questions around things like Social Security retirement benefits, where they're going to be 20 to 30 years from now. The bad news for all of this is people just have to save more. When you've got lower returns, you've got lower Social Security benefits, potentially, you've got lower pension benefits, it places more the burden on individuals to prepare retirement for themselves. And we just haven't been doing that collectively. You've got things like student loans that are kind of demanding additional monies for younger Americans. So, it's definitely a lot to tackle.

Ptak: So, is it realistic to expect those who maybe are at greatest risk of, let's call it a retirement-saving shortfall of sorts, is it realistic to expect them to step up their spending sufficient to close the gap and be where they need to be to have an acceptable retirement living situation?

Blanchett: So, I have a different perspective on this maybe than a lot of folks do. Because both of my parents were public school teachers. They both worked for 27 years. And they have an absolutely glorious retirement. They were not paid all that great by most metrics that you would use. However, they had forced savings via the public pension, very generous public pension. And so, I think the question is, is what is our desire as a country to save for retirement? And it's difficult to save. But we're, I think, too focused on consumption and shiny new toys. And so, yes, there are things demanding our attention. But other countries have long had savings rates much higher than ours.

Yes, there's different demands for dollars today, but I think we could get there if we wanted to. We just don't necessarily have the desire across. That's not to say that a lot of folks aren't struggling, that there's not a lot going on. But I think most of it is by choice, not because there's simply no money available.

Benz: So, delving into the nitty-gritty of working on a retirement plan, you've done a lot of work on the topic of income replacement rates: How much of the income I had while I was working will I need to replace when I actually retire? What you found is that there's this huge divergence, anywhere from, like, 90% of income needs to be replaced at the high end down to, like, 55%. So, let's talk about the swing factors in play there. Generally speaking, the higher income folks need to replace less, correct?

Blanchett: Yeah. One of the--so my very first job out of school was I worked for a financial-planning department; we did financial plans. And so, I would work through, like, 15 or 20 or 30 a month. It seems obvious, but then it shocked me, because everyone has a different number. You have the income and you have what they need. And they were related, but they were very different.

And it comes down to what is your lifestyle, what are you saving today, what do you want to live off of. And that's why, for example, in a 401(k) plan, we might estimate how on track we're based upon a 70% replacement rate, but in reality, everyone's different. What you need to get about retirement is your number. And that's why when you're doing a financial plan, it's for kind of understand what do you want to spend in retirement, so you can actually kind of save for that correct number.

Benz: So, let's talk about why the higher-income person while working would tend to need less of that, simply because they're saving more I would guess?

Blanchett: In theory, they're saving more. Yes.

Benz: Yes. Right. What else?

Blanchett: I mean, so when you retire, what happens? Well, you stop working and you stop spending money on certain things. So, you stop, for example, saving for retirement, you stop paying Social Security taxes. Certain expenses go away. And older Americans and especially higher income Americans should be, for example, saving more.

And so, given the fact they're saving more for retirement means they've got to replace less of their income percentage-wise than someone who was making lower income levels. And so, I mean, it really kind of varies by household. But to me, more interesting phenomenon by income level was how spending changes in retirement, where individuals that spend more at age 65, say, $100,000, tend to see much larger decreases in spending throughout retirement because more of their spending is discretionary. They choose to spend less over time. There's really interesting implications about income and spending not only at retirement, but through retirement.

Benz: So, let's talk about that, because your research in that space has been absolutely groundbreaking. So, you've examined the trajectory of retirement spending and found that there is sort of a pattern, where it's, you call it the retirement-spending smile, where you've got higher outlays at the beginning tapering off and then maybe heading up a little bit later in life. Let's talk about the key factors driving that trajectory. It seems like maybe pent-up demand to do discretionary spending at the early years of retirement would be the key driver why it would be high initially. Let's talk through that.

Blanchett: Yeah. So, I mean, again, like the logic for every household, I don't know what drives their decision, but what you tend to see is that younger retirees tend to increase their consumption by more than inflation. So, we'll define younger is like 60 and under. They tend to--if inflation is 3%, they spend 5% more than the previous year. And as you kind of move to older age, say by age 80, you're actually spending a little bit less than inflation every year. But then if you're still alive, by age 95, there's a pretty decent chance you're going to spend more than inflation because of healthcare costs.

And if you kind of net it all out, retirees, on average, spend about 1% less versus inflation every year. So, if you assume inflation is 3%, their spending only rises about by 2% a year. Now, it varies by income level, where households that have more discretionary spending, higher-income households, tend to spend less. But this just kind of questions that fundamental assumption of what do I assume as the retirement income need? Do I assume that it's a need plus inflation or similar number? And I think why it's important is just to help retirees understand when and how they should consume their savings. So, I think it might actually make sense to take that cruise when you're 70 years old, because you're not going to take it at age 85. So, kind of, maybe enjoy the money now while you can or just holding on to it, you know, until late retirement.

Ptak: So, given these vectors, the fact that there's variations in income replacement preferences, and also the trajectory of spending can vary depending on maybe one retires and other circumstances. These are things that we probably have to model in when we're making recommendations through the various services that we offer predicated on the research that we conduct. Can you briefly talk about how we approach that? How do we solve for things like variations and how much income needs to be replaced, and when someone will retire and the implications that has on their spending trajectory?

Blanchett: So, I would say that for the most part, as an industry, we do a pretty poor job modeling it. So, the industry defined as financial planning has moved away from what I would call a deterministic projection, where you assume a constant rate of return, there's no variability at all, to Monte Carlo. Monte Carlo is when you assume randomness and outcomes. Here is the thing: Most of these decision models, these tools, assume a single set of decisions are made when you retire, and you follow that same path for 30 or 40 years. In reality, shocks happen of all types. You can adapt as things change.

The metrics we use are things like success rate. So, that's not necessarily a great metric of the magnitude of failure. So, we're trying to model these things as best we can. But I'm not convinced that the tools we have are very good because it doesn't reflect the things that can possibly happen, as well as how we adapt to situations of retirement. So, I think what this means is that, you know, planning is a very fluid thing. So, a financial plan is not, "Oh, I got a plan two years ago, I'm good." Every year kind of asking the question, how is this still relevant? So that as things happen, you kind of make adjustments over time that are minor versus kind of major changes in spending or savings, things like that.

Benz: So, David, let's talk about long-term care. You hinted at healthcare costs spiking later in life in some households. So, let's talk about that issue of some enormous outlay for long-term care later in life. When I speak to retired audiences, that's like the hair-on-fire issue, where people are terrified of what will happen if they need to spend on long-term care. How should people approach that? It seems like there's really a dearth of good options.

Blanchett: Yeah, I mean, if you think about long-term care expense, it's like the definition of what you would want to insure. It's a low probability event that's high cost, right? But can you afford the insurance? A lot of folks can't. Can you get the insurance? You may not actually be able to get reasonably priced long-term care insurance.

Benz: And insurers are literally stepping out of that market every day.

Blanchett: Right. The costs are increasing. I mean, yes, you could have afforded the premium five years ago, but they've increased the rates, and so now you can't afford it. And so, I think that, to your point, long-term care is this thing that there's just no good answer for. Because in reality most individuals that have a long-term care expense that's significant, it's relatively rare. It doesn't happen all the time. But when it happens, it can just be colossal. It can be incredibly detrimental to a household, and you can always use the house as a last resort. But I don't know that there's a great option available unless there's some kind of public policy initiative, where kind of like Social Security, the government steps in for all income levels to provide that kind of guarantee, which I doubt would happen. But I don't have a good answer for retirees because, in theory, you insure against it but usually people can't afford it or they're not able to.

Benz: So, what do you think about these hybrid products that have come on line to replace the pure long-term care? So, it's like a life insurance policy that you can add a long-term care rider to, I believe.

Blanchett: Yeah, I mean, they've been around for a long time. I'm just not sure how attractively priced they are. But at the end of the day, what I'm not great at is the behavioral stuff. And even if it's a bad "investment," if it gives someone peace of mind, it could be worth it for them to own in retirement. You know, it's really--I would recommend if you're going to buy a policy that you understand the pros and cons. But if it gives you the peace of mind to say, "You know what, I've got something in case something happens," it could be worth it.

Ptak: Maybe we'll pivot and talk a bit more specifically about withdrawal rates, another topic that you've written prolifically about. You contributed to research questioning the value of the 4% guideline for retiree portfolio spending, whereby the retiree takes out 4% or thereabouts of his or her balance in year one of retirement that inflation adjust that number thereafter, and your issue has to do with the current market environment. So, can you expand on that and explain why it is perhaps we need to rethink 4%?

Blanchett: So, that was some research I did with Michael Finke and Wade Pfau, both of The American College, and there has been lots of research done on how much does someone have to have saved for retirement. The 4% probably is--it's probably the wrong metric to use, because it really is focused on what do you take out of the portfolio in the first year of retirement, where you then increase that amount by inflation. One divided by 4% is 25. You know, a better metric is you need 25 times your portfolio income goal when you retire to be OK. But if you look at Bengen's original research and others, they almost always use U.S. historical returns. And we have 90-ish years of data using the Ibbotson time series, you've got 120 using the Dimson-Marsh-Staunton dataset, you go back over 200 years using data from Jeremy Siegel. But while that might seem robust, that number changes significantly if you use different countries.

If you use Japan, the safe rate is like 0.5%. Italy, it's like 0.7%. And so, when you change the definition of what are the returns going to be, it changes dramatically. And that's important because of context. People created these rules using historical returns, not thinking well, "Is the U.S. representative of what history has been for markets?" It hasn't been. So, then a different angle, is to say what about the future? And I don't--I can guess what's going to happen the next 10 years in the markets, I don't know that I'm going to do great, I'm probably wrong. But a lot of people think that returns will be lower going forward. And you've got, for example, yields on Treasuries now that are 300 basis points below the long-term average. So, it would stand to reason that returns going forward are going to be lower. And if you adjust the return assumptions to what people assume as reasonable forward-looking estimates, if you use average historical numbers, 4% all of a sudden becomes 3%. And I'm not suggesting that 3% is the right answer, but, again, it's about context. You know, what has been safe historically, really hasn't been safe globally, nor will it likely be safe using, I think, more-realistic return assumptions.

Benz: So, it also sounds like based on our discussion of how people actually spend in retirement, that this idea of like a fixed real withdrawal per year just isn't realistic. That's not how people do it. Plus, it seems like a lot of the research that you and others have contributed to suggests that people should be somewhat variable in terms of their withdrawals based on what's going on with their portfolios. So, let's talk about that, some of these flexible withdrawal systems. It seems to me that one of the problems is that they can get really complicated, but let's talk about if people want to legitimately try to craft some sort of a flexible withdrawal system, what's the right way to go about doing it?

Blanchett: Sure. So, the easiest one, that's pretty good, is the RMD rule, which is just one over how long you want to plan to live for. So ...

Benz: … so, the required minimum distribution tables tell you how much to take out of your IRA.

Blanchett: I don't know that I would their tables ...

Benz: OK.

Blanchett: … but just pick a number. I want to plan to live for 20 more years, take out 5%. It's not perfect by any means. But as long as you go back in every year and re-adjust the expectations, it usually works pretty well. And it's interesting, the most important driver of a safe withdrawal rate is not actually flexibility, it's what is your existing level of guaranteed income? What is the magnitude of failure? You know, if you've got 90% of your income coming from Social Security and pensions, you could take out like 6% in the first year of retirement, because we know what is the actual impact on your consumption. And a problem with research on withdrawal rates is that it almost entirely ignores the impact of guaranteed income, it assumes that a failure from a portfolio is cataclysmic. And it might be if you have no pension income whatsoever, but most people will have a decent amount of income from Social Security, which significantly mitigates the impact of a shock to the withdrawal amount.

So, I would say that when advisors think about what is the safe withdrawal rate? Well, if you're using success as your metric for projection, you're not going to capture that, right? Most advisors don't have tools that actually model dynamic spending rates. And so, what you end up seeing is that, you know, so we wrote that piece and talked about 3% is the new 4%. Well, it's really not. I think the 4% is still a great number. It's all about context, what does it mean to have to make an adjustment in your spending if you can do so throughout retirement.

Ptak: So, if 3% is the new 4%, let's suppose hypothetically that we see a significant drawdown in markets and expected returns improve meaningfully. And so, in that scenario, all things being equal, would you say 4% is the new 3%? And to the extent that that's so, do you think that there are any sort of behavioral hurdles that one needs to consider that would maybe preclude a retirement saver from actually stepping up their spending in the face of what's been a significant drawdown with all the attendant worries it triggers?

Blanchett: Well, yeah, but I mean--so if 4% is the new 3%, your balance is only worth a third of what it was before. So, you know, like the net impact for you as an investor hasn't changed income-wise. But I do think it's really important across generations to think about how much I have to save. And this is, I think, critical for financial plans. I mean, a financial plan can last like 70 years, right? So, an important question is, what are you using as your return assumptions. And so, one thing that we do that I really like in our models is we have what we call a conditional return and an unconditional return. We think that returns might be low for the next, say, 10 or 15 years. We have no clue what's going to happen 20 years into the future. So, we assume that it drifts back to the long-term average.

So, why is this important? Well, you know, we think that if you're retiring right now, you're in a pretty rough spot. We think lower returns are going to happen for you. But if you're 25 years old, we're not going to assume that bond yields are 2% for the next 70 years. And so again, it's about context. I don't know that a lot of planners can do this. But I think it's really important to tell someone, "Hey, there's a pretty good chance that returns are low for you today, Mr. Retiree. But maybe, you know, if you're only 35 years old, things might get to a better place when you eventually retire." So, it's about kind of putting context around the uncertainty around future returns.

Benz: So that brings us to another raging debate in the retirement-planning community, which is what a retirement portfolio should look like. And there has been some research advanced by Michael Kitces and Wade Pfau, where they looked at what they called the "reverse glide path," the idea that because of some of the risks that you've just talked about of new retirees entering retirement and what could be a lousy market environment over maybe the next decade, they should start out pretty equity-light, that they should have more bonds, maybe more cash, and then ramp up equity exposure. I know you've pushed back very nicely on that research. You don't agree that that reverse glide path makes lot of sense.

Blanchett: Yeah, again, I mean these are all kind of rules of thumb. And so, I tested all these different market return scenarios and income preferences and inflation rates, and on average, the declining glide path makes the most sense. It's also the most intuitive. I mean, I think that a lot of research ignores retiree preferences. I don't think grandma who's 90 years old wants to be in a portfolio that's all stock. And maybe she can be, but I think that it makes more sense to have a balanced risk exposure when you first retire, say, 60/40, and then adjust that over time.

A problem with being conservative today, for example, is if you buy--you know right now, the whole Treasury yield curve is only about 2%. If you buy Treasuries yielding 2%, and you tack on inflation, fees, and taxes, that has a negative rate of return. That will certainly not last you more than 25 years in retirement. And so, in theory, if you don't have to take on risk because you're way overfunded, sure, be conservative. Most Americans need an equity risk premium. So, I'm a bit concerned to tell someone to be too conservative when today if you want to actually have your assets last more than 25 or 30 years, you probably got to have some equity risk in there.

Benz: Are there any asset classes or categories that you think retirees or maybe their advisors tend to kind of underdo when constructing retirement portfolios?

Blanchett: So, one thing that we do, that I like as well, is we have different model allocations for different lifecycle stages. So, for example, a 60/40 portfolio would look different for someone who was 25 versus 65. And that's because the goal of the portfolio kind of changes. If I'm 25 years old, I want the maximum return possible given a unit of risk. And risk we'll just call standard deviation for simplicity purposes. But if I'm 65 years old, I've saved my financial capital for a specific purpose, which is to fund retirement consumption. And so, the asset classes you use in that portfolio should look different than if I'm solely focused on maximizing return per unit of risk. And so, certain things like TIPS and real estate and domestic equities become a lot more efficient for someone who is at retirement and someone who's younger. So, I think it's just more to think about how is the portfolio that you created designed to accomplish the investor's goals given that the portfolio itself, the goal changes over someone's lifecycle.

Benz: OK, so you're talking about the complexion of the actual asset-class exposures.

Blanchett: Right.

Benz: So, suggesting that inflation protection is a bigger deal for retirees than it is for those young accumulators.

Blanchett: Right. So, someone that's really young, in theory, has a great inflation hedge via their human capital. As you age, you kind of somewhat deplete that asset, so you need to kind of get that exposure via your financial assets. So, it's--again, thinking about what can I own in my portfolio that reflects what I want to accomplish in retirement? And it's important to note, too, that people have TIPS in their portfolio already via Social Security retirement benefits, right? You know, that is a government "bond" linked to inflation. So, it might not be that you need any more of that at all in your portfolio. But again, it's what are you trying to accomplish? What is your risk tolerance? What is your income goal? Things like that.

Benz: You've mentioned inflation on a couple of occasions, and I've loved the work that you've done that has looked at retirees' consumption baskets. And the Bureau of Labor Statistics has been doing some work on this as well, looking at what retirees spend their money on. Can we talk about that? How big a deal inflation is for retirees, and why that is?

Blanchett: Sure. There's lots of fun definitions of inflation. There's the CPI-W, the CPI-U, the CPI-E, just to name a few.

Benz: So, CPI-E is the one for older adults.

Blanchett: The CPI-E is the one for elderly--if you're 62 or older. And it's just noting that if you use a broad basket of consumption, which is what the CPI baskets are, it doesn't necessarily reflect what retirees spend money on. So, they tend to allocate about double the average American on things like healthcare. And so, when you're thinking about how will cost grow over time, that's a really important thing. Because, one, the research that we talked about previously found that retirees spend about 1% less on average. There's some question about how that will actually manifest itself in the future given the rise in healthcare costs. So, inflation has been relatively low for most of the key expenditure baskets, but healthcare has been pretty significant, right. So, if I'm a retiree, how do I plan for a retirement that could last 30 years of healthcare rises by 5% a year? So, healthcare is the only expenditure that actually rises in today's dollars in retirement, everything else tends to go down. And I don't know how you hedge for it. In theory, you could buy a healthcare ETF, but that actually isn't a great hedge against actual healthcare costs. So, healthcare is kind of that big unknown that retirees confront today.

Ptak: I think you've published research that suggests that one of the underutilized tools in a retiree's tool kit could be annuities. We've talked about that earlier in this conversation. Maybe we can telescope in and talk about if I am sort of eligible for that type of instrument or tool in my retirement plan, how do I choose? What should I look for?

Blanchett: Yeah, the A word is always a controversial one. You know, I talk about them a lot in different contexts. And before I talk about annuities, it's always nice to level-set, right? When we think about mutual funds, there are really good mutual funds and really bad mutual funds. With annuities, there's really good annuities, really bad annuities. And to call a spade a spade, most annuities that I've seen personally, that my friends or family show me, have not been of high quality. But the fundamental purpose of an annuity as I perceive them is guaranteed income for life. And I think they can be a really valuable way for retirees to create income because people, for one, are terrible at spending their wealth. People tend to underconsume their portfolio, so it's really hard to know, "Gosh, I have a--let's say, I have a $1 million saved for retirement. I don't know how long I'm going to live, how much can I spend?"

So, I think, you know, if you don't annuitize, you worry more. I think guaranteed income gives you an assurance you have some income for life. And so, who should buy the annuity? Well, someone that values the certainty of guaranteed income, someone that was going to maybe invest more conservatively in the absence of buying the annuity, someone that's maybe less concerned about leaving money to their heirs because they want to kind of maximize their lifestyle, and someone that wants to live for a long time, or thinks they're going to live for a long time. And once you have kind of those attributes, you ask the question, well, you know, what product should I buy? There's immediate annuities, there's deferred annuities, there's these GLWBs [guaranteed lifetime withdrawal benefits], and there isn't one right answer for everyone. Academics tend to focus on what are called deferred income annuities, or DIAs.

They are also called longevity insurance, or what's called a qualified longevity annuity contract, or QLAC, inside of a DC plan. But long story short, these annuities you buy at, say, age 65 and the income starts if you're still alive, at age 75. And I think those make the most sense from a hedging perspective, because most folks don't need the guarantee right now. Like I'm 65, but at least I know what I've got, they need some assurance if I live beyond a given age. So, I like those the most. They're still very unpopular. But in reality, it's what are you trying to accomplish? And that should be the framework to figure out what is the best annuity for you?

Benz: So, it seems like one thing that's been kind of bedeviling the annuity space is a dearth of products that offer any kind of inflation protection, is that correct? So, if I buy this stream of income, it's not going to be inflation-adjusted, by and large, except for a few contracts out there. How big a deal is that for people?

Blanchett: So, I actually--again, it's like whenever you buy insurance, whenever you have a risk, it's reduce, retain, avoid, transfer; there's this whole decision matrix process. And so, inflation is obviously a risk that you face. There is only one provider today that actually offers inflation-adjusted immediate annuities. They do exist on some interesting GLWB contracts. But here's the thing, I think that you can get mostly they're just via like a fixed cost of an adjustment. So just tack on a 2% adjustment, where the benefits increase every year by 2%. And it's obviously not a perfect inflation hedge. But most households have inflation hedge assets. They've got Social Security, they've got their financial assets, they've got a house. And so, the question is, is it worth to plan for inflation? Yes, I think you should have a rising benefit. Is it worth it to explicitly tie the benefit payout to inflation? Probably not, given the payout rates in the industry at large today.

Benz: So, in addition to all of your retirement research, you've done a lot of work on asset allocation, generally, you and the team. One piece of research that I wanted to talk about was the research on homeownership. I think the piece was called "The Home as a Risky Asset." Let's talk about that. The basic conclusion was don't count on your home to provide an investment return that beats a liquid investment portfolio, correct?

Blanchett: Yeah, people I think for the most part think that homes are relatively safe. One problem that I've seen, even among advisors who think about homeownership, is that they often use like the Case-Shiller indexes when it comes to volatility. But here's the thing, a home is like owning a single stock, right? And how many financial advisors would ever recommend the client own a single stock? Pretty close to zero if you're good at your job. And so, what you have is a lot of idiosyncratic risk when you own a home. And what that creates is this likelihood that you could have a negative return for long periods of time. And so, I think that homes make a lot of sense for most people because they're both an investment good and a consumption good, but they're not necessarily a great investment. So, don't view your home as an investment. So, we view it as a way to accumulate wealth and to have shelter as long as you're there, but it's not as safe as most people or advisors think it is.

Benz: It's highly geography dependent, though, right?

Blanchett: Yes, incredibly specific to where you live. I mean, certain areas like California have seen phenomenal growth in home values for the last two decades, other places like Phoenix or certain parts of Florida or Detroit have seen negative growth over that same time horizon. So, the problem is, it's wherever you are, is what you're tied to, and you really can't diversify that away very easily.

Ptak: What about company stock?

Blanchett: I'm not really a fan of company stock. I mean, it's okay to own it in small batches, if you must. But here's the thing. I mean, you already have exposure to that company via your human capital, diversify it away as soon as you can. I mean, again, it's a single company, you know, things can happen--ironically, I used to talk about certain large companies that are diversified, like GE, would be a pretty safe company stock to own. I have since changed my perspective, post what we've seen happen with GE. So, I'm really--you know, you do it if you have to. But if you can diversify it, do it as soon as you can.

Benz: Going back to retirement planning. In your years focusing on the retirement planning space, what are some underappreciated aspects of retirement success in your view?

Blanchett: To me, it's just staying the course. I mean, investing really should be pretty dull. A good planner is just helping someone--you're like a fitness coach, helping someone stay on this path of wellness that requires not making a lot of changes and doing the right things. And someone might say, "Well, you know, you did the plan two or three years ago, and it hasn't changed. Why am I still paying you?" And to me, it's helping that person stay on that plan toward success. Because, you know, in my experience, people make like the worst decisions when they're left to their own devices. And having someone that you can kind of talk to and talk through things leads to better choices over time.

Ptak: Well, on that note, I think we'll close things out. David, thank you so much for your time and perspectives, they've been really valuable. And thanks for being our guest on The Long View.

Blanchett: Thanks for having me.

Benz: Thanks so much, David.

Ptak: Thanks for joining us on The Long View. If you liked what you heard, please subscribe to and rate The Long View from Morningstar on iTunes, Google Play, Spotify, or wherever you get your podcasts.

Benz: You can follow us on Twitter @Christine_Benz.

Ptak: And @syouth1, which is S-Y-O-U-T-H and the number one. Finally, we'd love to get your feedback. If you have a comment or a guest idea, please email us at TheLongView@morningstar.com. Until next time, thanks for joining us.

About the Podcast: The Long View is a podcast from Morningstar. Each week, hosts Christine Benz and Jeff Ptak conduct an in-depth discussion with a thought leader from the world of investing or personal finance. The podcast is produced by George Castady and Scott Halver.

About the Hosts: Christine Benz and Jeff Ptak have been analysts and commentators on investments and the investment industry for many years. Christine is Morningstar's director of personal finance and senior columnist for Morningstar.com. Jeff is head of global manager research for Morningstar Research Services, overseeing Morningstar's team of 120 manager research analysts in the U.S. and overseas.

To Share Feedback or a Guest Idea: Write us at TheLongView@morningstar.com

(Disclaimer: This recording is for informational purposes only and should not be considered investment advice. Opinions expressed are as of the date of recording. Such opinions are subject to change. The views and opinions of guests on this program are not necessarily those of Morningstar, Inc. and its affiliates. Morningstar and its affiliates are not affiliated with this guest or his or her business affiliates unless otherwise stated. Morningstar does not guarantee the accuracy, or the completeness of the data presented herein. Jeff Ptak is an employee of Morningstar Research Services LLC. Morningstar Research Services is a subsidiary of Morningstar, Inc. and is registered with and governed by the U.S. Securities and Exchange Commission. Morningstar Research Services shall not be responsible for any trading decisions, damages or other losses resulting from or related to the information, data analysis or opinions or their use. Past performance is not a guarantee of future results. All investments are subject to investment risk, including possible loss of principal. Individuals should seriously consider if an investment is suitable for them by referencing their own financial position, investment objectives and risk profile before making any investment decisions.)