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How much of our final salary? (And Dan Ariely blog post re: advisors)

Dan Ariely, author and professor of behavioral finance, wrote an interesting blog post yesterday
Asking the right and wrong questions From a behavioral economics point of view, the field of financial advice is quite strange and not very useful. For the most part, professional financial services rely on clients answers to two questions:
How much of your current salary will you need in retirement? What is your risk attitude on a seven-point scale?
He goes on to say that the clients suggest that they need 75%, which is a number they'd gotten from advisors in the first place, so it's useless. Then he suggests that the actual answer should be a *lot* higher -- 135% -- though he bases that on the answers to these questions, which are, in my opinion, similarly useless:
How do you want to live in retirement? Where do you want to live? What activities you want to engage in?
He then goes on to skewer the percent-of-assets model used by so many advisors to determine their compensation - in particular, given that the advisors (according to him) are so bad at figuring out how much clients need to save and how much risk they should be taking, they spend all of their time doing the easier job of rebalancing portfolios and, in his opinion, they get paid too much for doing so and probably shouldn't be doing so in the first place.
It's a controversial article - and my opinion is that he's both right and wrong, but I wanted to put it out there first and see what folks have to say -- and if anyone here has actually paid an advisor for financial advice (whether percent of assets, or through a commission-paid broker, or any other form of paid financial advice). This, of course, is not a typical crowd - folks in MIFP are more likely to manage their own money and to be more than capable of rebalancing on their own. But the recent discussion certainly suggests that the more difficult questions - how much you need for retirement (and something not addressed by Ariely or, in general, well enough anywhere -- how to actually extract that money once one has retired) -- are things that Ariely suggests *should* be things that professional advisors can and should help people with. And they should be able to make a living that way.
Here's Ariely's blog post:
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--
David S. Meyers, CFP(R)
http://www.MeyersMoney.com
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Reply to
David S Meyers CFP
Tad - can you elaborate on this? I went to engineering school, no debate team for me. I understand the general idea of logical fallacy and read
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to get an idea of what you meant. What hidden motive do you think Dan had? FWIW - the number he offered, 135% is pretty out there, I wonder how he came to the conclusion. No underlying data was offered.
Reply to
JoeTaxpayer
I think it is reasonable for a financial planner to investigate his client's risk tolerance, but rather than ASKING how much money the client will need in retirement, he should be TELLING the client how much he should save each year from now until retirement to more or less equalize his standard of living throughout his lifetime. This "consumption smoothing" approach to financial planning is rather new, I think, but has been facilitated by the software ESPlanner by Laurence Kotlikoff, an economics professor at Boston University. Kotlikoff and Scott Burns have written a book, Spend 'Til the End, that investigates many life situations with ESPlanner and comes to some rather surprising, non-intuitive conclusions.
Dave
Reply to
Dave Dodson
bo peep writes:
I imagine that Tad is talking about Ariely, not me. As I said, some of Ariely's argument is trivial to poke holes through. But it's worth reading, as he raises some other points, particularly about advisor compensation and just *what* folks are paying their advisors *for*, which are worth talking about.
I just liked that his starting point was the same discussion we'd been having here just now. As was discussed in much better detail than Ariely blew off, a reduction as a percentage of final salary makes sense for a variety of reasons, not the least of which are that one is no longer saving part of that salary for retirement, nor generally, paying part of that salary away as social security taxes, etc. Those two things alone account for a big drop in top-line income requirements. (of course, there are the ofsetting issues of potentially higher health care costs, etc, but overall, the old 70-80% of pre-retirement salary is not a terrible rule of thumb - it's vastly better than the 135% "I want to live like a king" answer Ariely came up with.)
So my question still stands - what exactly are people paying financial advisors for? And are they paying them for the right things?
--
David S. Meyers, CFP(R)
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Reply to
David S Meyers CFP
For many people, that would only be true prior to age 65. I've found that since I turned 65 earlier this year, and went on Medicare, my health care costs have gone down noticeably. (My health insurance, when I was working, was substantially subsidized by my employer). My younger sister currently has individual health insurance which costs *way* more than Medicare.
Reply to
bo peep
I'd think for homeowners, the payoff of the mortgage would add to the lower expenses, as well.
If we take Social Security to average about 30% income replacement, 80% implies we need to make up the remaining 50, as compared to Dan's numbers, still needing to replace 100. He's basically dropping the bomb stating we are targeting a savings of half what we should. Our original goal was still a concern as there's a constant discussion of how the US saving rate is too low. Of the fraction that was on track for the 80 retirement, I suspect only a tiny fraction can meet the 135.
Reply to
JoeTaxpayer
It's that construct of attributing a weak and indefensible position to someone, and then tearing holes in that straw-man position. The only response, given the limited hours in life, is to ignore the arguer -- because what follows is going to be an equally weak argument (flawed premise, flawed conclusion).
The Ariely piece begins "for the most part, professional financial services rely on clients [sic] answers to two questions:"
Really? To be a valid argument from that start, he'd need to quantify that it's a general practice in financial services to both ask and rely so much on those two questions. In classic blogger fashion, they appear to be pulled from out the wazoo. So I stopped reading.
For the most part, the field of medicine relies on patients' answers to two questions: does it hurt when I do this? And what is your BMI? This is why all doctors should be put in prison and the field of amethyst moonbeam field theory given full attention from the National Institutes of Health.
-Tad
Reply to
Tad Borek
My wife and I consulted a fee-only financial advisor about 15 years ago, after we were already retired and had some extra cash to invest. One thing I remember that proved valuable was his advice to look into DRIPs as a way of getting into stocks and saving on loads and management expenses. We eventually constructed our own little ?mutual fund? from a selection of blue chip DRIPs with histories or gradually rising dividends. We are glad we did.
At the time we were heavily invested in real estate and not much into stocks. However, he did not try to persuade us to sell rental properties and put the money into mutual funds (with loads), as some commissoned sales people had recommended (and whose advice we ignored). Instead he probably saw that real estate was our forte and give us some good tips about how to save on expenses in that area, even though we were not very well diversified. We think of the consultation as a positive experience worth the fee.
Reply to
Don
In a worst case scenario, we need enough income to finance a stay in a nursing home which is now running $168 per day.
I say assume the worst -- a person will live to 100 in a nursing home. If the worst doesn't happen celebrate and take trip, eat out, and get a fancy house and motor vehicles.
-- Ron
Reply to
Ron Peterson
Which of course you don't know until you need the nursing home, the timing of which you can't predict. And when you're that old, you might not be able to fully enjoy the trip, the meal, etc. I assume that is Ron's point. You better enjoy the pleasures of this life while you can.
BB
Reply to
Blind Broccoli
I think Ariely's blog post is worthwhile reading. A review of his credentials might help folks decide whether to take a look at it. Ariely is a professor of psychology and Behavioral Economics at Duke University and has two doctorates, one from UNC in psychology and another from Duke in business administration; a book on the NYT bestseller list; and numerous publications in journals. See
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. One thing Ariely is not is a paid financial advisor. He is not promoting his own business.
If anything I think Ariely's points reasonably add to the mix that demonstrate that financial planning is not an exact science, and one size does not fit all. Ariely's points, like many bloggers' and experts' columns, help laypeople understand the process and formulate questions for themselves or for their financial advisor, just as the mix of posts here at MIFP do. Though there is a real academic and practical leaning to Ariely's points. He refers to a study in his post. This might be worth finding and reviewing in another thread.
The meaning of "risk" is hard to explain to laypeople. But as Ariely proposes, it should be better explained. Also, how much is needed in retirement is, as a recent thread explored, individual dependent and a function of many factors, and I think Ariely's post makes this point.
Many financial advisors are the product of a multi-month trade school at best, where the instruction does seem to emphasize black-and-white. These folks in particular I think are ill-equipped to bring to their clients the critical thinking skills needed to make decisions. I would not compare financial advisors to physicians. Also I think Ariely does promote critical thinking skills.
Aside: Is one percent per year of assets really the typical fee for financial advisors? I think banks that are trustees typically charge one percent, but the legal obligations of a trustee are somewhat larger in my estimation. Also, commissions for stock trades are around one-quarter of what they were 30 years ago (not even taking into account inflation). Attorneys' fees for many basic services are similarly down, based on my reading and the surplus of attorneys today. I would hope financial advisors who charge a percentage of assets charge considerably less than one percent today. I would also hope there would be more and more financial advisors who charge by the hour. (Thanks to Skip for first drawing my attention to this option. After some study, when friends ask, I tell them of the two general schemes; encourage reading some Q&D online discussion on diversification as homework prior to any meetings with advisors; and that I think the hourly financial advisor is preferable.)
David here asked whether any of us had ever paid for financial advice. I have not. I did have the great benefit of fatherly and avuncular counsel now and then on the subject of stock investing, and motherly counsel on debt (generally, apart from a fixed rate mortgage, avoid it). Very to the point, no lectures per se and of the don't-lose-your- shirt-by-doing-xyz-cause-we-will-not-bail-you-out type. Great parents and uncle. I know this because I read _The Millionaire Next Door_ and the authors say so.
Reply to
Elle
Maybe people don't get it until they've assisted a relative, client or friend with nursing homes, but the reality of Medicaid and the implications of end-of-life, quality of life, deserves attention in one's financial planning, in my opinion.
I want to talk facts and law. If one cannot ably take care of an elderly relative, the law will step in and take him/her off your hands in as human a way as possible. Once a person's assets run out (and with some special legal treatment so spouses do not get financially ruined), today Medicaid pays the room and board of nursing homes. Not taj mahal nursing homes*. But certainly today highly regulated and monitored, activities a-plenty, colorful clean communities with kind, intelligent head nurses (or else, says state regulators) that take Medicaid patients. Not perfect. But far better than (let me be direct) casting a shriveled old body into garbage cans on the street or taking women in particular out of the workforce (and out of living sanely) to care exhaustingly for an elderly relative.
* Whatever "taj mahal" means to someone who just wants to make it to the bathroom by his/herself, has constantly filthy fingernails from eating with his/her hands; etc. With consideration for those who can still smile, wave goodbye and break your heart with every fall and bump on the head and resulting confusion and fear of no one being willing to take care of their most basic needs, should say a fire occur or a burglarist apppear.
I think not until one hears his or her relative ask desperately, pleadingly, with fear in their voice, "Who's going to take care of me tonight?" can one get it.
Reply to
Elle
On Sat, 3 Sep 2011 19:28:28 CST, Blind Broccoli
The plain-English odds of an extended stay in a skilled care facility is on Medicare's web site where it says that a 65-year old has a 40% chance of using skilled nursing care, and of that number, 10% will stay beyond 5 years. Here's the web site
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Considering those odds (4%), I just can't bring myself to get excited enough to put serious money into an insurance policy narrowly focused on that single event (an extended stay).
Reply to
HW \"Skip\" Weldon
If we parse out his dissing of planners in general, and focus on the his results, the observation that one's spending is ideally closer to 135% of pre-retirement earnings, it's an interesting discussion (to me, anyway.) As you note, he's not in finance, per se, but calls himself a 'behavioral economist.' He refers to the study that he did, but doesn't link to any of the underlying data. I can't help but wonder if his questions were constructed in such a way as to determine that it would take 35% more income for the average person to be a bit happier. There's something about coaxing someone to create an idealized retirement at an effectively higher standard of living vs simply trying to determine one's replacement income at current standard which opens a real Pandora's box.
Reply to
JoeTaxpayer

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