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Welcome to How to Retire on Time, a show that answers your questions about all things retirement, including income, taxes, Social Security, healthcare, and more. This show is an extension of the book How to Retire on Time, which you can grab today on Amazon or by going to www.howtoretireontime.com.
This show is intended for those within 10 years of their target retirement date or for those are are currently retired and are concerned about their ability to stay retired.
Welcome to How to Retire on Time, a show that answers your questions about all things retirement, including income, taxes, Social Security, health care, and more. This show is an extension of the book, How to Retire on Time, which you can grab today on Amazon, or you can go to www.howtoretireontime.com. My name is Mike Decker. I'm the author of the book, How to Retire on Time, but I'm also a licensed financial advisor, insurance agent, and tax professional, which means when it comes to financial topics, we can pretty much talk about it all. Now that said, please remember this is just a show.
Mike:Everything you hear should be considered informational, as in not financial advice. If you want personalized financial advice, then request your wealth analysis from my team at Kedrick today by going to www.yourwealthanalysis.com. With me in the studio today is mister David Fransen. Dave, thanks for being here today. Welcome.
Mike:Yeah. David's gonna be reading your questions, and I'm gonna do my best to answer them. You can send your questions in by either texting them to (913) 363-1234. Again, that number is (913) 363-1234, or you can email them to heymike@howtoretireontime.com. Let's begin.
David:Hey, Mike. How did you come up with the reservoir strategy?
Mike:K. Hopefully, we got some time to really this is a bit of a story. Okay.
Mike:But it was a story of distress.
David:Okay.
Mike:So truth be told, I first got into finance when I was about 14, 15 years old. If I remember, I got conned into going to this educational week program for adults and people in the summer. Yeah. I'm in high school at the time. Right?
Mike:Years ago, but there was a cute girl that said she was going, so I signed up for it. Showed up. She stood me up. Oh. And I just I was there, so I made the best of it.
Mike:And it was a lot of fun. I I took religious classes. I took dance classes. I took all sorts of emotional intelligence classes. It was actually a really good time.
Mike:Mhmm. So, you know, thank you. I won't say her name. Stood me up. Haven't talked to her since then.
Mike:But, but I ended up in a financial class. And usually, 14, 15 year old kids don't go to financial classes. It's not appropriate to go to a like, a dinner seminar if you're that age group because you have no money. But this was something I paid for, so I was able to go in there. So I audit this class, and he explains the 4% rule.
Mike:He basically says, look. If stocks average over 8% year over year and bonds average, bond funds specifically average 4% year over year, then if you can just earn a certain amount of money, then all you need to do is is hit that money and you drop 4% and you'll be fine. And he had all these charts and and, you know, gadgets and all that stuff. And by the way, this is I mean, it was a very convincing argument. And he had no sales incentive.
Mike:The university paid him to be there. He wasn't selling anything. Like, he was just he was there as more of an academic talking about how to do your personal finances.
David:Okay.
Mike:Brilliant. And I said, great. So I took the the amount of income I wanted to
David:have in retirement. You know, a teenager. I didn't really know. I so I put some arbitrary number, calculated, and said, alright. All I need to do is to get to that number, and then I can retire.
David:Done.
Mike:Yeah. That was it. Right? Life was simple. I don't need a financial professional at that point.
Mike:I was all set. Yeah. Well, then years later, what I realized was maybe that wasn't as sure as possible. I found out about something called sequence of returns risk. Sequence of returns risk suggests that the sequence of the returns matter.
Mike:Basically, that averages are deceptive. And when markets go down, if you draw income from an account that's lost money, you accentuate the loss and make it more difficult to recover. Here's an example. You lose 10% in your portfolio, it would take 11% return to breakeven, not the end of the world. Yeah.
Mike:But if the markets crash every seven or eight years, which historically they have, and you lost, let's say, 30% in your portfolio, which is putting it lightly for a market crash, it would take a 43% return to breakeven. Okay. You've got time. You know, it's if I'm working, fine. I can wait that out.
Mike:But in retirement, you can't. So let's say I took out 4% from my loss. I'm now down negative 34%. Mhmm. Now it requires me to have a 50% return just to break even.
Mike:That's a big deal. Mhmm. I'm not making 50% return in one or two years.
David:Mhmm.
Mike:It might take multiple years. And so then I sobered up and said, oh my gosh. Well, this is a problem. Can you guess who informed me of that? It was an annuity salesperson.
Mike:And I said, okay. So what's the solution? He says, buy an annuity, turn on income. This is what all and you know they're fibbing or they're selling you something when they make superlatives. Like, all reasonable economics agree that this is the way to go and blah blah blah.
Mike:And so I said, okay. Well, let's check this out. Yeah. And so then I did a really deep dive into annuities. And here's what I found out.
Mike:You wanna transfer longevity risk to insurance can be fine. But from an economic standpoint, insurance is transferring risk to the insurance company so that, basically, they're gonna come out on top in most situations. And if you happen to live longer than most, fine. They can afford to pay that out. But it's not financially in your best interest.
Mike:And then I started noticing things like proprietary indexes that basically weren't, in my opinion, designed to really make that much money. So it's almost like they were giving you false hope, letting the accounts drain down, still pay you out so they look like the hero. Mhmm. But then when you die, they don't have to pay the beneficiaries anything. Mhmm.
Mike:So it's like, hold on. If I got this right, we've got one half the industry that wants to keep all of your assets at risk and hope the market doesn't crash or the markets don't go flat. And the it works, but they can't guarantee it because it's the securities business. And on the other side, you've got the insurance industry trying to sell you an annuity, a turn on income for life, and that that's guaranteed and you should not have to, you know, don't ask questions. And by the way, they never talked to me when as they're trying to pitch me to sell the product, because I was a finance professional at this time.
Mike:They were pitching me this idea. Hey. You know, it's all fine, but they never talked about how if tax rates increase, that your net income would decrease. They never really talked to me about inflation risk. They said, oh, well, you could you could put on a rider and have a guaranteed cost of living adjustment.
Mike:Well, yeah. But you then your income starts at a lower rate. So it's like we've got two extremes. Neither, in my opinion, really were in the best interest of the client. And then you've got the dividend portfolios, which cause people to live well below their means.
Mike:You've got rental real estate, so you're basically stuck working for the rest of your life as a landlord. That's a problem. So can you see how basically I was incredibly frustrated with the industry economically? There wasn't a perfect solution that was out there and it kept me up at night for many years, mind you, until I figured out one simple thing. So I ran a Monte Carlo.
Mike:Monte Carlo is a fancy way to simulate probability. Ran a Monte Carlo and basically did the 4% whole bit. Right? You you have a a portfolio and you run a Monte Carlo and you put in the average standard deviation, all these metrics in there of what average returns are over a thirty year period of time, take out 40%. It works out.
Mike:It says you allegedly have a 90% or 99% probability of success. Right? And then if you put in a market crash, this is what also silver me up. You put a market crash in the Monte Carlo simulation.
David:Okay.
Mike:Same thirty year average, but now you've got, like, a 64 probability of success. Oh. That's a problem.
David:Right.
Mike:People doing the 4% rule, many of them don't actually understand how much risk they're actually taking. That bugged me until I realized if I were to allocate a part of the portfolio to principal protected accounts, and when the markets were to go down, I just pulled income from those principal guaranteed sources. It was then easier for the other accounts to recover.
David:Mhmm.
Mike:And if it was easier for the other accounts to recover, then your overall probability excess would increase. Basically, if we can get rid of greed and stop trying to be the richest person in the graveyard, and I know this sounds counterintuitive, but decrease your overall growth potential slightly, not by a lot, but slightly, you significantly decrease your overall risk or probability of of outliving your money.
David:Okay.
Mike:It feels counterintuitive, but it was as simple as some of the assets need to be principal protected. And then I started exploring, well, what are the different ways we can protect assets? You've got fixed accounts, CDs, treasuries, bonds, or fixed annuities. They're all basically a guaranteed rate for a certain period of time. High yield savings kind of, also a good fit in that category.
Mike:Or you've got index products. Index basically says if the markets go up, you participate with the upside. Markets go down, you don't lose money. And these are buffered ETFs with a % buffer, structured notes with a % protection, fixed index annuities as long as there's no fees associated with it, and index universal life insurance as long as you also need the death benefit. You shouldn't pay insurance for a death benefit you don't really need.
Mike:That doesn't make any sense. And then there's other more sophisticated ways to do this. If you've got 30,000,000 or more, we could talk about that. This is how you basically leverage irrevocable trust into lending money so you have tax free income. That's a whole thing unto itself.
Mike:But do you see how there's so many different tools and based on the duration and the needs of your plan, you can pick the different tools for different parts of your plan so that at any given time, if implemented correctly, you have a source of protected money
David:Mhmm.
Mike:That you can draw income from, allowing your other accounts to more effectively and more quickly recover. So you can sail through these market crashes that no one knows when will happen.
David:Right. So if I'm gonna restate what you said, the principal guarantee means that they can't go backwards. Right? Can't lose it. And if you are losing money in the market, so let's say, yeah, the markets go down by 30% and you take out your four, that ultimately, your account's gone down 34%.
Mike:Yeah. You don't want that to happen. You're accentuating the losses. That's why it's more difficult to recover. Mhmm.
Mike:I mean, put your portfolio in, take income out. You could do this on Excel. Look up the S and P's return from February on.
David:Oh, yeah. You're gonna notice some It's
Mike:a sobering experience. And, you know, if you really wanna go the extra mile, put your portfolio through February, Ellen
David:Yeah.
Mike:1965 on Yeah. 1929 on, or nineteen o six on. Yeah. That'll sober you up real quick.
David:It'll it'll illuminate that there are some, peaks, valleys, and long flat stretches.
Mike:But we don't like to think about these things. Right. So, yeah, the reservoir strategy came about because I was unsatisfied with what the industry was trying to tell me to sell. And I said, I can't sell things that I can't get behind. And I can mathematically prove that there is a lower probability of success for that strategy by itself than I'm comfortable doing.
Mike:And my job is to help people put a proper plan together and to sustain that for the next thirty plus years. I'm 37 years old. I've been doing this over a decade and I've got another three decades to go before I would wanna retire or at least consider it. Yeah. And so I had to have something that I could sleep well at night and not worry about my clients.
Mike:And so that's where the reservoir strategy came in. It was a dissatisfaction calling BS on the industry saying, this isn't good enough. Yeah. And if you notice, by the way, the reservoir strategy compliments all income strategies out there.
David:Mhmm.
Mike:So you can do the 4% rule if you want. You can do the dividend portfolio if you want. You can do all but you need the reservoir to get you through market crashes.
David:Yeah.
Mike:The trick is how do you fund that? You gotta put a plan together first, then you gotta explore the strategies to help find efficiencies and get more out of your money. Then you put together the portfolio and determine how then how much goes to the reservoir, how much goes to everything else. That's all the time we've got for the show today. If you enjoyed the show, consider subscribing to it wherever you get your podcast.
Mike:Just search for how to retire on time. Discover if your portfolio is built to weather flat market cycles or if you're missing tax minimization opportunities that you may not even know exist. Explore strategies that may be able to help you lower your overall risk while potentially increasing your overall growth and lifestyle flexibility. This is not your ordinary financial analysis. Learn more about Your Wealth Analysis and what it could do for you regardless of your age, asset, or target retirement date.
Mike:Go to www.yourwealthanalysis.com today to learn more and get started.