Do you know what is driving me crazy at the moment? It’s trying to figure out why common FI thinking is so different to the retirement establishment. By “establishment”, I mean the institutional investment industry and the actuarial profession that advises on all aspect of retirement risk. I’m interested in why this thinking is so different; is one way of thinking better than the other, is one group simply wrong?
So c’mon! Let’s explore whether one group’s thinking needs de-bunking or whether they can coexist, or more interestingly whether they can be synthesized to come up with a better solution entirely. You know you want to join me on this!
A case in point is a white paper released by one of the big actuarial consultancies on “Bold ideas for mending the long-term savings gap”.
I won’t be covering the whole paper here, but this is a bold paper setting out bold ideas (see what I did there?). Surely this should be of interest to, and resonate with, the FI community? After all this paper addresses the profound questions of the challenges and solutions to retirement.
The Challenges of Retirement
Today I’m only going to focus on the first two pages of the paper that describe a number of “challenges contributing to the long-term savings gap threatening public and private pension systems and individuals” and look at how establishment thinking diverges from FI. We are going to take each of the five challenges to retirement that have been identified in the paper and look at what the paper says and compare it with current FI thinking.
- Longer lives combined with lower old-age support ratios
The first point the paper makes is that people are living longer and will outlive their means. This, the paper identifies, as the key challenge of retirement.
However FI thinking conveniently sidesteps this issue by advocating an accumulation of wealth so that expected investment returns are sufficient to meet a calculated spending rate in perpetuity. If your expected return on your assets is 4% and your withdrawal rate is no more than 4% then there is a reasonable chance you will be safe.
But the FI community has some contingency plans if the above strategy implodes. If there is a recession or a market correction then FI has three fallback tactics: spend less, tighten your belt and be more frugal, over-save by having more in your savings than you forecast, or geo-arbitrage where you go and live somewhere cheap for a while until any market disaster blows over. So this first challenge seems to fall by the wayside with FI thinking.
But hang on, let’s reflect on this a moment, because this is quite odd. As identified by the establishment
The. Number. One. Retirement. Challenge. Is life expectancy.
But this is almost never identified by FI proponents as an issue. When have you seen a FI blog post detailing the latest life expectancy improvements and agonizing over the adequacy of savings? I would say that you are one hundred times more likely to see a FI blog post about identifying what makes you happy than anything on outliving your pension pot. This is such a big disjoint in thinking it deserves a post in its own right, so stay tuned.
- Lack of easy access to pensions and savings products
The paper bemoans the lack of employer sponsored workplace savings plans, and the increasing prevalence of workers in non-traditional employment (like blogging I guess). the second point is that we are creating a workforce with little or no institutional retirement savings, or access to traditional retirement vehicles.
What would the FI community think of this?
I just don’t think this is an issue with FI, I don’t see any assumption from FI followers that financial independence is predicated on having an employer or government sponsored retirement/savings plan. FI is simple; you earn money by whatever means you can, make sure you live below your means and save the rest. If you have the tax benefits of a retirement system, then take full advantage of it, but FI is not dependent on access to traditional retirement products.
- Individuals ill-prepared for greater responsibility
There is no doubt that this is a huge challenge for a large chunk of the population, but does FI recognize it as a challenge? I don’t think so. The FI community has built a large infrastructure around advising it’s members on issues such as spenddown strategy, tax minimization, and investment strategy. This knowledge is freely available and quite accessible for the non-expert. The paper goes on to describe a key issue as “it is actually very difficult for individuals to project how much money they will need to sustain themselves through retirement”, but this flies directly in the face of one of the most popular FI articles “The shockingly simple math behind early retirement”
So is retirement calculation “very difficult” or is it “shockingly simple”? I’m not going to get sidetracked with this here, other than to note another key discrepancy between the FI community and the Establishment.
- Lack of trust in financial markets and products
The thesis here is that individuals who mistrust the financial markets are investing in sub-optimal portfolios of cash or poorly diversified real estate investments. I don’t think the FI community views this as a significant challenge since they have adopted portfolios based on passive investment vehicles and are fervent promoters of Vanguard. However it remains to be seen from market experience whether the passive highly weighted equity, or property-heavy portfolios adopted by some FI proponents will prove to be robust in the future.
- Low growth environment
I actually think this is perhaps the one area that the FI community and the establishment agrees upon. Low interest rates and low growth forecast for equities based on current valuations will make it harder to realize financial independence and retire early.
So there we have it, five key challenges identified by the retirement establishment. But they are not the key challenges that a student of FI would identify as important. I’m being slightly unfair to the paper since they are trying to address retirement challenges on a global scale for all participants including employers, governments and individuals. Whereas FI is predominantly concerned with individuals (mostly) in the US. However we have some major disagreements over the main challenges we face, and plenty of interesting avenues to explore in the future.
What do you think?
So where do you stand on this? Do you think the establishment has something worth contributing to FI thinking here? Do you think I’ve been unfair to either (both?) sides? Drop me a note!