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Would you board a flight that had a 70% probability of safely reaching its destination? How about 90%?

While these are odds we’d avoid if our life was on the line, many people blindly trust their retirement to a financial plan with similar numbers.

In this episode, I discuss why probabilities can destroy your finances, and factors you must consider to plan for retirement on your schedule and your terms.

Show Highlights Include:

  • One crucial factor you must take into account in order for your future plans to succeed (5:23)
  • The misunderstood third phase of retirement planning and how getting it wrong can destroy everything you’ve spent decades building (9:40)
  • How to spend your retirement money without destroying everything you’ve decades building (9:40)
  • The “Monte Carlo” approach to a profitable and sustainable retirement (15:35)
  • How getting your “Distribution Rate” wrong could have you working until you die (17:00)

To schedule your free retirement tracking meeting, specifically for first responders, head to http://pensionattention.com/ or call us at 805-409-8150.

Read Full Transcript

Welcome to Pension Attention, the best show for first responders who want to take control of their finances.

After advising Los Angeles city firefighters for over 12 years, financial advisor, Brad Barrett now shares how you can grow your wealth, build your legacy and enjoy a life of freedom. And now here's your host, Brad Barrett. [00:19.9]

Brad: Welcome to Pension Attention, the show for you, first responders who want more out of their deferred compensation and pension plan. My goal with this podcast is to reach you where you are at whatever stage in your career you are in to provide my nearly 15 years of experience working with both active and retired service members on their investment and retirement planning. My team of fiduciary advisors here at ONE Fire and Police are dedicated to ensuring you take control of your finances and build the life you deserve. To find out more about me or my team here at ONE Fire and Police, you can go to our website at www.pensionattention.com, or you can give us a call (805) 409-8150. Let me ask you a question. If you were to board an airplane right now, and the pilot told you, you had a 70% chance of landing your destination and a 30% chance of landing somewhere completely different, would you board that plane? In nearly 15 years of being a financial advisor, I've had many different people come into my office or lately now through zoom, they might have, you know, they'll have their deferred comp plan. They'll have maybe some IRA statements or some old accounts that they have. And all of which are very typical for someone who will meet with me, right. [01:25.0]

And as I look through the 401k statements, for example, I'm often stunned to see how many are susceptible to accounts for market volatility, right. Many people are positioned with way too much risk given where they're positioned in their journey through life. Now this isn't, you know a across the board statement, right, but I've noticed that along the way. And you might be thinking this, think about this way when you first get on and you get involved with a deferred comp plan, you're typically one of those poor files that are like aggressive or ultra-aggressive, right? And then five or 10 years goes by and you really haven't changed that. Now that may not be a bad thing, but it's definitely something to look at when it comes to appropriately managing your risk. And I'm saying this largely, because as you get further in your career and really let's call it into your almost retirement years, let's say you're standing at retirement doorstep. You're, you're, you're in drop. You're looking at exit and you have this nest egg of defer comp plan and eventually drop, right. And it was invested as if they were years younger, right? As if you were in your thirties and forties, still assuming maybe too much risk. [02:19.4]

But unlike when we're younger, we don't have a whole lot of ton of time to recover from let's say, bad luck or bad timing, or maybe even an advisor's bad advice, right? So today's topic I want to talk about is going to be around probabilities and what we call Monte Carlo simulations. It's an analysis of returns and withdrawals that predicts and offers a probability of success. And based on Monte Carlo analysis, I actually see some people entering retirement armed with plans that have a 70, 80, or 90% possibility of success, which is great. And that's what we want to strive to build. And we do that through diversification of portfolios and building an overall holistic wealth management and financial plan. [02:57.8]

Now, back to my question, I asked at the top of the show around if you'd bought a plane that had a 70% chance of landing your destination and a 30% chance of landing somewhere else, you'd probably think even though that 70%, it may be high, it's still a question you're not normally used to being confronted with. You're like that 30% seems way too high, right? So you'd probably not board that flight. Yet, many people put their hard fought retirement savings or defer comp plans or their drops in the hands of investment advisors who build plans based upon probability to success. Now, remember if your retirement plan even has a 90% chance of success, which is very high, there is still a 10% chance you'll end up in trouble. And I mean, sometimes it can be major trouble, and we don't want any of our clients being in that situation. Probabilities of success, maybe great fun when you're say playing a sport, or maybe even a board game, right, with your children, or maybe even your grandchildren at this point. You know, just when the oldest child thinks they have a victory and it's assured the youngest child makes a surprise, you know, unexpected move and wins the game. You know we've all been there and that's also the way things play out in life, right? [03:58.0]

Sometimes what, what sometimes may seem so probable can pan out to be the opposite of what actually happens. I'm as you're listening to this, I'm sure you could think of a thousand examples of this happening in your own life. Life holds randomness. I'll give you a good example. I grew up in Thousand Oaks. Actually, I grew up in Camerio and moved to thousand Oaks when I was a kid. My wife, Veronica, she grew up in Santa Barbara. Now with 300 million plus Americans walking around this great nation of ours, I would suggest that the probability of my wife and me ever meeting was pretty low. Put another way. The odds were very high, that we never meet, that our paths would never even cross. In fact, I bet there was more than a 99% probability that we never know each other even existed. Yet, we met, fell in love and married and have two beautiful kids, in spite of all the probabilities. Life indeed is filled with randomness and random unpredictable unforeseen events, you know, can defy the best probabilities, random as can baffle and derived probabilities of success, turning some worlds upside down, flying in the face of what seems so probable. [04:59.7]

Let me put it this way. Professor Mehan Yari, a distinguished economic scholar and he's taught at Stanford and Yale. One of the pillars of his economic philosophy is that when making plans for the future, a person must account for uncertainty. If you're listening to this episode, you might've heard our previous episode around planning in a world of uncertainty. And as I've learned in my almost 15 years of work in the financial services industry, the only way to combat uncertainty and randomness is to have a disciplined plan to stick to. Something, we help our clients here at one foreign police build. I know as you're listening to, you're kind of thinking Brad, you know, we've, we've, we, we we've sat with you, maybe you're a current client of ours and we've gone through building out a wealth forecast and things change. I mean, a lot of my clients are still in their twenties and thirties, you know, five, 10 years on the job. And we need to adapt that plan as we get promotions, as we get married, as kids come in the picture and as we get into our thirties and forties and fifties as that family group is established, and we start getting closer to retirement, the plan needs to be able to be adaptive, right? [06:01.1]

And we help steward that along the way. But the reality is if we don't start with that plan, randomness and uncertainty can really take hold. It takes hold of our mind, takes hold of our emotions. And we react to those things. You know, 2020 was a great year to look at if you think about it, right. When it comes to having a disciplined, diversified allocation for our clients, I was really proud of our portfolio manager team. I told them on our weekly meetings, you know, when we look at something and we're looking under that hood for the fundamental value of it, not necessarily looking at the fear-mongering that was going on at the time, right? We're able to drive value for our clients and something that, you know, I really want to plant my flag in and really stick to. And, and that's something that we want to share, not something I'm saying, but also doing myself as, as a managing director and partner here at ONE Capital Management and ONE Fire and Police, and also sharing this with our clients in their own personal financial lives. You know, all too often, I'm actually exposed to even retirees who are maybe drop, have already dropped exited, and they have income plans or retirement plan that really lacks some, some, some basic diversification and some basic fundamental values inside there. And they're building like an income plan based on probabilities and predictions that are somehow supposed to guide them through a world, filled with randomness and unpredictability. [07:15.9]

Now they're plan to design, to have them carefully spend down their finite limited retirement account, but every expense is proportion to their probable life expectations, but then something unexpected happens. Something like someone living too long, for example. Look at it this way, and, and I know I'm speaking to first responders and, and, you know, growing up in the first responder household myself, you know, kind of the old rule of thumb was, you know, it's 50 years on from the time you get on is kind of life expectancy. And I understand that we are massively exposed to different elements than most us civilians are. But the reality is if you're a male and you're reasonably in good health, you're probable life, expectancy's about 85 years old. And if you're a similar woman, it's about 88 years old. But in 2010, check this out, there are more than 52,000 people in the U S who are over the age of 100, pretty cool, right? Now, these people are actually known as centenarians contrast that to 1950, when there were only 2,300 centenarians and with medical advances as they are, would you expect this number to grow or decrease? [08:17.5]

So if you're currently say 50 years old, okay. And in relatively good health, do you think it's possible that you might become a centenarian? Who knows maybe, maybe not. I mean, you could be likely thinking this alarm only 35 or 40 same thing, right? The reality is that we are living longer, so making sure that the assets that we're saving now. Put it this way, your retirement plan or exiting drop, isn't a finish line. I want to be very open about this. I, I share this with clients a lot is that it's not a finished line. Okay. It's actually the beginning of a new chapter. You know, there's three phases that I go through with clients sometimes when it comes to what we'll call overall investment or retirement planning. [08:53.4]

The first phase is the learning phase. It's where you're learning, you're in school, you're getting an education, you're learning your craft at some point. And then you get into the second phase, which is the yearning space, right? The, the buildup, the accumulation phase, right? You're saving, you're working, you're saving, you're working, you're saving, right. And that's a very long cycle, right? Your, your learning phase might be 1820 maybe into your mid-twenties, late twenties. And the bulk of the accumulation really starts some early twenties. Let's say, I'll be able to 50, 55, 60, maybe in 65 years old. Right? So that's a big phase that second phase of accumulation or yearning the third phase, which is something that most people don't talk about. Right. And something I've covered on this podcast before. And I share with my clients and you might've even heard me say at stations before is the spending phase. That third phase. That's essentially the decent down the mountain. So you've built this mountain. You've been climbing it. You've been learning. You've been accumulating, right? You've been ascending this mountain. Now, it's like, okay, you reached the top. Great. You have the drop deferred comp plan. You maybe have VC, SK time coming out, your bank hours, all this stuff going on, your wife or your spouse may be working and has a retirement plan and may build up a trust account as well. That's all great, now what, right. [10:04.0]

Do you know how much you should be contributing to your deferred compensation plan? Are you getting the most out of your current investment options? Looking at entering or about to exit the drop program? go to www.pensionattention.com to find out how we can help. [10:20.0]

My point here in saying that is, is it's not a finish line. In fact, it's the beginning of one of the best chapters of your life. And, and, and the biggest blessing we all can have is to be able to be, you know, healthy, still have, you know, energy to get going on things. And now having this freedom to be able to say, okay, build this account now. Now, now what Brad? You know, now what are we doing? So having an income plan is really important, making sure that you know what your withdrawal rate is and what we call your sustainability rate. That's hugely important if you're listening to right now and you don't know that, right, or you haven't spent the time, even with an advisor to figure that out for yourself, give us a call. You can reach us at (805) 409-8150. You can also go to our website at PensionAttention.com. You can actually set a free complimentary retirement track meeting; I call it right there with myself or one of our advisors to be able to take a look at currently where you're at. Cause it's really important for you to, to know this, right? I'm just, I'm a big proponent of this for all clients and for all first responders, to making sure that you keep track of where you're at and how this is going to play out for your retirement years. [11:24.4]

Now, if you were to sit with someone else, I know this is not our process at all, but if you were to sit with an advisor and what are you going to do when someone proposes or an advisor that you build a retirement income plan with a strategy that calls for your money to last to your probable life expectancy. But instead you become that card, carrying centenarian, are you to go back to work? No, we don't want to do that, right? Unless you really want to, we don't want to have our clients have to, or need to go back to work. You know, maybe comedian George Burns was still capable of working at hundred years old, but most of us won't be capable. Now, I don't know if many of you know, George Burns, I kind of grew up around him with my grandfather was kind of funny. Right? And he was funny, right? I watched George Burns interviewed on his 95th birthday. They asked George, how many cigars a day? He said eight. They, they asked how many martinis a day. He said five. Then they asked, Hey, so what does your doctor say about that? You know, what George's response was? He said, I don't know. He died years ago. I mean, George Burns himself was a good example of randomness. He died in 1996 at the age of 100. He was a card carrying centenarian. [12:24.5]

My point is this, plans built around probabilities can be scary and dangerous. Whereas plans built with a disciplined diversified approach can have a foundation on dependable and predictable, so to speak, right? Understandings of returns and how those are actually married with the amount that you need or want to pull from your retirement account. Now, as professor, you already said, a person must account for uncertainty. And, you know, especially after last year and just in general right now, boy are we living in uncertain times, right? World economies are slowing, you know, new lines are being drawn in international relations and tensions really high between America's political parties and how all of it will pan out is really anyone's guess. Our economy is often impacted by say, geopolitical events. You know, what goes on around the world can affect us markets. And in recent years, right, geopolitical events seem to carry more negative impact than positive. Combining that problem is the geopolitical events are really hard to predict. They're often too random, completely unforeseen and erratic. We even saw that in our own country last year, to some extent, right? [13:29.4]

So yet, as we discussed in the opening minutes of this podcast, there are some advisors that still want to construct your retirement plan based on probabilities of how fragile economy will react, unpredictable geo political crisis is. Now we as a firm managed on a multi-asset class level, so we are broadly diversified globally. And it's something that's really important for all portfolios. And it's amazing to me, in a real sense; it's like setting with the, the legendary wizard, Merlin gazing into his crystal ball, predicting how your stars will align. No one can tell you what tomorrow holds, let alone an hour from now, right? But building a sound plan that has a diversified approach, which was global cause like it or not, we're in a big, bad world out there that we need to have approaches globally, not just in the U S right. And finding investments where we are say like wishing on a star, normally result only in misalignment between you and the strategies upon which you built your retirement plan, a plan upon which you stake the wellbeing of your retirement years. And those stakes are high. At the point you retire, you will be nearly 25 or 30 years of your life in the accumulation phase, just within the department, right? Of accumulating the finite amount of retirement assets that you currently own. And in your retirement years, you'll likely last decades. I want to repeat that you will likely last decades. If God willing you will be here for decades in retirement. [14:47.8]

Building your sound strategy of a retirement plan now increases your chances of making sure that you have a proper allocated portfolio that, that encompasses by the way, not just your deferred comp plan when you're active, but also eventually drop and maybe other assets you've accumulated, right? That work together to make sure that you reach the amount of income you need to supplement your pension and to live the retirement life that you want to live. And I mentioned a few minutes ago that I wanted to talk about something that we use in our, in the financial service industry. And we use called Monte Carlo, a Monte Carlo analysis. You know, just by saying that you might feel like you're watching the, you know, Daniel Craig and the latest James Bond film, but when Monte Carlo analysis is applied, it's really important to understand what it is, right? The key word here is probability. Okay. What it can show, it'll show the probability of your nest egg, right, being depleted to zero calculated by using assumed rates of return balanced against certain withdrawal rates. And as we change each assumption, the analysis will show a range of outcomes from good to bad. [15:50.4]

A Monte Carlo is essentially an analysis it's used to evaluate the attempts to predict certain outcomes. It's a risk analysis tool, right. Think about it this way. If you had a hundred dollars and you withdrew $50 per year, the odds will be pretty high that you would run out of money in two years. I think everybody follows that, right. Okay. Now what if you withdrew $33 per year? Well, the odds would be pretty high that you run out of money say in three years, right? But what if you would drew just $5 per year? And what if your account we're simultaneously earning $5 per year consistently? Well, under that scenario, you would never run out of money and right there is the crutch between understanding what your return needs are in comparison to what your withdrawal needs are. Friends right here is like the largest thing I talk about at stations and one of the biggest things I bring up in probably every one of my client meetings. And if you're a client listening to this right now, you've probably heard me say this, but your distribution rate needs to be known by you and by an investment advisor. Really for our clients, us. Right. [16:55.8]

And if you don't have that investment advisor start having this conversation, or if you need to call us, give us a call because it's really important. Okay? Understanding your return needs, needs to be matched with what you know, your withdrawal needs are. The example I just gave basically said, you're earning 5% and you're taking 5%. So you are not maybe earning any money so to speak, but you're definitely sustaining your account. And therefore we're going to have a high probability of not running out of money in retirement. Guys right here, if you don't know that if you don't have an idea of what your return needs are based on your withdrawal rates, give us a call (805) 409-8150. You can also go to our website at PensionAttention.com. And if not us, ladies and gentlemen find someone you can build trust in because that's the biggest thing I want to share, reality is that is so important to know, because it does a couple of things. One, again, it smooths over the uncertainty of not understanding that basically saying if you're pulling too much money in your, your returns or the amount of money you're making in retirement, isn't up to par there, you're going to be drawing down on your investment accounts and that may not be the right scenario for you, right? [18:01.6]

Secondarily in the biggest thing I talk about that this won't necessarily show up on paper so much, but it's an emotional behavioral finance, relaxation, and almost a tool to get rid of the anxiety of pulling money in retirement of knowing that, Hey, the portfolio may be earning on a 5% pretty consistently with a good diversified approach, right? And I'm taking 5%. That's a good scenario. Now we may want to increase those spreads, right. You know, decrease the withdrawal rate, maybe increase, you know, the return rate. And that's a conversation each client has to have with their advisor based on their own circumstances and their own behavioral traits and, and risk tolerances. But that's such an important conversation to have. And that's what I want to make sure I'm sharing today when it comes to probabilities and what we can use in the financial advisory world of a Monte Carlos simulation, we'll call it right, understanding the probabilities of success. Now for a lot of our clients and why, when I build their wealth forecast and our cash flow analysis, we're building that in saying, okay, if we see a nine, 10% withdrawal need, and we marry that with a balanced portfolio of a five or 6% return, well, we just want our clients know, Hey, technically, you're going to be drawing down the portfolio, a couple of percentages and if you don't like that, then we need to tweak some things. [19:07.4]

And that lays the groundwork for a great conversation to have around risk tolerance. Not that you fit into some box like that you're conservative or aggressive. I'm sorry. I just don't. I don't prescribe to that notion. I don't, I don't like those little calculators where he just says, okay, based on the input you put in there, your concern you're conservative or you're aggressive, like it really needs to be more of a fundamental discovery process. And that's why an advisor comes in and helps you with this. Okay. It helps you build that investment management plan and helps you build the overall retirement plan that that investment portfolio sits in. Now, again, remember a Monte Carlo situation is just a, an analysis tool to understand the probabilities, right. It's not perfect. And it definitely has its holes in it, I'm sure. Right. But the reality is it kind of puts a framework and you can build a portfolio inside there, or use that as a, as a tool to analyze a portfolio, right? To understand its probabilities of success. Something that we want to know internally for our own selves. But we marry that with what we know the sustainable distribution rates are kind of across the country. And we use that to understand, have a great conversation about our clients on their returns, because I've said this before, and I want to reiterate it a return conversation or how much your account returns or the investment return on it is only one half of the story. I want to repeat that a return on your investment is only one half of the story. You have to understand the other half and the other half is how much are you going to be taking from your retirement plan? [20:25.5]

Back to my example, if you are earning 5% and you take 5%, then guess what you didn't lose, or you didn't gain, right. And you can play those numbers, however you need to, but that's that pocket you can sit in to make sure that okay, if I need to pull only 3% or so, like, wouldn't, you want to know that if you basically said you had a million dollars between deferred comp plan and drop, right, and you needed to pull 30,000 above and beyond your pension, that's 3%, 30,000 on a million, 3% right. Now, if that portfolio is earning five or six, guess what? You're actually earning net of everything that of, you know, your, your withdrawal rate, roughly 2%, two or 3%. So you're keeping pace with inflation and you're sustaining your account. Right there is what we build the foundation of a plan and make sure we marry that with your overall risk tolerance. And that's why understanding probabilities and working through a portfolio that fits in line with your overall retirement plan to help you define where you sit as your own behavioral finances and how that works into your overall retirement plan. Before acting on anything discussed today, remember speak with a financial advisor near you about your specific situation, or if you would like our help, you can give us a call at (805) 409-8150. Or you can go to our website at PensionAttention.com. Next week on Pension Attention, we're gonna be discussing five tips to minimize your taxes and retirement. I think it'll be a good one. I'm looking forward to it until then stay safe. [21:46.6]

The information in this podcast is educational and general in nature and does not take into consideration the listeners personal circumstances. Therefore it is not intended to be a substitute for specific individualized, financial, legal, or tax advice.

To determine which strategies or investments may be suitable for you consult the appropriate qualified professional prior to making a final decision. [22:10.0]

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