Conventional “Retirement Planning” is Code for Gambling
The core of ordinary financial planning is rotten and no one wants to talk about it.
Occasionally, clients of other financial professionals will contact me asking for a consultation. My advice is complimentary to my clients, since life insurance companies pay agents directly. But for clients of other agents, we have to make alternative arrangements. No big deal, we came to an agreement and scheduled the Zoom video call.
Here’s your mandatory caveats. None of what’s here should be taken as investment, tax, or legal advice. I don’t have nor do I want the government permission slips (licenses) that would legally authorize me to give that sort of advice. I’m an economist and a life insurance agent — that’s all. Consider what follows an educated economic opinion.
We’ll call my consult client E.
E is in his early, approaching his mid, 40s. He’s done fairly well for himself. One of his questions to me was what I thought of his overall situation with respect to long term financial planning. He was specifically curious about what I thought of his tax-qualified plan invested funds with a current market value of over $1,000,000.
What follows is what I told E about that tax qualified plan money, of which he was fairly, and understandably, proud.
The western economic and financial world operates on what’s called the fractional reserve banking system.
This means that commercial banks and the federal reserve can lend money that they previously did not receive from an antecedent source — money that previously did not exist. They’re legal counterfeiters.
A consequence of the fact of the fractional reserve banking system is the boom-and-bust cycle, or what some call the business cycle. The business cycle is the phenomenon of a general rise in the price of assets positioned at the top of the structure of production followed by a collapse. These are things that are most remote from the point of consumption. Think of the prices of things in and on which production processes occur (i.e. commercial real estate and land), and shares of the titles of the legal entities that own the real estate, production processes, and production goods (i.e the stock market).
Prices of stuff at the top of the structure of production are most sensitive to the business cycle because this is where value is most concentrated. Value is most concentrated at the top of the structure of production because this is where the most durable goods are (that is, goods that render services and generate revenue over longer periods of time — revenues which can be summed and discounted to a present value [which we call capital]). It’s because individuals appraise these durable goods in terms of money (i.e. they can calculate the net present value of future revenues), and thereby imbue them with capital, that participants in these markets are more likely to require credit (loans) to buy and sell them. It’s the same as saying that homes are “worth” significant sums because they’re capable of providing the on-going service of sheltering (either to the owner or renter).
The price of this credit — interest — is directly affected by the rate of money supply growth. This is because of fractional reserve banking. The greater the money supply, the greater the Federal Reserve and the commercial banks to issue fabricated (counterfeit) loans. All else equal, if there is a greater supply of apples for sale, the price per apple drops. Furthermore, in the dynamic sense, if the supply of apples is steadily increasing over time, the price per apple steadily decreases over time. Likewise, if the supply of money (and perfect substitutes for it) is rapidly rising, then interest rates decrease. That is to say that credit becomes artificially cheap. The relative affordability of credit thereby artificially incentivizes individuals to deploy (borrow and spend) it, which is to say, prices get bid up.
This is the boom.
The reverse or unravelling of this process is the bust. The rate of new money supply creation slows (virtually never in modern US financial history does the money supply strictly decrease — its just that the rate of new growth slows). The relative decrease in the availability of artificial credit reduces the downward pressure on interest rates. Organizations reliant on the on-going availability of artificially cheap credit experience “liquidity crises.” Bills go unpaid, production processes halt, marginal companies go bankrupt. Given the degree of interdependence and the pervasiveness of credit throughout the economy, this crisis can spread like something akin to a contagion. We call these recessions and depressions.
I provide this overview to say this: the business cycle will happen so long as we have a fractional reserve banking system.
The exact timing of the recessionary periods is a question of observing the change in the rate of new money production (a project I’m involved with — but that’s a story for another time). But the exact timing is beside the point. It’s a bit like saying the sun will rise each day while the exact timing will change but can be approximated (albeit with much greater accuracy than with recessions). It’s all just a matter of time.
Applied to long term financial planning with respect to publicly traded assets, often, though not always in tax qualified plans, we can say the following. The business cycle will affect the price of retirement assets, both in the positive and the negative respect.
Here’s the question: when will those negative effects manifest?
When will the business cycle come around and knock 10, 20, 30, 50% or more off of your portfolio value? When you’re approaching your desired retirement time (i.e. your desired distribution year), will we be in the middle of one of these business cycle corrections? Just before one? Just after one? What will the effect be on your retirement portfolio value?
The honest answer is you don’t know. I don’t know. And the advisor doesn’t know.
The elusive shifts of the business cycle are a function of the decisions of Federal Reserve Board and commercial bank presidents. And not even they can tell you what they’ll do with the money supply growth rate in 5, 10, or however many years.
There are those who will defend their allegiance to the stock market as the basis of retirement planning.
“Just shift your allocation to fixed income assets (bonds) as you get older dummy! Duh!”
Apparently, this response has served satisfactorily as justification for relying on the uncertain future value of assets deliberately exposed to a system of price volatility.
But the retort just moves the goal posts! If the problem before was that you don’t know whether a crisis period will align with your selected retirement age, what’s to say that this problem will be rectified by simply substituting the term “retirement age” with “reallocation dates?!”
You do not, cannot eliminate the problem of timing the market by selecting multiple reallocation dates instead of one retirement date. The same question arises! Will there be an economic crisis caused by changes in rate of money supply growth at, shortly before, or shortly after you decide to alter your portfolio allocation?
I don’t know. You don’t know. The adviser doesn’t know.
“Well Ryan that’s why we turn the job over to professionals!”
Oh?! And since when did Wall Street stumble upon the noble calling to look out for your best interest? What really surprises me is that typically it’s conservative-minded people who are relatively more likely to save. And since tax-qualified plan stock market investing is accepted as the way to allocate savings, it’s typically conservative savers who are left with what must be an extremely awkward position of defending the integrity of Wall Street money managers.
“Well Ryan that’s why we turn the job over to algorithms and Target Date mutual funds!”
Oh?! And who do you think wrote the algorithms?! Are the Wall Street software developers endowed with virtue that just happened to skip over the Wall Street traders?
Morality aside, what data point in history would suggest to you that wise, talented, economically informed asset managers can and do successfully preempt changes in Federal Reserve and commercial bank lending policy?
The fact of the matter is that attempts to justify the use of non-guaranteed assets — the value of which is a function of the unpredictable fluctuations in the business cycle — is simply an attempt to rationalize and defend previously unexamined preconceived ideas.
An honest opinion, and what I told E, is that the market value of publicly traded stock is what it is. It’s the tradeable value at a point in time. Can you depend on that value in 20 or more years to provide for on-going, passive cash-flow? Maybe. Maybe not. Will E capture gains, correctly time the market, and make the necessary reallocations between now and distribution time? Maybe. Maybe not (historical statistics would suggest not).
If you want to think of retirement, or late life passive cash flow time, in terms of annual cash flow and the number of years over which that cash flow will be available you cannot use non-guaranteed values. Period.
The industry has a word for this by the way. It’s called Sequence of Returns Risk. But I’m sure your conventional financial planner covered that risk in detail before you signed up to contribute beyond whatever required minimum to that tax qualified plan.
The good news is that you can opt out of this entire paradigm. You can choose guarantees instead of inextricable uncertainty. And you can take control of the banking function in the process!
But there’s a subject for another time…