Michael Kitces, the financial planner's financial planner talks Roths, asset location, and managing sequence of returns risk. He also tells the story of how he got into the financial advice biz, and offers some career-development and time-management advice.
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This video was recorded on Nov. 30, 2021.
Alison Southwick: This is Motley Fool Answers. I'm Alison Southwick, joined as always, by Robert Brokamp, personal finance expert here at The Motley Fool. Why is the title of this week's episode so boring? Because it's that good. Bro sits down to interview financial planner Michael Kitces on a sundry of things. If you know Michael Kitces, you're excited. If you don't know him yet, well, I'm excited for you. That's that on this week's episode of Motley Fool Answers.
Robert Brokamp: Every financial planner knows a thing or two about money. But who do they turn to when they have a question or are looking to further their educations? That person is very often Michael Kitces, one of the more prominent thought leaders in the financial services profession. Michael is the head of planning strategy at Buckingham Wealth Partners, co-founder of the XY Planning Network, among other companies, the host of the Financial Advisor Success podcast and the publisher of the Kitces Report newsletter, and the Nerd's Eye View blog at kitces.com. He has eight professional designations, including the certified financial planner and master of taxation. He gives 50/70 presentations at professional conferences each year, he's also an avid bridge player and the longest standing volunteer and now board member of the Washington Improv Theater. Finally, the man loves a good blue shirt. Michael Kitces, welcome to Motley Fool Answers.
Michael Kitces: Thank you so much, I really appreciate the opportunity to be here and join you today.
Robert Brokamp: Let's start with your story. How did a psychology major with a theater minor, as well as all the pre-med requirements, become a financial planning nerd?
Michael Kitces: God bless the liberal arts education. A psych major, theater minor, pre-med student, the only thing I figured out by last semester of senior year was I was really certain I didn't want to go into psychology, theater, or medicine full-time. Of course [laughs] my parents were thrilled.
Robert Brokamp: Money well spent.
Michael Kitces: Absolutely. I did love my liberal arts education. I don't want to knock it, but there was a lot of like, "We taught you to do some critical thinking, now go figure out what you want to do in the world." [laughs] I really ended in financial services by a very random and haphazard path. A long time ago, my grandfather passed away when my mother was fairly young, and my grandmother had to work to support at the time two young daughters who were teenagers. Back in the 1960s, she went and worked for a life insurance agent, for a long-standing life insurance company called New England Life or the New England at the time. She was a secretary to a life insurance agent at the New England and after a few years when she'd been working there, my mother grew up, got married to my father. My grandmother's boss did what any good life insurance agent does when your secretary's daughter gets married. He gave the new husband a life insurance policy, gifted my father the first-year premium and then basically made it back on all the commissions and all the renewals for all the years thereafter.
Robert Brokamp: Of course.
Michael Kitces: The gift that gives back. Decades later, my grandmother is long since retired, the original agent is long since passed away. So my father has what in the industry is known as an orphan policy, which means someone who owns the policy but there's no agents assigned to the policy anymore because he had retired and passed away a long time ago. My father gets a phone call from the local office of the New England and says, "Mr. Kitces, you have this long-standing life insurance policy, but there's no one's been out to see you for very long time. Could we come out and review the policy?" Obviously, sure he'd had the thing for 20-odd years. The agent comes out, reviews the life insurance policy, gives my father an update on what's going on with it. The New England, the life insurance or the sales managers are often also life insurance agents, so this gentleman was actually a sales manager who is doing the review call. When he finished, he took off his agent hat he put on his sales manager hat and said, "By the way, do you know anybody who's interested in coming into the business?"
My father said, "Funny thing. My son is about to graduate from college, has no idea what he wants to do with his life. You need to talk to him." So spring break for senior year, I came home on break and got my interview with the life insurance company and frankly at that time they didn't tell me I was going to be life insurance agent. They told me I was going to be a financial advisor. I didn't realize until later that this particular job is really just a life insurance sales job. I came home, got the interview for the financial advisor. Thought like, it sounded neat. I had a little bit of interest in money stuff. I didn't do anything related to it in college. Sounded neat. They said, great opportunity, great potential. We want hard workers, all that stuff that sounds great when you're 22 years old coming out of college. I graduated in Memorial Day 2000 right at the peak of the tech bubble. Graduated Memorial Day, Saturday, packed home everything I had on Sunday, drove home on Monday Memorial Day, and that Tuesday reported for work in the life insurance company and I've been in the industry ever since. I'm only here because my grandmother's boss gave my dad a life insurance policy 40 years ago.
Robert Brokamp: Obviously, it kindled something there. You've written before that you spent the next 20 years not only doing that job, but it's basically being a part-time student, gathering various degrees and certifications, and now you are just really impressively successful. I've said before on my show here that I think one of the neglected aspects of financial planning is developing your career. What suggestions would you give anyone trying to build a successful career in any field, really not just financial planning? What have been the secrets to your success? What nuggets of career advice do you think you'll be passing along to your three kids?
Michael Kitces: I'm a huge fan of the idea and framing that our greatest asset, our greatest financial assets, I'm putting that in air quotes. Our greatest financial asset is not our investment accounts and the dollars that we build, it's our human capital, it's our ability to work, it's our ability to earn, it's our ability to try to invest in ourselves in ways that get us to higher levels in our jobs, in our career paths and our tracks and what we're doing. As you said, I took that very seriously through my 20s. I was a full-time worker, part-time student throughout. As you mentioned, I've got half a dozen advanced designations for the industry. I picked up two masters degrees along the way. I did all of that very part-time. I literally took the absolute minimum course load that I was allowed to take without being kicked out of the institution, like one or two classes a year, three if I had to because one of the programs I did had a trimester structure. Never more than the class at a time. Which for most of them was like two nights a week and Sunday mornings were my routine. Tuesday and Thursday evenings all my friend just knew, Michael doesn't go out on Tuesday and Thursday evenings because I'm hanging out with my books for a few hours.
Then Sunday mornings, I had a local coffee house where I would just wake up the morning get going, trudge over the coffee house, hang out there for probably the better part of four hours just doing my homework, doing my reading, doing my studying. Just did that as a continuous routine for the better part of about 10 years, maybe nine years of doing that. Cumulatively over time, it pushed out what ultimately was the proverbial alphabet soup of degrees and designations after my name. But what that did for me career-wise was, that's ultimately what launched and vaulted my career. It's what got me promotions, is what got me raises. It's what ultimately led me down the path of discovering, "Oh I actually like learning about this stuff so much I'm actually going to start teaching some others" and opened the door toward writing and speaking. Even though I was a theater minor in college, I was a backstage guy. I was a stage management, lighting design person, never, ever on the stage. The idea to me that I've ended up 15-plus years later with speaking at conferences and being out on the front part of the stage as a part of what I do was never even part of the vision context. I stayed continuously invested in learning, and particularly for the early years.
I'm just a learner reader type, I'm always going to be learning and checking out something. It's just my brain always churning on things. But I was very conscious, particularly my 20s, I'm going to do it. I'm going to be doing a little bit more of a structure context where I get a thing to show for it at the end. Like industry designation, degree. I would have probably done a lot of that reading just because I like reading. But I made sure that I did in a way that would bolster my resume over time. While it was not nearly as linear as I would like, got a designation, got a $3,000 raise at work. Did this program got like a $2,000 bump. It was never quite that clean. But when I zoom out and look back over the span of the first seven or eight years of my career in particular where I was really focused on this, there was just a very steady stair step function of growth of my career, and a lot of the doors that opened were very directly connected to, wow it seems like this guy is really learning stuff and putting in his time, I think that's a person that we want in our organization. I think that's the person we want to give more responsibility in our organization. Just the way I explain it or think about it sometimes is if you're a young person and you've got a couple of thousand dollars and you're trying to figure out what I'm going to do with a few thousand dollars?
I finally saved in $2,000, so I'm trying to figure out what I'm going to do with my $2,000 and the classic recommendation in the business world these days, usually something that effect of put it in a good old fashioned Roth IRA, and I let that thing grow tax-free for the next 40-odd years. If you pull out a calculator and do the math, it's going to add up to tens of thousands of dollars over the better part of 40 years with a moderate growth rate. But then I step back and say, well, what would happen instead if I took the $2,000 and I took some course or program, and I got a $1,000 raise? I didn't even get a $2,000 raise from $2,000 of course I got a $1,000 raise. For most of us, a $1,000 raise though isn't just a $1,000 raise, it's a $1,000 raise. That gives me a little bit of a bump this year than it's next year because that's my base salary than I go change jobs somewhere else, and eventually they always ask what did you make at your old job? I got to tell them a number that's bumped up a little bit because of the raise that I got because of the program that I did. If you are in your 20s and you map that out over just what is an extra thousand dollars of income do when you get to grow that, you get inflation raises on that, you get to take that money and then save and invest that in the future.
What you find is you got 2x, 3x, 4x the wealth creation in the long term by not putting the money into your retirement account, but putting the money into yourself, into something that trains, educates, lifts you up. There is some point where maybe we're far enough along in our career where there's not as much room to lift our careers up as much in that math and that math shifts. I do think there's early you sow the seeds and then eventually you harvest them later in life and later in career. But particularly in the early years, I think we just tend to really underestimate the return and the value we get by reinvesting into ourselves and putting those dollars toward programs that lift us up, that lift our career up, that let us change careers, that let us change industries within our career, but finding a different industry that better rewards the career.
There's a lot that we can do in that direction. But just a lot of the focus these days seems to be, in which accounts can I invest it and get the highest investment return with the best tax treatment? I love nerding out on that stuff. We'll probably talk about it later on. I've done a lot of research about like exactly how to optimize all of those assets and all the different accounts and types and everything that goes with that. But if you're listening and you're in your 20s, even your 30s and possibly if you're in 40s, if you're still pretty energetic about work in the long run, you've got enough time horizon that investing in yourself actually drives a much greater ROI. It really can just come down to $2,000 program, a $1,000 raise a year from now, which feels depressing to get your dollars back. But it really pays in the long run. It really, really pays in the long run.
Robert Brokamp: I'm glad to hear you say that by the way, since I'm working on my masters in personal financial planning. But since you mentioned accounts, let's move into to some questions about accounts. Specifically Roths, they're all the rage these days, everyone's worried about higher tax rates. In fact, they will go up at the end of 2025 unless Congress does something. Do you think all the attention is warranted? Should everyone, even those is in higher tax brackets, at least consider boosting the amounts they have in Roth assets?
Michael Kitces: I've to admit I'm really wary about this, we've cautioned about those. Look, I've been listening to this discussion, particularly in our industry for literally 10 years now. When we got through the financial crisis and the federal reserve did quantitative easing and deficits exploded, all the discussions of time, there were two things that were known truths to happen in the decade of the 2010s. We were going to have outrageous inflation and tax rates were going to go through the roof.
Robert Brokamp: Absolutely.
Michael Kitces: Neither of them happened. Not to try to make the case of people made this investment call I made this other investment call, and frankly, I don't know that we want to open the inflation can of worms for now, but particularly given what's actually maybe finally cropping up. But from the tax policy end, because I'm a more of a tax nerd than an inflation nerd. From the tax policy, and I think there's a few things that we tend to miss in this conversation. The first is, we tend to look a lot at tax brackets and not at nearly as much as effective tax rate. Effective tax rate, just take all of your income divided by all of whatever your tax bill was and that matches together. There were some tax brackets and there were some deductions and there were some exemptions and there's some things that exclude like all of this stuff, mix all of it together. What you find if you look back over decades of tax history, is that brackets are really volatile and effective tax rates are remarkably ludicrously staple, our effective tax rates just aggregate burden of citizens relative to aggregate income has really moved like single-digit percentage points over the past 50 years.
I can count it on one hand, we're not even north of five percentage points of change. Well, back in the 1960s we had these top tax brackets where the big tax relief went from 90 percentage top tax rates down to 70 percent top tax rates. That's often used as a contrast to 37 percent rates now. But the distinction is, well, back then we had huge piles of exemptions. We had huge positive deductions, nobody paid those rates, in fact the big controversial thing in 1966 was Congress did this huge study to analyze how effective these ultra-high tax rates were working, and they found more than 200 people who were making top tax bracket income paying zero dollars in taxes. Sound very familiar, and decided that we had a problem with the tax system and that we needed to change it. The change that they made is the thing that we know today as the alternative minimum tax that was implemented in 1969 in response to this report from 1966.
It was meant to take all of these deductions, and exemptions that were being used by some ultra-high income folks because, they had really high rates. But no one actually paid the really high rates because, we have really high deductions. Much of what's evolved over the past 30 or 40 years since is, we actually got rid of a lot of those, really aggressive deductions and loopholes that existed back in the '50s and '60s, and as we've gotten rid of the deductions and loopholes, we brought the tax brackets down because it was actually basically the same net rate. We just decomplexified the system, and the Tax Reform Act of 1986 under Reagan, was rather famous for that it brought tax brackets way down, but it didn't crash revenue off a cliff, because it also just cut out tons of deductions, and loopholes that existed at the time that we just looped out of existence. There was this view that tax rates must go inevitably higher because they've been higher in the past and just like well, OK but when we raise the brackets, we tend to also raise the deductions, and it doesn't actually necessarily significantly move effective tax rates all that significantly, or more importantly, moves it less than just how much our brackets move at the margin by living our lives.
The point being, if your effective tax rate is 23 percent in the long run, it's going to end up being 25 percent, because we do lift up aggregate taxation a little. But as it exists right now, you're having a low-income year. You can put the money into a Roth at 12, that's probably going to win no matter what, and conversely, if you're sitting up there at 37, and next year you might be down in the 20s, because you just had a high-income year because a bunch of stuff happened. I would just wait, and do my Roth stuff next year when my bracket goes down 13 percentage points because just my life moves. That's actually our lives move brackets much faster than congress actually changes effective rates is the point to it. Navigating what's based on what's going on with us from year-to-year, I think, becomes much stronger as a tax approach to it than saying tax rates must be inevitably higher, no matter where I am or what's going on in any particularly year, I'm just always going to Roth. That's before you get into the whole second branch of taxes must be higher in the future, which is, income taxes is not the only lever that Congress has to pull.
We can change the state taxes, we can change corporate taxes, we can change things that we apply levies to, which was actually what Congress did for most of its history up until the moderate income tax system. We can have a national sales tax, national consumption tax. We're the only developed nations in the world that doesn't have one. We have at the state level where we get our state sales taxes, but not necessarily a federal one. We may end up with a federal version, either a national sales tax or a value-added tax, which is how it's done in most of Europe. The taxation does hit you. It doesn't hit you on your tax return, it hits you at the cash register. If you put a national sales tax or VAT tax in place, everything at the register ends up being a few percentage points more expensive, but that will be true whether you buy it with your traditional dollar or your Roth dollar. They'll just get it by other means. Even if you believe the tax are coming, it doesn't necessarily mean the policy level is going to be, let's jack-up the ordinary income tax brackets on everyone. In fact, it's a particularly unpopular thing to do because it's just very visible.
We don't like our tax brackets. I'm a native Washingtonian. There's a rule that we have around here. Politicians like getting reelected. They tend to do things even that just show better than others. Consumption taxes are less controversial than jacking up income tax bracket significantly. To me, it still comes down to the variability of what happens within our lives gives much more Roth conversion planning or Roth contribution planning than just saying tax rates must be higher in the future, therefore, I'm just going to put all my dollars in a Roth. I'm much more of a fan of focus. Well, let's look year by year. Last year you were out of work for a while because of the pandemic. Cool, let's get Roth dollars in. Your income's lower this year. Let's still your Roth dollars. But you got a great job, and then turns out they have stock option then the next year, this crazy SPAC thing happens, and all of a sudden you have a big income year because your options got liquidated. Time to go 100 percent traditional, and we're going to jam in as much traditional dollars we can, and take a tax deduction at our high tax brackets. Then when I come off my high income year, maybe the next year, I'll do a Roth conversion. I've contributed in a high income year, and then I'll convert it in a subsequent low income year, and the difference in those tax rates is free money that you got.
Much more the individually tactical from year to year or even a couple of years at a time or a decade at a time because our lives move around, we have a lot of clients that we work with where our 60s after work ends, and before social security, and required minimum distributions begin, become an opportunity where we take what could be years or decades of pre-tax dollars that we contributed at high tax rates, and convert them all out at low tax rates, tens or hundreds of thousands of dollars a year, year after year in our 60s when there's no wages, so if we retired, there's no social security yet, there's no required distributions yet, and we can do it at ultra low tax rates. With Roth to me, just think tactical.
Robert Brokamp: I think most people will have at least a taxable brokerage account, and maybe a pre-tax deferred. Then maybe there's following your advisor at low tax year, they got some Roth assets as well. So you have multiple accounts. The next decision is, which eggs am I going to put in which baskets? In other words, which investments should go in which accounts, which in our profession is known as asset location. How do people make those decisions?
Michael Kitces: When you think about asset location, there's really two dimensions to think about. One is the obvious one that tends to come up a lot, how tax efficient is the thing in the first place? I got bonds that already create ordinary income, so I want to put them in my IRA, because it's already ordinary income no matter what. My stocks trading capital gains treatment, that's a favorable tax rate, so I want to put that in my brokerage accounts because I get the favorable tax rate. That's the classic view of it. Line up the tax treatment with the account type. The caveat though is there's really a second factor to it, that I find is often missed, which is, you also actually need to think about just what the overall expected return is, of the thing that you're investing in the first place. The sad reality is getting ultra tax deferred compounding growth on bonds right now just doesn't actually produce much more than having it in your taxable accounts, and getting it whacked every year by Uncle Sam. There's just not enough growth to compound. The yields are just too low.
Would've been different 20 years ago, but there's just not a lot on the table today. The cool thing about compounding is, how much it adds up over time. But if you want to get better compounding returns in a retirement account, you need some compounding. You see some return [laughs] to compound in the first place. I actually think of it on more of a two-dimensional scale. If you envision a little chart X and Y axis, going up on the chart is the return, and going across the chart is the tax efficiency of the thing in the first place. If you graph this out, you get the shape that I call the asset location smile because it's a smile. It's a U-shape. Where on one end are high return investments that are very efficient. Those are still the things I want to put in my brokerage account. An S&P 500 index fund that I'm just going to be sitting on as a core position for the next couple of decades. Great, I'm not turning it over. It's an ETF. It doesn't have internal turnover that kicks out capital gains. The dividend yield is at least even relatively low. I don't love that from a dividend investing perspective from a tax perspective. I like not having a dividend kick-out and crank up my tax obligation. So maybe I'll put that over in my brokerage account. Then I'm going to look over the other, and say, hey, there's also this sector rotation fund that I really like. The manager has a cool strategy. It's got equity-like returns. I'm hoping they'll even generate a little bit more than that. But the thing's got 127 percent turnover ratio because the manager's doing their sector rotation thing, and it's in a mutual fund format, because that's how the manager manages it, which means all those capital gains are going to kick out to me at the end of the year, and that is not good from a tax perspective.
That equity holding, even though it's capital gains treatment, I'm actually going to put that in my IRA because it's going to be fairly high turnover. I can get short-term capital gains. At best, I get long-term capital gains but much of them are kicking out every year. That's very different than my S&P 500 core funds where it's going sit there for decades. That equity position I might put in my IRA. I might also take something like an emerging market and say "I'm just really bullish on emerging markets." This is not an investment call, just an example. Maybe I'm super bullish on emerging markets structurally over the next 20 years, I don't know what's going to happen the next 1, 3 or 5, but I think it's going to be big over the next 20. I'm going to take my highest return investment, and I'm just going to drop that right in my Roth, highest expected return investment. It's going to be a wild roller-coaster ride. We'll see if it works out, but if it does, I think that's the thing that can compound the best for me, and so I'm dropping that over into my Roth account.
Robert Brokamp: Because that's the tax-free account, and that's the one you want to grow the most.
Michael Kitces: Because that's the tax-free account. So I take my highest expected return investments, I tended to open toward Roth. I take my highest return inefficient investments, they start filling my IRA. I take my highest return efficient investments, and I fill my brokerage account. Then basically whatever's left lands where it lands. This is usually how the bonds end up getting placed in this framework. Look in practice, my dollars exist in some combination. I got 50 grand in my Roth, I've got $100,000 in my IRA, and I've got $150,000 in my brokerage account. So I can start placing the things I'm going to pay some high-return things in my Roth, and some high-return efficient stuff in my brokerage account. At some point you will place the things that have high returns are important, and you'll get to the other part of your diversified portfolio that maybe is a little bit less bullish, but we held it in there for some other reasons.
That will just land where it lands. We have clients where their IRA dollars are heavily with bonds because they actually have a lot of IRA dollars, not a lot of brokerage account dollars, and so the brokerage account gobbled up the few high-return efficient investments, and then it ran out of room. We have other clients where all the bonds are in a brokerage account because they don't actually have a lot of IRA dollars, and so whatever IRA dollars we do have, we're capturing the highest return inefficient stuff we can, so we get some better compounding on the few investments that matter the most, and then the bonds land outside. But the key to all that is just thinking, you're not just trying to place by tax efficiency alone. It really starts with what is the overall expected return, and literally mathematically, the part that matters is the highest return investments, whatever you are the most bullish about, the most optimistic about, you think you have the most return potential, placing that in whichever account is best based on how efficient it is, that's what matters first. Then let the rest, which is usually bonds in today's environment, let the rest fall where it may. I'm not trying to pick on bonds at some point, all willing, we'll have higher yields, and higher returns. That balancing point looks a little bit different, but particularly for where we sit right now. You place the high-return stuff first, that's the part that literally matters the most to get the asset location right.
Robert Brokamp: You've written and spoken publicly about sequence of returns risks in retirement, and I think it's also an important consideration for those in the last decade of their careers, since a string of bad years could delay their plans. Depending on how you define terms, some people would say that's not technically sequence of returns risks as maybe like more red zone risk as it's come to me down. Explain what you consider to be sequence of returns risks, and how people close to and in retirement should manage it.
Michael Kitces: To me, the purest aspect of sequence of returns risks is just this recognition that even if market returns average out in the long run to what we're hoping, what we're expecting, we don't necessarily get there in a very favorable pattern. Once you're in retirement and taking withdrawals, you run this risk that I'm taking ongoing distributions, I get a string of bad returns. I'm taking distributions while I'm getting bad returns. Then by the time the good returns finally show up, I've dug myself so much of a hole, that I can't actually recover. I and many others have made all charts and illustrations that show this point that you can get the long-term return you thought and you can still end out running out of money in the meantime, even though you would have made it for your whole retirement with the return that you were supposed to get. Because you got it with a bunch of bad returns at the beginning, good returns at the end, which means you spent down your money in the bad returns at the beginning, and then when you get the good returns at the end, there is no money left or there's not enough left to carry us through.
That leaves us to all these different strategies and ways to defend against this, both in the early years of retirement and as you've noted, really even in the years leading up to retirement, because at least for some of us, the retirement date is a little bit fungible, like I want to retire 62-ish, but hey, if I get a great run-up in the markets and I can get my number a little bit early, I'll retire a little earlier. If I'm getting close to my number and then terrible market stuff happens, I might have to work a year or two longer to get there because markets didn't quite cooperate. We usually have at least a little bit of flexibility around that if we're not just being forced to stop working from a health-related issue. Very true that the sequence starts to crop up not only once we pull the trigger on retirement, but even in the years leading up. The most straightforward way to deal with this, the most basic level is why we don't hold all of our dollars in stocks when we retire, or ideally, even in the final years leading up to retirement. Mathematically in the long run, stocks out return bonds, which means I should have the most wealth and the most spending by just being a hundred percent in stocks all the way throughout my lifetime and straight through retirement.
But sequence of return risk show it doesn't actually work that way, because stocks can still have some really horrific decades. If the decade is too awful, by the time the decade recovers, you have drawn down your portfolio too much to be able to survive, and so we get decades like the 1970s and the 1930s that did this historically, and the 2000s or at least close as well. The most straightforward way that we do this is we just A, we hold a more diversified portfolio. That's part of why we tend to hold stocks and bonds and not just a hundred percent in stocks. But the second way that we can manage this is you actually build a little bit more defensively either in the early years of retirement or even in the years leading up to retirement. I like to call this the bond tent strategy. If you imagine like a graph with your allocation to bonds, what percentage of my portfolio is in bonds. Maybe you start out in 30 or 40 percent in bonds in a traditional 60/40 portfolio. As you are approaching retirement, that 30 or 40 percent allocation of bond starts going up, it starts ramping up and it might ramp up as high as even 60 or 70 percent as you're heading into retirement. Then when you get to the early years of retirement, you're now huddled safely inside of your bond tent, and you start using it. You start drawing disproportionately from your bonds to draw them back down.
Because I don't necessarily want to be really, really heavy in bonds throughout retirement because if I live a long time and particularly if inflation picks up, I don't have enough growth to get me what could be 30 or 40 years with medical advances. I build up this bond tent as a protective layer leading into retirement. I hang out my tent in the early years, first five, 10, 15 years in retirement, I window down my bond, my excess bond holding, my bond tent, my bond protection in those early years, some people think of these as cash buckets or bond buckets. By the time I get 10 years in, I'm now through the danger zone in retirement, basically, one of two things has happened. Markets have been terrible for the first 10 years in my retirement, in which case, it wasn't too bad because I mostly been withdrawing from my bond tent, and now my stocks are just like a coiled spring and much more favorable valuations and ready to grow forward, or market returns have been great. In which case, the amount I had in stocks is probably still giving me more than enough growth to last 30 or 40 years of retirement. It'll just be in a really good bull market carries you pretty far pretty quickly. If you've got a bad sequence, you are in a good position. If you've got a good sequence, you are in a good position.
That's the point. The other way to look at this, and some folks actually know us by the research that I published on this with Wade Pfau, I guess now almost like seven or eight years ago, we had originally written about it more in the context of equities that you dial down equities leading up to retirement in the early years of retirement and then you let them glide back up as you go through retirement, so it get labeled as a rising equity glidepath. I know for some folks feels a little bit weird to think about like, if I'm going to be in retirement, I'm having more equities as I get older. It makes a little bit more sense when we think about it in the bond tent analogy, but it's really just the same thing. It's this idea that when I get to the danger zone, it's not rocket science. When I get to the danger zone, how do I protect it? I put a little bit less money in the danger area. I build up a little bit more bonds as protection, and then I winnow them down through the danger zone, and then I get back to whatever my long-term allocation was going to be in the first place, like we're not spending bonds down to zero and ending out with 100 percent in equities when we're 80 years old, but if we were going to be a 60/40 in the first place, we might start with 40 percent in bonds, it builds up to maybe 60 or 70 percent, and as we get into retirements, then maybe it comes back down to the original 40 percent, or maybe you keep it a little bit higher because you are feeling a little bit more conservative in retirement. But just build up some protection, use the protection you built up, and then move on with your retirement once you've gotten through the sequence risk.
Robert Brokamp: Speaking of retirement, long- time listeners will know that I just love talking about safe withdrawal rates, something you have talked about and written about many times. Let's get your take on this. You mentioned Wade Pfau. We had Wade on the show a couple of months ago. He thinks that safe withdrawal rates should be pretty low in these days of high stock valuations and low interest rates. What's your take?
Michael Kitces: I have to admit I have a lot of trouble with this one in pulling safe withdrawal rates down and much respect to Wade. I mean, we openly politely disagreed around this for a while and we've done joint research together and have gotten to know each other pretty well. Here's the core challenges. I've been a financial advisor for more than 20 years. There's one thing you learn pretty quickly in your career as a financial advisor which is trying to predict markets is a pretty cruel punishing thing. I'm not in the stock investment prognostication business, I'm in the how do we make the most of the dollars that we've got. Tax strategies, retirement strategies, asset location, all the different ways that we can optimize around what we've got. But our market returns are going to be good or bad over the next 1, 3, 5, 7, 10 years I'm always worried about. That being said, I was one of the first people that actually published research back in 2008 that showed pretty clearly safe withdrawal rates are very, very tied to market valuation.
The safe withdrawal rate, if you just look back to the overall historical average like returns the past 150 years and what was the safe withdrawal rate that would've worked on average, it's actually about 6-6.5 percent. Because on average, markets are not terribly valued, they're on average value by definition, being on average. On average, markets are average valued and the average safe withdrawal rate that actually works is about six percent, 6-6.5. Now, the problem with that, if I imagine saying, well, since the average withdrawal rate was six percent I'm going withdraw six percent is like the person who walks through a river that has an average depth of five feet, like you may keep your head above water most of the time, but then you get to the deep part, you drown. Be wary of the averages. If you look back even at the original banking research, that's where this Four Percent Rule safe withdraw rate came from, was this acknowledgment of, well, the average withdrawal rate that would've worked historically is about six percent, but I don't want to do this based on the average because sometimes we get results that are much worse than the average, I want to know how bad it gets. When it's really, really bad.
The whole origin of the Four Percent Rule in the first place was really nothing more than Bill Bengen ran this chart that looks at all of the different withdrawals that would've worked over the better part of 100-plus years of history. What he found was the worst thing we've ever seen, the worst scenario we've ever seen of anything in history, had withdrawal rate of 4.15 percent, which Bill rounded to 4.1, and then the industry rounded to four, and that's where we came out with the Four Percent Rule. The key thing to understand about that is it's not in any way, shape, or form based on average returns. It's based on the worst sequences we've ever had. We published about this a little ways back just to look at how bad those returns actually were. They're pretty horrific. You're talking about retiring in the eve of 1929, right before the crash. You're talking about retiring in the late 1960s for an entire inflationary decade of the 1970s. Now again, because of the sequence rates, it's actually less about what happens in 30 years of retirement, it's mostly about what happens in the first 15 years of retirement. When we look at these historical scenarios, the average real return after inflation that was generated by a balanced portfolio on these scenarios, was a 15-year return of less than one.
Robert Brokamp: By real you mean inflation-adjusted?
Michael Kitces: Inflation-adjusted. Because if you did this in the late 1960s, first 15 years of inflation was five or six percent over, like per year, over 15 years and it got to double digits for some of that. If you did this through the Great Depression, your inflation rate was barely over one because we actually had deflation for much of that time period then little inflation at the end of the 15 years with World War II. But if you look over 15-year time periods, the average real return after inflation on balanced portfolios was less than one percent a year for 15 years. That still got you to the end with a four percent withdrawal rate. That still got you to the end. If you imagine an environment where your portfolio adjusted for inflation over 15 years is not even up 15 percent from where it is now. It's 2036, Social Security already imploded. Your portfolio hasn't gone up more than 15 percent after inflation for that whole 15-year period, that would still survive under a Four Percent Rule. I'm certainly not here to say, it's an ironclad law of nature that it won't fail.
We can have a future that's worse than anything we've ever seen in the past like that. Always have to acknowledge and put that on the table. But I think just the reality of, at best history fades from view. For some of us we just haven't really looked at the history. I think most of us just don't understand how absolutely horrifically, catastrophically bad these time periods were that originated the Four Percent Rule in the first place. You are talking about environments where you couldn't get better than one percent on a rebalanced portfolio for 15 years. If you went through this through the great depression, your equities dropped more than 80 percent in the first three years. Now granted, that's why we have stocks and bonds, so like not whole portfolio, but your stocks fell by more than 80 percent in the first three years and that still survived Four Percent Rule. I understand valuations are bad and you want to talk about 80 percent market declines and four percent still worked. Just recognize how horrific market returns actually would have to be. Truly horrific beyond any stuff, frankly, I'm hearing anyone talk about today to break the Four Percent Rule.
Now, I will certainly give a shout out for Wade and David Blanch and some of the others that have done the research around this and then we published some around this as well. This is a high-valuation, low-yield environment. These are the environments for which the Four Percent Rule was made. This is not like, let's go do the six percent because that's what worked on average. Heck, almost a third of scenarios historically you could take a seven percent withdrawal rate and it worked fine. I wouldn't be talking about that right now as a recommendation. [laughs] We are in the environment that is concerning. But to me that's not a, "Therefore, the Four Percent Rule is broken." To me, it's more of a, "Therefore, this is why we're taking four and not six." When you are going from 6-4, you are cutting 1/3 of your lifetime spending just to protect against bad sequences in the first place. That's a big haircut. But it's in there. We've taken that haircut. That's how we got from 6-4.
Robert Brokamp: Let's move on to the financial advice business and you're a mover and shaker in the profession, co-founding the XY Planning Network among other moves and shakes. What in your view is the current state of the financial services industry and what about it inspire you to form a new network? Did you think that something was broken and needed to be changed?
Michael Kitces: I think our industry is pretty broken in, frankly, [laughs] a couple of different ways. I guess living it as an insider for my career. The biggest one that I think is finally changing. It's frankly a version of what I went through when I started my career writ large. I was hired to be a financial advisor. That's what it said in my business card. I was not, I was a life insurance salesman. I literally refer life insurance company that manufactures its own product and my job was to sell it. Not anybody else's product, not the best life insurance product that was out there, ours. Now, we were taught that ours was the best life insurance product that was out there, so therefore, everybody we met should need it. But I literally wasn't in the business of giving advice, nor did I've any training and education. Like I was a psyche major, theater minor, pre-med student who was told, I should give people advice about their life savings the first day after college and the only advice I had was buy the product that my company sells.
Robert Brokamp: Exactly.
Michael Kitces: I think this is a huge problem writ large across the industry, that I do see slowly and sadly changing. It's why you see so much momentum out there, including and specially in the media around, asking whether your advisor is a fiduciary. Fiduciary is the legal term for, I actually have to act in your interest and product salespeople don't. They represent their products company. Their legal obligation is to sell their company's products. That's what they're supposed to do. I see that shifting in the focus on fiduciary. Consumers recognizing you need to look for RIAs or registered investment advisors who have fiduciary obligations anytime you see registered representative on a business card and an explanation of their broker-dealer affiliation. A broker dealer is an entity that was legally created to facilitate the sale of securities products, of investment products. If you see insurance company, if you see broker-dealer, just almost by definition, these are salespeople and not people in the business of advice. Not that salespeople don't sometimes give some very helpful advice as part of what they do. It also happens to be for sales. But they're literally not there to be your advisor and if you're looking for advice that matters. I've long spent a lot of time at the forefront of trying to push forward the industry actually being advisor, like being what we say on our business card, [laughs] frankly. Just if I look broadly at the industry of how many advisors are out there with all their different affiliations, the truth is, it's only maybe 1/3 of people who say they're financial advisors, who are actually legally advisors.
Robert Brokamp: Interesting.
Michael Kitces: Sadly 2/3 of them are still affiliated with insurance companies or brokerage firms where their legal obligation is to sell their company's products and you're not even their client. You're clients of the product company. The first piece for me is just understanding the difference between the salesperson and an actual advisor. I've taken, they're calling them financial advisors. Just people who are really in the business of advice, not simply those who are advising. The second shift that I think is happening in the industry is, so the good news is, there is this movement from advisor-to-advisor, commissions are getting wound down. Fewer people are representing product companies than they used to. Granted, it's still about 1/3 advisor, 2/3 product, but it used to be 10 percent advisor, 90 percent products. The shift is on. The bad news of that though is the one's that have moved into the advisor end, have mostly moved into one particular business model which is giving advice while managing portfolios and charging the percentage of assets or management fee. I don't think that's necessarily a bad model. In fact, I'm affiliated back to an advisory firm called Buckingham Strategic Wealth and we work with retirees who want to enjoy the retirement and want someone else to worry about the dollars and delegate to us to do that and our fee is a percentage of assets and our management for helping to manage their retirement portfolio and giving them all of the tax advice and the spending advice and the sequence of return risk advice that builds around that. It's a fine model for people who have accumulated some dollars and want some help in how to manage it.
The industry, because of that, the advisor segment in particular, is really focused on retirements these days. Let me say, there are a lot more human beings in the country, [laughs] who have some financial complexity and maybe would like to get some advice and really struggle to do so because so many of the advisors are working on assets or management basis and the conversation usually goes something like this, "I'm 37 years old and I've got a lot of stuff going on in my life. Could I pay you for some financial advice?" They say, "Well, we'd be happy to work with you; $250,000 as a minimum, we'll give you all the investment advice you want." He's like, "I don't have 250,000." Like, "I'm coming to you because I would someday like to have $250,000." [laughs]
Robert Brokamp: Exactly.
Michael Kitces: I don't have that now, that's why I want advice. Some firms are 500,000 or a million or even go up from there. We saw to specifically change this XY Planning Network as our founding mission of focus, which was to put forth the idea that we can make financial planning more accessible by simply structuring as a monthly subscription fee. We have a network now of more than 1,500 advisors across the country who all give financial planning advice on what we call a fee-for-service basis, which means just charging an advice fee for the service of giving advice. Most of them work on a monthly subscription basis. Cost can be anywhere from $100 a month to $200 or $300 a month, some are $500 a month or more because they have very focused expertises deep in certain areas. But all built around the idea that if we want to get some financial advice before we've accumulated all the wealth, that's why we want the advice, the industry has to not only work on an assets or management basis.
It works fine for the people it works for, but it's incredibly exclusionary to all the other folks out there that want financial advice as well, and so we really set out to change that at XY Planning Network or XYPN, as we call it internally, and have really found over the past seven years since we started it, a very rapidly growing movement of advisors who actually really want to serve a wider range of people, particularly those in the 30s, 40s, and 50s. That's usually when we may have some complexity and are willing to pay for some advice, but there's just not accumulated portfolio dollars available to hand to some advisor yet. We really become a network for financial advice for those in their 30s, 40s, and 50s, even some in their 20s that are getting a little bit more complexity and seeking out advice. Nothing wrong with grabbing information on the internet as well, but sometimes life just gets little more complex or time gets a little more compressed. We don't have time to do that. We need to hire an advisor, and that's really the area we're trying to solve for.
Robert Brokamp: We only have a couple of minutes left. I know you have a meeting coming up, but I do want to get one last question. Besides your breadth of knowledge, you're known in the financial planning world for getting an astounding amount of stuff done. Give us your 3-5 productivity tips. How do you get so much accomplished?
Michael Kitces: The biggest thing for me by far is I am pretty brutally focused on having focus, on figuring out just what is the highest and best use of my time, of my working day, supporting the businesses that I'm involved with, supporting the organization I'm involved with. If it's not really the best use of my time, I'm just not going to put it on my calendar. For me, it very heavily starts with a calendar management of what am I even willing to allow in my calendar in the first place and make sure that people don't gobble up my time on my calendar. I put everything on my calendar. I even put the time that I'm supposed to not be doing anything on my calendar like, hey, next Tuesday I'm going to be working on writing an article, I got some retirement research thing that's bouncing around in my head. I want to sit down and put it down on paper. I'll go on my calendar and just block the whole day, like Tuesday, writing day. No other meetings allowed.
Now, I know that I am going to get the writing down on Tuesday that really needs to get done, that I think was really important to get done because I prioritized it. It's a version of the philosophy that at least I had first heard is attributed to Stephen Covey of the rocks pebble sand analogy. You can think of your time as a glass mason jar in front of you, fixed, big, old glass jar. That's the time we've got. We all have the same amount of time from global world leaders to us to normal average folks, we all get the same 24 hours in the day, 168 hours in a week. The only thing that defines the outcomes is what we do with the time that we're given. You can think of the things that we have to do, sitting next the jar in three different types. There were a couple of big rocks, a big physical rock. These are the big things that are really important that move us forward in our lives, in our careers, and whatever it is we're working on, maybe it's a big work project, maybe it's a new initiative, maybe it's a program studying for something I got to go back and do, it's a big thing.
It's going to be a big lift. Beyond that, I have a bunch of things that are pretty important and urgent that I need to deal with. These are like little pebbles. Got to deal with them, can't push them off too much, got a handle. They're not really as big as the big rock but they're out there, I've got to deal with them. Then there's the sand, big pile of sand. Sand is all the little miscellaneous stuff that's constantly throwing through our lives, the one-off questions, the knocks on the door, the hey can I pick your brain for a moment? The unimaginably large flow of email, and social media, and all that stuff. Now, the problem for most of us is the jar fills up with the sand because it just constantly coming out, it's the email, the social media, people knocking on our door, all that stuff. Then we go like, oh my God, there were a few things I was really supposed to get done today. We start picking up those pebbles and we get the pebbles in there and we at least do most of our pebbles.
Then by the time you go back and look at the jar, it's like 90% full with sand and a couple of pebbles on top, and there's this big rock sitting next to the jar and there's no way the big rock is going to get into the jar at this point because there's only a tiny little bit of breathing room left at the top and does not fit the big, old rock. We never get to the big stuff that matters. The idea that Covey had put forth originally, and I very much live this as a philosophy is, if you want to get stuff done, you have to put in the big rocks first. Pour the whole jar back out, dump all the sand and pebbles back out, and take the now completely empty mason jar and put the big old rock in there first. If you just imagine a glass jar with a big rock in it, it's spherical inside the cylinder, it's like there's a bunch of wide space and gaps around it. Great, you've got the rock in there.
Now pour the pebbles in. Now the pebbles are going to bounce around, it will fall into the corners where there was open space around the rock. Now take the sand, pour the sand in. The sand is going to fill every single possible nook and cranny. It's going to find every gap around the big, old rock and all the pebbles that are in there. You go and fill that thing absolutely to the brim. But not all the sand is going to fit in there, because there's always more sand, rock, and pebbles in total than there is room in the jar. But when you put the big rock in first, what you don't get to at the end is some of the sand. By definition, that was the part that mattered the least. That was the part that was OK to get to. What happens in my world? Yes, there's a lot of messages I get on email that I just can't reply to. There's a lot of social media pings that I get, because we do a lot of stuff on social media, and I just can't reply to all of them. I would love to reply to all of them. But if I reply to all of them, I wouldn't get to the big rocks that are actually moving us forward, and I always place the big rocks first.
Robert Brokamp: Got it. Well, Michael, it has been a pleasure speaking with you again. Thanks for coming on the show, and I hope to see you in person again at a conference sometime in the future.
Michael Kitces: Yes. Hopefully, we'll get back in person as pandemic finally leaves.
Robert Brokamp: Yes. Great to see you again.
Michael Kitces: Thank you.
Alison Southwick: That's the show. It's edited ride or dyingly by Rick Engdahl. Our email is [email protected]. For Robert Brokamp. I'm Alison Southwick. Stay Foolish, everybody.
