It was Tuesday, April 15, 2008. Yes, the infamous “tax day.” It was about 11:00 a.m. as I sat outside on the deck of our office speaking with a client. She was there to sign the last tax return that I had to do for the 2008 season. The feeling of relief was very nice. However, the topic of our conversation muted my joy and saddened my spirits. This client had a story that hurt to hear.
They Had Done Everything Like They Should
Her husband had joined a Fortune 500 company right out of school. He worked very hard in their manufacturing operations until he had become a very essential part of the entire operation. He often worked 12-16 hour days. It got to the point where only he and two others had the knowledge and experience necessary to perform certain critical functions in the operation.
Then, out of the blue the company announced that they would be dissolving that area of their business. My client was not quite sure what to do. He was in his mid-forties and was not mentally prepared to start over, even though the company offered to transition him into a new role. He and his wife discussed their options and decided to take an early retirement.
You see, in addition to working very hard in his career my client had done something else right. During the twenty years that he worked for this company he also put a ton of money away into his retirement plan. Now, facing the choice of a new career or retirement, he had $1,200,000 available to help him make that decision. He had done exactly what any good advisor would have told him to do. He saved really well throughout his working life and, because of that, he had options when life changed. And so he retired.
Well . . . Almost Everything
Now, with a very large sum of money in their bank account, they knew that they needed to invest it. Along came a friend that had recently entered the financial industry. He assured them that he could invest their money in a way that they would have a very comfortable retirement. They trusted him and did exactly what he told them to.
Ten Years at a Glance
He told them that they could invest their money in a way that they could earn 12% a year and withdraw 9% to live on. That way their money would continue to grow at the rate of inflation and they would always have enough. They did the calculation and figured out that they could withdraw $108,000 per year, and so they did exactly that.
In 2002 alone their portfolio value dropped by $500,000. However, they continued to pull the same amount of money out of their investments each year. Well, with $500,000 left that meant they were pulling out 20%, then 25%, then 33%, then 50%, then . . .
In 2007 they were out of money. Now, in a panic, she scrambled to start a business and he scrambled to get trained in a new industry and find a job. They held on for dear life to their house and possessions and did everything they could to keep it all together. They were starting over from scratch!
Who’s to Blame?
Probably both are to blame – the advisor and my clients. My clients made two big mistakes. The first was putting their trust in an advisor who, at best, was doing a lousy job for them. In fact, it seems to me that once his commission was earned he wasn’t doing anything at all for them. But I only know one side of the story, so I will withhold that judgment. My clients, when deciding what to do with their entire financial future, should have at least interviewed a few financial planners and gotten second opinions about the advice that they were about to follow. It could very well have saved them from impending ruin. The second big mistake that they made was not paying attention to what was going on in their portfolio. When they saw the value dropping at a very fast rate they should have clued in much sooner and made adjustments before it was too late.
What did the advisor do wrong? First, he never should have planned for them to be able to take out 9% and have their money last – especially with a 40-50 year time horizon for their retirement. There are multiple studies that show that planning to take out more than 5% is a dangerous prospect. Once you cross the 5% line your likelihood of running out af money increases substantially.
Second, in order to try to achieve a 12% return, he had to invest their money way too aggressively for someone in retirement. When invested aggressively there is too great a chance for a substantial downturn and loss of money, which can devastate the portfolio and which, in fact, is what happened.
Last, he should have been monitoring their situation. To have lost half of the value of their portfolio and then to not advise them to take out less money is like seeing someone hanging off a cliff, clinging to a rope, and then cutting the rope. There is no way that the money could last or recover if they continued to pull it out at that rate. He should have been meeting with them at least annually, monitoring the situation and advising them to reduce the amount they pull out if they want it to last.
Significant, Lasting Effects
A good advisor could have kept this from happening, at least if his advice had been followed. Yes, there could have still been ups and downs in the value of their investments, but they would never have run out of money so fast had they received sound advice in the beginning and continued to receive it on a regular basis. I hurt for them, and after talking with them I am certain that they will not make the same mistake again.
* This article is commentary on basic principles. In no way should the things said in the article be construed or interpreted to be advice for your specific situation. Before making any financial decision you should consider all factors and consult with a professional.