014: Finding Your Purpose and the Importance of Fulfillment - with Todd Tresidder *
Todd Tresidder effectively retired at the age of 35 to find a new purpose and to enjoy life day in and day out. He exited the hedge fund management industry to focus on giving impartial advice – unswayed by bias or products to sell – at FinancialMentor.com. There, he has been providing financial education resources, including a number of powerful retirement calculators, since 1998 – well before anyone else was truly in the online financial education space.
Todd has had a long, tough journey to get where he is today. He is rethinking the nature of what retirement truly means and the models we use to determine how much money retirees will need to live comfortably after they quit working their primary jobs. He’s also digging deep into why so many retirees become listless and unhappy when they stop working – and exploring the reasons so few people are thinking seriously about living fulfilled lives.
In this podcast interview, you’ll learn:
- Why Todd exited the hedge fund management industry to become the first person to focus exclusively on unbiased financial education online.
- The reason Todd believes we need to retire the term “retirement” – and why retirees are often in for a shock if they think retirement as we know it is the same thing as vacation.
- The 3 financial models Todd uses to overcome the financial issues that many retirees face.
- Why the traditional retirement model is so unstable over the long-term – and what to do about it.
- The key assumptions about retirement, what makes them often inaccurate, and why several qualified financial planners might offer completely different guidance.
- The importance of fulfillment in everything you do – and why Todd believes that it should be a bigger part of our school and work lives.
- Todd’s basic piece of advice for investors of all ages.
“Entrepreneurship creates the bulk of wealth. Real estate is second. Paper assets is a distant third.” – Todd Tresidder
How Much Money Do I Need to Retire?
Day Job to Dream Job: Practical Steps for Turning Your Passion into a Full-Time Gig
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Casey: Welcome to Retire With Purpose and today we have a very special guest. Todd Tresidder is with us with FinancialMentor.com. Todd’s going to share with us some really insightful advice and I think we really want to start digging into where Todd is today and how we got there. So, Todd, first of all, welcome to the podcast. We’re excited to have you.
Todd: Thanks, Casey. Thanks for having me on the show.
Casey: Well, this is the second time around we've attempted this interview so hopefully, we get rid of our technical difficulties here today and you’re in a lot better shape than our last time we got together.
Todd: Yeah. So, just so people understand what shape means, it’s not physical conditioning. I smashed a mountain bike before our last interview and I've got multiple broken ribs so still in a lot of pain but we’re functioning here so good enough we’re talking on an interview at least.
Casey: Well, Todd. You’re a perfect guest for us today because you’re someone that has effectively retired and found a purpose to continue to enjoy day in and day out. You live life to the fullest. You’re wrecking bikes which might not be most people's idea of living life to the fullest but you're doing the things that you have a passion for and one of those things you have a passion for is the business that you started. After retiring at 35, you got into this coaching program in something called Financial Mentor and I think it's really unique to the financial industry what you're doing. And it's good to offer people the background and what they’re going to hear here because I think one of the neat things that they get here is they get someone with a lot of financial experience, actually, coming from the hedge fund industry and now offering financial guidance and coaching. And I think that's very powerful because you're coming at it in an impartial way where you don't get swayed by commissions and compensation and things that often people get concerned about. So, just offer a little bit of background, how you got where you're at today, and what Financial Mentor is all about.
Todd: Yeah. So, I built my wealth in the hedge fund industry, as you alluded to, and for those that don't know what hedge funds are, they’re skill-based investments. So, the idea is that normally there’s passive investments where you depend upon market return. You know what market does for your returns, market goes up, you make money, market goes down, you lose money. In the hedge fund business, it's a skill-based strategy where you can make money in upmarkets, downmarkets. You can lose money in upmarkets and down markets. It's a function of the skill of the investment advisor. And so, that’s where I cut my teeth. I came on the quantitative side so I was one of the early pioneers of quantitative research so it’s those guys that spend a lot of times at computers, programming, trading systems in the markets. My focus was risk management. I kind of figured out early on that the game is really risk management. There’s a certain amount of opportunity in the markets but it's the game of risk management that determines how much you net over the long term over a full cycle. We can go into that in a little bit if you want but anyway, so my background was hedge fund investing and hedge fund returns. That’s where I built my wealth. I then exited the hedge fund business 1998, a little early.
Right at that point, just to give historical context, the markets were at a higher valuation than they had been even at the Great Depression, prior to the Great Depression, the big decline then. I got very uncomfortable about trying to manage risk for my clients as valuations continue. I was early, I was still learning a lot back then, I didn't have to make decisions I did, but I chose to just exit the industry and I entered real estate so I took the wealth from my hedge fund business, sold that company, and got into real estate. Back then I was buying apartments really cheap and that was before the big run-up in the real estate boom. So, I exited the stock market too early but got into real estate a little too early, but it was still good. That's kind of my hallmark. I tend to be a little early, but generally pretty much accurate. And so, rode the real estate boom until about 2005, 2006. I started getting pretty uncomfortable.
I already had Financial Mentor going. I started Financial Mentor, which is the company we’ll talk about here in 1998 when I sold the hedge fund and that's an education business. We’ll talk about why I did it. So, I had Financial Mentor going the same time as I was building the real estate portfolio, had a pretty substantial real estate portfolio, got really uncomfortable starting about 2005, again a little early. It took a while to unwind and I had apartment buildings, large apartment buildings, commercial structures. It takes a lot to sell that stuff. You don't just turn around and sell it by clicking your mouse on the screen like stocks and bonds. I was completely out by the end of 2006. It sold everything right before the big decline in real estate. The only thing I owned was my house when the big decline finally came and that's when I chose to really focus on Financial Mentor. Up until about 2008 or so, Financial Mentor had been kind of a sideline passion project. I'd always had this idea of a financial education company that’s separate from investment product sales business. So, most people get their investment education, their financial education through biased resources or unqualified resources so that could be parents, family, things like that, or it could be from your broker, your advisor, people who have a vested interest in certain types of investments and I wanted to provide just a pure education model in the Internet.
The advent and growth of the Internet gave a basis for developing a wholly different business model based entirely on education and educational product sales as opposed to investment product sales. And so, the founding basis of Financial Mentor was to get unbiased education out there and it's been a long road. It's been a really tough road building it. I fumbled around with it a lot until I sold the real estate. When I sold the real estate, it was really as much about getting out of real estate as it was me committing to the financial education business. It was about me saying, "You know what, I'm not okay going to my deathbed,” as you could tell I'm older if you were looking at the video part of this interview. I'm not okay going to my deathbed without getting this stuff out of me. I had figured out my clients, the people that follow me say that my viewpoint is quite a bit different from the traditional model and it works, and I kind of figured something different out and I need to put it in a form that people could consume at a cost-efficient price point and make a business out of it. So, that's what I've been doing ever since.
Casey: That's awesome. That's great value that people can get through a coaching program with an impartial resource and that's one of the reasons I really enjoyed your book, which we’re going to get to in just a moment, which was titled: How Much Money Do I Need to Retire? and I think that's one of the biggest questions people have and there’s a 60-minute financial solution. You put different ones of these out and being that we are a retirement planning show, I think it makes a lot of sense for us to answer the biggest question that most people have and I think there are probably some folks that are going to be listening to this going, "Well, Todd retired at 35 years old but he was in the hedge fund business. He was making all kinds of money. The average person can't just retire at 35. That's just impossible for most people.” I think that's how most people feel today and do you think that what you did as far as kind of pseudo-retiring at age 35, do you think that other people can accomplish that that early in life if they don't have exceedingly just really large incomes?
Todd: So, first of all, the criticism would be valid, okay. So, the fatter your income, the easier it is to do because you think about it. It takes a certain amount to live a comfortable lifestyle and so if you have huge income above that, it's very easy to save a high percentage of your income and not suffer on lifestyle. And so, if your income is much lower, let’s say your schoolteacher is an example, and it takes most your income just to support your living needs, it’s much harder to save a high percentage of that income. And so, from a savings-based model, that criticism would be valid. However, in the end, the criticism is not valid at all and the reason for that is a lot of people who are "retiring early”, achieving some level of financial independence at an early age, 35. I was kind of an early pioneer in the field, but there's a lot of people doing it now. There’s a whole movement out on the Internet called the FIRE movement. Fire is an acronym for Financial Independence Retire Early and there's a lot of people pursuing these goals and they’re succeeding. So, it's to say that, "Oh, only Todd could do it because he had a fat income,” first of all, the criticism is valid because the fat income makes it easier but the criticism itself is fundamentally invalid because there's a ton of people doing it.
You just have to have the right model. You have to prioritize it as the goal. In other words, you're not going to save 50%, 60%, 70%, 80% of your income. I mean, like I was saving 70%, 80% of my income, which was easy because the income was big but there are people saving that on much smaller incomes too and the difference is they’re just very dedicated. It's a priority for them, they want to achieve the goal, and they managed their entire financial lives and their personal lives to achieve that objective. So, it is achievable, but it's not easy. It takes commitment. You got to be determined to do it, you got to have a smart strategy, and you have to apply it relentlessly to get the goal.
Casey: Well, and you didn't retire in a traditional sense, which, as you alluded to, that is something that’s kind of evolving. Retirement still is a relatively new concept and today we've got folks that are thinking about retirement completely different. We’re working with people that are 50, 65 years old and they're stepping in retirement going, “I don't just want to sit on the back porch. I don’t want to just move to Florida and relax for the rest of my life or watch TV on the couch for the rest of my life. I really want to start something new and live a fulfilling life, a filling purpose,” and that's what you really did as I think what Kary Oberbrunner had talked about in one of our past podcast, one of our initial podcast where he wrote a book called Day Job to Dream Job and that's really what I see you doing here. You didn't just hang it up in and sit back and relax. You went from a day job that maybe you didn't really enjoy and maybe I got that wrong but you can tell us that and then you started more of a cash flow business I guess I could call it and the things that you really enjoyed. What did that look like? How did you retire at 35?
Todd: I’ve loved all the work I've done at the times I've done it so like when I was in the hedge fund business, I was absolutely fascinated with figuring out how to build models around the markets. For me, it was about building a cash flow machine, an investment return machine, because again I was building quantitative-based models and I was fascinated with the subject just as I’m fascinated with the business I'm in now, which is about building cash flow off Internet-based business models and about educating people and about driving value through those models and how you do it and still have a viable business. So, I've always been fascinated with what I'm doing. The difference I think is the key point you're driving toward here, Casey, is that I can do it based on fulfillment. In other words, if Financial Mentor had to support me, it would've died long ago. I worked on Financial Mentor for years and years and years before it ever paid the bills. It was a long road to success. This was a fairly unproven model at the time.
I was the first financial coach on the Internet, legitimate financial coach on the internet, the first one. I was the one that pioneered that whole subject. Back, this is before the days of Google, you have AltaVista and all that. When you’d search “financial coach” back when I had Financial Mentor, I was running a full-time coaching business, there was like eight or nine returns for the term “financial coach” and all but me were financial advisors using the euphemism of financial coach. They were trying to reposition themselves away from financial advisory profession because it's basically second only to attorneys for reputation. It's not a well-loved profession so people are always trying to repackage themselves like, “Oh, I’m a financial coach instead,” whereas I legitimately pioneered it as an education business operating on the education exemption within the financial advisory laws, which strictly governs what you can and cannot do as a coach. So, anyway, and I talk more about that on the website. I have a whole section explaining the difference between financial coaching and financial advice.
So, I’ve always loved what I do but the key is I do it because that's what I want to do and, yeah, I try to build smart business models but that isn't necessarily the fully driving force and that's what you're getting at like this business now is about fulfillment. And I think that’s one of the big miss in retirement is people think it's about the pro-leisure circuit like when you're working a day, working your butt off, and life's hard, and you get two weeks of vacation, you think that retirement is like this endless vacation like you’re just going to hang it up for a lifetime and it's going to be like that two-week break and it's not. You know, that's why people when they retire within about six months that honeymoon period, six months to a year, suddenly it gets old and they get listless and they don't know what to do, and they want to take on different responsibilities and stuff. And so, people will say, "Well, Todd, you’re building a business and you're not retired,” and the answer is that's true depending on how you define retirement. I think retirement is just a misnomer. We need to retire that term. What it is, is there's really, in traditional models, there are four stages to life. There’s birth, school, work, death, right? You're born, you go to school, you develop a career, you work, and then eventually you die.
And so, what I'm trying to do is I'm trying to develop a model here, pursue a model where you insert fulfillment and so you still go through birth, school, and work because you have to go through birth and then school to develop your knowledge and then work a career to get your financial base underneath you. Once you have your financial base then I advocate pursuing fulfillment as a career choice where it’s not driven as much by monies. You still have to be financially responsible, but because you've already developed your base, you’ve got your home, you've got your cars, you got your basic assets, you got your basic consumer items, control your spending and focus on the fulfillment of your life and how your career contributes to that fulfillment as that next stage of life. And what that does is that radically changes the math of retirement because now your money doesn't - your money has many, many more years to compound while you're in that fulfillment stage and has far fewer years where it has to pay the bills in those final years before you decline into old age and dependence. And so, it's a completely different model. It has different math. It requires far less assets and that you can hit it much faster and you can spend many more years in a fulfilling lifestyle.
Casey: What I think what you hit on there is something that I'm really passionate about. You found yourself at 35 and you set yourself up in such a way that you could have financial independence so that you could take some risks that you wouldn't have been able to take otherwise. It enables you to take some risk with your business and live this fulfilling life. I always ask at our live events one question in all our podcast, which is, "If you could take one word and define retirement, what does that mean to you?” And I had a room of 60 individuals that were together here last night and when I asked that question, immediately that there is a gal over to my right that said, "Death,” and you know what a sad outlook on what retirement is all about. I think you’re really trying to turn that around.
Todd: Yeah. The word retirement, to me, retirement is just euphemism for old age financial independence and so what we really want to do is get rid of the old age and say let’s pursue financial independence at any age and the sooner the earlier. And there are different models you can adopt in order to do that so you can pursue a lifestyle model. So, basically in the book that you're referring to, I provide three models, one of which is the lifestyle model I was referring to, where you can reshape your lifestyle to change your numbers, which then changes your ability to “retire” or at least pursue fulfillment as a priority in your life and then another one is a cash flow-based model and another one is the traditional model, which is the asset accumulation followed by amortization of those assets. Now, none of the models are necessarily better or worse than another. What they're all doing is they’re providing different perspectives on the same puzzle. So, there’s not a right, wrong answer here. There are just different perspectives based on what you want and what fits your life and your needs.
Casey: Well, I think what you said there really illustrates your unbiased approach to retirement planning where that seems most advisors or most brokers or most financial educators for that matter say what everybody needs to be doing this and that’s just not the case because we all have our own investor DNA if you will and our own retirement DNA, which is also going to lead us down a different path and so…
Todd: I’m going to jump in for a sec, Casey.
Todd: That’s a word that’s getting used on my teaching more, more, more now is nuance. In other words, I'm bringing nuance to the discussion where normally this discussion is polarized. It's black and white, like, “Oh, you're supposed to have 80% of your income before your retirement,” these black-and-white things. Now, I’m coming back and I’ve worked with a lot of clients. I coached for over a decade, one-on-one, and the thing about coaching one-on-one is that your stuff has to work. People aren’t going to pay you month in and month out a bill to work with them unless they’re getting value. And so, it has to work and it has to work for everybody that comes to you. You can't just drop these platitudes and think that people are going to keep coming back for more. It has to deliver value. And so, I've developed a very nuanced approach recognizing there's a lot of subtleties to this. There’s many different life situations, there’s many different needs, and there’s three asset classes to work with. And if you think you're just going to lay down rules of thumb and it's going to work, it’s naïve.
Casey: Yeah. Well, let's get to some of those models and I think we can start by talking a little bit about the model you used to overcome some of the most common concerns that retirees have, and for most people, I mean, they’ve done study after study and they always find, well, the number one concern about retirees over death is running out of money and that equation largely comes on life expectancy. If we know exactly when we’re going to die, then we know exactly how much money we need for retirement and the equation becomes very simple. And so, finding financial independence at 35 you go, “Boy, I could live to 100. I could live to, heck, I could live to 110,” and with that being a reality and a difficult thing for you to predict let alone at 55 or 60, but at 35, how did you overcome that risk of running out of money or really determining your life expectancy as part of the financial equation?
Todd: Yeah. So, let's get clear on the problem first. Okay. The problem is in the traditional model, traditional model was never designed for retirements that run 30+ years. The traditional model when it was set up, Social Security was set up the average life expectancy was 65. Gee, what a surprise. Retirement age was 65. It was a neutral model. There’s supposed workers compensating for those that survive beyond. That’s why the age was set at 65. That was life expectancy. And so, now life expectancy has grown where one spouse of a couple at 65, depending on the study you look at, you could get a life projection of at least one of the spouses making it to 95. Sometimes it's less, some people say 92, and those numbers are growing every year. And so, you're looking at 30+ your retirement. Since the traditional model was never designed to accommodate that then you take somebody like me who’s trying to “be financially independent or retire at 35” and you're looking at a projection which makes the model completely unstable. So, that's the key point I want to drive home is the traditional model is unstable for long periods of time. It's perfectly acceptable for 20-year retirements or lower. And so, like I’ve worked with clients where they're in their 70s and they've got numbers in the 20 years or less for life projection and I’ll say, "Gosh, the traditional model is fine. Let's keep it simple.”
Casey: What would you define as a traditional model just for our listeners?
Todd: The traditional model is what you hear everywhere where it's I'm going to build this diversified pool of paper assets, stocks, bonds, mutual funds, ETFs. You build this diversified pool of assets, you acquire it, you grow the amount of assets, and then you hit this magical day of retirement, and then you begin the amortization equation which anybody who's had a mortgage is familiar with. You start spending down those assets. And there's a variety of rules for that. You got the 4% rule is the most common as guidelines for how you can spend down those assets and try not to run out of money. And so, that's a traditional model. It’s an asset accumulation, asset amortization model where you build the mountain and then you amortize the amount of assets and then there are alternative models that I teach like the lifestyle model and the cash flow-based model. The problem with the traditional model or an amortization-based model is its unstable over longer periods of time. Now, that's going to be intuitive to most people, when they think of their mortgage.
When you have a 30-year mortgage, those first payments, the amount that goes to principal is very, very tiny. And so, it’s the same thing when you're trying to retire and you’ve got a time horizon of 30 plus years. The amount you can amortize from the assets is so tiny that it's just not a stable equation because if you get it just slightly wrong in any of the variables that go into that equation, which include, and we’ll go into them probably in this discussion, things like inflation, investment rate of return, life expectancy, cost of living, all these things that you're going to go through that’s part of this model, any slight variation can completely overturn the model. It can make you need two, three, four times as much money or half or a quarter as much money as you thought depending on how you vary the assumptions and so it's completely unstable. And so, intuitively, most people get that. My experience in working with people who spent some time developing their financial knowledge, you can always tell because they're pretty uncomfortable with the traditional model. They get that it’s unstable, fundamentally unstable.
I was shocked when I started when I sold the hedge fund and I was trying to pursue a traditional retirement because I was making a lot of mistakes like everybody else. I mean, I didn’t know at the time. And so, I started looking at traditional retirement plan and I went, “Oh my gosh. I mean, if this is the rocket science of the industry, is this the best the industry can do?” I mean, I had spent 12 years developing trading systems, so I understood what created a stable model versus what created an unstable model and I looked at all the dependencies in the model. I went, “No way. There has to be a better way,” and that's ultimately what resulted in that book.
Casey: And the method, just expound a little bit on the method that you've utilized in order for you to eliminate some of these concerns of inflation and life expectancy and things like that.
Todd: Well, the no-brainer model, but it's a harder one to achieve but it's extremely stable as a cash flow-based model. And it's fundamentally different, right? So, in a traditional model, you're trying to grow a pile of assets so your focus is growth, whereas in a cash flow-based model what you’re trying to do is grow a pile of cash flow and so you're focusing on the cash flow of the assets as opposed to the growth rate of the assets and that's fundamentally different and that opens up different asset classes as a priority. So, typically, once people start to focus on cash flow, they start looking at independently-owned real estate or directly-owned real estate, or they’re looking at business entrepreneurship. Now, there are reasons those two asset classes start bubbling to the top. They have both leverage and tax advantages and they lend themselves towards converting towards cash flow much better than a traditional paper asset portfolio. They produce higher yields of cash flow for any given equity level.
And so, it sounds like it's a little subtlety. It sounds like, oh cashflow base model, okay, so cash flow base model is defined as your passive income from your assets exceeds your spending level in retirement. When you do that, you're infinitely wealthy. And so, that would be the definition of it and you think, “Well, that's not a big deal. I could have dividend paying stocks and still use a paper asset portfolio and achieve it,” and that would be correct. But when you really start digging behind, get under the covers if you will, look under the hood, you start looking at things a little bit more differently and you start realizing the traditional paper assets are not a priority and they play a different role in a plan based on cash flow.
Casey: And I think Harvard did a study here not that long ago that talked about this generation of retirees have been focused on accumulating assets for so long, decades and decades just focusing on that top line number, my averaging 7% or 10% or 5% or 6%, and then getting to retirements saying, "Well, I've made 7% a year for the last 30 years and if I only need 4% income that should be perfect perfectly fine,” this is a big risk because they're focusing on investment return, return on the asset, not return of the asset, or cash flow, which puts a different focus on the things you talked about whether that's businesses or real estate or annuities or dividend equities, places that can generate income or yield on a regular basis, rather than just return on investment. Does that make sense?
Todd: Yeah. It makes sense and there’s also a huge thing in there that we’ve got to drop in this conversation, which is sequence of returns risk. So, you can have an average return like you’re quoting of 7% or 8% but you can’t spend anywhere near that. That was actually a mistake that it’s so common before the Trinity study. It was Peter Lynch, no less, made the same mistake. He was saying, “Well, stock returned 7%, 8%. You can spend 7%, 8% in retirement,” and it's just not true. And that's because the sequence returns risk there’s a volatility effect in the portfolio that lowers the amount you can spend relative to the average return of the portfolio. And so, this is well documented. Anybody can look it up on the Internet, sequence of returns risk, and study the issue. And that's one of the reasons why alternative assets and different strategies can be applied so effectively is because when you bring them in, you diversify at a fundamental level and it affects the sequence of returns risk favorably.
So, for example, let's make it specific since I’m kind of talking in theory here. Let's say you have an apartment building and it throws off $10,000 a month in excess cash flow, you know, rents exceed expenses and mortgage payments, and so you’ve got $10,000 a month coming out. Let's say you spend $10,000 a month. That's a very different situation and you've got a paper asset portfolio behind that. When you hit a drawdown period in a negative performance period for your portfolio, the nice thing is you don't have to draw down those assets through spending because you’ve got cash flow from your other assets. In addition, the real estate won't necessarily correlate with the stock market. It did in the 2008/2009 decline but that was unusual. Usually, real estate won’t correlate directly with the stock market and decline. That was because the real estate was to try averting the decline in 2008/2009. And so, when you diversify fundamentally by asset, by asset type, and source of return, you can stabilize your sequence of returns risk and so you’re diversifying at a fundamental level, and that completely changes what you can spend out of your portfolio and how stable and safe your portfolio is.
Casey: Well, let me get this right. I don't hear you necessarily advocating that all of your income should come from real estate. Let’s just convert your IRAs and other piece of these assets and to update an apartment building that's going to kick at 10,000 a month and take care of all your needs because we know that's still not guaranteed. We don't know that that income is going to be there forever and I think this brings us to a concept that you touched on in your book, which was called the three buckets of risk. Would that be applicable to the discussion here?
Todd: Yeah. So, buckets of risk is a strategy where it's applicable but slightly different. Okay. So, let's back up and so let me address what you're saying and then we’ll go to buckets risk. I would never bet my financial security on any one asset class or any one strategy no matter how good or how much history you have with it. So, to me, people that are investing in passive index funds and they think they’re going to retire off passive index funds, I wouldn't do it any more than I would be willing to take the opposite side and say, “I’m going to retire just off of a real estate portfolio,” or there's people who retire just off their business income. I think that each one has its own risk profile and its unique and what you want to do is diversify those risk profile so they never overlap and that's the objective. Is it easy to do? No, it takes some effort, but you don't ever want to constitute your risk in one specific risk profile. That's too dangerous. Because the reality is eventually it’s going to come home to bite you. I mean, risk always comes home to bite you at some point. It's just, you know, it's a question of when, not if. And so, you’ve got to have the other strategies and asset classes in place for when that occurs to stabilize things. So, do you want me to go into buckets of risk now?
Casey: Yeah, sure. I think that is very affable, right, having different buckets of risk for different types of expenses, right?
Todd: Yeah. So, the idea in buckets of risk is nuanced from that though and the idea is that you have different expense priorities. Okay. So, there are certain spending you have to do just to support your lifestyle like if you own your home outright, you still have to buy food and you’ve got to pay for insurance and pay for health bills and whatever. If you own your home, you still got your mortgage payment. There are certain expenses you’re going to incur that you’re just not all that flexible on. And so, that's that lowest bucket of risk. You can take the least risk with that. And so, that's where like when I’ve worked with clients on building the wealth plans, you want to start developing basis of cash flow that covered those primary expenses that you've got to incur. You’re going to incur them every month, you’ve got to be able to support them, and then you’ve got a different class of expenses, that second bucket, and those different class of expenses or things that are optional like travel, getting a new car, going out to dinner. These are what we’ll call luxuries. They’re not necessities. You can kick the can down the road on those if you hit hard times. So, let's say you get your two, three, four years of adversity in the markets and you get a really bad bear market. You don’t have to keep spending down that portfolio at the same rate. You can pull back on your spending, and most people do naturally. They naturally do that as the assets decline.
And so, that's the buckets of risk model and so what you do is you try to isolate the lowest risk assets and identify causal-based assets that can support that primary need for spending. So, for some people, I've had clients where they had extremely lucrative, your company offered very lucrative conversions from 401(k) assets into annuities. Unusual. I mean, I can think of some companies out in California that were doing that and the numbers were unusual as I said. And so, it made sense to convert a certain amount of their plan or wealth plan over to those annuities that supported that primary bucket of risk and that changed their plan entirely. I had clients that they’ve lived in the high return real estate areas, Texas, places that are better cash flow for what you spend for the real estate as contrasted with premium markets like New York, California. And those clients who found that they can convert a lot of their paper assets into capital producing real estate and they’ll get a higher yield that’s more stable and they can do that for that lower bucket of risk, that primary spending need. And so, what they’ll do is they’ll buy real estate like an inflation adjusting bond.
So, they might buy, let's say, two fourplexes so let’s just make up some theoretical numbers. Let's say they spend $6,000 month and so they have these apartments that rent for a thousand a month so let’s say they buy two fourplexes and they own them free and clear, $8,000 a month net of taxes, insurance, and expenses. Maybe they’re netting $6,000 a month on the rental on that. That supports their base level spending and then their paper assets are optional and they’re trying to compound those in the background. So, that’s an example of buckets risk. You can use it with annuities. You can use it with fully paid for real estate. You can do a lot of different things with it to make it work.
Casey: Well, I really like where we’re headed with that because that is something we talk about all the time on our show and in our book says, “Paychecks versus play checks,” is how we have defined that. So, we have these paychecks. We have to have this payment every single month that cover our basic expenses. We can't live without them. We have these other needs, these play checks. Those other buckets of risk and we can cover those paychecks with more secure income sources be that annuities or pension, Social Securities, and then we can get into those play checks and provide it let’s say real estate income or dividend equities and more at risk, cash flow, income sources. So, I really like what you said there but I have to make sure we get to something that I found to be really interesting in the bucket and I think can provide a lot of value to the listeners and that is really diving deeper into this traditional retirement planning. Because as our listeners are going around, they’re shopping and meeting with different financial advisors, they’re running into this traditional retirement planning model that typically uses some type of financial calculator. And you tear apart financial calculators in your book and I love it.
Because we just had a couple the other day that had come in to our office for a first visit and we had gathered information, we put together a plan, we got together a second time and they said, "Well, you guys told us that we’re not going to be able to retire right now. You want us to postpone a retirement for a couple years because you think it's too risky.” The other guy we met with just the other day, he said that we’re going to be able to retire and we should just go ahead and step into retirement. So, we’re going to go work with him because he told us we could retire and you didn't. I think that exhibits a real problem with the retirement calculator.
Todd: Yeah. So, the retirement calculation is always accurate as the assumptions that are put into it and so, return to calculus, first of all, let’s kind of get a balanced perspective on them. I mean, I have a retirement calculator. It’s one of the most popular on the Internet. It's called the ultimate retirement calculator. Pretentiously named but for good reason.
Casey: I've used it. It is good.
Todd: Thanks. Yeah. It was designed specifically for working with my coaching clients. It’s free on the Internet. You can link to it in the show notes. I don't make anything off it. I don’t do advertising revenue on it so it's just a service but I did it because nobody else had one design the way I wanted it designed for how I work with because I do scenario analysis with clients. I try to create bands of confidence intervals based on scenario analysis. We also plot different asset mixes to see how it affects because people are often shocked once they start playing with cash flow versus amortization-based models. They don't realize how easy it is to do on a cash flow basis. And so, I developed this model for - I developed the calculator for easy modeling. But to get to your question, the problem with return of calculators as they are traditionally used which is what you're getting at here is they are dependent upon assumptions. There’s a variety of assumptions so let's kind of go through a few key ones and understand why they're so unstable and why there’s such a problem here and why you can get two qualified financial planners giving completely different results.
The first assumption is life expectancy, which we touched on earlier. Your assets have to support a certain amount of life expectancy. Now, the traditional approach is they’ll take an average life expectancy from IRS tables or insurance tables, and such a model works for IRS or insurance. It does not work for an individual. There is no statistically valid life expectancy for a sample size of one which is what you have and what I have and what everybody listening has. We are all sample sizes of one and I could die today, hope not, but I could or I could live for another 30 years, 40 years, who knows? Depends on how things go. Excuse me. Scratchy throat. Let me clear again. So, anyway, that means on life expectancy you have to bet on a very long one because the alternative is to risk running out of money and so that puts you in a position of being your own actuary and the unfortunate reality is you have to defer to risk management. You have to choose a very long life expectancy. Other people will choose an average that will change your numbers considerably. Now, let’s go to two key numbers. There's a couple of key numbers that will affect your retirement planning. One is your savings rate as a percent of your income. Your savings rate as a percent of your income is your single most important factor in the early stages of retirement planning so I call this the life cycle of wealth.
In the early stages of the lifecycle of wealth, the most important thing is your savings rate as a percent of your income. That's the biggest determinant to your overall wealth in your lifetime. In the later stages, it’s your return on investment, net of inflation. So, let's look at this those two numbers, return on investment, net of inflation because ultimately that'll determine your entire outcome. Your return on investment is an assumption that people just throw in there. They have no idea how to estimate it accurately. And so, they’ll typically choose long-term returns from the stock market. They’ll say, "Hey, the stock markets return 8%. I’ll throw that down as an average return,” or they’ll make an equally bad mistake but it’s a different mistake, but it's equally as dangerous and they’ll choose Monte Carlo-based assumptions where there’ll be randomization of returns or they’ll take historical returns and run scenario analysis using actual historical returns.
Casey: The Monte Carlo, that was a casino, right?
Todd: Well, Monte Carlo is a sampling algorithm that use - it’s just the name for it, right?
Casey: It’s kind of funny that it is the same name as one of the most famous casinos in the world.
Casey: And we’re going to base our whole retirement success on this.
Todd: Well, we can laugh but it's state-of-the-art retirement planning today is they’ll use Monte Carlo algorithms. They’ll put them in and they think they're doing something smart but the problem is investment returns are not random despite all the research that shows it. There's a definite relationship between sequence of returns risk and your expected return as correlated with the starting valuation at the beginning of your holding period. So, if you look at market valuations and interest rates at the beginning of the holding period, it’ll give you a better understanding of what your expected return is over 10 to 15 years. Now, that's a key number, 10 to 15 years, because 10 to 15 years is all you really have and this is…
Casey: Well, what you're getting into here is something you called the investment returns triangle, I believe, which is ultimately a tool to help us figure out which return number we should really be using, which is one of the most important numbers we can plug into these retirement calculators.
Todd: Bingo. So, investment return and inflation so let's, first of all, let’s recognize it. Nobody knows their investment return. You're sitting here plugging numbers into a retirement calculator and you're supposed to assume an investment return over the next 30, 40, 50 years depending on what age you are when you're doing this calculation. Good luck. I mean, nobody can guesstimate their investment return for next year. Not to mention over the next 30, 40, 50 years. If you think you can just throw an average number and you are wrong because I go into this in a second if you want to prompt me later on, which is you’re really dealing with a series of 15-year returns. You're not dealing with the 30-year return and I’ll explain why in a little bit. And so, the other big number is your inflation rate. Your inflation rate, you're putting in there. Most people just take a historical inflation rate again, right, because what else are they going to do? There’s no other real answer and so they’ll take like 3% because that's a long-term struggle return. There are huge differences in inflation rates both internationally as well as domestically. We had I forget what the number is for in the 60s and 70s, but it was higher. It was like what, 7% or 8% or something at one point inflation rate. People can go figure it out. Look it up. I don't have it off the top of my head, but it’s much higher and there's inflation rates that are negative. We had deflation at periods of time. So, people throwing this long-term projection of inflation rate as if we can realistically expect that the past is going to be the future. The past is not the future. The government finances are radically different now than they were when that 3% inflation rate was created.
Here's the funny thing though. That's a key number, your investment return net of inflation. Not only can you not get either side accurately but it's the net of the two that determines your financial outcome in life. And so, if you think you’re going to get it accurate within one or two percentage points, you're not. If you do it, it's just pure luck. It's like throwing a dart. And so, what will happen is that number compounds. That's why it’s a key number. It's a compounded number. It compounds over time within the calculator. That's why it produces such a huge difference in results and that's why it's key number in the calculation.
Casey: So, expand a little bit on this investment returns triangle. I found it to be a really interesting topic because I think everybody as they’re stepping into retirement they’re going, “Well, what's an appropriate number?” and today it's really being called into question if we can still use these historical rates as investment returns year-over-year. If we look at long-term averages versus last, say, 10, 15, 20 years, they have been falling. So, what's the right number? And how do you arrive at it? I found your method there to be really interesting and maybe you can cover those 15-year returns and why we should be focusing on that there.
Todd: Yeah. So, what happens is 30-year returns do revert to the mean, which is kind of technical terminology for you do get average returns running out towards 7%, 8% depending on exactly how you crunch numbers where they include dividends, net inflation, all the different stuff. So, the numbers that are often quoted are not wrong. What happens is they’re measured over multiple market cycles to get that average return. The reason those exist is simple, your long-term return from holding stocks is dividends plus economic growth plus or minus change in market valuation. Now, dividends are determined at the point that you begin your investment holding period because you’re going to invest at whatever dividend level you've got and then growth is surprisingly relatively constant. I'm using growth loosely. It could be defined growth and economic growth, growth in corporate earnings. They’re all correlated. If you look at the research, they’re all correlated. So, I just loosely use the term economic growth but all those numbers are correlated and they come up pretty close and they’re remarkably stable over time. So, we’ll treat growth as a constant. Even through up-and-down markets, it’s remarkably stable.
And so, the big thing, the tail that wags the dog is the plus or minus change in market valuations. Well, plus or minus change in market valuations is what causes all the short-term volatility and investment returns. That's why you can be up 50% one year and down 50% another year, up 30 or down 10 or up 20. You get this long-term return, but the number of years that you get a return is actually close to long-term return is very small. Usually, you’re way higher or way lower and the long-term return is an average of all this volatility that you get in stock market returns. And so, what's funny though, what's interesting is that valuation is highly correlated. Not a predictor. Okay. There's not cause-and-effect but there is a reason why it works. Valuation is highly correlated with your 7 to 15-year expected return from the stock market just as interest rates are highly correlated with your expected return from bonds. Okay. Because ultimately, all you get is bonds as long as you hold them to maturity. All you get is the interest rate on the bond or the coupon.
And so, those two factors can pretty much tell you what your investment return would be for 7 to 15-year time horizons. Now, as it turns out, that's good enough and the reason it's good enough is because all you really have in life is a series of 7 to 15-year time horizons because that's where the sequence of risk, sequence of returns risk kicks into play is because when in retirement planning, the key factors are the final 10 years before retirement and the first 10 years after retirement.
Casey: Also known as the retirement red zone.
Todd: Yeah. And so, what you've got is a series of these 7 to 15-year time horizons before retirement and after retirement that ultimately determine, that before retirement determines how many assets you’ll have, what your mountain will accumulate to, and your 7 to 15 years after retirement determines what is the spending rate you can spend from that asset mountain. So, you don't have a 30-year time horizon. You cannot average it. You've got a series of 7 to 15-year numbers. Does that make sense?
Casey: Well, I can hear our listener right now sitting there, driving down the road going, "Boy, he seems to know what's going to happen,” so I’m going to have to ask you the question that everybody's thinking right now which is, “Well, what are they going to be for the next 7 to 15 years?” How would you answer that question?
Todd: It's negative to low single digits.
Casey: And then how would you say that? How would you come up with a number that says negative to single digits? What would be the factors that would make you come to that conclusion?
Todd: You're at the extreme point in stock market valuations and it depends on exactly the measure you use. The most common is CAPE is Cyclic Adjusted Price Earnings ratio. That's most common that it’s used most in academic research. It’s pretty well proven. Everybody really likes to naysay it, but most of the naysayers have been knocked down. It's pretty stable. You can use other measures too. You can use price book, you can use all kinds of different measures. They come up with pretty much the same conclusions which is that you're in the top 5%, give or take, of historic valuations in the market. And so, that means that you're going to be in the lowest decile of expected returns over the next 7 to 15 years and similarly with bonds, as the other portion of the conventional asset allocation portfolio, your record low-interest rates, and interest rates are rising so the expected returns on bonds if you hold the maturity is the coupon, but again that's just a nominal return. If you net out inflation, you’d be lucky to break even.
Casey: Well, it sounds like today given that those facts, well, it sounds like today given those facts that you'd be a little concerned with following that traditional retirement model maybe more so today than you might have been 10 or 15 years ago due to current market valuations and interest rates. Is that correct?
Todd: Yeah. Absolutely. Yeah. I think this is one of the single most difficult times to properly plan a retirement and to retire and be dependent upon assets that’s existed historically. We are literally out of sample. I think I'll make a bold prediction here and it's not really a prediction. It's really more mathematically driven is we will probably see the first 20-year period of negative returns on the S&P 500 based on the 2,000 top in the foreseeable future here. Go ahead.
Casey: Well, we've covered a lot of really good information and things that I hope are really helpful to everyone and you’ve had so much great experience talking to so many people over the years and we know the most important part of this equation at least I believe is not investment returns or inflation. These are all great things, but it really comes down to our expenses and how much we’re actually going to spend in the first place. And that's how we kind of start basing this equation to come up with that magic number. And one of the things you alluded to in the book was we need to focus on our expenses and by reducing those expenses, we might be able to greatly reduce what's known as the magic number. And you shared a story in your book about how you're able to shave $1 million off of one of the clients you worked with, magic number by adjusting their expenses or working with them on their budget. So, I'm really curious, how could you possibly eliminate $1 million from their required amount that someone might need as they step into retirement?
Todd: Yeah. So, the math is really simple. So, you’ve got the 4% rule is really the rule of 25. It's the reciprocal so the reciprocal of 4% rule is the rule of 25, which means you got to have 25 times the assets of what your annual retirement spending is. So, then you can take to really simplify that. You can take and say, "Well, let's make it the rule of 300 which is 25×12,” so you get it down to a monthly number. So, now it's 300 times your monthly spending just to make it really clear. And so, for every thousand dollars you reduce off your monthly spending you reduced roughly and these are just rules of thumb but their approximations are reasonably accurate. They do hold up when you actually start playing tighter with the calculator, you’ll see they hold up pretty close. And so, rule of 300 says for every thousand dollars you reduce in spending, you'll knock 300,000 off your required asset level and so it's not hard to knock 3,000 a month off certain people’s spending patterns. Most people who have been earning good money have gotten pretty relaxed about how they structure their lifestyle. So, if they’re a million short, it's usually a lot easier to knock 3,000 a month that of spending and still lead a fulfilling life than it is to figure out how to work long enough to accumulate another million. Well, so just different approaches to the equation, you can come at it from reduce the spending because ultimately financial independence the assets is just a multiple of your spending level, I mean, that's the simple understanding.
Casey: Well, I'm sure they with all of your experience, meeting with all these people over so many years that you’ve had some pretty funny stories along the way and some pretty interesting conversations. Can you share with us any of the funny stories that might've come up along your path here?
Todd: You know, Casey, I’m going to let you down. I've done so many that’s like my brain is numb. I'm not coming up with anything right off the top my head. I'm sorry to let you down on that.
Casey: Well, hopefully, we get to that at our next interview. The next time we get together we can dive a little bit deeper maybe into one of your other books that you've put out that are just so valuable and I hope people that head on over to Financial Mentor and pick up some of these great resources that can really cut through all the garbage that's out there and give you some black and white, really common-sense advice. And as we wrap up, I'd like to ask you maybe one of the more stock questions that we have and that is if you could deliver one 5 to 10-second message to the entire world, what would it be and why?
Todd: Life is short. Live fully. I mean, the whole reason I pursued financial independence was not because I wanted a pile of money, it's not because I want to drive a fancy car. It was because I wanted to live my life free for the bulk of my life. I didn't want to be bound by having to work to make money. This game is about fulfillment. It's about pursuing a life that's worth living. It's about not having to report to the man and work each day on something you don't want to work on. If you love your job, great. If not, get financially independent, go do something you want to do.
Casey: Well, being that you retired at 35, I am wondering if you could go back to that time, that time when you're 35 years old and revisit yourself, what kind of advice would you give to that person?
Todd: Buy more real estate. I’m serious. That’s the one mistake I made. I did it the hard way because I was in the hedge fund business and I was building paper asset models, I was completely focused on paper assets. The world's easiest model when you're young is just to buy a bunch of real estate and put it on fully amortizing fixed-rate mortgages and in 20, 30 years, you're guaranteed. I mean, you got it down. You just got to hold the asset long enough.
Casey: That was the business my dad was in for over 40 years. We started by living in a little apartment and he got a little house, fixed it up, and we lived in over a dozen homes that I remember as a kid and we ended up owning apartments. He was an investment advisor. He was in the financial advice business for over 40 years, but his real-life savings, his wealth is created in real estate and I said majority of millionaires today are created in the real estate industry and I see that time and time again with the people that walk in our office.
Todd: Yeah. The majority of wealth is actually created to business entrepreneurship. Real estate is second. So, business entrepreneurship creates the bulk of wealth. Real estate is second. Paper assets is a distant third. And where you find wealth in paper assets is very discouraging because the people that get wealthy in paper assets, they’re generally very old. In other words, it’s accumulation of assets over a very long period of time and compounding over a very long period of time. And so, if you want to have your assets when you're really old, great, versus the traditional model, but if you want to enjoy your life in pursuit of fulfillment, you’re going to have to look at nontraditional models.
Casey: I think what you said there is very insightful because we hear the statistic that most wealth is created in real estate but that’s kind of pertaining to the traditional investment-based model and not this freedom and independence model of going out and starting as an entrepreneur and creating your own business and creating your own cash flow and your own independence, which is what you've done and it’s so cool to see someone that's gone through that and I hope that we get a chance to get you back on the show and dig a little bit deeper. There are so many other topics that you have that are so valuable. Thank you for joining us.
Todd: Oh, thanks for having me in the show, Casey.
Casey: Do you have anything else you'd like to share with our listeners before we depart?
Todd: Yeah. So, the hub of everything I do is FinancialMentor.com. That's the main website. I mean, I have social media outlets but I drag social media around like a ball and chain. I do it because it’s part of the business and so really go to FinancialMentor.com. I have one of the largest collections of financial calculators. They’re free on the Internet. I have thousands of pages of printed content, educational content, all free, and there are courses for people who want to take to the next level and there are some books for people who want to take it to the next level. So, it's up to you but there are tons of free resources. Come on over and enjoy them.
Casey: Yeah. And I can contest that those are some awesome resources as I've dug into them myself. Thanks, Todd, for joining us and we look forward to catching up with you again.
Todd: Thank you, Casey