Traditionally, people saving for retirement and financial advisors relied on the 4% rule when calculating how much to save for retirement and the associated income those savings would provide after retirement. What if you found out it does not work? Is there another option? Today, we offer you an alternative approach, which is the 2% rule for retirement spending. Before we delve into today’s main topic, we update listeners on the recent London meet-up, what to expect on upcoming shows, and who our special guest is to kick off the first episode of 2023. Then, we discuss today’s main topic and learn what the 2% rule is, how it compares to the 4% rule, and whether the safe percentage for retirement is actually higher. We unpack retirement spending through the lens of several empirical papers, historical data, and market comparisons. We also find out why the US market has always been able to bounce back from uncertainty and whether there is empirical data to support the 4% rule. We also talk about the many financial challenges and opportunities that young people face, the biggest mistake people make regarding retirement, the value of financial literacy, book reviews, and more!
Key Points From This Episode:
An update on the 22 in 22 Reading Challenge. (0:05:21)
Outline of today’s content and the main topic: the 2% rule for retirement spending. (0:06:27)
An overview of the “2% rule”, the motivation behind it, and how it was formulated. (0:08:17)
We discuss if the safe withdrawal rate for retirement savings is higher than 4%. (0:13:31)
The inspiration for the higher average realized rate of return on investment theory. (0:19:59)
Whether the past returns on US stocks will repeat in the future. (0:21:54)
Why the US stock market has been historically exceptional and resilient, and how other markets compare. (0:23:44)
The biggest limitation of the seminal work which helped established the 4% rule. (0:28:38)
How data gaps were dealt with in the paper by Scott Rieckens and results are discussed. (0:33:16)
Other aspects to consider regarding the research on retirement funds. (0:38:35)
The challenges and opportunities that young people face today. (0:42:24)
How financial literacy impacts investment opportunities, returns, and overall happiness. (0:46:59)
What are the potential solutions and reasons to be optimistic regarding the current financial market. (0:47:48)
Our usual episode review under a minute: episode 30 with Larry Swedroe. (0:52:31)
This week’s book review and choice architecture. (0:54:35)
We discuss the reviews and feedback received on a previous episode. (1:02:32)
Hear an update about our idea regarding CE credits and reviews about the show. (1:06:01)
Read the Transcript:
Ben Felix: This is the Rational Reminder Podcast, a weekly reality check on sensible investing and financial decision making from two Canadians. We’re hosted by me, Benjamin Felix and Cameron Passmore, portfolio managers at PWL Capital.
Cameron Passmore: Welcome to Episode 229, and welcome to December. We're recording this on November 25th, which is just incredible to me that we're a month away from Christmas. Before recording this this week, you've had some health challenges with some sort of bug going around. We're supposed to interview a guest on Wednesday, had to defer that, so there's a lot going on going around.
Ben Felix: Yep. health challenges make it sound pretty serious. But yeah, had some kind of respiratory thing, not COVID. We tested, but it was a very rough couple of days. My whole family was knocked right out.
Cameron Passmore: Well, you sound pretty good. I got lucky I was in London last week. I got lucky from a health standpoint where I ended up staying healthy through the whole trip. I just wanted to reach out and thank all the people that came out to the meet-up we had in London. Probably had 20, 22 people that came out last Monday night. It was an incredible experience to get to talk to so many listeners, so many backgrounds, young graduates, advisors, institutional salespeople. There's a math teacher, a gardener. It was just amazing to finally get a chance to meet people that are on the other end of all of this. The consumers is what we talk about. They were great, they were gracious, they were interesting, they were kind. None of them other than two guys knew each other, so connections were made. We were there almost five and a half hours. It was supposed to be like a happy hour kind of thing. As you know, we dialled you in a couple times, which is pretty cool. I doubt you could hear a whole lot, but it was fun for people to get a chance to meet you.
Ben Felix: I could hear, but I don't think anybody can hear me because I was on your iPhone speaker so I could hear what people who were saying to me, but they couldn't hear me back.
Cameron Passmore: Yeah, it was kind of fun, because obviously, people would talk about you and I say, "Well, do you want to talk to Ben?" So I dialled you up on Teams, so that was pretty fun. Some of the feedback I got, which is really interesting. They love your deep dives. That's kind of the heart of the podcast. They really appreciate that. But they also, and I asked the group point blank, I said, "What do you think about this intersection of finding and finding a good life and how we've taken your deep dive academic investments stuff along with fulfillment, happiness-type content?" They really value that intersection, and said, "Do not change that," which I thought was interesting. I was kind of expecting more of a math-based kind of nerdy audience, and that wasn't the experience at all. They really liked the casual ending how we change it, so they kind of – I think what you're calling now, the after show, the casual after show. They really appreciate that, and they said, "It does feel different."
They appreciate the mission of this podcast, which is so much more than just having some sort of advertising based or behind a paywall kind of thing. That was a highlight. They asked that that not be changed. I just want to thank everyone, I had a total blast, it was so much fun, lasted till 10.30pm. I think I'm the one that shut it down, because I had a big day the next day, and had a little bit of jet lag going on.
Ben Felix: Awesome.
Cameron Passmore: It was so much fun that I think I'm going to keep an eye out, maybe you will too as we travel to have more of these kinds of meet-ups. I'm actually in Orlando over the Christmas holidays, so if there's any interest in meeting up in Orlando, happy to go out and do a meet up there. So if you're interested, just drop a note to info@rationalreminder.ca.
Ben Felix: Very cool. Be cool to see you do an Orlando meet-up. I won't be there.
Cameron Passmore: You won't be there, but I think we should also do one. I was talking to Angelica about this, and maybe do one in Ottawa, and do one in Montreal perhaps in Toronto, which then could be super fun. Speaking of holidays, we're not taking a week off this year, like we have the past three years. So the year-end copulation show, which we're working on now will drop on December 29th, but we keep on rolling. Then we have a big guest, which I don't think we should announce yet until it's recorded. But we have a big guest to kickoff 2023, but the show just keeps on rolling unlike past years.
Ben Felix: I already told the community about that, so a portion of the audience knows. They helped me with the questions.
Cameron Passmore: Okay, there you go. So you can you can announce it then.
Ben Felix: Okay. It's Professor Robert Merton. He's the guy that created the ICAPM model that we've talked so much about. He also did ground breaking, or maybe even earth-shattering work on option pricing, which fundamentally changed the way that the field of finance, but also the – I think the world in many ways operates. That's something that we'll talk to him about, hopefully when he's on. That should be a really interesting episode. I didn't know that we were making a surprise, but there was a –
Cameron Passmore: I didn't know it was in the community, I've been busy lately. He's also a Nobel laureate, which is pretty cool.
Ben Felix: Yeah, his work on option pricing brought him the Nobel Prize. There is a very passionate discussion going on about the ICAPM in the community, where some people were basically saying this model is ridiculous. How can it possibly be useful? I said, "Well, actually, we may have because it wasn't booked yet. We may have Professor Robert Merton as a guest, why don't we put together the questions that we might have for him related to this. Anyway, that's where a lot of the inspiration for the questions came from. Then after that, we actually confirmed the booking, which was nice.
Cameron Passmore: Awesome. 22 in 22 Reading Challenge still continues. One more month to go. Of course, 57 participants have completed the challenge, 378 book reviews are in the Readwise app, which is pretty cool, 3,600 books have been read, and we're going to continue it into 23 in 23. In fact, we're going to be surveying the team here at PWL to come up with 23 book recommendations for next year. That will be a neat crowdsourcing. I just finished my 54th book this morning, actually. A lot of people asked me last week, "How do you read so much?" There really is no magic, right? It's just a daily habit. I read like 45 minutes to an hour every morning, literally every morning. I rarely miss a day. If you do that, the books just kind of melt away.
Ben Felix: I have a question.
Cameron Passmore: Sure.
Ben Felix: I love the PWL team, but why would we not survey the podcast community or also the podcast community about books for 23 in 23?
Cameron Passmore: We could – the turn in the thinking was, “Here’s some ideas from our team,” but we can raise that with Angelica
Ben Felix: Could be interesting. Lots of interesting, smart people in the community with diverse interests.
Cameron Passmore: Yep. In two weeks, we're going to have Professor Amer Kaissi, author of the book, Humbitious as our final inspirational guests for the 22 in 22 Challenge. We reviewed his book, Humbitious back in episode 189. Today's episode you're diving into, do we dare call the 2% rule for retirement spending?
Ben Felix: That's what I called it. Yeah.
Cameron Passmore: And you're going to discuss challenges and opportunities for young people today. This was from an event you participated in, right?
Ben Felix: Yeah. There's this C.D. Howe, which is I think like a policy think tank in Canada. I wasn't super familiar with them to be honest, before they invited me on this panel. But they actually, apparently, according to what they said during the panel that I was on, they initiated the creation of the TFSA in Canada, which is kind of cool.
Cameron Passmore: Oh, wow.
Ben Felix: Yeah. They were quite proud of that, as they should be.
Cameron Passmore: For sure.
Ben Felix: Yeah. I was invited to speak on this panel about challenges and opportunities for young people. Today, I was with Rob Carrick, the journalist from The Globe and Mail that has been on our podcast twice. We each did eight minutes of prepared remarks, and then we took questions from the audience. I was kind of a – it was a nice little event. Lots of questions from the audience about crypto and real estate, but I think it was overall a good discussion. But since it was just like eight minutes of pretty concise remarks about stuff that's probably relevant to portions of our audience, I figured I would repeat the remarks here.
Cameron Passmore: Cool. I'm also going to do my 62nd review of a past episode. Our longtime friend, Larry Swedroe was on back in episode 30, so I'm going to do a quick review of that. Then we also do a quick book review of The Elements of Choice: Why the Way We Decide Matters by Eric Johnson. By the way, we just booked in Professor Johnson as a guest in the new year, which is pretty cool.
Ben Felix: Very cool.
Cameron Passmore: Anything else?
Ben Felix: Nope. Let's go ahead to the episode.
***
Cameron Passmore: All right, Episode 229. Take it off with your 2% rule, Ben.
Ben Felix: All right. People are going to hate this. People don't like being told that the 4% rule doesn't work. I actually, to preface this, a couple years ago, I guess, when I did one of my earlier videos on the 4% rule that got people very, very riled up. I had done my own Monte Carlo simulations, using our current expected returns at that time. I had found that 2% was the safe spending rate, people hated it. Thought it was way too low.
Cameron Passmore: So that number is too low and the fact that it was a rule.
Ben Felix: Well, the rule as a whole. I mean, yeah. Rule is a bad name, just like my 5% Real Estate Rules. It's a bad name. None of these are rules. They're tools. The 2% tool for retirement spending. Anyway, why I brought that up is that I found this 2% safe spending rate using Monte Carlo. I think I probably adjusted the time horizon too, because the 4% rule is based on 30 years, and people were like, "That's way too low." Fine, whatever, maybe it's 3% whatever. We talked about this, we did our deep dive. What did we call it? I can't remember what we called it. Comprehensive overview.
Cameron Passmore: Oh, yes.
Ben Felix: We had all of our past guests that had discussed that. What's interesting is that this new empirical paper comes out from Scott Cederburg, who was a guest in a recent episode. They fined 2.26% as the safe spending rate. Now, we'll talk about their methodology and how it's different from the 4% rule as we go through this. Anyway, I just found it interesting that my Monte Carlo simulation with current expected returns ended up being not so crazy from an empirical perspective when you take a broad sample adjusted for survivorship bias.
Okay. Have you heard of the 2.26% rule for retirement spending? Probably not, unless you listen to our episode with Scott Cederburg because he did actually mention it during that conversation. Everybody's heard of the 4% rule, especially if they listen to our podcast because we've talked about it many times. The basis of the rule is that you can safely spend 4% of your portfolio in the first year of retirement, and then adjust that dollar amount for inflation each year thereafter, for the rest of your life with very little risk of running out of money. It's like maybe a 5% failure rate, depending on how you model it. We did that deep dive episode, the comprehensive overview in Episode 164. We dug into this topic with a whole bunch of different guest perspectives. I thought that was a pretty cool exercise to go through.
Now, we've also in many past episodes discussed the flaws with the 4% rule, which we also rehashed with that panel of guests in the in the comprehensive overview episode. To give a very quick overview, because I know, at least regular listeners have heard these many times. Bill Bengen. who was a guest in Episode 135, super nice guy. He wrote a paper in 1994, titled ‘Determining Withdrawal Rates Using Historical Data’. We talked to him about this in the episode. It was fun talking to him about it. Nobody knew this was going to be such a big deal, but it was the first fairly rigorous empirical approach to determining how much you can safely spend from a portfolio. Nobody had done that before, which is kind of crazy in 1994. Anyway, I guess he came from a sufficiently computational background that he had the capability to run this and he happened – he ended up working in financial planning. It's just the right skills in the right field at the right time.
Anyway, he did this analysis, and it just totally flooded through the world of financial planning, and it hasn't gone away. Even though lots of economists detest, like Moshe Milevsky, for example, detests the 4% rule. What Bengen did is he took historical data for US stocks and intermediate term treasuries. He tested how long a portfolio of 50:50, 50% stocks and 50% bonds, would be able to sustain various levels of withdrawals. Stated as a starting percentage of the portfolio and adjusted for inflation, like I mentioned earlier. The result is a historically safe constant inflation adjusted spending rate. That's the 4%. He tested withdrawal starting each calendar year, starting in 1926. He observed how long the portfolio lasted at each starting point for a 30-year retirement period with the 50:50 portfolio, he found the 4% rule, or the 4% figure, which became the rule. Then there was another 1998 study with similar findings, retirement savings, ‘Choosing a Withdrawal Rate That Is Sustainable’. Between those two studies, we arrive at this 4% rule.
Now as a tool, not a rule, I think safe withdrawal rates are useful.
Cameron Passmore: Absolutely.
Ben Felix: Right. And you remember, we talked to Scott Rieckens about that in Episode 95, where I kind of – he'd seen my video on the 4% rule, and he kind of knew that I had rubbished it. I asked him like, "Okay. You've seen my video, what do you think? What do you think about the 4% rule given that?" He basically said, "I don't really care if it's not perfect, but it's been super helpful for us to put numbers to our objectives” and that's hard to argue with. Even if 4% is the wrong number, I mean, whatever. If it's allowing people to save or motivating people to save for retirement when they wouldn't have otherwise, maybe that's not such a bad thing.
Cameron Passmore: And as I've said in the past, I think many people think their safe withdrawal rate is higher than 4%.
Ben Felix: What do you mean?
Cameron Passmore: I'm sure a lot of people think, Well, 5%, 6%, 7% is safe. I think 4% is kind of a cold shower to a lot of people, let alone a lower number than four.
Ben Felix: Huh, interesting. Yeah. Maybe 4% is an improvement.
Cameron Passmore: To Scott's point.
Ben Felix: Yeah. This is where it gets tricky, because from that perspective, 4% is motivating. And if we come out and say, "No, it's 2%." That's demotivating. Because people have to save twice as much, and the numbers get a lot bigger, and a lot less approachable. It's a touchy subject. To Scott's point, just to think through the numbers, if you know you want to withdraw $40,000 per year adjusted for inflation from your portfolio, the 4% rule says you need $40,000 divided by 4% or $1 million saved up to sustainably fund your lifestyle. I think, again, to the point I just made, if people look at that and think, "Okay, a million dollars. If I save this much at this expected return by this date, I'll have a million dollars.” If you double that to two, all of a sudden, it's a lot more challenging.
Now, withdrawal rates have shortcomings in general. Again, we've beaten this to death in the podcast, constant withdrawals. This is something that Braden at PWL has done a lot of interesting work on, constant withdrawals are likely to be inferior to variable withdrawals. In a lot of different ways, you can measure inferiority, but from most metrics. Other than a strong preference for constant spending, constant withdrawals look a lot worse. They're less efficient, they're more likely to make you run into money. Anyway, the 4% rule or any constant spending rule does not account for that. That you may be better off being flexible with your spending. They also don't account for taxes, which are going to be different for every investor.
Then the other piece of this, and this is one of the common counter arguments when I say, "Well, no. The 4% rule doesn't make sense." People will say, "Well, you're not going to actually spend 4% the whole time because your government pensions are going to kick in." I think on one hand, that's valid. On the other hand, the 4% rule just tells you how much you can spend from your portfolio. It's somewhat irrelevant. But the reality is, at some point, most people will have some level of government pensions or otherwise, types of pensions that kick in. Like in Canada, especially with a CPP expansion, that can end up being a pretty significant portion of expenses at age 65 or later.
Now, those are general shortcomings for safe spending rates, but I think the 4% rule specifically in the way that it was arrived at has some big problems. The focus that we're going to have of those problems, the one that we're going to focus on today is that it was based on US data. There are two papers really, that I want to speak to. One is specifically on the US experience, and I find this paper fascinating. Then the other one is Scott Cederburg's paper on safe withdrawal rates, adjusting for success bias and survivorship bias. The US stock market experience has been exceptional. I mean, this is fact. Everybody kind of knows this. When you compare the US to other markets, it's not even close. That's not true. Australia has been close, Canada was close until 2009 or 2010, and then the US took off. Then, I'm going to speak to that further in a in a minute.
All of that calls into question how representative US historical data are for future expected returns for a diversified investor, or even for a US investor. Again, I'll speak more to that in a minute. I do want to go through how exceptional the US experience has been, and some of the theory around why it has been exceptional. I think if we're forming expectations, it's important to ask why we got the outcome that we did, because that can contain a lot of information about how representative that experience is of the future. The US is a long-surviving – relatively, there are older stock markets, but it's a relatively long-surviving and successful market. I think it's very possible that the observed outcome for US stocks is biased upwards relative to what investors should expect going forward.
The US stock return experience is what created this thing called the equity premium puzzle, where US stock returns are much higher than what most economic models would predict. It's called a puzzle, it's a mystery. Why our US stock returns so much higher? There's a 1999 paper, and this is not one of the main ones I want to talk about. I'm just going to touch on it for a second. ‘Global Stock Markets in the Twentieth Century’ by Jorion and Goetzmann. They document using price-only indexes. That's not perfect. But anyway, in the cross section of 39 countries, that the longer a market survives, the higher its average realized rate of return is. Suggesting that survivorship bias may be an important contributor to the measured performance of markets that are still in existence at any point in time. Interesting finding.
One important of survival of a market is luck, just good-old fashioned luck. The other paper I want to speak to has this example in it. If you take the perspective of an investor in 1920, there was no way to predict that the US would not be heavily impacted economically on their home soil by either World War, or that crises like the Cuban missile crisis would resolve themselves peacefully without economic devastation, without the economic devastation that could have occurred in an alternative reality, where that specific situation turned out differently.
Now. the interesting thing is investors are still compensated for taking the risk that a catastrophic outcome like that could have materialized. They still earn a risk premium for taking that risk, but the risk doesn't materialize. There have been multiple instances of crises that could have happened but didn't for the US. So that contributes to the realized experience. So you're still collecting a risk premium for taking the risk, but the risk isn't materializing so you're getting lucky outcomes. In the case of the US, there have been many, many lucky outcomes.
Now, again, if we take the view of a 1920 investor. Argentina at that time was one of the 10 richest countries globally. They had growth exceeding Canada and Australia at the time. I remember I mentioned Australia has had returns on par with the US, and Canada did until 2010 or so. But instead of the good luck of the US, Argentina's success in the 1920s was followed by a decline, stagnation, and really poor stock returns. If you were making an asset allocation decision as a global investor in 1920, with the information available at that time, there was no way to predict the relative outcomes of these countries' stock markets.
Cameron Passmore: That is so interesting.
Ben Felix: Yeah. Those ideas weren't mine. They came from a paper from actually, Jules van Binsbergen and some coauthors. It's called, ‘Is The United States A Lucky Survivor: A Hierarchical Bayesian Approach’. In that paper, they evaluate the effect of survivorship on realized US equity returns from the perspective of an investor in 1920, when the US equity market had not yet developed into the large and accessible market that it is today. They find that their realized historical risk premium on US stocks exceeds the expected premium by 2%, so that's the puzzle, the equity premium puzzle. They find that the excess return is approximately equally split between contributions from luck. This is my favourite part of this paper, and I got to tell you, when I was reading this paper, I was thinking to myself that they were going to say what they ended up saying. When they actually said that in the paper, I was like, "Yes, I guessed correctly about the explanation." Alright, “Luck, is where cash flows ended up being higher than expected due to disasters that did not materialize,” There's a cash flow effect. Higher cash flows put push up returns. “and learning, where investors lower their required return on US stocks over time, driving up their valuations.”
Cameron Passmore: Bingo.
Ben Felix: Because the catastrophic events didn't materialize, that could have, investors reevaluate their discount rate, their required return on US stocks, which pushes up valuations. The current situation in the US is characterized by decades of good luck pushing up cash flows, and a low equity risk premium, because catastrophes have not happened, which has made investors require a lower return on US stocks.
Cameron Passmore: Do you want to hear something interesting?
Ben Felix: Yeah.
Cameron Passmore: I did not read these notes before choosing the Larry Swedroe episode. This was the main point of Larry's interview back in Episode 30.
Ben Felix: Oh, yeah?
Cameron Passmore: The implications of financial planning have lower expected returns going forward. So fortuitously, the two link up here.
Ben Felix: Nice. Very cool. Okay. So given all that, I think if we look backwards at the return on US stocks and assume they will repeat, it's not only a bet that the US is going to continue to have good luck. It's also a bet that there will be enough luck to more than offset the currently low expected returns, which are low at least argued in this paper because of people's perception that the US market is safe, because catastrophes that could have materialized didn't. That's the Bayesian approach, like they're saying investors learn about the perceived riskiness of the US market and because catastrophes have not materialized, they lower the required return, which pushes up valuations. I think that paper is fascinating. I actually got that from when Scott Cederburg was participating in the discussion, the community following his episode, he pointed people to that paper. I went, and read it and thought it was pretty cool.
Cameron Passmore: So I can hear some listeners saying, "Yeah, but there was the 9/11 attacks, there was the GFC housing crisis of '08." There have been risky events that have happened.
Ben Felix: Some, but nothing like Germany's economic devastation or the long-term stagnation in Argentina. The US has always bounced back from crises quickly, which again, I think feeds into the perception that it's always going to come back after a crash.
Cameron Passmore: Well, look how fast it came back after the pandemic broke, March of 2020.
Ben Felix: Yeah. I mean, listen, I think it's Warren Buffett that says, "You don't want to bet against the US" and maybe he's right. Who knows? But in terms of expectations, I think the point is just that it's not super obvious that the historical US experience is indicative of the future. If it's explained, of course. If it's explained by luck, and a falling discount rate, you can't count on that giving you high returns in the future. One of them gives you low expected returns, and the other one luck is tough to bet on.
Cameron Passmore: Yep.
Ben Felix: Okay. This is a known issue. I hadn't read that paper before, but the fact that the US has been exceptional is a well-known issue. In an earlier attempt to address these issues with respect to the 4% rule, Wade Pfau, and we talked to him about this in our podcast. I love being able to say that with so much of the research we talked about. Wade Pfau used data going back in 1900. He used the Dimson, Marsh, and Staunton data. He found that the only other country that kind of historically sustained a 4% withdrawal rate for a 30-year retirement periods was Canada. Eighteen other countries would have had failure rates between 8% and 62% for a 4% rule. The global stock market as a whole could have sustained a 3.5% withdrawal rate historically, keeping in mind the US is a big chunk of that, especially more recently. That alone I think takes some of the shine off to 4% rule. GlobalX US was a 3% safe withdrawal rate historically.
Now, it's important to keep in mind that the DMS data that Wade Pfau was using still has some survivorship and easy data bias in there. That's what as we talked to Scott Cederburg about in our episode with him. They've put in a whole bunch of, I think as you called it, Cameron, archaeological work to dig up data that was previously hard to get your hands on. If people haven't listened to that episode and you're listening to this, it's worth listening to Scott describe how they built their dataset.
Okay. So then Scott has this 2022 paper that came out, I think they published it on SSRN, not published in a journal. They put it out, I think the day we recorded, so we didn't talk to him about it because it wasn't out yet. But he alluded to it in the conversation. Anyway, it's called ‘The Safe Withdrawal Rate: Evidence from a Broad Sample of Developed Markets’. They used a comprehensive data set of real returns for domestic equity, international equity, government bonds, and government bills in developed economies to investigate safe withdrawal rates outside the US sample. They look at the US sample too, and they compare it to the experience of developed investors in other countries, sort of. I'll explain why sort of.
They have approximately 2500 years of asset class returns in 38 developed countries over the period of 1890 to 2019. They include data for countries that don't typically make it into historical data sets, because that market failed or the data or otherwise difficult to obtain. That was their archaeological work. They use a Monte Carlo simulation approach to study the portfolio outcomes as a function of the real withdrawal rate. This is their safe spending analysis. Now, this is the part that I want to make sure people understand. Each draft in the simulation tracks the retirement account balance of the heterosexual couple from retirement at age 65 through the death of the last survivor. Heterosexual is relevant. I'm not just saying that to be weird, because they're using mortality. They're using mortality tables. I guess they chose a heterosexual couple as that being relatively common for forming mortality expectations.
They simulate portfolio outcomes using a stationary block bootstrap approach, where the underlying data or their real returns on domestic stocks, international stocks, bonds, and bills for developed countries. They simulate the longevity outcomes for the couple using the Social Security Administration mortality data. They draw matched sets of returns on all the asset classes from the same country months to preserve cross sectional relations across assets. They draw blocks of returns that span a random length drawn from a geometric distribution with an average length of 120 months to reflect short term characteristics like volatility, clustering, and long-term characteristics like mean reversion. That part I think is important.
Cameron Passmore: It's so cool.
Ben Felix: They're simulating possible return experiences by drawing blocks out of their sample data. Each block has an average length of 10 years, 120 months. But the length is randomly distributed across this geometric distribution. You might have a block that shorter than 10 years, you might have a block that's longer, but on average, there are 120 months. Then they're linking these blocks together. Now, in their paper, they did look a little bit at international stocks, and I'll talk more about this later. But for the most part, they're looking at domestic investors. So they're looking at the experience of an investor in their home country, in stocks, and bonds as their main analysis. They're linking together multiple blocks, I guess, on average, three-ish blocks of domestic investors in different countries. You're not getting a 30-year experience of somebody in Canada. You're getting a portion of whatever, whatever it is, Canada, a portion of Czechoslovakia, and a portion of the US and maybe some other countries, depending on the block length that the actual block length in that simulation. Makes sense?
Cameron Passmore: This is exactly why I don't read your notes ahead of time. Because I'm kind of here as a test for the audience to see if it makes sense. It makes perfect sense to me. I get it and it sounds really interesting.
Ben Felix: Oh, yeah. That's cool. I mean, block bootstrap is cool in general, and I think the way they've done it is very cool. Now, I know I just said this. I want to reiterate, though, because this is important. I've talked to Scott about this. He has taken the recommendation. I don't know if they'll actually add it to their paper, though. Most of their data are for domestic investors. They did look at – and this is important, because if you remember when we talked to Scott, international stocks in terms of loss probabilities, international stocks have a lower loss probability over long horizons than domestic stocks. Domestic stocks were 12% loss probability over 30-year horizons in real terms. International stocks were 4%. They only looked at – for fixed asset allocations, they only looked at domestic investors. I think that's – well, I don't know if it's a shortcoming or not.
The 4% rule originally used domestic data, and US data. So is it a shortcoming of this analysis? That's maybe not a fair thing to say. They did look at international equity in a target date fund. There are some international data in there, but the problem in my view is that the target date fund has a very high fixed income allocation for most of the period. Elsewhere in their paper, they show that in their samples, 60:40 is the optimal portfolio for the lifespan of the investors that they're testing. If you go higher on equities, you have worse outcomes. If you go higher on fixed income, you have worse outcomes. So they have the target date in there that does have international stocks, but the target date is really heavy on fixed income. Which we know from their other fixed allocation analysis is going to drive down the safe withdrawal rate.
Anyway, I would love to see this data for an internationally diversified investor. But for now, we have to deal with their findings on domestic investors. I've got more commentary on that too. I'll just say it now. Even if we had the international data, the part that I would struggle with a little bit is the cost of investing internationally are higher. Like in Canada, if you're investing in an Registered Retirement Savings Plan (RRSP) or a Tax-Free Savings Account (TFSA), you're giving up depending on whether it's international or emerging markets and depending on how you own the securities, you're giving up. Relative to investing in Canadian or US stocks, you're giving up 30,40, 50, 60, and 70 in some cases, like for emerging markets in a TFSA. Relative to owning Canadian stocks, you might be giving up 65 or 70 basis points in ownership costs. Once you account for that, how much improvement do you really expect from international stocks? I think that would be an interesting thing to add to the simulation. I'll leave it at that.
Okay. Each block in the simulation is pulled from the real experience of real returns for an investor in a country in the sample. Then the next block is probably from a different country, and they're linking all these together until they have a full sample for the simulated mortality of the couple in that simulation. They ran like a million simulations per allocation, I think, so there's a lot. A lot of computing going on.
Now, an investor in 1890, they had similar commentary to the other paper about just how somebody at that time would have viewed the world. I think it's interesting to touch on this again. I think it's actually from what Scott said, I don't know if it's from their paper. An investor in 1890 would view countries very differently than we view them today with the benefit of perfect hindsight. The example Scott gave when he was on our podcast, the Czechoslovakia emerging from the Austro-Hungarian empire. At that point in time, Austria and Czechoslovakia would have been very comparable in terms of per capita GDP. Both would have been considered developed countries. Then through a series of unfortunate events, which Scott went into more detail about than I will. Investors in Czechoslovakia ended up with near total losses over the following decades.
If you were an investor in the 1920s, you're probably pretty optimistic about Czechoslovakia and almost certainly did not expect to lose the majority of your investment in the country. I said an investor in 1890, I don't know. I think the Czechoslovakia emerged in the Austro-Hungarian empire, I think it was in 1918. Anyway, Nevada investor at that time would have viewed these as developed markets and not expected them to incur total losses like they did. Ignoring those outcomes, when we think about the future, kind of like the Argentina example. I think it's a mistake. I think we probably have, even though people do like doom and gloom, I think we probably have an optimism bias where the way things are today is the way that they'll always be. We can't imagine major countries disappearing or having their markets collapse, although I guess that happened with Russia, but it's a relatively small market.
Cameron Passmore: That was Morgan Housel's line, "Save like a pessimist, invest like an optimist."
Ben Felix: Yeah. I think I have that in my challenges and opportunities for young people. I put that quote in there. Rather than adding these countries that failed in, they also deal with gaps in the data due to events like market closures. Those occur around bad events, typically. So like wars, political revolutions, banking crises. It's easy to ignore those gaps or just omit those data sets. But that creates unrealistically optimistic view of history, which is the whole premise of this research that Scott and his team have done. This approach they've taken provides a much better characterization of their range of potential investment outcomes, including that left tail risk, which is pretty much non-existent if you look at just the US, the US data.
Okay. Anyway, they took all that data, and they applied the block bootstrap approach that I mentioned, and they go and test safe withdrawal rates. Their baseline case is a 60:40 portfolio, 60% domestic stocks and 40% domestic bonds. They look at US data, and they look at the bootstrap experience of domestic investors in the full sample. They also test various alternative asset allocations from 0% stocks to 100% stocks to see what's optimal. As I mentioned before, they find 60:40 to be optimal, and then they also have the target date fund in there, which follows a glide path, increasing the fixed income allocation until the end-of-life expectancy, but it's very heavy on bonds for most of the period. I don't think it's super interesting for comparison purposes. Instead of using a fixed 30-year period, they use mortality tables from the Social Security Administration to incorporate longevity risk. There's a distribution of life expectancies in their analysis as well.
Based on these data, the life expectancy for a couple aged 65 in 2022 is 24.7 years, but the fifth percentile of time to death is 12.3 years, whereas the 95th percentile is 35.5 years. There's that distribution. They include that variability in their simulations. With this setup, they find for a 65-year-old couple, so you got to think like the worst outcome is you got a bad market outcome and a long-life expectancy. With this setup, they find for a 65-year-old couple in 2022, the 4% rule has a 17.4% chance of depleting financial wealth prior to death and a 16% chance of depleting wealth and living for another five years.
Cameron Passmore: Wow.
Ben Felix: Yeah, so not great. Not great. I don't think most people would take those odds. You certainly wouldn't get into a car with a 17% chance of crashing. You probably wouldn't get into a car with a 5% either, 5% chance either.
Cameron Passmore: This is depleting wealth, this is not just having to reduce future spending. This is depleting.
Ben Felix: 17.4% chance of depleting wealth prior to death and a 16% chance of depleting wealth and living for another five years.
Cameron Passmore: No joke.
Ben Felix: No joke. Now, again, this is portfolio assets. Like I mentioned earlier in Canada, you probably have a chunk of your expenses covered by government pensions. If your assets go to zero, you might even get additional pensions like we have the guaranteed income supplement in Canada if your income is really low as a retiree. Anyway, okay. So 2.26% rule, which is their empirical finding here, so they allow for a 5% probability of financial ruin. They find that the safe withdrawal rate at that level of financial ruin probability is 2.26% in their full sample, which is clearly less than 4%. Across the alternative asset allocations from 0% to 100% stocks, they show – I already mentioned this. They show the 60:40 portfolio gives the highest safe withdrawal rate. At least in this data, getting more aggressive with stocks does not help to increase safe spending. That's an argument that I've seen many times, and I've found that myself in simulated data. If you increase your equity allocation, you can spend more.
But this is one of the big takeaways from this research and from Edward Macquarie's research that we talked about in a previous episode, that a lot of the data showing that stocks are safer in the long run is due to survivorship bias. If you look at the markets that survived, yes, stocks mean revert, and they're safer in the long run than bonds or you include the markets that didn't survive, and you include the gaps in the data that had very poor returns, that is less, less true. Then the other important point here is on longevity. So the 65-year-old couple in 2022 expect to live the 24.7 years. Mean 24.7 years, but retirees in 2065 expect to live 27.6 more years, and people retiring 2085, which is supposed to be for – I think 2065 was young adults today, expect to live 27.6 years in retirement. And newborns today, so retirees in 2085, expect to live 28.7 years in retirement. Those increased longevity assumptions, have a meaningful impact on safe spending. With the 2065 retirees being able to safely sustained 2.02% instead of 2.26. Newborns today being able to sustain 1.95% just based on the longer life expectancy. Yeah, sobering, I guess. I don't know. Or maybe unrealistically pessimistic. I don't know. I don't know if it's unrealistic, though. The big thing is the international stocks. That's the big question mark for me on this.
Okay. So an important note is what I was just saying. This is based on domestic stock returns. and we know from Scott's other analysis that international stocks have much more attractive real loss probabilities over long periods of time. Maybe adding international stock to increase safe spending. But as I mentioned earlier, I think we have to be mindful of ownership costs and higher fees, typically to own international securities. How much would that impact the numbers? I don't know, to be honest. It's maybe probably a net positive after costs, but I just don't know how much. We would need Scott to run that analysis. I hope he does. The data used to calculate the safe withdrawal rates are also based on market cap weighted indexes. We don't have factor data going back to 1890 for small cap and value and stuff like that. We do know that for periods where we have those data, that small cap and value have performed better than market cap weighted indexes, including from the perspective of safe withdrawal rates.
That's why Bill Bengen added small caps to his analysis and boosted his 4% rule to 4.5% rule. We've run analysis similar to this, where we found the highest safe withdrawal rate I believe, was with small cap value stocks. We did that analysis in an episode a while ago. I don't know how much improvement you get from doing that, but to say, instead of 4%, say 2.26% is the floor. You can probably get more out of that by tilting toward higher expected returning securities. Then of course, there are other considerations like annuities, which help with that longevity risk, maintaining flexible spending, which helps with spending efficiency and decrease the probability of depleting assets. Deferring government pensions, like in Canada, we have Canadian Pension Plan (CPP) and Old Age Security (OAS). If you defer them, you get a boost. The same I believe with social security in the US and probably similar with other government pension schemes. You defer, you get a higher benefit, which is inflation indexed, and provides a longevity hedge.
The other big one probably is that in this analysis, they don't have inflation protected bonds, like tips in the US, or real return bonds in Canada. But did you know that Canada stopped issuing real return bonds?
Cameron Passmore: I did not.
Ben Felix: Yeah, they made that announcement recently. That's an interesting one where it's like, maybe that helps because when bonds perform poorly, it's usually due to inflationary periods, but it only helps if your government keeps issuing them. Okay. So to finish on this. Most safe withdrawal rate analysis is based on US historical data, which we know as we discussed is ex-post, one of the best performing markets in documented history, partially due to luck, and currently has high market valuations. Other efforts to expand the sample to broader global data like Wade Pfau's work, I think they still suffer from some easy data and survivorship bias. Drawing in the more comprehensive data set corrected for these biases in spanning 38 developed countries from 1890 to 2019, gives what I think is a more realistic and pretty sobering view on safe withdrawal rates. And on the long-term performance of – or the long-term safety of stocks.
Based on the currently 65-year-old couple, they can safely spend 2.26% of the portfolio. Then for young adults today, and for newborns today, those numbers are even lower, just based on their longer life expectancies. Canada actually has longer life expectancies than the US.
Cameron Passmore: Oh, interesting.
Ben Felix: It's by – oh, geez, I don't remember. It's meaningful, though, like a couple of years, maybe three years. These numbers are even worse if we're looking at Canadian mortality. As I mentioned earlier, it's always a touchy subject. I hope I didn't upset anyone.
Cameron Passmore: It's quite to pick me up, though.
Ben Felix: Yeah. It's basically telling if someone was previously following the 4% rule, we're basically saying you have to almost double your savings.
Cameron Passmore: Which is a pretty good segue to the next topic, which is challenges and opportunities for young people today.
Ben Felix: Right. Yeah. This should be relatively quick. It was designed to be quick. Should I just go through it?
Cameron Passmore: Sure. Fire away.
Ben Felix: Did you read this?
Cameron Passmore: I did, but let it roll.
Ben Felix: Okay. These are remarks I prepared for a panel. I just thought it was interesting. I wasn't sure, I sent it to you Cameron. You said it was gold and that we should –
Cameron Passmore: Did you present this or was it part of a Q&A type thing?
Ben Felix: I presented this as prepared remarks, and then there was a Q&A afterwards. Okay. Young people today are faced with increasing life expectancies, as we just discussed, high housing costs, particularly – well, I don't know if that's true. In Canada, for sure. I think it's an issue in a lot of places. High debt levels. Again, a lot of this is, I guess, Canada specific, but it's probably broadly applicable. High debt levels, high inflation, and related to that, rising interest rates as the government's trying to – or the central banks try to combat inflation.
Young people are also faced with lower expected returns and financial assets, high investment costs in Canada. We got some interesting data on that. I mean, talk about sobering. That's another thing. None of that safe withdrawal rate analysis accounts for fees, and it's like – we're in this bubble of people who are debating whether four basis points or 15 basis points is a low-cost fund. Canada – well, I'll get to the data in a sec, but Canada's like almost still asset weighted. Canadians pay still almost 2% to own equity funds on average for mutual funds and Exchange-traded funds (ETFs). Now, a lot of that is the embedded commission. But still, it's very high.
The other big one that I think is an issue is weak financial literacy. We have low expected returns, high investment costs, and poor financial literacy. All that contributes to financial fragility, which is a metric that the Government of Canada actually tracks, which is kind of cool. They've got data on – Canada has these cool social surveys, where it's not like demographic surveys. It's like, "How are you feeling?" basically. Canada has this really interesting data on this. Compared to financially resilient households, which is the opposite of financially fragile households, financially fragile households report lower financial, emotional, and physical well-being. Less satisfaction at work and less social connection. It was kind of a big deal.
I took Scott Cederburg's work, and just based on those withdrawal rates that we talked about and calculated how much more young adults today have to save compared to retirees today to fund the same future expenses, all else equal. They need to save about 10% more, accumulate 10% more in total assets at retirement to account for their longer life expectancies. Housing affordability, I mean it's the big issue. The high prices mean people have to save more. People who bought above current market levels because there was a peak in Canada and prices have come down since then. I've seen discussions about this on Reddit. Some people are feeling stuck in their homes. They've paid more than the house is worth and that limits economic mobility. This is a risk with homeownership. On the other side of that, rent is not necessarily the better option at the moment because rents have also been going up like crazy. So housing is a tough, it's a tough situation right now with, I mean, I don't know what the solution is there.
Debt levels are high in in Canada, a lot of that is mortgage debt. But households with high debt levels are more vulnerable to a decline in income and they're more sensitive to interest rate changes. We've also got high inflation. I think a lot of people are seeing that, not just in Canada. If it's persistent, that's tough. There have been historical periods where inflation has been persistently high and it can be pretty devastating. My comment was that it can have generational effects, where entire cohorts of people just by nature of living through that time period end up with a bad outcome due to persistent inflation. We've also got rising interest rates, which is putting pressure on borrowers. It's also driving down asset prices to an extent, and we've seen that big time in the bond market. But also, with stocks and a bit with real estate in Canada, at least. Low expected returns because interest rates were going down, down, down, basically since the 1980s. Expected returns are still currently low, although they've come up a bit from where they were. But that means young people today need to save more to achieve long term goals.
Then the high investment costs. That's what I mentioned before. The asset weighted average fee for an equity fund in Canada is 1.76%. That's like current data, which is – I mean, it's kind of crazy. Even if you say 1% of that is for advice that people are getting a value from. Seventy-six basis points is still a lot to own an equity fund, when you can get one for whatever, five, for a market cap weighted fund. On financial literacy, only about two-thirds of Canadians are financially literate at the most basic level. We did an episode on this. Now, outside of the core financial literacy questions, the Ontario Securities Commission also did a study. They found that the worst knowledge category for Canadians is related to investment costs. That maybe speaks to the fact that we have such high average investment costs in Canada.
Less financially literate households tend to take less equity risks with their investment, which is a bad thing in the long run. They tend to have stronger behavioural biases, and they tend to hold under diversified portfolios. Crypto investors who have mostly lost money. There's a new study that actually just came out on that, that we have not discussed yet in the podcast that found that most people who have invested in crypto have lost money at this point. Then those investors have tended to have low financial literacy. Those are all problems.
Given those problems. What are potential solutions and reasons for optimism? One of the things that I said is, and I don't know if this is a popular opinion or not, but I think one of the biggest mistakes, and this – I might have originally heard this from – did I hear this from Larry Swedroe? I think I got this from his book on retirement, how people like rush into retirement to do full stop, "I'm not going to work anymore," but don't plan out what they're going to do. They end up getting depressed often. I think that came from Larry actually. I think one of the biggest mistakes that retirees make in general is working themselves to the bone at a job they dislike to retire at some arbitrary age, without a vision for what they're going to do.
I loved what Jonathan Haidt in Happiness Hypothesis that love and work are two of the most important inputs for human happiness. As a solution to the longevity, and low expected returns and all that stuff, planning to work longer at a job that you enjoy improves the financial planning outlook quite dramatically. Changing that perception of the full stop retirement as the ultimate goal I think can be a valuable tool for young people today. Another one that's like not super exciting at all is saving more. This is the Morgan Housel comment, "Save like a pessimist, invest like an optimist." Saving more of course means spending less. The good news is that there's not a whole lot of evidence. There's anti-evidence in fact that the pursuit of luxury goods and material possessions increases happiness. I think there are probably still opportunities for young people to adopt lifestyles that focus on things that do increase happiness, like relationships, engagement and being outside. None of which have to cost a lot of money.
CPP, I mentioned earlier that Canada Pension Plan is currently going through an expansion. I think a lot of people see this as bad news. I know they do. There was a discussion on Reddit about this that was – it was unbelievable to see, but there's this perception that increasing CPP is net a bad thing at the individual level. It's like fine insurance, it's good social safety net for people who are stupid and irresponsible. But for me, I could do better investing myself. Maybe that's true, but like, this is – it's not easy to get an inflation indexed pension asset. This is one of the rare opportunities to get that in Canada at I think a pretty reasonable price, anyway. CPP is expanding, meaning the benefit will be larger, the contributions will also be larger.
Related to working longer, if you defer that pension to age 70, the benefit typically increases pretty significantly. I say typically, because we had Jordan Tarasoff on the podcast a while ago talking about some nuances there. Then unexpected returns, I think we may be, I'm not going to make a prediction. Who knows what happens if rates keep going up and asset prices keep going down? There may be a generational buying opportunity for young investors today. That maybe speaks to Morgan Housel's comment about saving like a pessimist and investing like an optimist.
The last thing is financial literacy, where I think like I mentioned, 1.76% is what Canadians are paying to own equity funds on an asset weighted basis. The generational advantage that we have today is easy access to low cost, well diversified investments. That hasn't always been a thing, but people have to know that they exist and know how to use them. I think financial literacy is one of the paths to achieving that. That's one of the papers that we we've talked about, has the estimate that 30% to 40% of wealth inequality can be attributed to differences in financial knowledge. That was based on access to higher net of fee expected returns. I think you get that by knowing that stocks are good long-term investments, and knowing that costs are important. Financial Literacy also helps people avoid scams. Again, like on Reddit, you see so many posts about people who have lost everything in crypto at this point in time. I think a lot of that can be avoided with financial literacy, hopefully.
Then financially literate households are also more likely to plan for retirement, and people with high financial literacy, and those exposed to financial education tend to have higher financial well-being. Which as we talked about earlier with financial resilience, which is kind of related, that has major impacts on all sorts of other aspects of life. I think there's a big opportunity, I guess is what I would call it for improving financial literacy globally. But even in developed countries, two-thirds of the population, Canada scores pretty well compared to other developed countries. But a third of the population being financially illiterate is still – there's a lot of room for improvement there.
Cameron Passmore: See, that was gold.
Ben Felix: I hope so.
Cameron Passmore: It's great. It fit perfectly with the initial topic, and it fits perfectly with the next segment, which is the third time we're taking a crack at one episode in 60 seconds. You're ready to go with that Ben, or I'm ready to go. Anyways, we'll see if we can do it in time. So Episode 30 was with Larry Swedroe. That was released back in January 2019. Larry's had a huge impact on lots of people through his incredible career in finance, and also in his many books. In that episode, Episode 30, we focused on his book, Your Complete Guide to a Successful and Secure Retirement. I tell you, that title really represents Larry. For decades, he's been helping people to become successful and secure. His main message, and this links back to your comments was that, since 1982, 60:40 investors have had an incredible run of great returns. However, looking forward, one should expect lower returns. If you combine that with longer life expectancy, you have a generation that needs to save more and invest more intelligently.
Therefore, his main point was, you must have a robust financial plan, one that accounts for all sorts of return possibilities, and also, one that contemplates a risk that can happen to you between now and when you retire. That also includes the life and disability insurance protection. Of course, any robust financial plan must include a robust investment plan. Larry is an absolute master at communicating that. Three big points. Markets work, risk and return related, and diversification is your friend. With a solid investment strategy, combined with a solid financial plan, you can head into retirement with confidence. Anyone who is heading into retirement, planning forward, this conversation, Episode 30, along with Larry's book are highly recommended. I'm sincere in saying that on behalf of you, Ben and I were very grateful to Larry. He's been a longtime friend of us personally, as well as the firm for many years. All right. I think those over 60 seconds, but what can you do?
Ben Felix: I didn't have the timer go in that time. But you're right, that does line up very nicely with both of those things that I just talked about.
Cameron Passmore: Yeah. That was almost four years ago, 2019. Okay. Onto the book review. This week, the book that I chose was The Elements of Choice: Why the Way We Decide Matters by Eric J. Johnson. Very interesting book. I loved it. As you say in the intro, every week one of the objectives of this podcast is to help people improve the decision making, obviously, decision making is about making choices. But when you make choices, you always have a hidden partner. This partner can be your own biases, recent events, current environment, your mood, and also how the choices are presented to you. Many internal, external factors are at play when you make a decision.
The interesting thing is that we're often completely unaware of the impact of these factors as you're making a decision. This book is absolutely jam full of really cool examples that highlight the challenges you face when you make a decision. The author, Eric Johnson is a business professor at Columbia Business School, and is director of Columbia Center for the Decision Sciences. He released his book, The Elements of Choice in 2021. Material in the book is very similar to Nudge by Thaler and Sunstein, also of course, Kahneman's Thinking, Fast and Slow, both of which are excellent books. And I'm guessing, many listeners have read one or both of those books.
Ben, do you actually ever stopped to think when you make a decision, how the environment around you is when you make that decision? Because I don't, but I'm now much more aware of it, even though I have read the other two books. But basically, what goes on when you make a decision is that you're assembling your preferences in real time, leading to the decision by thinking about the different aspects of the potential options that come out of that decision. How you think about those preferences, how you think about these preferences affects the decision. This is so cool to me. For example, more recent events can have a higher weighting in that decision process. How the choices are presented, it can also have an impact. This is called choice architect, which I'm sure many people have heard of.
One of the goals of this book is to help you realize that the interface that you make this decision via something online affects how you make your choice. You need to be aware of this if possible when you're making a decision. The examples they give, the obvious ones. When you choose something such as a restaurant, or hotel online, or the classic example of which jam you choose on the shelf in a grocery store, how these choices are offered to you impacts your decision, and the effects can be huge. I mean, we're all so busy. We make lots of decisions every day. That's kind of the point of Kahneman's book, Thinking, Fast and Slow. We prefer to make decisions using our lazy system and the system one as he called it. Anytime we can have a choice as easier, we will take that – typically, we'll take that option.
Of course, this was popularized in the book Nudge. One of the classic famous examples from that book was a default participation in company-sponsored pension plans, where you have a default opt-in option. Anyway, defaults were a big part of this book and defaults in choice presentation have a big impact, so defaults matter. Default option, and I haven't thought about this, but the default option endows the chooser with ownership of that default options. You get more confidence with those default option. There's huge power in default options. Changing the defaults can have dramatic changes in decision making. In my mind, this is anecdotally. But to me, Costco has absolutely mastered the default choice. There is one strawberry jam at Costco, right? There's one ketchup. There's one size of ketchup. The decisions are so easy. It's just ketchup.
Ben Felix: Until they decide to smoke the name brand by bringing the Kirkland version.
Cameron Passmore: Correct. Well, another example –
Ben Felix: You always go Kirkland, always.
Cameron Passmore: Ketchup this week used to be Heinz, now it's French as I noticed. Or the energy drink, sometimes Gatorade, sometimes it's the other brand. I don't know what it is. But they make the choice easy. Another example that he gave was at Rutgers University. Get this. Researchers changed the default from printing, for printing on photo copiers, from single-sided to double-sided. That was a default. They reduced the amount of paper by 44%, which is 55 million sheets of paper a year.
Ben Felix: Wow.
Cameron Passmore: Another one is organ donation. A recent survey shows that 70% of people are willing to be donors, but only 50% have signed up. What default should you put? All kinds of interesting questions. You put the default that you're going to donate, you'll get a higher donation. But then people have to opt out if it's against what they want to have as a choice. Super interesting.
Other stuff, the environment matters. The environment you're in can affect how you decide. For example, how hungry are you when you go grocery shopping? He shows it. The temperature in the room can increase your belief in global warming. How's that for wild? A clear day increases by 12% the probability of buying a convertible when you go car shopping. A snowfall will lead to increased sales of all-wheel drive vehicles. Just to be aware of the environment. How cool is that?
Another one is sequencing. So many listeners might remember the 2000 presidential election in the US, Bush versus Gore. In Florida, they were separated by like 500 odd votes, but the whose name was first in the ballot was not randomized. It makes you wonder how to randomize which name was first, because many people just pick the first name. And it would take a very, very tiny percent of the population that choose the first name. Which had you randomized it, you could have had a different outcome. Hotels that are listed first online are selected 50% more often than the second choice, and twice as often as the third choice. This is all choice architecture.
Anyways, the point of the book is in the section to be aware of these presentations and how they affect your choice. From what you said earlier, the underestimating of the effect of compounding has a huge impact in decisions. If you don't understand compounding, saving looks less attractive. Likewise, if you don't understand compounding, borrowing doesn't look so bad because you don't really understand the math behind it, you don't appreciate the math behind it. This goes right back to all of our talk about financial literacy, and the basic misunderstanding of compounding can lead to less than great decisions. Formally, the highlights, this is called the “exponential growth bias” and applies to many other areas, such as underestimate the long-term consequences of adding carbon to the atmosphere, growth of pandemics, both of which have exponential impacts.
Also, from a daily habit standpoint, by not appreciating the power of compounding, those daily habits, whether you don't exercise, don't eat the way you probably should, drinking, smoking other habits, if you don't appreciate the long-term compounding, that has an impact as well. I was checking out reviews on Goodreads this morning, and I came across one that said, "This book basically shows that absolute free will is an illusion." Thought that was really interesting comment. Because so many things impact your choice, even though you think you're making free decision, you're guided by all sorts of things all the time. The design of the options, the default, the environment, your mood, the sequence that is presented to you, all of this matters.
I don't have any great takeaways in terms of lessons, but it's more about, be aware of these influences. I think it's smart to stop and consider if you are being influenced in a way that maybe contrary to what you think you should be doing. I'm trying to be more aware of it. Professor Johnson is going to be a guest in the new year, so that'll be a very interesting interview, and I highly recommend the book.
Ben Felix: Cool. I definitely knew about some of those, like grocery shopping when you're hungry. I don't do that. I eat before I go to the grocery store. Very intentionally. Otherwise, I come home with a bunch of snacks that I regret the next day.
Cameron Passmore: Cool. So now we're at the after-show part. Some people told me that we're different in the after show. I sound more casual and easygoing. Obviously, it's true.
Ben Felix: We noticed it first. I wonder if we influenced people to think that though, because we said that the we conditioned people to think that we said we're casual because we said that we were.
Cameron Passmore: I liked your notes you put in here but the Chris Hadfield episode. I personally thought it was a spectacular episode. I thought it was gold that he shared with us. But you're absolutely right, there's a lot of comments, and the listenership is much lower than I think we would have expected.
Ben Felix: The episode of Chris is great. His book is great. I got a copy of it and give it to my almost eight-year-old son and told him to read it. He devours books. It's crazy. But I gave that to him and told him to read it because I think there's just so many good lessons in there that if you hear those lessons and learn them when you're younger, super valuable. Yeah. So downloads and views for that episode were low, lower than normal, like by quite a lot. We know that every episode is not going to do it for all of our listeners, but I think like talk about a value play. Talking about high, high quality low, I guess, appreciation in this case. I think this is a deeply undervalued episode just based on the download numbers.
You're right, I wanted to read a few of the comments because I thought that they were illustrative of what was going on. This first one in particular, this is from a regular listener who's active in the Rational Reminder community. Well, here, I'll just read it. I think it's – I took this as explaining why numbers were lower than maybe they should have been. So they said, "As somebody coming here only for the finance stuff, I started watching this episode with very low expectations, just because there was nothing new in my other subscriptions, and I had to do the dishes. Well, it blew my mind. I love that guy's philosophy. I think I'll rewatch it later, maybe multiple times. I wish I'd had someone like him to coach me in my formative years.” I just thought that was so good, because I can imagine many of our people that come to the finance content, seeing this episode and thinking, “No, I'm going to skip this one,” but I think was worthwhile. You want to read the next one.
Cameron Passmore: "This is my favourite and your best episode to date. The topics of goal setting, self-improvement and preparedness are important to living a good life, but also applies to personal finance. And at best, his greatest enemy is himself so applying these guides will help combat it."
Ben Felix: Yep. Another one, "I listened to this on Spotify, but I just have to come here to comment how –" This is on YouTube – "to comment how incredible and humbling this episode is. I will listen to this episode more than twice, for sure."
Cameron Passmore: Then I got one from a long-time friend and listener. I was quite surprised by this one. He said to me, "I loved the Chris Hadfield interview [even though I thought I would hate it.]"
Ben Felix: There you go. There's another one that I think is, yeah, at least in my mind, it fits the explanation for why the download numbers were low for that episode. I'm like, I don't care if the download numbers are low. I'm not trying to boost the numbers or anything like that. Who cares? But I just think a lot of people who probably would have appreciated this episode has skipped it. I don't know if it's the title, or the who the guest is, or I don't know. But for whatever reason, I think this has been an underappreciated episode.
Cameron Passmore: A lot of people I talked to you last week in London weren't aware of who he was. That might have been that also. Of course, he's an icon in Canada, but perhaps less so worldwide to be it.
Ben Felix: Interesting. Maybe that's it. Anyway.
Cameron Passmore: CE credits. You have the note here. Way bigger response than we expected. I actually thought we get a good response. I think it's a terrific idea.
Ben Felix: Yes. We had this idea of doing continuing education credits for listening to Rational Reminder episodes, with the idea being that we will create little mini courses based on each episode. Then the idea was, if you're a financial professional in Canada, who is required to maintain continuing education credits, we would get those little mini courses accredited by the designation issuing regulatory bodies, so you could qualify for your CE requirements by taking the quizzes. We put a little form out when we did our last episode, and asked people to fill it out to gauge interest. A ton of people who were Canadian financial professionals filled it out, and a ton of people who weren't also filled it out, saying that they would be potentially willing to pay like a small subscription fee to access the quizzes to help solidify their knowledge from the episodes.
Anyway, I wasn't expecting as big a response. I guess you were, but it was well over 100 people that filled that form out and the vast majority indicated that they would be interested in this as a service. So based on that feedback, we're going to continue with the project. I had made, I think two or three sample quizzes that I like posted and let people sign up for free to test it out. That's still up in the Rational Reminder community if people want to check it out. But I think we'll continue building out educational content for past episodes. We'll also continue building it for future episodes, and we'll start the accreditation process. I don't know what the timeline is, maybe it's something we launch in the new year. Not exactly sure, but we will push ahead with that. The other thing that we were thinking about is that we would maybe do two pricing tiers. We have to pay for the accreditation, if we want to get the thumbs up from the designation issuing bodies and the regulators. So we would maybe charge more for financial professionals who want those credits and maybe charge less for casual users who just want to learn. We have to figure out all that stuff.
Cameron Passmore: Cool. Got some nice reviews in. We actually got one in this morning. Said, "Love it. Best pod." From Jonas B in Sweden.
Ben Felix: Nice.
Cameron Passmore: Then we also got, "Best finance podcasts out there. Very academic and not reactive towards headlines." From Psi NZ in Australia.
Ben Felix: We talked about some news headlines last week. I actually feel like filthy when we talk about the news. I don't know why. It just feels gross. We even had some people complaining about – joke complaining, but complaining about – because remember we have that no net worth challenge, or no net worth November challenge. Part of that is not talking about financial news, or like any market return data or anything. So people were complaining that we had talked about the news, and messed up their challenge. I don't know.
I've noticed for a long time that like Richard, who does the Plain Bagel YouTube channel, he's always been very good at putting out videos that coincide with major events that people are very interested in. When there was the China debt real estate bubble thing that was in the media a whole bunch, he did that one. I can't remember what else. One of his first big videos I think was when the yield curve inverted years ago. He had made a video about that, it blew up. He's always been very good at making stuff about the news.
I just have so little interest in the news that I've never been able to catch those waves like that. I just, I don't know. I like what – I can't remember if it's on our podcast or somewhere else, but I heard Fama say that he looks at the data three years after it comes out.
Cameron Passmore: Classic line from Fama.
Ben Felix: I kind of like that.
Cameron Passmore: As always, connect with us on Twitter and LinkedIn. I'm on Goodreads. Also on Peloton, CB313 and #rationalreminder. I didn't tell you. When I was in London, I actually went to visit the studio. One of their studios is in London. I know it's super geeky, super weird. If you're into Peloton, you'll get it. Anyways, you got right into outside the studios where the trainers go. It was pretty cool experience in Covent Gardens, which is beautiful part of London. Spectacular space.
Ben Felix: The studio is like, the instructors go there to record their classes?
Cameron Passmore: Yeah. First of all, it's a beautiful facility. I think Sandra is going to put a picture up on wherever on the platform. But the technical part of like all the recording equipment, and all the engineers and stuff is all like – you can see from the street, which is really cool. You see like it's a big production facility. Then you actually go in and you can go up to the lounge chair and looked down on the three entrances to the studios. You're just seeing a door to the studio, so they don't get in the studio. But still, it's pretty cool when you've ridden so many rides that originate from London. It was a neat experience.
Of course, the podcast is on YouTube, and both of us are on Instagram. Oh, you're not on Instagram. I'm on Instagram and the podcast on Instagram. Of course, now, this December, don't forget the merchandise store. Got all kinds of stuff: hoodies, t-shirts, socks, mugs, Talking Sense cards are all available free shipping in North America, $15 internationally. Plus, you get free stuff with every order. Again, if you're interested in a meet-up in Orlando, email info@rationalremider.ca. Ben, you're nodding anything else?
Ben Felix: No. It feels like we did less like hanging out and chatting. I don't know. Maybe because we didn't talk about news headlines or something in the – I don't know. Didn't feel like an empty after show.
Cameron Passmore: We can chat some more if you want. Are there some topics you want to talk about?
Ben Felix: I don't have anything. I don't have anything to talk about.
Cameron Passmore: Yeah. Well, I mean, the other big story is going on, which has been quite something to watch is the whole SMB and FTX debacle. It's just been wild to watch, what a new story. How this can all play out is something.
Ben Felix: Yep. I think there's a Bitcoin maximalist who genuinely, and I don't disagree with him. Genuinely, I think this is good for crypto. Because most of the implosions have been centralized, unregulated banks, basically, and those tend to blow up. That's why we have a central banking system in most developed countries. If all that goes away, then maybe Bitcoin does become the relatively stable store of value for people who don't want any government intervention. Maybe it is really good for the – Cameron, we need to finish our crypto series.
Cameron Passmore: Yeah. I think Sam Backman is actually speaking at a New York Times event. I think it's around now.
Ben Felix: The whole thing is wacko.
Cameron Passmore: Really? He's going to be live in person in New York City? Really?
Ben Felix: It's totally nuts.
Cameron Passmore: I don't understand.
Ben Felix: Yeah. Neither do I.
Cameron Passmore: Yes, but we do have to finish up that series for sure.
Ben Felix: Yeah, we still have – they're still two more episodes that I wanted – three more episodes that I want to do. Just been busy with other stuff. Something we'll pick up maybe in the new year.
Cameron Passmore: Beautiful. All right. Well, happy December and thanks, everybody for listening.
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'Determining Withdrawal Rates Using Historical Data' — https://retailinvestor.org/pdf/Bengen1.pdf
'Retirement Savings: Choosing a Withdrawal Rate That Is Sustainable' — https://www.researchgate.net/profile/Carl-Hubbard/publication/265279441/
'Global stock markets in the twentieth century' — https://onlinelibrary.wiley.com/doi/abs/10.1111/
'Is The United States A Lucky Survivor: A Hierarchical Bayesian Approach' — https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3689958
'The Safe Withdrawal Rate' — https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4227132
'The equity premium: A puzzle' — https://www.sciencedirect.com/science/article/abs/pii/0304393285900613
'Long-Horizon Losses in Stocks, Bonds, and Bills' — https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3964908
'Financial System Review 2022' — https://www.bankofcanada.ca/2022/06/financial-system-review-2022/#:~:text=The%20tightening%20of%20monetary%20policy,remain%20two%20key%20interconnected%20vulnerabilities.
'The financial resilience and financial well-being of Canadians during the COVID-19 pandemic' — https://www150.statcan.gc.ca/n1/pub/75f0002m/75f0002m2021008-eng.htm
'Hopefulness is declining across Canada' — https://www150.statcan.gc.ca/n1/daily-quotidien/220517/dq220517d-eng.htm
'Global Investor Experience Study: Fees and Expenses' — https://assets.contentstack.io/v3/assets/blt4eb669caa7dc65b2/blt60e320775385837a/62431900eed9f60f2de8ad55/GIE_2022.pdf
'Financial Literacy Around the World' — https://gflec.org/wp-content/uploads/2015/11/3313-Finlit_Report_FINAL-5.11.16.pdf
'Ontario Securities Commission Investor Knowledge Study' — https://www.osc.ca/sites/default/files/2022-09/inv_research_20220907_investor-knowledge-study_EN.pdf
'Measuring the Financial Sophistication of Household' — https://www.nber.org/system/files/working_papers/w14699/w14699.pdf
'Investment Literacy, Overconfidence and Cryptocurrency Investment' — https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3953242
'Financial Literacy and Attitudes to Cryptocurrencies' — https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3482083
'Bitcoin Awareness, Ownership and Use: 2016–20'— https://www.bankofcanada.ca/wp-content/uploads/2022/04/sdp2022-10.pdf
'Optimal Financial Knowledge and Wealth Inequality' — https://repository.upenn.edu/cgi/viewcontent.cgi?article=1093&context=bepp_papers
'Financial Literacy and Retirement Planning in the United States' — https://www.nber.org/system/files/working_papers/w17108/w17108.pdf
'Financial Well-Being of the Millennial Generation' — https://gflec.org/wp-content/uploads/2019/12/Financial-Well-Being-of-the-Millennial-Generation-Paper-20191122.pdf