By Dr. Rikki Racela, WCI ColumnistAs I delved into my financial literacy journey—which included reading the first couple of WCI books, reading this blog, and taking the Fire Your Financial Advisor online course—I would continually come up with one name over and over again when it came to academic retirement research outside of WCI: Wade Pfau.
His work is prolific, delving into all aspects of retirement—from questioning Bill Bengen’s 4% rule all the way to (much to my chagrin) supporting uses of whole life insurance in retirement. His support of products like whole life insurance and annuities is controversial. To me, it's almost like a smart Houdini who, instead of pulling a rabbit from a hat, uses phenomenal skill and keen intellect to make these products seem reasonable in retirement.
But one thing is for certain: Pfau's perspective on a retiree’s feelings on creating a retirement income is profoundly creative and thoughtfully unique, and it seems quite accurate. Even the leader of this website has great respect for Wade's work and acknowledges the merits of Wade’s safety-first vs. probability-based paradigm. And nothing sums up the culmination of his research on retirement behavior and spending as his latest tool: the RISA.
The RISA was worked on by Wade, Alex Murguia, and Bob French (son of famed Ken French) under the umbrella Retirement Researchers. I had the pleasure of virtually attending free informational workshops on the RISA, and I even had the chance to go through it myself. What follows is my review of this latest paradigm and how it can be helpful to certain white coat investors trying to define their retirement plan.
[AUTHOR'S NOTE: Super important disclaimer: There is no financial relationship between WCI and those who run RISA, and this column contains only my thoughts on the product and should not be considered a WCI endorsement.]
What Is RISA?
RISA stands for Retirement Income Style Awareness, and it identifies how a particular retiree feels and prefers to fund retirement. Famed Morningstar finance writer Christine Benz wrote an excellent summary of the RISA, but I will try to be more specific on how the RISA can be applied to white coat investors. It goes beyond just the basic selection of your asset allocation based on your risk tolerance. You look at funding retirement through how you feel on a spectrum of two different dichotomies: safety first vs. probability and commitment vs. optionality. You can plot these two metrics on a graph, and a retiree can fall within four quadrants: total return, time segmentation, protected income, and risk wrap.
To find out where you lie in this RISA matrix, you're asked a series of questions—similar to a risk tolerance questionnaire, with a slight bend toward how you feel about where your retirement money will come from. For example, one question in determining safety first vs. probability asks how much you agree with the following statement: “I see my investment portfolio as funding the majority of my retirement expenses.” For an example of determining where you fall in the optionality vs. commitment spectrum, you might be asked how you would rate agreement with this statement: “I prefer more flexible retirement income strategies to accommodate my changing preferences as I age.”
There are a lot of these types of questions, all honing in on your feelings about drawing down your nest egg in retirement along the safety first vs. probability and commitment vs. optionality spectrums. This ensures that you are placed accurately in one of the four quadrants.
Now, what does it mean to be placed in one of these quadrants? Well, I’m glad you asked! Let’s start with the quadrant where I landed.
RISA Result: Total Return Approach
This type of income style is exactly what it’s called. The total return approach retiree wants to maximize as much money they can for retirement, and they are willing to take more risk on the amount of income they might have in retirement to accomplish that goal. Realize that this doesn’t necessarily mean you have high-risk tolerance and that you should be 100% equities in retirement, although I would argue that there is likely a strong relationship between risk tolerance and your retirement income style.
More accurately, a total return approach will forego the use of annuities or paying for other insurance products that might guarantee a retirement income stream. While risk tolerance is more to assess how you would respond when the stock market tanks, the RISA is trying to see how you respond to swings in income during retirement. And with the total return approach, you can tolerate possible swings in income to max out how much you could possibly spend during your retirement years.
RISA Result: Time Segmentation
It would seem that those retirees who prefer an optionality-based way of creating retirement income, as opposed to committing their money to a product like an annuity, would also prefer probability-based investments as well. However, Pfau’s research suggests otherwise, and some individuals want to keep their investment options open in creating a retirement income but want those options to provide safe and stable cash flows.
This is sort of a hybrid personality where you want stable income yet don’t want to lock up your money for a contractual guarantee of income. Pfau refers to these retirees as “time segmentation,” and the previously mentioned Christine Benz falls into this quadrant. The preferred solution for these types of retirees is the bucket strategy, where safe investments like cash and short-term Treasuries that provide short-term cash needs stay in one bucket, moderately risky assets that are needed a little further into the future hang in the second bucket, and risky assets to fight inflation and provide longer-term cash needs grow in the third bucket.
More information here:
Is Now a Good Time to Retire? Here’s What Christine Benz Thinks
RISA Result: Protected Income
These retirees want the safety of their cash flows, and they are willing to lock up their money/buy a contractual guarantee like an annuity to provide safe and stable income without the options that characterize the previously mentioned time segmentation folks. It is important to note that not all spending has to be safe and committed to satisfy the people in this quadrant. Many protected income retirees would rather have just their fixed expenses fall into the protected income quadrant and have riskier assets to cover more discretionary spending needs. This is why the RISA does not necessarily dictate a particular asset allocation. Instead, it shows how you feel about where certain money should come from during retirement. Based on your feelings, the RISA will place you in a quadrant that just helps guide how you use investment assets and insurance products to fund your retirement.
RISA Result: Risk Wrap
We come to the final quadrant of the RISA universe. Risk wrap is just how it sounds. You are still taking volatility risk to boost retirement income because you prefer being probability-based, but you want that risk limited by locking it up in a particular contract or strategy. These retirees want to invest in riskier assets for possible higher retirement income, but they don’t want their retirement income to tank too much and are willing to pay and commit to a contract or guarantee for downside protection. This is where Wade and the rest of the retirement research team mention . . . brace for it . . . the use of variable and indexed annuities for these types of retirees (I just vomited in my mouth!).
Not to sound too much like a horror story (though I did mention annuities already), this is a nice lead-in to a somewhat sinister feature of the RISA . . . Getting scared yet? You should be.
More information here:
Some Sobering (and Scary) Statistics on People’s Retirement Preparedness
NewRetirement Review: An Online Retirement Calculator on Steroids
The Sinister Side of the RISA: Bad Annuities Have Found Their Problem!
During the RISA seminar I took, the following solutions to these four quadrants were depicted below:
When I saw this, I was freakin' floored. I experienced commotio cordis of the brain! Many of the “bad” annuities are seen in this picture: VAs (Variable Annuities), RILAs (Registered Indexed Linked Annuities), and FIAs (Fixed Indexed Annuities).
Dr. Jim Dahle is not a huge fan of annuities, although he can see uses for SPIAs (Single Premium Immediate Annuities), DIAs (Deferred Income Annuities), MYGAs (Multi-Year Guaranteed Annuities), and IOVAs (Investment-Only Variable Annuities). These other “bad, evil” annuities were always touted as solutions looking for a problem. Well, the RISA is that problem!
I can unfortunately see salespeople touting themselves as financial “advisors” and using the RISA to justify the sale of these expensive and wealth-sucking annuities. The team at Retirement Researchers is not wrong in suggesting the use of these “bad” annuities. The “bad” annuities can solve and satisfy the retirement income styles uncovered through the RISA. What makes the annuities “bad” and evil is the fees and loss of wealth through commissions that are hidden in the complexity of these products.
If I were super-duper smart Princeton PhD like Wade Pfau, I could appropriately discern and prevent the loss of wealth when purchasing a “bad” annuity to fulfill my retirement income style. But most of us do not come close to Wade’s intellect. If we, as mere math mortals, try to satisfy our RISA needs with bad annuities, we will get burned.
Wade Pfau is Bruce Lee on Hans Island of annuities—he will dominate because his financial smarts will dissect bad annuities—while I (we) would just get screwed in fees and commissions. The RISA might make that boat to Hans Island of annuities look attractive, much to a future retiree’s detriment. Whereas Wade will survive the island of annuities with the lowest-cost variable annuity to meet his retirement income style, I (we) will be whimpering on the ground during retirement as our wealth was eaten up by thousands of dollars of fees within a VA, lining the pockets of the insurance company and salesperson.
We must recognize the danger the RISA holds in justifying the purchase of financially evil VAs, RILAs, and FIAs.
(For those that don’t understand the above reference, stream the kung-fu classic, Enter the Dragon!)
Should You Take the RISA?
For the individual retiree and the pre-retiree, the RISA is an insightful tool that I would encourage anyone serious about retirement to take. I definitely do not agree with the use of “evil” annuities to satisfy your retirement income preferences, but insights from the RISA could help you identify how you should structure your asset allocation, plan your withdrawal of said assets, decide whether to annuitize a pension or pay out a lump sum, and/or possibly purchase a “good” annuity like a SPIA. When I took the RISA, I fell into the total return income style, and the report that I got back not only explained what this quadrant meant but also had a recommended plan to fit my retirement income style.
I am not sure of the recommendations for the other quadrants, but based on the RISA characteristics, you could build a retirement plan that fits your needs in a framework that is fully unique from just asking somebody’s risk tolerance. I mentioned above the time segmentation folks would use a bucket strategy where you have the options of what assets to put in each bucket, yet each bucket has a safety-first quality where it covers a particular spending need at different times. A protected income retiree might partially or even fully annuitize their nest egg and any pensions they have available to them. Finally, risk wrap retirees might want to commit a portion of their retirement to a SPIA or DIA (I am going to emphasize again, avoid the “bad” annuities!) while also having a buy-and-hold strategy consisting of low-cost index funds. That way, the risk wrap retiree fulfills their feelings for being committed to a strategy but still has some fluctuation in their portfolio to make potential excess returns.
I do have to congratulate Dr. Wade Pfau and the entire Retirement Researchers team for an innovative insightful tool into how to plan for retirement. Though I don’t agree with the use of some types of annuities to fulfill the needs of these different retirement income styles, a retiree can build their retirement assets and buy good annuities within this perceptive RISA framework to maximize the happiness and security they can squeeze out of their nest egg.
What do you think? Have you heard of or even taken the RISA? Do you find it accurate and innovative like I did? Were you disgusted with the promotion of annuities within the RISA framework? Have you ever thought Wade Pfau would be compared to Bruce Lee?
I haven’t taken the questionnaire, but it is pretty easy to figure out where you really stand just based on what you have in your portfolio (assuming that you’ve actively participated in creating the portfolio). One important caveat about annuities. Insurance companies are increasingly subcontracting their investments to entities based in the Caymans and Bahamas etc. If they go south, the state insurance regulators are toothless – and your “guarantees” worthless. I’ll stick with stocks and bonds and a bucket approach.
wow- I didn’t know that. does that mean the State Guaranty funds won’t apply then? I thought that the funds would kick in based on where the annuity purchaser lives, not where the company is based out of. I would check that because from my understanding, the State Guaranty is there for the best interest of the insurance companies, and insurance companies would lose out if these state guaranty funds don’t kick in and some people will stop buying annuities knowing these state guaranties may be worthless.
Dr. David Graham gave an excellent talk that included RISA (at WCICON21 I believe?). He felt most “Whitecoat Investors” are or should be in the Total Return bucket. That helped me understand where I am.
The other part of RISA is helpful to understand your relationship to a financial advisor. The options range from DIY (Why should I pay someone to tell me what to do with my money?) to Delegation (I got a money guy and he’ll take care of everything).
It turns out I’m a “Validator.” I check in with a Fee-Only financial advisor every year or two to get an outside professional opinion. I have blind spots and lack infinite knowledge of all things financial.
RISA can be helpful to clarify your own thoughts around money.
yeah dude that’s true! the other part of the RISA is if you need an advisor or not which I didn’t delve into.
In what ways has meeting with a planner every couple of years been helpful? I’d think that once you’re on track, after a few years, you wouldn’t really need the reassurance.
Nothing earth-shattering. Sometimes I learn of different ETF options, advice on where to put which asset, changing rules on Roth, etc. I can’t keep up on all aspects of planning. And I have blind spots as all humans do. They also use different cash flow software and return estimates.
Wade Pfau is supported (?paid by?) the Annuity Industry-
“It is difficult to get a man to understand something when his salary depends on his not understanding it.” – Upton Sinclair
yeah he is! Wade is definitely not bias free, which kind of makes him sort of dangerous as he is wicked smart, and supporting those evil annuities is like using your powers for the dark side 🙁
I’ve asked Wade about that. He notes his interest preceded being paid by anyone in the industry. But the agents sure do like to use some of his articles to try to convince skeptical buyers.
Yeah, I remember asking him about this during the RISA presentation, and he said his interest was because of the “annuity puzzle” in academic Economics. He then went into a brief yet deep discussion of how annuities are not being bought as predicted by economic theory. I brazingly responded the puzzle is easily solved by saying good annuities aren’t bought because salesmen aren’t selling them due to minimal commission, and that the bad annuities are sold more b/c of huge commissions but those extra costs are financially evil giving annuities a bad wrap in general so thus even more people don’t want to buy an annuity.
Wade then smiled, did mention I make a good point, but not in so many words said my thinking was way too simplistic.
Like I said/pictured in my article, he’s Bruce Lee and I’m the random Han’s island guy on the ground
What would be wrong with simply investing in a mix of stock, bond, REIT and ETF’s in a brokerage account with an overall yield of 3%; and having that as your retirement income. No counting on any capital gains -those would be your inflation hedge.
nothing wrong with that! although if you are planning in retirement on not selling assets and just living off the income you will a hell of a legacy left to your heirs! but if you are happy living off that yield in retirement, have at it 🙂 I myself have a more die with zero mentality so I am counting on using capital gains in my retirement income calculations.
These are not close to equivalent financially or risk-wise. A joint life SPIA bought at age 65 will return like 7% per year of the lump sum, and a large chunk of that won’t be taxed as it will be considered return of principal. The yield on the portfolio will be taxed (some at ordinary income, some at LTCG rate). Yields are not guaranteed either — Bill Bernstein says you can put a floor at 50% of your dividends, but let’s say he’s being too pessimistic, and it’s 75% instead. Your 3% can become 2.something% in bad times, which may necessitate drawing off the principal of a diminishing portfolio to support spending needs.
All that said, probability based is the way to go for vast majority of high income people. White coat investors should be able to accumulate enough to build a very solid consumption floor to account for worst case investment results. The positive delta from the actual performance can go toward upgraded retirement lifestyle and increasing the size of bequests.
Annuities are really built for the people who are cutting it closer, for whom the stock/bond/social security/reverse mortgage blend does not set an adequate consumption floor.
It certainly works, but when you spend ONLY income, you leave a heck of a lot of money on the table that you could have spent and may have worked longer than you needed to.
https://www.whitecoatinvestor.com/the-pros-and-cons-of-income-investing/
I took the free RISA workshop over a year ago. At the time, the follow on “sales pitch” was for paid subscriptions and courses. The mapping of annuities to “RISA type” seems more recent.
yeah, I took the RISA over a year ago too, but yes they have had multiple presentations and I might have missed the initial ones not mentioning annuities. I guess Wade may have realized later the RISA’s place within the annuity puzzle, especially the bad annuities. The bad annuities have been solutions looking for a problem. Wade has elegantly found that problem. But RISA solves why even the good annuities may not be purchased- not all investors are extemely safety-first to prefer the good annuities as the RISA matrix suggests.
But from my simple minded investor standpoint it seems the annuity puzzle is really not that puzzling. To a non-academic hobbyist investor like me, seems obvious that most good annuities aren’t bought because salesmen aren’t selling them due to minimal commission, and that the bad annuities that are sold more b/c of huge commissions but that extra costs are financially evil, giving annuities a bad wrap in general so thus, not many people go out and buy an annuity. Puzzle solved!!!!
This may just be me, but I took the RISA on 2 occasions several days apart some time back and came up with results in 2 distinct quadrants: many of the questions seemed to be 50:50 balls, or at least easy to interpret in different ways. As I approach projected retirement in several years, I continue to debate “safety first” (ie, SPIA + SS + heavy exposure to equities) vs “total return,” and taking the RISA didn’t provide any additional clarity regarding that. I have found useful information in Pfau’s Retirement Planning Guidebook, with the caveat that there is a bit of “this is too complicated for you to be a DIYer” flavor I think many/most WCI aficionados may not agree with.
Hey thanks for reading and yes! like a personality test you could be on the cusp of safety first vs. making the most money possible because these are 2 highly valued things. The beauty of the RISA is that even if you are on the cusp, that is pretty useful information and it seems you recognize that are you mentioned you are debating SPIA/SS/equity portfolio which is on the line of safety first/optionality. Given this it is probably inappropriate to go 100% equities with no SPIA for you given your RISA.
This was an interesting post on RISA. Agree that Wade Pfau’s intellect powers reasoning in annuity/WL.
Does anyone know if Pfau is factoring in surrender rates for WL (and to a lesser degree annuities)?
That may change the calculus…although I bet you can make similar arguments for poor investor behavior of selling low and buying high.
Hey thanks for reading. from what I know he doesn’t factor in surrender rates. Many of his studies look at whole life that is paid up and never really delves into the risks and cost of surrendering a WL policy, nor utilizing the death benefit, but really focusing on the buffer asset aspect of the product. It would be hard to quantify but he’s pretty smart, and I think he should include that risk of having to surrender the policy like in my situation given I couldn’t keep up with the cost of the policy, or compare the opportunity cost of not getting a WL policy and having that invested and how much you would have made vs. now havin WL as a buffer asset.
Annuities are great if inflation stays low, or you only get hit with a couple years of high inflation, which has been the case for the past 30 years. However with many years of high inflation (even something like 4-5%) not so good. There’s no dramatic drop like a stock crash, but after 20 years of 4-5% inflation you will have lost a lot of value.
That’s after the advisor has already retired or separated from you so no longer their problem. Since there are no inflation protected annuities (except social security) be cautious. Best is to defer social security to 70 and if an annuity allows that to happen perhaps worthwhile.
Hey Greg I definitely agree! Annuities because you can’t buy them with an inflation adjustment are not great in high inflation enviroments. Really relegates them to being a floor to retirement spending, but with inflation its as if the floor is sinking every years. You really can’t rely on just an annuity and bonds in your retirement, but need equities as an inflation hedge.
Rikki – I really like your columns. I keep meaning to tell you and have been terrible at actually getting that thought down on paper. Keep up the great content, the fun style, and the meaningful contributions to the community!
awww, thanks man. I love yours too! Just like with my patients, I try to breakdown complex stuff so it’s easily digestible.
Whether you agree with all/some of Pfau’s conclusions or not, I must say that his book, The Retirement Planning Guide, is an outstanding compendium of retirement research. It’s the best single source of retirement planning info/data that I’ve read and particularly addresses tax issues very well. I’m not going to lie, it’s dry and reads like a textbook but it’s a very good resource. I personally did find his (and a few others’) recommendation to use a low cost, no-frills SPIA as a conservative bond substitute because of the potential mortality credits to be very compelling and I’m doing so in my portfolio. He also makes an excellent point in the book and on his podcast that these simple annuities are not to be thought of as alternatives to equities but rather to bonds. He also doesn’t recommend inflation riders in SPIA’s due to cost but rather to get your inflation protection from the equities or alternative investments in your total return assets. Like many people, I found the RISA reinforced what I thought my “style” is and for me, that’s Time Segmentation. I’ve just chosen to use the SPIA as an adjunct/substitute in my short and medium term buckets. I strongly agree with his point that if you have a reliable source for your baseline expenses, you can be more aggressive in your equity/risk portfolio.
Hey thanks for reading and definitely his book is on my reading list. awesome that you are using a SPIA and getting those mortality credits, and because of those mortaility credits likely pays out better than just short term treasuries, maybe even approaching even intermediate term treasuries without the interest rate risk. And yes, that is awesome analysis by him to see if a COLA adjustment is worth it on a SPIA, but seems like because it is not truly adjusting using CPI, a COLA adjustment rider is not worth it.
I do find Wade a little hypocritical in supporting those bad annuities however. Like you said, a SPIA is an annuity could be thought of as a bond substitute. The bad annuities can’t, and are trying to getting closer to having more equity like characteristics in order to justify higher punitive fees and screw investors. I did ask him why not fulfill your RISA by using a combination SPIA/equity portfolio instead of buying an annuity product like a VA, and he said that was reasonable. But then why have that stupid chart with the bad annuities in certain RISA quadrants???!!!!
Agree—there are too many moving parts and difficult to predict variables and assumptions AND fees in the other types of annuities. I’ll take my risks in equities and just use the SPIA (or simple straight deferred income annuity if you don’t need the income w/in 12 months) for my “safe”/contract income floor.