Motley Fool Answers: This Is the "New Normal" for Retirement in the U.S.

Imagine this -- two veteran stock-pickers pitted against each other in the ultimate investor face-off. The first contender: the legendary Charlie Munger. The challenger . . . Orlando the cat?

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Amazingly enough, there are more than a few examples of animals taking on Wall Street and besting them with superior returns (at least in the short-term). On this episode of Motley Fool Answers

And for the many investors out there with retirement on their minds, Alison and Bro look at five elements behind the "new normal" for retirees and what you can do to better prepare for your golden years.

A full transcript follows the video.

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This podcast was recorded on June 21, 2016.

Alison Southwick: This is Motley Fool Answers. I'm Alison Southwick and I am joined by Robert Brokamp, personal finance expert here at The Motley Fool. He's also the advisor on The Motley Fool's Rule Your Retirement newsletter. Hi, Bro.

Robert Brokamp: Hello, Alison.

Alison: Gone are the days of getting a gold watch and a stable pension when you turn 62. Your retirement is going to look way different from your parent's. In some ways that's good. In some ways, not so much.

Robert: Mmm.

Alison: So today we're going to talk about the new normal for retirement and how you can prepare for it. We're also going to tackle your question about weighted index funds and see how animals fare at picking stocks. Monkeys! We finally get to work monkeys into the show. All that and more on this week's episode of Motley Fool Answers.


Alison: Today's question comes from Chris from Northern Minnesota who, at this exact moment, is milking a cow.

Robert: Do we know that for sure?

Alison: We do know that, because Chris is a dairy farmer and he listens to Motley Fool podcasts...

Robert: Oh, that's nice. Hi, Chris!

Alison: ...while tending to his cows.

Robert: Say hi to Bessy for us.

Alison: Chris writes: "I buy individual stocks, but have been diversifying with buying a Vanguard S&P 500 ETF. I was just wondering if it would make sense to diversify that market-cap-weighted index with a fundamentally weighted index." Bro, define some terms for me, here.

Robert: Well, first of all I'd like to say to Chris that I think you're doing a very smart thing in that you're buying individual stocks but also diversifying into an index ETF. You're hedging your advisor risk, which is the risk that your retirement is riding on the investment skills of one person (in this case, you), so I think that's smart.

The S&P 500 is a market-weighted index. What that means is bigger companies have a bigger weighting. For example, if you were to put $1,000 into an S&P 500 index fund today, about $32 of that would be invested in Apple, the biggest company in the index.

Alison: Oh, OK.

Robert: The smallest company, Diamond Offshore Drilling ... you'd have a grand total of about a dime. In other words, you'd own 331x more Apple than Diamond Offshore Drilling. And this has led to some criticisms about market-weighted indexes.

First of all, the performance is really driven by the biggest 50 to 100 stocks, so it's not really as diversified as some people will say, and the performance of the small companies really have no effect. Your Diamond Offshore Drilling could double in price and your $0.10 holding is now $0.20. It's essentially meaningless.

But also, as a company's share price goes up, it has a bigger influence on the performance. It's sort of like buying a stock after it has already gone up. A big concern about that is some stocks go up way too much, and that exposes more people to these stocks when it might be time for a bubble.

For example, if you look back at 1999 at the top holdings of the S&P 500 (right before the tech bubble crash), among the top 10 stocks were Microsoft, Cisco, Lucent, Intel, America Online, and IBM. So of those top 10 stocks, only one (IBM) is worth more today than it was way back in 1999. It was the same right before the Great Recession. In 2006 among the top 10 holdings of the S&P 500 were Bank of America, Citigroup, and AIG, which then went on to lose 99% of its value. So several folks have said that we should change this and weight things differently.

One easy way to do that would be to take the 500 stocks in the S&P 500 and just put an equal amount in each of them. You can do that with a Guggenheim ETF. It's called the "Equal-Weight S&P 500 ETF."

Alison: As advertised.

Robert: As advertised. But then there are other methods where people say we should weight the index according to a company's fundamentals, like its sales. Its profits. Its dividend. These have become known as fundamental indexes.

Alison: OK.

Robert: So instead of saying, "I'm going to build an index based on the market cap of a company. I'm going to build it based on sales, so that the company with the most sales is the one that has the biggest holding." Or the biggest dividend yield. Or something like that. And one of the first ones to come out was the PowerShares FTSE RAFI US 1000.

Alison: Woo woo woo! That sounds exciting!

Robert: Exciting. It's been around for about a decade. So when you look at the performance of these -- because it is relatively new to do these sort of alternative ways to weight indexes -- they actually do outperform the S&P 500.

Why is that? Because what you're generally doing, relative to the S&P 500, is you're taking some of the money away from big companies and investing in small companies. You're also putting less money in more growth-ier types of companies and more...

Alison: Growth-ier? Is that the technical term?

Robert: That is the technical term. And putting more money into companies that are cheaper by some metric (like price-earnings ratio). Over the long term we know small caps generally beat bigger companies. Value-oriented stocks, as a group, tend to beat expensive companies.

So, I'm all for the theory of fundamental indexes. I think it's a smart idea to diversify your individual stocks into something like this. But you can accomplish something very similar by just buying a small-cap index fund or a value-oriented index fund. I wouldn't abandon the S&P 500 totally, because despite its flaws, history has shown the vast majority of mutual fund managers and the vast majority of individual investors just can't beat it.

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Alison: Chances are one of your goals is to retire, someday, and Bro is here to deliver some bummer news. It's some good news?

Robert: It's mostly bummer news, but there is some good news, and we hope to go out on a positive note about this.

Alison: Perfect. So some bummer news, but some good news about the new realities of retirement. We've got five aspects of retirement that are different from what maybe your parents or your grandparents experienced.

Robert: Right.

Alison: Let's do the first one, shall we?

Robert: Well, yes. So for a while, now, we've had a certain model of retirement. You enter the workforce at 22, retire at 62, and die at 82. But life expectancy is important.

Alison: That was very blunt. That's a short bio of Robert Brokamp, CFP. I think my description of you is longer than the bio you just did, but OK.

Robert: Well, as we'll discuss later, life expectancy is important because that's potentially the end of your retirement, and you have to make an estimate of how long your retirement's going to last. But there are five ways why the future of retirement will look different than the golden years of yore, and one of them is investment returns will likely be lower.

Alison: Aw! That's bummer news.

Robert: That is bummer news, and that's why we're all investing for our retirement and, of course, while in retirement you still will be investing. If there are going to be lower returns, that's obviously something that's important to factor into things.

Why the lower returns? Well, we talked before about how the best, although not perfect, indicator of future returns for the stock market is valuations. Right now the stock market is at least fairly valued if not overvalued.

As for bonds, the best indication of future returns is current interest rate, so you look at the long-term history of things. You always hear about how the stock market has returned 10% a year since 1926. Part of that is a 4% dividend yield. Right now we're only at 2%. That knocks out a couple of percentage points, right there, so I think it's more reasonable to expect like 6.5-7%. Looking at bonds, historical returns for long-term governments were like 5.6%. Right now they're only yielding 2.3%. So you have to assume a lower return on your portfolio.

Alison: But for how long? Like if the stock market tanks tomorrow, then are you going to be like, "Well, actually now things are looking up, but that's because we've sunk so far."

Robert: That's exactly right. Whenever financial planners or anyone look at this, they're looking at a period of like seven to 10 years, generally speaking, so even valuation, when you stretch it out to like 30 years, is not very useful. You're looking at the next decade, roughly speaking. That's number one. Investment returns are going to be lower.

Alison: So manage your expectations, there.

Robert: Right. And you have to factor in you're probably going to have to save more. The stock and bond markets are not going to bail you out.

Number two -- and this is something we all know -- is that we're going to have to expect less help from our boss and Uncle Sam. Social Security we know has issues. In terms of when the issues will likely hit people -- at least according to the recent Trustees Report -- taxes cover most of the benefits. We have to tap the trust funds a little bit, but those are going to be out in 2029. At that point, people have to expect around 70% of what they're currently promised.

I don't think it will get to that point. They're going to make a change before then, but what you have to expect is that either (a) if you're working, you're probably going to have to pay more taxes and (b) certain people will have reduced benefits either because it's means tested or you just have to wait longer to get them.

When it comes from your boss, we all know that decades ago people could generally expect some sort of help, whether it was that traditionally defined benefit pension. Even [up until] 1988 -- I found this amazing -- two-thirds of big employers provided healthcare for their retirees.

Alison: Oh, wow!

Robert: Isn't that amazing?

Alison: That's amazing.

Robert: And now it's about one-quarter, and most of those folks are government folks. So compared to what our parents experienced and even what current retirees have, you're just not going to get as much help from employers or Uncle Sam, which means the onus of it is really going to be on you to do your retirement planning.

Alison: That's another piece of bummer news.

Robert: That is another bummer.

Alison: All right, number three.

Robert: This one is just a trend in what we're comfortable with these days, and that is more debt. More people are getting near retirement or in retirement with more debt. For example, if you look at the 65-74 age range, according to the Federal Reserve, back in 1989 only about 20% of those people had a mortgage. Today it's about 40%. And not only is the percentage more, but the size of the loan is bigger, even adjusting for inflation. So we're just more comfortable going into our retirements with debt.

Transamerica did a study about what your number one priorities are or even your greatest fears in terms of your expenses and your money in retirement. Number one was just getting by, but number two was paying off credit cards and number three was paying the mortgage. So it's just become more a part of reality for people that they have this debt.

I'll definitely say that for me, personally, it is definitely my goal to have my mortgage paid off before I retire. I met with some people, recently, who have a good bit of student loans, and they're paying about 7%, but they also had a lot of cash on the side earning less than 1%. I think for a lot of people -- that saved part of your portfolio, or just money you have on the side not really earning anything -- paying off debt beforehand makes a lot of sense.

Alison: I should know the answer to this, but if I have a lot of debt and I die, does it come out of my estate? Or does anyone else have to pay my debt?

Robert: It does. So one of the jobs of your executor is to settle the claims of the estate before money is distributed to your heirs.

Alison: But what if there's not enough money in my estate to cover my debts? Then it's like, "Sorry! She died on ya!"

Robert: Yes.

Alison: So go out in a blaze of glory, is what you're telling me...

Robert: That's what I'm telling you to do.

Alison: ...if I don't want to leave anything to my daughter.

Robert: Right, exactly.

Alison: Let's get to some good news. Number four.

Robert: Here is some good news, and that is we're just living longer.

Alison: That's good news!

Robert: That is good news. So when you look back at like 1940, which is the year the first Social Security check was sent out (and it was sent out for like $23), if you made it to 65, you could expect to live another 13 or 14 years. Now, if you make it to 65, you can expect to live another 20 or 21 years, and even longer if you're married, believe it or not.

Alison: Aw!

Robert: Yeah. So people who make it to age 65 if they're a married couple -- it's about a fifty-fifty chance that one of them is going to make it to age 90. So that's great news. From a financial planning perspective, it means that that's a longer retirement. If you're going to try to retire at 62, but you're living longer and longer, that means you have to have saved a lot more while you're working.

Generally speaking, people haven't done that, so they need to work longer. That's not horrible, because you're going to live longer, as well. This leads us to the fifth thing that we're going to see as a change. It's something that just recently started to shift, and that is the average retirement age will go up.

If you look at where it was in the year 1900, for example, the average retirement age is almost laughable. It was 76.

Alison: Wow.

Robert: If you were born in that year, chances are you weren't going to make it until 50. If you made it to 65, you might make it another decade. So basically people really didn't retire...

Alison: Didn't retire.

Robert: So over the course of the 20th century, we decided to live longer. Well, we decided...

Alison: I'm making this conscious choice.

Robert: Yes, a conscious choice to live longer. But we also retired sooner to where by the year 2000, the average retirement age was 62 or 63. And that's sort of an unsustainable formula where you work less and want to retire more, because it's asking more of your working years to save more and more, and we just haven't been able to do that.

So after the Great Recession, the retirement age, after declining for decades, finally ticked up, and that trend, I think, is going to continue to a point where in the next 20 or 30 years, you're going to look at people mostly waiting until their 70s. They're going to be living longer, and that's not a horrible thing.

A study from the Center for Retirement Research found that for most people, about half would be retired at age 65 or going to have to cut back on their lifestyle. They don't have enough saved. However, if they just delay it to age 70, almost 90% of people will be fine. So a lot of this can be resolved by waiting until age 70.

Alison: And perhaps a lot of people are working longer because they enjoy their work and they're physically able to keep working. That's good news. So this could be good news or bad news?

Robert: That's what a lot of the research is indicating. People are working later, but money isn't necessarily the number one reason. And I think one of the big changes we'll see over coming decades is a whole different concept about what retirement is. Just tomorrow is the 12-year anniversary of the very first issue of Rule Your Retirement.

Alison: Oh, congratulations!

Robert: And in that issue I interviewed a guy named Mitch Anthony, who wrote a book called The New Retirementality. He pointed out that we are a binge society. We binge on education in the beginning, then we binge on work for a few decades, and then we retire and binge on leisure.

And what you're going to see over the coming decades is there being more of a mix of that -- where people will go to college and start their careers. But then maybe they'll go back to school and work part-time. Might take a year or two off as a sabbatical. Maybe once they get to their older years, they'll do a phased retirement or seasonal work.

Consider where the life expectancies could be in the future. About a year ago Time Magazine had a cover with a picture of baby. The title was "This Baby Could Live to Be 142 Years Old." When you think of living that long, retiring at 62 just isn't sustainable.

I actually find that inspiring, and one of the big messages from people like Mitch Anthony, or a group called Age Wave that does a lot of great research about this, is that society is changing to a point where it is offering more opportunities (for people who would be normally close to or in retirement) to go back to school. To do different kinds of work.

Alison: But the bottom line about the new normal for retirement is it's good. Just plan for it. What do you think? How do you want to put a bow on this? Put a bow on this.

Robert: I really do think it's this. Rather than looking at work, work, work, work, work ... reach your early to mid-sixties and then stop working ... ask yourself what it is you want to do with the rest of your life. Especially once your kids are in college and out of the house, you have more freedom. For many people that's their peak earning years, yet they don't have a lot of those financial responsibilities. They might have saved up a lot of money. It might even be in their 401(k). You can still use that money for education, or for doing something that's more rewarding for you rather than doing something that pays you the most money.

Alison: Bro, what do you want to do in your retirement? For your new retirement?

Robert: I imagine that if I'm still in this financial planning thing that I will be doing more financial planning for lower-income folks. Something along those lines. I was actually premed in college and I would not be surprised if once my kids are out of school, I go to med school and then do what my sister does in Orlando, and that is community healthcare. She works at a clinic for the working poor. I would imagine I would be doing something like that. One of those two things.

Alison: Oh, good for you. Now any answer Rick and I give will be totally shallow and self-centered.

Rick Engdahl: That's why we're not going to give any.

Alison: Yup. You're going to go save the world. Rick and I are going to go sit on a beach.

Rick: Leisure World, here we come.

Alison: Leisure World. Hello, Villages! We're on our way.


Oh, oh, oh, oh, oh. Oh, oh, oh, oh, oh, oh, oh, oh, oh, oh

Alison: It's Eurocup time, and I'm going to have Rick explain what that is.

Rick: That is the world's most popular game, played in the most popular place for it to be played, by all the most popular players.

Alison: Really? Eurocup is the most popular game in the most popular place with the most popular players? Why isn't World Cup the most popular game with the most...?

Rick: It is, of course, but it's like off year. You have the Summer and the Winter Olympics. It's kind of like that. The World Cup and then there's the Eurocup. And the Copa Amrica, which is happening here...

Robert: Yeah, I knew that.

Alison: This is so exciting. So Rick's job is to bring the excitement when it comes to talking about soccer! So yes, it is Eurocup. It's a thing. It's a big deal, apparently. You may remember that back during the 2010 World Cup, Paul the [Psychic] Octopus correctly predicted the winner of eight matches, and ever since then people have been looking for animal oracles for advice, even for the Eurocup. We have Nellie the Elephant, and a koala bear named Oobi-Oobi...

Robert: Oobi-Oobi?

Alison: ...making predictions. Isn't that a great name? So far, Nellie's gotten one right and Oobi-Oobi has not. But, whatever. So how do animals fare when it comes to stock picking? Because yes, people have made animals pick stocks.

Robert: [Laughs]

Alison: Back in 2013, I believe it was the London Observer that decided to have a cat named Orlando pick stocks against a team of professionals (stock-picking professionals and also some students). Each team invested about 5,000 into five companies from the FTSE and every few months they could exchange the stocks and replace them with others from the index.

While the professionals used decades of investing knowledge and traditional stock-picking methods, the cat selected stocks by throwing his favorite toy mouse on a grid of numbers allocated to different companies.

When it was all said and done, Orlando the cat managed to have an average return of 4.2% to end the year with about 5,500...

Robert: Nice...

Alison: ...compared to the professionals at about 5,200.

Robert: Aw...

Alison: So the cat out-invested them. But it turns out it's not just cats that are good at investing.

Robert: What other animals are good at investing, Alison?

Alison: Monkeys!

Robert: Monkeys!

Alison: But before we go into the monkeys, Bro, why would someone have monkeys do investing?

Robert: Well, when you read about this, it usually harkens back to a book that came out in 1973 by Burton Malkiel called A Random Walk Down Wall Street, and one of his arguments (and he was one of the first people to be making this argument back then) is that it's very hard to beat the market.

Alison: The quote is, "A blindfolded monkey throwing darts at a newspaper's financial pages could select a portfolio that would do just as well as one carefully selected by experts."

Robert: Right. And the theory being that it's actually hard to beat the market, and the average "expert" actually doesn't do that well. And ever since he wrote that book, various people have tried to simulate his hypothesis one way or another...

Alison: With monkeys!

Robert: With monkeys and darts.

Alison: So in 1999, it was a chimpanzee named Raven. You might remember her from Babe: Pig in the City. She threw 10 darts at a dartboard of 133 internet-related companies and she managed to outperform more than 6,000 internet and technology money managers and earned an astonishing 213% return. Remember, this was in January of 1999.

Robert: Right.

Alison: So apparently on there's a headline that said, "Chimp '99 champ! Makes monkey of Wall Street." Obviously she did very well, but then 2000 happened and after the dot-com bust, she did very poorly, leading a finance professional to say, "Any monkey with a dart can potentially make money in a rising market."

Robert: Didn't they make an index named after her? I think they called it the Monkeydex.

Alison: Yes! The picks were so impressive that they created the Monkeydex, an index based around her picks. Thrown with a dart. We also have the circus chimpanzee Lusha, who did very well in Russia. Her portfolio topped 94% of Russia's mutual funds. And then there was also a monkey name Adam Monk which I would argue is the worst name for a monkey ever. Why would you name your monkey Adam Monk?

Robert: He was very contemplative.

Alison: Eh, whatever. He worked for the Chicago Sun-Times. He's a Brazilian cinnamon-ring tail cebus monkey and he picked stocks by circling them in the newspaper with a red pen. He outperformed the indexes four years in a row, from 2003 to 2006, and he did it again in 2008 with a portfolio that only lost 14% while most money managers were losing upwards of 35%. So the bottom line -- monkeys!

Robert: Monkeys, everybody.

Alison: Not only are they fun, but they're also really good at investing. This would make me feel like maybe Malkiel was right and I shouldn't bother investing in individual stocks.

Robert: Well, not necessarily. There are other studies that show things like this. Research Affiliates did a simulation of this where they would pick random stocks that also would beat the market. And one of the conclusions they drew is actually similar to what I mentioned earlier with Answers, Answers in that part of the reason why some of these dart-throwing monkeys and other stock-picking animals do well (at least compared to the overall market) is that by chance they're randomly choosing smaller companies which historically do beat larger companies.

But it does go to show that a lot of what happens in the market, in terms of investing over the short term, is luck. I think that's one lesson about this. I actually sent this article (the one about the stock-picking cat, Orlando), to Tom Gardner, founder of The Motley Fool and CEO. I said, "Aha, isn't this pretty funny?"

And his response (and I dug it up today), was, "I find these stories kind of funny, but mostly absurd. One year tells me nothing as an investor. You put that cat up against Charlie Munger over 10 years and it will be begging for mercy."

A lot of these things are very short term, and I think any stock picker and any mutual fund manager (anyone who's managing any kind of money) will tell you that they don't know what's going to happen over the next six months to a year. So, who knows? Measuring a cat or someone over a longer period of time would be a little more interesting. Or not more interesting, but more meaningful, maybe.

Alison: And that's what we're really looking for, here.

Robert: We're looking for...

Alison: We're really looking to get some meaning behind monkey stock pickers. Rick, if you had a pet monkey, what would you name it?

Rick: In high school we had a toy monkey that was passed around between people. It had like Alice Cooper makeup and a sword in his hands. It was really scary, horror movie stuff. And it was named Zip the Monkey, and that is probably what I would name my monkey.

Robert: Zip the Monkey.

Alison: Bro, how about you?

Rick: I'd want it to get Alice Cooper makeup, too.

Alison: Yeah, absolutely. Bro?

Robert: Michael Nesmith, my favorite Monkee.

Alison: Oh, that's cute. [crosstalk 00:27:07]

Robert: Yeah, yeah.

Alison: My monkey would be named Lord Archibald Fuzzy Britches.

Rick: That, by itself, is the funniest name.

Alison: Yeah, well...

Rick: Monkey, or no.

Alison: Yeah, that's just a good name. We would have named our daughter that, had she been born a boy.

Robert: Or a monkey.

Alison: Lord Archibald Fuzzy Britches Southwick. The 1st. The first of its name.

I have no more than I did before, but now I've got all that I need, for I love you and I ... know ... you ... love ... me

Alison: All right. That's it for today, dear listeners. You can drop us a line at You can also follow us on Twitter @AnswersPodcast or join our Facebook group. The show is edited monk-i-ly... Is that a word?

Robert: Animal-istic-ally?

Alison: Ugh. By Rick Engdahl. For Robert Brokamp, I'm Alison Southwick. Stay Foolish, everybody.

Alison SouthwickRobert Brokamp, CFPfree for 30 daysconsidering a diverse range of insightsdisclosure policy