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Karen Gibbs and Geoff Colvin Karen Gibbs Geoff Colvin Geoff Colvin Karen Gibbs
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Retirement discussion, Aug. 23, 2002
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Relevant Links
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» William Sharpe profile
» How a Nobel was won
» Monte Carlo modeling
» Allocation models for retirement
» Retirement questions to ask
» Aug. 16 interview with Arthur Levitt

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GEOFF COLVIN: If you sometimes think it would take a genius to plan your retirement, we may have just the guy for you. William Sharpe is a professor at the Stanford University business school and a winner of the Nobel Prize in economics for work he did on the risks and rewards of investing in stocks. In addition, he's chairman and founder of a company called Financial Engines, which gives online investing advice to individuals. He joins us from Stanford, California. Bill, good to see you.

WILLIAM SHARPE: It's great to be here.

COLVIN: Also with us is Terry Savage, personal investing columnist, author of The Savage Truth About Money, well known to PBS viewers through appearances on The News Hour and Nightly Business Report.

And we're joined by Craig Brimhall, vice president of wealth strategies at American Express Financial Advisors. Retirement planning is something he thinks about all day, every day, and something his company advises millions of clients on every year

Terry and Craig, thank you for being here.

Bill, the work you have done would suggest that investors, what would it suggest investors do that they mostly don't do?

SHARPE: Well, I think the first thing it would suggest is that they get good, realistic forecasts of where they're likely to end up in retirement if they continue to do what they are doing. And by realistic, I mean taking into account not only the return side, but the risk, not only how good it could be, but the bad and the ugly, so that they have some realistic view of their future if they continue to do what they are now doing.

Having done that, they can begin to ask the questions: "Should I save more?" And very often the answer to that is yes. "Should I take a different amount of risk?" "Perhaps am I not diversified sufficiently," etc.

COLVIN: And is it your impression or your experience that people often are not considering the down side?

SHARPE: Yes. Unfortunately, the simplest way to make a forecast is to assume that your portfolio will give you 10 percent a year or nine, whatever the number may be, and just forecast it as if you're going to get that like clockwork every single year, and that just isn't the way markets work.

COLVIN: And what about the amount of risk? You mentioned this, but I know it's a big thing with you, the amount of risk that people assume in their total investments. What do people normally do wrong in that department?

SHARPE: Well, I think the first thing they do wrong is they don't try to understand the amount of that risk and in particular the impact of that risk on their personal situation. Having done that, having a forecast, having a procedure that allows you to see those impacts, then you can decide how much you are willing and able to take and whether you want to take more risk in the pursuit of higher long-term returns.

COLVIN: Well, of course a lot of people do decide they want to take more risk, but they could say, well, that's easy, I go out and buy shares in a biotech startup. Is that the kind of risk you're thinking of?

SHARPE: No, au contraire. One of the big messages from the kind of work that academics have done in this field for a long time is that the kind of risk for which you are likely to be rewarded in the long run is not just risk. If it were, we'd all go to Las Vegas. Rather, it's the risk of doing badly in bad times.

There's a certain basic risk in any economy or society that must be borne, and the way the markets work you can expect to be rewarded if you're willing to step up to the plate and be in a position where you will shoulder some of that risk, if the bad times come.

COLVIN: So you're talking about the risk of being in the market, simply being in the stock market.

SHARPE: Absolutely.

COLVIN: And to increase that risk, you'd put more of your assets into stocks, and to decrease it you'd simply take more of them out.

SHARPE: Without question that's the cleanest way to do it. There are nuances, but that is forthrightly the best way.

COLVIN: Yeah. Terry, Craig, let's think for a second about the effect this declining market has had on people's retirement plans. We have an example here. Just to keep it simple, we took the example -- and some of this data, by the way, comes from Bill's company, Financial Engines -- of a single female, age 52, income 65,000 a year. Her goal is to retire at age 65 with $52,000 a year, which is 80 percent of her current income. She has a 401(K). As of January 1st of 2000, it was worth $200,000.

That was about the top of the market. Invested in a broad array of investments. As of this past July 31st, even with 2+ years of contributions, it was worth only $177,000. And so if she still wants to meet that retirement goal, her options are either to save a lot more in her case, $9,750 a year more than she was or work longer, retire at 68, not 65, or reduce her goal and get along on $42,000 rather than $52,000 a year at retirement. How do people respond when you present them with that kind of reality?

TERRY SAVAGE: Well, I think that's the advantage of It's one of my favorite web sites -- I'm not affiliated with them -- but because people have had an, people haven't had retirement plans. They've had retirement dreams, and those dreams have not been well grounded in reality. So to get an actual forecast based on sophisticated computer modeling, not just a guess, not just a percentage should be here or there, or averages, which we've seen, can be very dangerous.

But to be able to go and enter your dreams, your goals, your plans, and then get an investment strategy that will give you the likelihood of reaching those goals is very important. We made 42 million Americans their own pension fund managers when we gave them 401(K)s with no training. Now it's a little late, but not too late.

COLVIN: Well, it's a great big point. And, Craig, I know you have some views on it, because there is the point of view that we have, just as you say, Terry, made people in charge of their own retirements with 401(K)s, and a lot of people simply aren't equipped.

CRAIG BRIMHALL: I would agree with that. I think it was Yogi Berra who said averages don't mean anything. If they did, you could have one foot in the oven and one foot in a bucket of ice and feel perfectly comfortable. It's the range of returns, and that's the thing I learned the most from Dr. Sharpe. I have to teach it to American Express advisers. It's the range of returns that matters.

Now volatility can be your friend while you're accumulating, if you understand the math, the dollar-cost averaging, especially if you're getting an employer match. That particular person getting the employer match right now is picking up a lot of cheap shares. But the numbers will then change on you when you retire, and volatility can be your enemy when you retire, and you probably have to look for a less volatile portfolio. So we have two different things going on there, the accumulation phase and the payout phase, and the rules will change along the way.

COLVIN: Bill, I want to ask you about this because what we're getting at is you should be invested in the market in your view, right? If you're going to invest in stocks, invest in the market presumably through an index fund, yes?

SHARPE: Yes, but first there are other issues. If you work in a high-tech firm in Silicon Valley, you may not want to put all of your investments in Silicon Valley stocks to the extent that they are present in the market. You may want to shade that back a bit. So there are personalization issues. But generally, yes, investing broadly, you know, the first big rule of investments and the second and the third, as people say, is diversify, diversify, diversify.

COLVIN: Terry, Craig, what do you think about this? Bill is a big advocate of index funds, and in particular he advocates the Russell 5000 as the broadest possible index. Do you like it?

SAVAGE: It makes it easy. You know, one of the things we've learned is that you don't have to beat the market. All you have to do is be there. The Ibbotson graphic that's so famous that shows there's never been a 20-year period, going back to the early 1920s, where you would have lost money investing in a broadly diversified portfolio of stocks and including the dividends. So you don't have to beat the market. Just being there ought to far outpace safer investments.

COLVIN: But there are a lot of people who are nearing retirement or in retirement, okay, who think, "I've got a lot less money than I had 2+ years ago, I can't afford to just match the market now, I've got to get more aggressive." What do you say to them?

BRIMHALL: The more aggressive you get, the less your likelihood of hitting your target. And so there's a problem in that. A lot of people are going to have to rethink their retirement goals. As much as we hate to say it, that's the reality. Because as we've talked about a little while ago, that irrational exuberance, we got a little bit spoiled by the 1980s and '90s by the returns we saw.

Regression to the mean being what it is, we're getting back to reality. So people need to be careful to rethink their goals. Being more aggressive just to try and make up for lost time might not be the smartest approach. It might win, but it might not.

COLVIN: So basically you, generally speaking, wouldn't advise it, right?.

BRIMHALL: Well, obviously we have to see that the person has the profile to be able to take the additional risk, but that can get you into a lot of trouble.

SAVAGE: And that's a key issue. I think you make a very good point. We used to think of retirement, we'll get to be 65 or maybe retire early at 60, and that's a kind of a concept that's changed over the last half century when people retired and lived another few years and then died. We're all now, God willing, going to live into our '90s, and you have to have a longer term horizon and you have to balance the kind of risk you can take.

It's one thing to take risk when you can keep investing and putting that $300 or $400 a month in and getting a match. It's quite another perception of risk once you stop having money to contribute. But on the other hand, even at 65 you've got another 25, 30 years. You need some exposure. And getting that balance right either requires an advisor, a sophisticated one with access, or some of these models. Financialengines is terrific...

COLVIN: But I know you have some other web resources that you like. What are they?

SAVAGE: Yeah. is one of my favorite places. But at MSN Money you can access mPower, which does a similar Monte Carlo modeling. Morningstar has Clear Future, and Fidelity has its Portfolio Planner service. They all cost a little bit, except mPower in its basic version is free, and if you're a Fidelity customer you get their Fidelity Portfolio Planner. And they're all using something beyond simple averages. They're using this Monte Carlo modeling to model history and potential outcomes to give you not a guess and not an average, but a realistic way to adjust your investing and your planning.

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