W. Scott Simon
I thought that I’d kick off the new year by discussing two disparate subjects–neither of which merits coverage in its own column, but both of which I believe are of importance to advisors. The first is Bernie Madoff, who was in the news last month as we marked the 10-year anniversary of his arrest for securities fraud. The second subject is one which a colleague first brought to my attention years ago: the double-barreled benefit achieved by working longer.
Let’s Not Forget: Bernie Madoff Was a Broker/Dealer
The former chairman of the Securities Industry and Financial Markets Association (the trade association for the securities industry) wrote an article recently entitled “Let’s Not Forget–Bernie Madoff was a Fiduciary.” That’s right–Madoff, mastermind of the greatest Ponzi scheme in history–was an RIA fiduciary subject to the Investment Advisers Act of 1940 (’40 Act) for just over two years from Sept. 12, 2006, to Dec.11, 2008. (On Aug. 10, 2006, Madoff agreed to the SEC’s requirement that, because he was engaged in providing discretionary asset management, he register as an investment adviser.)
However, the two-year life of his RIA–Bernard L. Madoff Investment Securities LLC–was preceded by the 48-year life of his broker/dealer of the same name. Yes, Madoff operated solely as a broker/dealer for all but two years–the last two years–of the nearly half-century that he was in the investment business beginning in 1960 and ending in 2008. As such, Madoff was a dually registered (hybrid) broker/dealer and Registered Investment Adviser for just over two years.
According to the Dec. 11, 2008 press release issued by the Securities and Exchange Commission in which it announced that Madoff and his firm were being charged with securities fraud, Madoff had been a “prominent member of the securities industry throughout his career.”
Specifically, Madoff served as vice chairman of the National Association of Securities Dealers. The NASD, a self-regulatory organization, was charged with operating and regulating the NASDAQ stock market and over-the-counter market. NASD merged in 2007 with portions of the New York Stock Exchange to form the Financial Industry Regulatory Authority, a private corporation that acts as a SRO with regulatory oversight over securities firms doing business in the public securities markets.
Madoff was also a member of the NASD’s board of governors and chairman of its New York region. In addition, he was a member of the NASDAQ Stock Market’s board of governors and its executive committee, and served as chairman of its trading committee.
In his article, the former SIFMA chairman points out that Madoff didn’t use a custodian, but simply held client assets in a bank account over which he had sole control. Statements were sent by Madoff directly to his clients; there was no intervening source, such as an independent custodian from whom clients could get accurate (not to mention honest) information about things like the value of assets held and the performances they achieved.
This was rectified in 2009 by the SEC’s adoption of custody rules that govern RIAs (see Custody of Funds or Securities of Clients by Investment Advisers, Release No. IA-2968 (Dec. 30, 2009)) to ensure that investors’ assets are held safely. In 2013, the SEC also adopted custody rules for broker/dealers (see Broker Dealer Reports, Release No. 34-70073 (July 30, 2013)).
Since Madoff was solely a broker/dealer for 46 of his 48 years in the securities business–during which time he may have been conducting his nefarious activities clear back to the early 1960s–the RIA custody rules would not have been a countervailing factor, since they weren’t adopted until 2009. Further, RIAs usually don’t have physical custody of their clients’ assets, unlike broker/dealers (and banks).
Pure and simple, Madoff was part and parcel of the broker/dealer world from the very get-go, not the RIA world. The broker/dealer world is the arena in which he carried out his infamous, long-running felonies.
Anyone implying otherwise by associating the word fiduciary with Madoff’s crimes has little (or no) understanding of the fiduciary world. At a minimum, such inferences could easily be construed as spreading misleading information.
The Power of Working Longer
For some, it may be surprising to realize that an investor with a $1 million portfolio who, in retirement, withdraws 4% annually generates income of $40,000. The numbers here are few and simple to compute. Nonetheless, some of those finding themselves in this fortunate circumstance may stop to think: I’m a bloody millionaire and all I get in retirement is a lousy $3,333 per month? $1 million versus $3,333 per month–psychologically, these numbers just don’t seem to add up.
In comparison, a retiree who was a higher income earner when working may be entitled to, say, $3,000 per month from Social Security (admittedly, likely having to wait until age 70 before claiming Social Security and working until then or living off non-Social Security savings until then), or $36,000 per year.
While these examples may demonstrate the surprising “deal” that Social Security can be, it’s even better for lower income earners because, in retirement, Social Security replaces a higher proportion of their income than higher earners.
All this was brought to mind when I began reading a paper, “The Power of Working Longer’ that was issued in 2017 by, among others, John B. Shoven at Stanford. (In my 1998 book, Index Mutual Funds: Profiting from an Investment Revolution, I cited a number of academic studies by Shoven and found them to be unusually illuminating.)
This paper looks at the relative importance of working longer compared to saving more prior to retirement in order to determine which factor has greater influence on increasing retirement income. The paper’s abstract describes its basic finding: “delaying retirement by 3-6 months has the same impact on the retirement standard of living as saving an additional one-percentage point of labor earnings for 30 years. The relative power of saving more is even lower if the decision to increase saving is made later in the work life. For instance, increasing retirement saving by one percentage point ten years before retirement has the same impact on the sustainable retirement standard of living as working a single month longer.”
In short, the longer that retirement is delayed, the greater the amount that can be saved prior to retirement and the less time necessary to finance retirement. More expansively, applying this double- barreled benefit of working longer favorably impacts the standard of living in retirement for a number of reasons: (1) delaying the receipt of Social Security generates higher monthly benefits (topping out at age 70, at which point it makes no sense to keep delaying), (2) working longer generates additional contributions to retirement accounts, and (3) delaying withdrawals from retirement accounts results in added compounding of already-existing account balances.
Lower income workers benefit the most from working longer. Such workers, however, may more likely be employed in physically demanding jobs. This may lead some to claim Social Security benefits at the earliest possible age–62–but, as a result, their benefits are significantly reduced. (Almost 50% of retired Social Security recipients claim their benefits at age 62.)
In my view, it’s still best to save as much as possible in order to get the favorable effects of long-term compounding working on those savings as soon as possible. Life is full of surprises, such as unforeseen personal medical problems or the systemic “failure” of Social Security. (Social Security actuaries calculate that the system will be broken by 2034, a mere 15 years from now. That doesn’t mean, however, that recipients will no longer receive any benefits; rather, based on current calculations, they will receive about 79% of their promised benefits because the system will have run through its reserves. Workers will still be paying into the system, though.)
It’s always better to have more assets rather than fewer to counter these and other unforeseen risks. This approach doesn’t mean investors should save, say, 36% of their income while living in a cave and eating beans. Although some may prefer to live that way, most desire a more balanced lifestyle. And it doesn’t mean that workers, especially those in physically demanding jobs, should work themselves to the bone until age 70 in order to claim the highest amount of Social Security benefits available to them.
It does mean, however, that savers (such as participants in retirement plans) should take a moment and see if they can contribute an extra 1%, 3%, or 5%–or whatever–without crimping their current lifestyles. Doing so will help give them, over the long run, more assets that will provide greater freedom to decide just how long (or how short) they wish to work before retiring.
W. Scott Simon is an expert on the Uniform Prudent Investor Act, Restatement (Third) of Trusts and Title I of ERISA. He provides services as a consultant and expert witness on fiduciary investment issues in depositions, arbitrations and trials as well as in written opinions. Simon is the author of two books including The Prudent Investor Act: A Guide to Understanding. He is a member of the State Bar of California, a Certified Financial Planner® and an Accredited Investment Fiduciary Analyst™. Simon received the 2012 Tamar Frankel Fiduciary of the Year Award for his “contributions to advancing the vital role of the fiduciary standard to investors, capital markets and to society.” The author’s views expressed in this article do not necessarily reflect the views of Morningstar.