Withdrawal Strategies for Retirees

Christine Benz: Hi, I'm Christine Benz for Morningstar. In an era of ultra-low yields, many retirees struggle with how to generate cash flows from their portfolios without taking too much out. Joining me to discuss some strategies for doing that is Colleen Jaconetti. She's a senior investment analyst in Vanguard's Investment Strategy Group.

Colleen, thank you so much for being here.

Colleen Jaconetti: Happy to. Thank you.

Benz: So, I want to talk about some of the strategies that retirees might use to extract cash flows from their portfolios. Let's start with the one that is probably familiar to a lot of our viewers. This is the idea of taking a percentage withdrawal and then taking that dollar amount and just inflation-adjusting that in the years after that. Let's talk about some of the benefits of that strategy.

Jaconetti: Sure. I mean, the main benefit of that is it's a known, stable income stream, right? So, each year you know you're taking out that amount, say, plus inflation, so you can really budget around what your expenses are.

Benz: So, if you start with that 4% withdrawal initially, then give yourself an inflation adjustment--that's the Bill Bengen research that points to that being sustainable over a 25- or 30-year period, assuming that you've got a balanced portfolio. In terms of drawbacks of that strategy, one is that it doesn't adjust at all for market performance.

Jaconetti: Correct. So, the problem is, it ignores market performance. And what can happen there is that if the markets are doing well, you can actually underspend. So, that is actually a drawback, because people might be able to have a more fruitful retirement. But then, also what if the markets are underperforming? And if they're underperforming and you continue to just spend the portfolio, ignoring the fact that your portfolio is going down, you could end up spending well more than 4% each year and then run out of money prematurely.

Benz: So, another strategy that someone might be considering would be to just take a static percentage, hold that steady from year-to-year. And the big advantage of that is that you are tethering your withdrawals to what's going on in your portfolio. If you're taking 5% out, year in and year out, that's going to make you very sensitive to market performance.

Jaconetti: Exactly. So, that sensitivity also brings in fluctuations in spending. So, some retirees maybe have a fixed budget or a higher amount of expenses that are fixed. So, sometimes it's hard for them when they don't know if their income is going to be up 5,000 or down 5,000 or 10,000 in a given year. So, the lack of stability in the spending can cause problems for some retirees.

Benz: Right. So, let's talk about another strategy that you and your colleagues have written about. And this is the idea of using a fixed percentage as a baseline but then giving yourself a little bit of a ceiling and floor on those withdrawals. So, in a bad market environment, you won't take less than X and in a really good environment, you won't take more than Y. Let's talk about the benefits of doing a strategy like that.

Jaconetti: Yeah. I mean, I think one of the big benefits is, actually, it's very intuitive for investors. It's kind of what people do. If the markets are doing well, sometimes they take an extra vacation, or they do something. If the markets are not doing well, sometimes they consider spending a little bit less. So, it's intuitive for investors. But then also adding a ceiling and floor actually when the market is up, you actually reinvest a little bit of the extra. So, if the market is up, say, 10%, and you only increase your spending by 5%, that extra 5% gets reinvested in the portfolio, so that if the market is down in the future, you don't have to take your spending down as much. So, you're, kind of, putting a band around the volatility in your spending so that you can have some sort of stability or known year-to-year spending ranges.

Benz: And your research really points to that sort of strategy as kind of striking a happy balance where you are plugging into what's going on in the market, you're not ignoring it, but you're also giving yourself a little bit of stability in cash flows, which I think, in talking to retirees, it's what retirees really want.

Jaconetti: Definitely. Yes.

Benz: So, another factor in the mix is just trajectory of spending. There's been some research about this topic that retirees tend to spend less as their retirements go on. How should retirees think about that?

Jaconetti: Yeah. So, I mean, I think that it's so varied because everyone is so unique and individual. But in general, a lot of retirees maybe from the time they retire until their mid-70s, say, maybe their discretionary spending is higher. So, they maybe go vacations or golfing or out to eat more, and then sometimes they start to slow down a little bit. So, they may voluntarily decide to spend less. And this is where I just caution people, you may be spending less on discretionary things, but you actually may have some more health-type considerations to come in. So, we definitely see in here that there is a reduction in spending, but we're not always sure: Is it because people want to do less or they're a little bit concerned and kind of holding back on spending in case they should have some sort of health event or live longer, so they want to keep a little bit of their money for longer-term expenses.

Benz: Right, right. Lots of different variables to get our heads around. Colleen, thank you so much for being here to shed some light on them.

Jaconetti: Yeah, thanks for having me. Appreciate it.

Benz: Thanks for watching. I'm Christine Benz from Morningstar.com.