How To Not Outlive Your Money

Must-Know Number Five: Consider a Variable Strategy

Christine Benz: We examined a variety of different flexible strategies. You could use a simple fixed percentage each year. In fact, I sometimes encounter retirees who tell me that they’re taking just 3% or 4% of their portfolio each year regardless of what their portfolio’s value is. The big trade-off, of course, with a strategy like that is that your cash flow is buffeted around a lot by whatever is going on with your portfolio. So, my view is that such a strategy would tend to be best for people who have a lot of nonportfolio income sources, so where they have a pension or where Social Security is meeting most of their income needs, and they’re just using their portfolio for extras. Such a strategy would only be appropriate in those situations.

There are refinements to that basic fixed percentage strategy, which we explored in our paper. One would be to use an RMD-type method, a required minimum distribution type method. The basic idea is that you are looking at your portfolio’s balance per year, but you’re adjusting your withdrawals based on life expectancy. And those are really the two key variables that you’d want to bear in mind if you’re making any sort of adjustment to your withdrawal rates.

We examined a pure required minimum distribution system in our research. We also looked at the guardrails system, which was developed by financial planner Jonathan Guyton and computer scientist William Klinger. The guardrails is a system that in our 2022 research and in our 2021 research showed itself to be a really good system in terms of delivering the highest lifetime withdrawals, especially for equity-heavy portfolios.

You can also just make simple tweaks to a fixed real withdrawal system. One system that I like for people who are looking for simplicity is simply to forgo the inflation adjustment in the year following a year in which the portfolio has lost value. So, coming out of a 2022, for example, if you’re going for a strategy like this, the trade-off would be that in 2023, you would not be able to take an inflation adjustment based on what happened in the market last year. That illustrates the potential trade-off of that strategy. But it’s certainly a simple system, and in many market environments, where we see portfolios going down, especially equity portfolios going down, that’s because we’re in some sort of a recessionary environment when inflation is pretty mild. In other market environments, that may not be the case.

Variable Methods Entail Trade-Offs

Just a quick look at some of the trade-offs that these variable strategies might entail. This is a look at safe withdrawal rates. So, that’s what we’re seeing on the vertical axis, and then the horizontal axis is the standard deviation of these various withdrawal systems. So, you can see at the far right that is a system of taking required minimum distributions that, because it is so tethered to portfolio balance, means that you have to be willing to put up with a lot of volatility in your cash flows. Again, might be appropriate for people with a lot of nonportfolio sources of income but might not be appropriate for folks who are taking most of their cash flow needs from their portfolio.

The guardrails is that goldish-yellow dot. You can see that it shows well in terms of lifting portfolio withdrawals, lifting starting safe withdrawal amounts, and also is a little lower on the standard deviation scale than that RMD system. And then, clustered over there on the left-hand side of the screen would be more-modest adjustments. So, we have the fixed real withdrawal system and a couple of other related systems on the left-hand side of the slide. You can see that those systems do help elevate starting withdrawals a little bit, so the system of forgoing inflation, for example, or taking a 10% reduction after the portfolio has had a loss, those elevate starting withdrawals a little bit, and they do so without incurring substantial volatility in terms of the retiree’s cash flows.

Lifetime Withdrawals Are Higher for Some

This slide illustrates the lifetime withdrawals for the various systems. You can see that the RMD system, the required minimum distribution style system, which we talked about how volatile it is in terms of cash flows, actually delivered the highest lifetime withdrawal, and that’s because an RMD-type system gets you spending your portfolio. You’re spending more in good years, and that tends to ensure that you consume your portfolio over your time horizon. Other systems—the fixed real withdrawal system, for example—you can see led to the lowest lifetime withdrawal amount, along with the system of taking the inflation haircut. So, you can see that there are some trade-offs with these various systems.

But Paydays Can Be More Volatile

This slide illustrates the volatility of paydays, which we talked about, that some of the systems lead you to a very stable sort of paycheck equivalent, whereas others would have more volatility in their cash flows. And again, I think it comes down to how much of your cash flow needs are coming from nonportfolio sources. If a lot of your cash flow needs are coming from nonportfolio sources, you’re probably more comfortable exploring some of these more dynamic and variable systems.

And Ending Balances Can Be Lower

Finally, I wanted to touch on how ending balances fit into all of this, how residual balances at the end of that 30-year time horizon that we modeled in might change depending on the system. What you can see is that that fixed real system that has become a convention in retirement planning circles tends to lead to very heavy residual balances in a lot of instances, and that’s especially true with portfolios with large allocations to equities. On the other hand, an RMD-style system, for example, gets you to consume more of your portfolio and all but ensures that there’s less of that portfolio in place at the end of that 30-year time horizon. So, again, this is a very personal consideration whether you want to leave assets for heirs or charity or whatever the case might be, or whether your goal is to maximize your own consumption. It really comes down to your own vision for your retirement plan. But this is another one of the trade-offs that we think it’s important to think about and explore before settling on your own withdrawal rate system.

Watch “5 Must-Knows About In-Retirement Spending” for the full webcast from Christine Benz.