By Mark Hulbert
Published:
Sept 15, 2019 10:35 a.m. ET
New research explores
various retirement spending strategies
Do you expect to spend
the same amount in each and every year in retirement?
Of course not. Yet many
financial plans nevertheless assume that you will. The famous 4% rule, for
example, grew out of research about what steady withdrawal rate you could
maintain throughout retirement and never run out of money—even if the markets
perform as terribly as they have in the worst periods in U.S. history.
By definition, of course,
avoiding the worst-case scenario ends up, in most cases, leaving a lot of money
on the table. New research shows that there is a better way.
This new research, which
began circulating in academic circles earlier this month, was conducted by
Javier Estrada, a professor of finance at IESE Business School in Barcelona.
His new study is entitled: “Managing to Target (II): Dynamic Adjustments for
Retirement Strategies.”
In it, Estrada measured
the success rates of various strategies that adjusted withdrawal rates
depending on whether your portfolio in any given year is ahead or behind of
what your retirement financial plan had assumed it should be. It will be ahead,
needless to say, if your investments perform better than had been assumed by
your financial plan—and behind if your investments have performed more poorly.
Estrada refers to
strategies that adjusted withdrawal rates as “dynamic,” in contrast to the
“static” strategy implicitly assumed by many financial planners.
To illustrate: Let’s say
you retire with a $1 million portfolio, want to fund a 30-year retirement, and
your investments grow at an annualized rate of 5% above inflation. Assuming you
do not intend to leave a bequest, and assuming your portfolio’s investment
return is 5% in each year along the way, you can withdraw the equivalent of
$61,954 in today’s dollars in each and every one of those 30 years.
In fact, of course, that
italicized assumption is unrealistic. Given the inevitable variability of
yearly returns along the way—some good and some bad, it’s not unlikely that, at
some point along the way, your portfolio’s performance would be insufficient to
support that rate of steady withdrawals. You’d run out of money, in other
words.
Estrada wanted to know if
it would be a better idea, at the first sign of trouble, to temporarily reduce
your withdrawals—rather than wait until your portfolio is completely depleted.
He found that doing that significantly increased the likelihood of achieving
your retirement financing goals. And increasing your chances of success didn’t
require overwhelmingly large adjustments. Even reducing your withdrawals by 10%
or 20% had a significant impact—meaning, in the above example, that your annual
withdrawal would be no lower than $55,759 or $49,563 (for a 10% or 20%
temporary reduction, respectively).
You might find such a
reduction intolerable, of course. But bear in mind several things. First, the
required reduction wouldn’t come as an immediate surprise, since it would be
obvious nearing the end of a particular year that your portfolio was falling
short—giving you time to plan for the reduction. Secondly, there aren’t any
great alternatives when your retirement portfolio falls short. Not reducing your
withdrawals only postpones your pain, since eventually you will have to reduce
your spending.
Thirdly, the dynamic
strategies Estrada explored also allow for increased withdrawals following
years in which your retirement portfolio is ahead of its targeted value. There
is no requirement that you spend that extra amount, of course, and you could
put it in a rainy-day fund to support you in those years in which withdrawals
are lower.
Estrada also explored
another type of dynamic retirement financing strategy, which involved adjusting
your equity allocation according to whether your retirement portfolio is ahead
or behind its targeted value. Though he found that these strategies also
helped, they were not nearly as helpful as those dynamic strategies that adjusted
withdrawal rates.
Estrada’s new study
complements an earlier one that focused on strategies during the preretirement
phase of your life when you’re saving and investing. You may recall that I devoted
another column to that earlier study, which also found that
dynamic strategies are superior to static ones: A willingness to adjust the
amount you save and invest, depending on the performance of your portfolio,
increases the chances you will achieve whatever goal you have set for how big
you portfolio should be when you retire.
This new study extends
that conclusion, allowing us to conclude generally that being dynamic—a
willingness to adjust investment or withdrawal amounts—increases your chances
of reaching your goals.
The even broader
implication is that the world is profoundly uncertain, and no amount of good
planning can possibly deal with ever eventuality. So it behooves all of us to
plan for flexibility.
Mark Hulbert is a regular
contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a
flat fee to be audited. Hulbert can be reached at mark@hulbertratings.com.
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