How about Bill Bengen? Twenty-six years after publishing the paper that launched a slew of research on withdrawal rates and portfolio sustainability, the “retired” financial planner is giving us new things to think about. If you haven’t already, check out the cover article of Financial Advisor’s October issue on what he thinks a “safe” withdrawal rate might be for a 2020 retiree. You can also look for a longer piece in an upcoming Journal of Financial Planning and a book on how he would apply the research in advising clients.
Is he right that 4.5% is a good bet for an initial withdrawal or will it be below 4% as many other have predicted? News flash, we won’t know for quite some time. With good financial planning, it really doesn’t matter.
One thing to keep in mind with all the predictions about today’s safe withdrawal rate is that the studies make key assumptions upon which most of the models are built. They typically assume a few things that are both reasonable yet deeply flawed:
• A steady spending pattern in which withdrawals increase in lock step with inflation
• An asset allocation that never changes or changes on a fixed schedule
• A fixed rebalancing schedule
• A 30-year or longer time frame
Steady Spending
Almost every withdrawal rate study illustrates a steady spending pattern beginning with a specified amount that is increased in lockstep with an inflation assumption throughout retirement. Such a pattern is reasonable for these studies but in the three decades I have been a financial planner, I have yet to see a client begin retirement with a specified spending amount and either increase that amount each year by a fixed rate to compensate for cost of living increases or increase the spending amount in lockstep with the actual inflation rate.
Instead, clients tend to add up their bills, tack on a few more bucks for discretionary expenses and few fun things like travel or gifting, and if their pension and Social Security payments don't cover these costs, they pull the difference from their assets. Most of the time, the withdrawals will be identical year to year with no real thought about inflation. An increase occurs typically only when clients begin to feel the effects of rising costs. More often than not, as they age, they decrease withdrawals.
This spending jibes with what David Blanchett, CFP, CFA, described as a spending “smile.” On average, retiree spending decreases in real terms for a time until the latter years when health-care costs can increase. Despite the increase, total spending is still typically lower for the elderly than younger retirees once adjusted for inflation.
Anecdotally, at least with my clients, this smile effect is observed. Most of my clients have not experienced an increase in overall real spending even if they experience higher health care costs. I attribute this to the fact that my clients have good insurance and that they typically stop spending money on other things as health-care costs rise. They don’t travel or go out to eat as much, for instance.
The primary exception that stresses a client’s finances is a shock event. Greg Sullivan deftly outlined a variety of these such as supporting descendants and gray divorce in his book, Retirement Fail: The 9 Reasons People Flunk Post-Work Life and How to Ace Your Own.
Steady Asset Allocation
Virtually all withdrawal rate studies show clearly that avoiding stocks entirely through retirement is not likely to produce an acceptable spending level for a long period of time. Therefore, most retirees will own some stocks in their portfolios. The studies usually assume that the ratio of equities to fixed income does not change throughout retirement.
Many of my clients have in fact maintained the same allocation throughout retirement. The most common way clients change their allocation is they get more conservative over time. They get to a point, usually at an advanced age, where preservation becomes a higher priority than growth. This change should not endanger their cash flow sustainability because they recognize they have enough money and are opting for less excitement from the financial markets. The decrease does not come on a schedule.
Some shifts to conservatism can be problematic. A shift that comes too early in a long retirement, is too severe (such as 100% treasuries), or is made out of panic can all cause a portfolio to be at risk of exhaustion or cause a severe reduction in cash flow.