The best way for retirees to navigate the current economic climate, which includes dips in the economy coupled with high inflation, is to have a flexible distribution plan and investment savings portfolio, according to experts.

The economy has been undergoing significant volatility this year, with equities failing to provide the performance investors are searching for. The Morningstar U.S. Market Index is down 24.9% so far in 2022. Normally, investors rely on bonds to bail a portfolio out when equities are down. But that has not been the case this year, as the Morningstar U.S. Core Bond index had fallen by more than 14% by the end of the third quarter.

Speaking on a panel Tuesday at the “Investing in Inflationary Times,” webinar sponsored by Financial Advisor and MoneyShow, Christine Benz, director of personal financial at Morningstar, highlighted the difficulties retirees are having in determining their spending amounts.

“It has been a tough environment, especially for retirees,” she said. “Complicating things is we have had this big inflation shock.”

This one-two combination has made it difficult for retirees to react. In the past, when the economy faltered, the standard recommendation to retirees was to spend less, Benz said. However, with the soaring inflation numbers, the cost for everyday items has ballooned, making it difficult for anyone to curb spending, much less retirees.

As the S&P 500 has declined this year, advisors have had to rethink their strategies in dealing with sequence risk—the specific damage done to withdrawal plans when markets fall right after a person retires. Advisors have traditionally recommended that retirees withdraw money at a 4% rate from their investment funds. But Benz said that number is not realistic.

“When we look at the data, people don’t really spend that way, and we all know from our own lives that our spending tends to be lumpy from year to year,” she said.

Jamie Hopkins, director of retirement planning at the Carson Group in Omaha, Neb., also spoke on the panel and agreed that the 4% rule was good as a discussion point in academia but otherwise wasn’t practical in the real world. His firm takes a more holistic approach and treats spending as an evolving equation. 

“We use a more dynamic approach that tracks a person’s actual spending and where they will be over time,” he said.

Morningstar also uses a series of different dynamic withdrawal strategies. Even when there are minor tweaks to a strategy, it can significantly elevate the starting safe withdrawal rate, Benz said. Morningstar favors a guardrail approach that calibrates withdrawals based on what is going on in a person’s portfolio.

“We examined a whole host of flexible or dynamic strategies,” she said. “The guardrail does stand out as one that we really like that does help preserve a retiree’s quality of life while also giving them the opportunity or permission to spend as much as they can throughout the whole drawdown cycle.”

Another option is bucketing, which the Carson Group has used. This is a retirement strategy in which assets are divided into three categories—or buckets. The first is for short-term expenses and includes more conservative investment vehicles such as short-term bonds, savings accounts and certificates of deposit.

The second is an intermediate bucket, which uses longer-term bonds and real estate investments. The final one is a longer-term bucket. It contains riskier investment vehicles such as stocks, cryptocurrency, private equity funds and hedge funds.

“We do use bucketing a lot,” Hopkins said, “in the sense that we like to time-segment things out, which I do think gives people a bit more permission to spend earlier in retirement when they’re going to get more enjoyment out of it.”

Bucketing is a popular strategy among advisors like Harold Evensky. Benz said she has spoken on the matter with the well-known founder of the Coral Gables, Fla.-based Evensky & Katz/Foldes Wealth Management.

To provide ongoing liquidity, Evensky told Benz he includes a cash bucket with a total return portfolio. This way his clients can continue to support their lifestyle regardless of hiccups in the market.

“All the things that constituted quality of life for his clients was preserved by having that cash bucket alongside the total return portfolio,” Benz said.

Even if advisors shy away from the bucketing strategy in practice, Benz said it is an ideal teaching tool to demonstrate topics like asset allocation.

One other area that has been on the minds of retirees, though it’s been neglected, is the subject of cash, Hopkins said. He said advisors need to get smarter about how they deal with it as an investment. Investors and advisors can no longer be content sitting on cash with their custodian, since they could be giving up 1% to 3% in returns.

“When we’re thinking about a world where inflation feels higher, withdrawal rates might be coming down, if we’re holding one to two years of cash in a very ineffective way, we’re giving up a lot of yield there,” he said.