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 intriguing cover article of Financial Advisor’s October issue on what he thinks a “safe” withdrawal rate might be for a 2020 retiree.)
Is he right that 4.5% is a good bet for an initial withdrawal, or will it be below 4%, as many others have predicted? News flash: We won’t know for quite some time. But with good financial planning, it really doesn’t matter.
One thing to keep in mind with all the predictions about today’s safe withdrawal rates 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:
•That there will be a steady spending pattern in which withdrawals increase in lockstep with inflation;
•That the asset allocation will never change or that it changes on a fixed schedule;
• That there will be a fixed rebalancing schedule; and
• That the time frame will be 30 years or longer.
Steady Spending
Almost every withdrawal rate study illustrates a steady spending pattern, beginning with a specified amount that increases in lockstep with inflation assumptions 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 that either increases for cost of living by a fixed rate each year or increases in lockstep with actual inflation.
Instead, clients tend to add up their bills and then tack on a few more bucks for discretionary expenses and a few fun things like travel or gifting. 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 and the clients will give 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 advisor and professor David Blanchett describes as a spending “smile.” On average, retiree spending decreases in real terms for a time until the latter years when health-care costs increase. Despite that increase, total spending is still typically lower for the elderly than it is for younger retirees once adjusted for inflation.
I’ve seen this smile effect with my own clients. Most of them have not experienced an increase in overall real spending, even if they experience higher health-care costs. I attribute this to the fact that they have good insurance and typically stop spending money on other things as their health-care costs rise. They don’t travel or go out to eat as much, for instance.
What can stress a client’s finances is a shock event. Greg Sullivan, the president and CEO of Sullivan, Bruyette, Speros & Blayney, deftly outlined a variety of these shocks, including the need to support 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 through retirement.
Many of my clients, in fact, have maintained the same allocation through retirement. The most common way they change it is by getting 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 that 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, however, can be problematic. A shift that comes too early in a long retirement, is too severe (such as a move to 100% Treasurys), or is made out of panic—these things can all cause a portfolio to be at risk of exhaustion or cause a severe reduction in cash flow.