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.

A 2014 study conducted by Michael Kitces, the head of planning strategy at Buckingham Wealth Partners and publisher of the Nerd’s Eye View blog, and Wade Pfau, professor of retirement income at the American College, showed some benefit to increasing equity allocations through retirement. For instance, at a 4% initial withdrawal rate, holding on to a portfolio with a 60/40 allocation to stocks and bonds through retirement resulted in a 93% success rate. An even better success rate of 95% could be achieved, however, by starting the portfolio at 30% equities and increasing that allocation by a percentage point annually until it reached 60% after 30 years.

Similar patterns resulted from most balanced portfolio mixes. Unfortunately, Kitces and Pfau’s research also noted that a rising equity glide path was consistently inferior to a static allocation in many scenarios that used lower-than-historical returns or a higher initial withdrawal rate (of 5%).

Steady Rebalancing
Withdrawal studies typically use a portfolio rebalancing strategy based on the calendar. I see three conflicts with this assumption. One is academic, one is practical and one is behavioral.

The academic objection arises from the studies suggesting that rebalancing quarterly, semiannually or annually is not optimal. It’s more effective to set the rebalancing around tolerance bands guided by the funds’ original weightings (according to the work of researchers Gobind Daryanani of iRebal TD Ameritrade and Marlena Lee of Dimensional Fund Advisors).

In practice, it makes little sense to incur the costs associated with rebalancing simply for the sake of trading on a certain date. This is especially true for taxable accounts, where the tax costs can be quite high, especially over time, as assets tend to appreciate. As a result, many practitioners employ a tolerance band methodology or use their judgment to override the calendar’s prompt.

The behavioral problem is that when markets sink, many clients will balk at rebalancing because that means buying more stock. In their minds, they are buying more of the very thing that is causing them stress. Mathematically, this can be a problem because a portfolio that is not rebalanced will tend to not recover as fully as a rebalanced portfolio once markets turn up. If clients don’t rebalance in a disciplined way, their odds of success decrease.

Longevity
Most of your clients will not need money for 30 years. Most life expectancy tables show that for a married couple, both of whom are 65 years old, there’s a probability of almost 20% that one will live 30 years. Of course, traditional financial planning clients are not average. They are generally of above-average means and educated, both factors highly correlated to above-average life spans.

Mortality tables used in pricing annuity products provide some insight. The people purchasing the contracts must be confident they will live an extended life, and the insurance companies depend on this confidence and adjust for adverse selection. Most of these tables tag the probability of one of the 65-year-old spouses surviving to age 95 at near 40%.

Almost every client I have ever worked with cited a long, healthy life span as an explicit goal. It is a bit unnatural to plan to "fail" on that account, but failure is the likely result for most clients.

We are rightly concerned about clients spending too much and running out of money in their lifetimes, but there is a price to pay for being too conservative, too. For retirees, that price is a retirement doing less than they could have. The more conservative they are about their assumptions, the greater the odds that they will be giving their heirs the ability to do more financially because they did less. That might be the approach they want, but they should choose it based on good information, not statistics that make something good (a long life) sound like something bad.

Using Safe Withdrawal Studies Wisely
The flaws in these assumptions do not render the studies useless. Far from it. The body of work around the subject gives us a framework for discussion and planning. I have found that by explaining the basic framework, results and flaws in the assumptions in these studies that clients can more easily understand the choices they have now and the ones they will likely face. What causes problems? How will we spot them? When do those problems warrant a change? What changes should be made?

Not much can be guaranteed in life other than that it’s full of changes. If you know one might happen and what can be done when it does, a change can be far less scary. Rather than relying on predictions, rely on the ongoing and dynamic process of financial planning.         

Dan Moisand, CFP, practices in Melbourne, Fla. You can reach him at [email protected].