How to Enjoy Retirement Without Going Broke – A Policy-Based Response
Peter Coy’s post in the Opinion section of the New York Times titled “How to Enjoy Retirement Without Going Broke” opens with a quote from William Sharpe, Nobel laureate and famous economist, who describes the puzzle of figuring out how much a retiree can spend as “the nastiest, hardest problem [he’s] ever looked at.” While we agree that it is often times the most significant planning item in our Clients’ plan, we think the policy-based approach we take to helping our Clients spend sustainably in retirement offers a straight-forward solution.
We’ve written about our Safe-Spending Policies before, and as we read Coy’s post, we began formulating our own responses to the questions he posited in his article. We’ve copied his questions below (in bold) and offered our own answers.
Do you keep your spending steady and allow the assets in your portfolio to fluctuate, or do you do the opposite – keep your portfolio steady and allow your spending to fluctuate?
To this question, we respond with our own question – why not try a blended approach? Our Safe-Spending Policies anchor our Clients to a baseline Initial Withdrawal Rate (usually about 5% of their portfolio balance). That withdrawal rate is determined by the market valuations at the beginning of their spending path and the percentage of stocks in their portfolio: if stocks are relatively cheap at the outset, the initial rate is higher (and vice versa); if the Client’s portfolio is invested more aggressively (read: more stocks), the initial rate is higher (and, again, vice versa).
Although the Initial Withdrawal Rate operates as an anchor, it’s not a static target. Each year, we assess how the portfolio has performed to determine whether the target spending rate still fits given the new portfolio balance:
- Assuming the portfolio had a positive return, the spending rate is increased by the inflation rate over the past 12 months.
- If the portfolio performed exceptionally well, we may adjust the spending target up by 10%.
- Likewise, if the markets dealt the portfolio an especially rough hand in a given year, we might adjust the spending target down by 10%.
Note, however, that although the spending target can be adjusted from year to year given market fluctuations, it can’t shrink by more than 10% when we do our analysis each January. As such, we encourage our retired Clients to build a lifestyle that fits comfortably within their Initial Withdrawal Target, such that if the spending target had to be adjusted downward they wouldn’t even feel the pinch. And that aligns with Coy’s comments, as he says to “try to keep your lifestyle fairly stable, but bow to reality and cut back at least a bit in years when your portfolio is down.” We’re able to provide confidence and clarity with our system, as the decision rules that feed the aforementioned spending adjustments are rooted in robust research. And we’ve found that our Clients derive comfort in knowing that there are guardrails that keep their spending level on a sustainable path in an uncertain (and sometimes chaotic) world.
Do you keep a big nest egg, or do you convert your savings into a stream of monthly checks?
Again, our reaction is: why not a little bit of both? Our approach allows Clients to recreate the feeling of receiving a paycheck in that we establish an explicit spending target that can be used to fund distributions on whatever cadence feels right. Want to get paid once a month? Easy, we just set up recurring transfers on the day of their choice. Prefer to get your money on the 1st and 15th? We can make that revision at the push of a button. Oh, you used to get paid every other Friday? Say no more – we can make that happen.
And yet something our approach does not force our Clients to do is to actually annuitize their portfolio. So, our Clients get the benefit of a stable stream of income without having to lock themselves into an annuity with high internal expenses and low transparency regarding the underlying investments. It’s the best of both worlds, enabling them to keep their options open and maximize their flexibility while knowing their retirement “paycheck” will show up like clockwork on the schedule of their choosing.
How much risk do you take?
In a word: enough. Our traditional portfolio for a retiree invests 70% of their money in a globally diversified basket of stocks that provides enough growth potential to preserve (and, generally, increase) their purchasing power over the course of a long retirement (we plan for at least 40 years of spending in our models). And yet the remainder of their portfolio is invested in stable bonds and cash, providing adequate liquidity for at least seven years’ worth of spending regardless of what’s happening in the stock market. The blend of growth and stability provides a mix that is robust and reliable. And it’s the reliability that our retired Clients most often cite and the greatest value this framework provides – they can always count on our Safe-Spending Policies to provide clear feedback and a structure that makes the path ahead feel more secure.
To learn more about our Safe-Spending Policies (which work for anyone considering leveraging their portfolio for their spending needs, not just retirees), contact a member of our Financial Planning Team.