Reframing Retirement Success: How to Improve Spending Conversations
How can you strategically deplete your assets for maximum retirement spending?
If your thoughts are just taking 4%/yr from your portfolio assets adjusted for inflation for 30 years - God bless you - but you’re highly likely to make your beneficiaries of your estate very happy.
Retirement planning research has come a long way since William Bengen’s 4% portfolio spending rule.
Following Bengen’s 1994 research, there was the Trinity Study in 1998 which further confirmed 4% rule and success of portfolios with 50-75% stocks.
Enter the early 2000s and Monte Carlo simulations became popular for using probability-based modeling of diverse outcomes for retirement portfolios.
Then came dynamic withdrawal strategies which adjusted withdrawals based on market performance and portfolio health.
Today, much of the retirement spending conversation stems around probability of success.
Meaning:
Running 1,000 market scenarios given the current assumptions - how many scenarios out of 1,000 end up with at least $1 in assets.
This leads many planners to look at probability of success through the lens of:
If the plan has an 80% probability of success this means, there’s a 20% probability of failure.
An easy metaphor to think about this could be:
Would you get on a plane if you knew it had a 10% chance of crashing?
Of course not.
But this metaphor, or derivatives of this metaphor to convey the idea that success or failure in absolute terms fails to recognize proactive planning in between these two extremes.
Taking the same idea above, consider:
Would you get on a plane if you knew it had a 10% chance of a detour?
Sure you would.
This is where proactive planning plays a large role in the ability to comfortably spend on an ongoing basis.
The flexibility of planning reduces the importance of needing to have a high probability of success.
Consider research from PhD Kitces Researcher Derek Tharp discussing probability of success guardrails using a 50% and 95% probability of success maintained throughout a 30-year retirement:
The glide paths look surprisingly similar.
Why?
Because when you proactively review the plan on a quarterly/semi-annual/annual basis it allows you to take the adjustments or detour needed to keep the plan from running out of money.
When we know that the plan will be adjusted, this allows a wider range of probability of success to drive more spending throughout the life of the plan.
This flexible ongoing approach recognizes that:
Risk in retirement is slow moving.
Adjusting to change, is the one constant in planning.
Minor adjustments make large differences in long-term plan success.
In practice, this could look like:
$4M portfolio with a $200k/yr initial spending.
If the portfolio increases to $5M, then increase portfolio spending to $220k/yr.
If the portfolio decreases to $3.2M, then decrease portfolio spending to $180k/yr.
If you’re looking for how to maximize your lifetime spending, a systematically monitored, adjustment-based approach to retirement spending will allow you to achieve this goal.
BUT:
This requires an acceptance in not just increasing retirement spending in any given year, but also decreasing spending provided market conditions are unfavorable.
Depending on your willingness to adjust spending through time will depend on how large of a guardrail you set on retirement spending.
The retirement risk-to-reward trade off is:
Lower spending with a low change of future adjustment for a more constant retirement spending.
Higher spending with a high change of future adjustment for a more varied retirement spending.
There is no right answer but you can think of the ultimate outcome as either:
Increased lifetime spending
Higher ending estate value
Your financial plan shouldn’t be about giving you a score on how well you’re doing but to provide you with direction on how where you are now will impact where you’re going.
Spending guardrails do this; they just so happen to allow for you to increase your total lifetime spending as well.