Imagine you are landing on the surface of Mars. You have only so much fuel to slow your descent – burn it too quickly and gravity takes over and you crash. Burn it too slowly, and your speed of descent remains too high …. and you crash. With a bit of thought (and with the help of a rocket scientist) you can pre-program your lander to arrive safely. In retirement, this is equivalent to having your last cheque bounce.
The bad news is that retirement planning is not like landing on Mars: you are landing on the planet Vulcan. Vulcan is a nice place but has strange goings on in its liquid core that causes its gravity to vary unpredictably. To make matters worse, the fuel cell on your lander is not working properly and the rate at which fuel is produced also varies unpredictably. You ask your rocket scientist what you should do. He smiles, and says that he is late for a meeting, but knows a Portfolio Manager who might be able to help.
Constant spending rules (e.g. the 4% Rule) for retirees are very inefficient: typically leaving 20%-30% of retirement savings unspent. Using constant spending rules is like prepping to land on Mars when you are orbiting Vulcan. Lowering the withdrawal rate, to avoid the possibility of running out of money, only makes the likelihood of leaving unspent assets worse, because trying to extract a pre-defined, constant withdrawal, for an uncertain period, from a volatile asset is flawed. A lower withdrawal rate reduces the probability of running out of money, while increasing the probability that a large portion of the retirement assets will be unspent. To solve this dilemma requires a dynamic approach that adjusts spending depending on market outcomes and expected longevity.
We launch a series of papers discussing how to plan retirement income more effectively, starting here. Future papers will be case studies based on our experience with client’s planning for, and living in, retirement.
1 This and the other headings are, of course, from Star Trek
