Executive Summary
In theory, the whole point of saving and investing for retirement is that upon reaching retirement, it’s time to spend down the money and enjoy it. In practice, a growing base of research finds that for most of their retirement, retirees are just continuing the growth of their pre-retirement portfolios, suggesting a “consumption gap” between what retirees could and should spend versus what they actually do.
However, the reality is that for a long-term retirement, where compounding inflation can double or even quadruple spending needs after 30 years, retirees actually should allow their portfolios to grow at least slightly for at least the first half of retirement. It’s a necessity just to cover later-years’ spending needs at their inflation-adjusted levels.
Furthermore, given uncertainty about the length of retirement, how high inflation will be, and whether portfolio returns will be favorable or not, often retirees spend even less in the early years just to defend against these risks – an approach now dubbed the “safe withdrawal rate”. Yet given that most of the time markets and inflation don’t actually spiral out of control, following a safe withdrawal rate approach just further increases the likelihood that retirement portfolios will continue to grow throughout retirement.
The end result is that while in theory a retirement portfolio is meant to be spent, in practice most retirees faced with an ever-open-ended potential of living many more years will feel compelled to keep extra assets available, just in case… and never actually reach the point of depleting the retirement portfolio at all! Which, notably, isn’t a sign of inefficient portfolio spending or a consumption gap, but merely the prudent reality of dealing with an uncertain future!
Retirees Aren’t Spending The Way They “Should”
The classic view of retirement is that in the early years people save and invest (the accumulation stage) in order to retire and consume all of their savings (the decumulation stage). As the saying goes, “you can’t take it with you”, so you may as well spend it while you can. Arguably, the whole point of retirement is to enjoy the fruits of your labor.
Of course, the caveat is that spending down retirement assets smoothly is no simple feat. From coordinating amongst various sources of retirement income, to the tax consequences of portfolio withdrawals and IRA and Roth distributions, to the timing of when to begin Social Security (especially for couples), helping people to successfully liquidate their retirement assets is a big business for advisors. Even if that business is to be provided to a declining asset base.
However, the biggest caveat of this conventional view of retirement is that it simply doesn’t appear to be happening. In a recent study entitled “Spending In Retirement: Determining The Consumption Gap” by Browning, Guo, Cheng, and Finke in the Journal of Financial Planning, researchers showed that affluent retirees relying on their portfolios in retirement are failing to even spend their annual income in their retirement years (and the more affluent they are, the worse the trend tends to be). In fact, not only are retirees not fully spending their available income, but their spending actually begins to decline in retirement. As a result, from the beginning of 2000 to the end of 2008 – a very challenging time of mediocre returns for retirement portfolios, when in theory account balances would have dipped with ongoing withdrawals – the average financial assets of wealthy retirees still continued to increase in retirement. Thus, the researchers identified a “consumption gap” between what spending the retirement portfolios could support, and the lesser amount that was actually getting spent (which in turn left room for the portfolios to continue to grow).
Yet given these results, suggesting that retirees are “doing it wrong” by not even spending the full amount of their retirement and portfolio income in retirement and allowing their portfolios to grow, the question arises: are retirees really under-spending in retirement, or is this actually a rational retirement spending strategy for a long retirement time horizon?
When Should Retirees Spend Down Their Retirement Assets?
While the conventional view is that once you hit retirement, it’s time to start spending down retirement assets, in practice the process isn’t so straightforward. While leaving over all your principal at the end of retirement may mean you “under-consumed” your retirement assets, spending down too quickly and running out early clearly isn’t a good result either.
Timing the liquidation of retirement assets is especially complicated by the role that inflation plays in a long-term retirement plan. After all, over a multi-decade time horizon, even modest inflation can add up significantly. As the chart below shows, what starts out as $40,000/year spending can wind up anywhere between $70,000/year and $164,000/year after 30 years, just to maintain the same standard of living, depending on whether inflation averages just 2%/year or is as high as 5%/year.
Given the impact of inflation, it’s problematic to start digging into retirement principal immediately at the start of retirement, given that inflation-adjusted spending needs could quadruple by the end of retirement (at a 5% inflation rate). Accordingly, the reality is that to sustain a multi-decade retirement with rising spending needs due to inflation, it’s necessary to spend less than the growth/income in the early years, just to build enough of a cushion to handle the necessary higher withdrawals later!
For instance, imagine a retiree who has a $1,000,000 balanced portfolio, and wants to plan for a 30-year retirement, where inflation averages 3% and the balanced portfolio averages 8% in the long run. To make the money last for the entire time horizon, the retiree would start out by spending $61,000 initially, and then adjust each subsequent year for inflation, spending down the retirement account balance by the end of the 30th year.
As the chart reveals, though, projected spending that plans to spend down assets by the end of a 30-year retirement still would spend less than the growth for the first 10 years, and wouldn’t actually dip into principal until the 17th year (out of 30)!
And that’s assuming “modest” 3% inflation and long-term returns of 8% (the approximate averages for the past 100 years). If instead, the retiree had a gloomier outlook, and projected a balanced portfolio to grow at only 7% while inflation could be as high as 4%, spending would be only $49,000 initially, the portfolio would peak in year 11, and dipping into principal wouldn’t occur until the 18th year!
Notably, in the context of this more conservative scenario, a 65-year-old retiree’s life expectancy is only to their mid 80s (or early 90s as the joint life expectancy for a married couple). Which means a significant number of retirees who use this as their planned retirement spending strategy will pass away before they ever materially dip into retirement principal at all!
Similarly, the fact that most “spend-down” strategies won’t actually begin to spend principal until the final decade of retirement also means that for a portfolio-based retirement strategy, required minimum distributions won’t likely deplete the retirement portfolio either, and to the extent they’re not needed may even just be “forced transfers” of investments that were growing in the IRA and will now grow in a taxable investment account instead (but still not be spent, yet).
Managing Sequence Of Return Risk And Spending From Principal
In addition to the reality that even a retiree who intends to spend down principal won’t likely do it until the second half of retirement at best, the additional challenge is that returns (and inflation) are not as ‘certain’ as even straight-line conservative projections suggest. Instead, as we know from the research on Sequence of Returns Risk, even if the returns average out in the long run, if they come in an unfavorable sequence, the retirement portfolio can still fall short.
The solution to this challenge is to spend less – at least initially – “just in case” an unfavorable sequence occurs, which is the origin of the “4% rule”: it is an initial withdrawal rate low enough to have been “safe” and sustainable in any historical bear market scenario.
Of course, the caveat is that on average, the 4% rule is unnecessary. As noted earlier, given long-term average returns, the “safe” withdrawal rate would be over 6%. The 4% rule is built for environments that have horrible returns in the first part of retirement.
Which means if the retiree starts with a 4% initial withdrawal rate and actually does get anything close to merely average returns (and not an especially bad early sequence), the portfolio will just compound even more growth in the early years and get even further ahead.
Accordingly, the chart below shows the path of wealth that would have occurred in any particular 30-year historical scenario going back to the 1870s, assuming a 4% initial withdrawal rate (with the dollar amount of spending adjusted each subsequent year for actual inflation) invested in a 60/40 portfolio (annually rebalancing, with the actual stock and bond market returns that occurred year by year).
As the chart reveals, the decision to follow a 4% initial withdrawal rate makes it exceptionally rare that the retiree finishes with less than what they started with, at the end of the 30-year time horizon; only a small number of wealth paths finish below the starting principal threshold. In fact, overall, the retiree finishes with more-than-double their starting wealth in a whopping 2/3rds of the scenarios, and is more likely to finish with quintuple their starting wealth than to finish with less than their starting principal!
Can Retirees Ever Really Spend Down Their Principal?
The bottom line is that from the perspective of whether retirees will likely spend down their assets in retirement, a normal retirement spending pattern suggests that it wouldn’t typically happen until retirees were well into their 80s at best, and following the 4% rule to defend against the risk of running out of money just further amplifies the likelihood of never spending down the portfolio at all. Even a rule that ratchets up spending in the later years still has a high likelihood of leaving significant dollars over at the end as well. The more conservatism in the early years in the face of retirement uncertainty, the more likely it is to have ever-larger retirement account balances later (since “most” of the time, the bad risks don’t actually manifest). Which is even harder to spend down in those later years given a growing base of research suggesting that the growth in retiree spending lags inflation as the years go on.
In point of fact, figuring out how best to balance the need for prudent spending in the early years with the potential for accumulating “excess” retirement dollars in the later years is arguably the greatest opportunity today in retirement income planning. Unfortunately, lifetime immediate annuities don’t necessarily do any better at accomplishing the goal right now, given today’s environment where a lifetime inflation-adjusted immediate annuity for a married couple only pays out about 3.5% at today’s rates as well (no better than following a 4% initial withdrawal rate, and forfeiting the upside potential as well). Although perhaps improving payout rates for longevity annuities, paired with a retirement portfolio, may eventually help to close the gap.
But at a minimum, it’s crucial to recognize that accumulating “excess” retirement dollars and seeing the retirement account balance grow, particularly in the first half of retirement, doesn’t mean the retiree is underspending. In fact, spending down the retirement principal early in retirement would be a sign of trouble. Accumulating continued growth throughout the early years of retirement is actually the normal, prudent course of action for anyone who anticipates living a long time, fears the potential impact of future inflation, and therefore recognizes the need for the retirement portfolio to grow in the early years to defend against the uncertainties of a long retirement future.
So what do you think? Do you see your retired clients actually spending down their retirement portfolios? If so, when do they actually begin to draw down? If not, is it because they're still protecting against an unknown future, or some other reason?
That was pretty good. This is why I once fired an advisor that was openly dismissive and vaguely contemptuous of my frugality early in a retirement that started closer to 50 than to 65. I moved assets to someone that “got it” and that I trusted as quickly as I could. The other thing that is implicit here is something that Pfau once mentioned: “people are often surprised to learn [the 4% rule] is specifically designed for a thirty-year retirement. The 4% rule wasn’t necessarily meant to apply to eighty-five-year olds, nor can it be safely used by early retirees who leave the workforce by age forty.” By that I mean to say that anyone who has the courage to retire in their 50s should pay especially close attention to the message in this article.
That’s true — but the other consideration is that most people reduce spending in almost every category except healthcare as they age. The 4% rule assumes continued inflation for spending across the board every single year, and we simply know that isn’t true. Having an understanding with your advisor, and a prudent spending plan is key, but many advisors are very conservative with their recommendations which ultimately leads to clients spending less of the money they saved hard for.
Ross,
Ultimately this has little relationship to the 4% rule. It just happens to be an illustrative example.
You could assume that spending will fall by 50% in the final decade. You’ll STILL have an overwhelming likelihood of finishing with a huge account balance, because spending in the early years will be constrained by early sequence risk, and if the sequence turns out favorable there will just be even more ‘under-spending’ in the later years.
In fact, I suspect you’d find that assumed spending declines in later years actually exacerbate the problem even worse than discussed in the article here. :/
– Michael
Michael – in many respects I think you and I are making the same point here, I’m probably just not doing it nearly as eloquently. WKS comments made me think that they were dismissive of the 4% rule as not being conservative enough for an early retiree. I’m certainly no advocate of reckless spending early in retirement. But, I do believe that spending the money when you can enjoy it is important for a lot of folks.
Ross,
No disagreement about the value of that timing. But part of the point here is that’s the unfortunate ‘tyranny’ of sequence of return risk – cutting spending in the later years does remarkably little to relieve the risk.
Simply put, if you spend “too much” in the early years and get a bad sequence, it doesn’t matter if your later years’ spending is flat or reduced if your portfolio already went to zero. Yet if you’re conservative enough to avoid that early sequence risk, the most common outcome will simply be an extremely large portfolio left over (which only compounds further if later-years’ spending declines). :/
I don’t mean to endorse that outcome. It’s simply the math of it. :/
– Michael
The real trouble with the 4% guideline has nothing to do with the stock or bond market.
Instead, it is the extraordinary expansion of disease care costs since the catastrophe of the “Great Society” starting in the mid-1960s.
It is far more likely, IMO, that retirees will end up penniless or dead because of rising insurance and medical bills than “normal” inflation, panics, or interest rate crises.
That is, unless the government disengages from distorting the medical economy or goes all in like other first-world countries.
I would like to see who see the demographics of retirees are in this position. They are either in the top 5% or heavy pension recipients. Depending on only technical past market returns (100 years when you are 66 years old) with out fundamentally where we are today is just foolish IMHO.
i agree with your last remark. it’s hard to believe someone will do well with the 4% rule starting with the shiller pe10 [cape] over 26 and 30 year treasuries at 2.1%. these are not “average” times.
The 4% rule is predicated on VERY BELOW AVERAGE returns. See https://www.kitces.com/blog/what-returns-are-safe-withdrawal-rates-really-based-upon/ for further history on this.
The “safe withdrawal rate” at average returns is about 6.5%. The haircut from 6.5% to 4% – a 1/3rd reduction in lifetime standard of living – is done specifically to defend against low return environments like today. That’s the whole point. 🙂
– Michael
thanks. that’s an interesting blog post you referred me to. currently, we have gmo’s latest 7 yr projections of -1 to -2 on equities, and about -1 on bonds. hussman’s 10-12 yr equity projection is zero. at this moment the 10yr treasury is paying 1.36, the 30yr 2.13. i don’t know who’s got a clue about the next 15 years of inflation. it looks like a new retiree will get to test that 4-4.5% minimum.
Jeff,
Certainly ‘at best’ this is the kind of low-return environment for which the 4% rule “was made”. It’s definitely not a time to be optimistic for higher returns.
But bear in mind that the lower returns here are at least slightly mitigated by the lower inflation environment we’re in. (And which the bond market continues to price in.)
On a real-return basis, the 15-year real return from 1929 was -1.5% on stocks and -0.40% for bonds – for 15 YEARS of compounded returns – and the 4% rule still survived that.
Certainly, an inflation surprise from here could be damaging. But the average of the historical ‘bad periods’ from which the 4% rule came was a -0.7% real return on equities for 15 years, which is at least ‘comparably bad’ to projections like GMO and Hussman?
– Michael
good points. thanks.
Those last two paragraphs make great points Michael.
I wish the perma-bears who suggest it is “different this time” and the 4% rule will not work going forward because of current equity valuations and bond yields should consider how bad some periods of historical returns really were.
I’m not saying those entering retirement today (myself among them) are doing so in great circumstances. Rather that the 4% rule itself was intended to cover some pretty dark and dire circumstances coming to fruition.
Michael, I’m an individual investor, and have fun building my own retirement plan and portfolio – thanks for your reasoned discussion. Certainly, every era has it’s own challenges, but it’s always far more unsettling to live through them than to look back at them afterwords. The 4% rule is tough to beat as a simple, safe base withdrawl scenario. I triangulate everything, so this kind of benchmark is very valuable.
I think it’s important to simply be aware of all the potential dangers to your portfolio when building it, so that at the core it can withstand any environment, and then you can decide what factors, conditions, themes, you may want to weight; keeping in mind the price you pay when the unexpected strikes.
Michael,
Interesting commentary, as usual, and very helpful. My only reservation has to do with your comparison of annuities to following the 4% rule since that really is a bit of an “apples to oranges” comparison. The 4% rule provides for a full inflation adjustment each and every year. I am not aware of any commercial annuity that does that.
The thing that makes that difference particularly significant is that, as you have previously noted, the failures at higher withdrawal rates in the Bengen model happened at times of high inflation and were more due to the high inflation than they were the poor returns. Annuities may help to protect against longevity, but are disastrous in an inflationary environment.
David,
The commercial annuity quote I cited is specifically for a CPI-inflation-adjusting annuity. There are a number of immediate annuity carriers that offer such products (including Vanguard, last I checked).
Ironically (or not), they’re very unpopular with consumers, ostensibly because that guaranteed spending amount is so low once you include the guaranteed inflation adjustments…
– Michael
Michael,
Thanks and it may be a limitation of where I am or the annuities I have found, but Vanguard’s was the only one I have seen and even it was capped, I believe at 10%, which is far less than we saw in the 70s which seemed to be the killer environment for the 4% rule.
i’m one of the consumers with whom indexed annuities are unpopular. i think indexed annuities are way overpriced because it’s too hard for insurance companies to adequately hedge the risk. thus it takes a very, very long time before you come out “ahead” in terms of your cumulative income stream. an indexed-annuitant risks leaving a lot on the table- which is what i thought you were trying to avoid.
A very informative article, thanks. I recollect very high inflation from about 1973-1983. If someone retired in 73 any idea where they would have been in 2003 assuming a 50-50 bond and S&P 500 portfolio?
Hi Jcar–check out http://www.cfiresim.com for your “what if” scenarios. 50/50 may not be the best option…
Once again I think you’ve nailed an important issue, Michael. One of my observations is that once people retire their attitude towards spending changes. Since they no longer have any income other than Social Security (or some fortunate pensioners) they want to preserve what they have. People who were savers all their lives psychologically don’t shift to being spenders. It just doesn’t feel right for them. Some of the more astute have examined their assets, discussed strategies with advisors, and understand the “Go-Go, Slow-Go or No-Go” stages of retirement and the concomitant spending. David Blanchett’s work documented what we all sort of “knew”. They consciously spend a bit more early, knowing and planning to scale back at some time to preserve an adequate base to provide a relatively comfortable income stream.
I’m constantly amazed at how little some people live on in retirement. They don’t seem to feel deprived. I encourage them to spend more and show them how they might do so; they just are happy enough to proceed. I have worked with people who have an income stream in the low $40’s annually and don’t complain they are poor. My observation is that if you are used to not having much money, you can retire relatively easily with not much income stream. The tough cases are those that had a terrific income while working; spent it all (or at least saved far less than desired) and then have to adjust. They seem to think there is a rule that if they earned $300,000 a year they should be able to retire on a mere $250,000 a year. And yet they have no pension and $2 million in a 401k. One would think someone who earned that kind of money could do simple arithmetic and figure out they are coming up short. One of my least pleasant tasks is to break the news to them!
Hi Michael,
Thank you for your interesting look at how many wealthy retirees appear to be managing their early retirement years, however I think your graphs could be more revealing if they measured real dollars. At the Bogleheads forum, one person (#Cruncher) analyzed your data in real terms and came up with quite a different conclusion with regard to when this hypothetical retiree actually begins drawing down their principal. I hope you can take a look at it:
https://www.bogleheads.org/forum/viewtopic.php?f=10&t=194794&newpost=2968978#p2968957
I’d love to hear what you think of it. Thank you.
David,
Thanks for the feedback.
Ultimately, I view any threshold of “principal” as a purely arbitrary threshold. I could have analyzed “when does the retiree reach a threshold of 113.2% of starting retirement principal as well.”
The reason I framed in terms of principal, and in nominal dollars, is that behaviorally we have a lot of evidence that that’s how humans think (and retirees act). No one 15 years into retirement says “I have $1,000,000 today, but given that I retired 15 years ago, in 2001 real dollars it’s actually only worth $683,172 [or whatever the inflation-adjusted prior dollar value would be].” We think in terms of the dollars we have on the day we’re thinking about the dollars.
Similarly, the reason cited earlier in the article by Finke et. al., and other studies that look at retiree spending as well, are framed around nominal dollar behaviors, because people act in real time based on their nominal dollars (not what they would be, inflation-adjusted anchored back to a distant prior year).
I don’t mean to belittle the significance of inflation at all, and yes, it’s certainly true that on a real-dollar basis the charts would look different. But given that “starting principal” is a purely arbitrary threshold anyway – and one that we cling to for psychological rather than actual mathematical reasons – I would maintain that the more relevant threshold for evaluating the behavioral phenomenon is the one that ties to behavior (which is then-current nominal dollars, not adjusted-to-original-retirement-date real dollars)?
I hope that helps a little to clarify the context? In any event, glad to see this spurred an interesting Bogleheads discussion! 🙂
– Michael
Michael – thanks for the plug about our research! Always good to know someone is actually reading our articles.
The point that one does not always spend down assets during a period where asset values are growing when following a 4% rule is important to make. During this period the equity market was essentially flat and bond yields were low, so one would have drawn down if following a 4% rule. In fact, most in the top wealth quintile didn’t spend their income. This means that they are implicitly growing their legacy in retirement, which means that they better have a bequest motive. If they don’t have a strong bequest motive and their primary goal is living well, then they are making a mistake.
This really opens an interesting philosophical argument about the value of thrift. Just looking through the comments, you can see evidence that people feel good about preserving and growing assets in retirement. This is fine if you acknowledge that growing assets makes you happy – but then you need to have a sound plan for giving away those assets when you die. If you have already funded a legacy goal, which in my mind is the right way to do it since heirs can better plan for a future bequest, then the goal really should be getting the most out of the money you have.
There will always be a tradeoff between living well now and the risk of outliving assets. The best strategy is to take the right amount of risk given your own spending flexibility preferences. Our new research looks at which retirees tend to be overly thrifty and which are at risk of spending down assets too quickly.
Michael,
Thanks for the comment!
Indeed, this does open all sorts of philosophical arguments around thrift as well. Though it’s worth recognizing that “people who already accumulated a portfolio because they were thrift” may be a biased sample of thrift behaviors. As I’ve long noted (and I know you have as well), affluent retirees, advisors, and the clients who advisors serve (who are often affluent retirees) have a self-selection bias and are not necessarily a representative sample. (Though they’re still an interesting one to study nonetheless, with conclusions that MIGHT be generalizable.)
Regarding behavior under the 4% rule in the 2000-2008 time frame though, I would challenge a bit the question of whether retiree wealth actually even “should” have gone done. I’ve written separately about this – see https://www.kitces.com/blog/how-has-the-4-rule-held-up-since-the-tech-bubble-and-the-2008-financial-crisis/ – that from 2000 to (pre-crash) 2008, the 4% rule actually wouldn’t have depleted retirement dollars much at all. And if you assume even just a slight decrease in real spending over that time period (per David Blanchett’s work), you would expect that 2008 nominal wealth would be almost exactly the same as 2000.
I’ll admit from the data in your study, the biggest questions to me actually are: why is affluent retiree wealth basically the same in early 2008 as late 2008 (don’t seem to see the actual market crash in the data?), and why did most wealth quintiles trim spending in 2004 but not 2002 (is there a delayed reduce-spending-not-during-but-AFTER-bear-markets phenomenon we’ve never identified before?)?
Definitely interesting data to study further… 🙂
– Michael
Thank you Michael for an interesting topic and read..
I am not in the Consulting business but certainly fit the “saver” and “low spender” profile you describe in your article. In general, as a customer… I always find it fascinating the way the financial business approaches these incredibly “human” topics with charts and 2nd grade math. I mean really, think about the concept of spending your last dollar on the day you die. Utterly ridiculous.
I think JRPower below nails a number of the issues that your article didn’t cover.
For myself, I save aggressively, and enjoy watching my wealth accumulate .. I enjoy even more the power it gives me to assist (where necessary) the lives of my loved ones or the social issues that move me. These pleasures trump the joy that can be derived from merely spending, and they are pleasures that are worth saving for.
So I’m a saver not a spender. I bought in early to the idea of saving for a “retirement of consumption”, perhaps without really thinking much about it. Along the way, while saving for that mirage, I became frugal. Changing now would be traumatic for me.
It’s not that I don’t enjoy a steak dinner with wine.. its just that I can make myself one with premium organic ingredients, for much less than the $100 Ruth Chris version. I’ve mastered the BarBQ and my steak doesn’t have to be huge or mailed to me. I don’t have steak more that about once a month, I don’t want to dilute the pleasure of it.. I usually like cigar/whiskey/music/conversation after a special dinner.. my point here is that I deny myself nothing.. but my average daily food costs are probably shockingly low compared to what I “should” spend on food. Henry Thorough is a good source for more philosophy along these lines.
Bucket list items in early retirement .. my wife and I often camp or cook our own food when we travel .. we enjoy it this way.. the above speaks to EARLY retirement (the “High Spending” years) .. what about later?.. well I take care of my mother now who is 86.. she spends about $10,000 a year and this while living in her own (very nice but small) house and not denying herself anything that she wants.. admittedly, final year medical costs are unknown and a concern.. but we’ll manage it frugally and more importantly Humanely. Bottom line; the idea of 60-80% of pre-retirement income? For thirty continuous years? Way off target.
Inflation? Housing costs rising? Doesn’t matter, we are savers, we lived moderately and payed off the mortgage. Gas and energy? Wear a sweater, use a wood furnace. Transportation? Walk, bicycle! Groceries? Learn to cook, buy raw ingredients. Clothing and other costs? Recycle. Entertainment? Deflationary not inflationary, I spend less now on Entertainment than ever, and continue to be saturated with options. BTW .. these practices support good health, are good for the planet, and increase the likelihood of a long life. What am I missing?
With regard to WHY people are frugal when they don’t have to be … I think its complicated.. Probably most honestly, they simply don’t enjoy the passivity of spending, they enjoy the challenges of doing the things that save and create wealth. At a deeper level perhaps they want to be able to provide their children with a degree of safety (its a wilder world these days).. perhaps they would like to leave something to a world that made their comfort possible .. finally, perhaps it just doesn’t feel right to waste wealth when so many others have nothing (deserved or not).
Summary, I think the financial profession has always provided usable models that present clear and defendable retirement strategies, and this has been on the balance a good thing for some. I say for some because many models are not presented in good faith or are not defendable. The profession has a poor track record on the whole and this is a shame for the good guys.
But even for the good guys, the assumptions made about Savings, and more deeply, about Happiness, are simply not well thought out. At the core is an immature value System, a System of “he with the most toys wins..”, you can’t take with you”, etc,etc. Rubbish. We live in a world of excess. That doesn’t mean excess is good or right. Excess is neither a good thing or a bad thing. Excess creates misery just as easily as it creates happiness.
Many people Grow Up and learn this. Happiness and Money, as it turns out, have a surprisingly low “correlation”.. this should be great news to Savers and Spenders everywhere! Even those “high spenders” JRP mentions will discover freedom, and maybe happiness, when they ultimately face reality!
Cheers.
Simplifying your living is the right way.Great!
I’m 55 and have never posted a comment on the internet – EVER. But MikeP nailed it. Bravo brother. I love the wisdom in your words.
Thanks for sharing Dennis. Glad to hear the comment inspired you! 🙂
– Michael
Thanks Dennis M for the kind words.. BTW I don’t publish much either, but the topic moved me I guess.
Not in the Consulting business, just someone drawing down their portfolio.
One of the main problems that I see today, is that we are faced with very low returns in Bonds and the potential of very low returns in Stocks as well, due to higher valuations. This causes retirees to be ultra-conservative.
The solution for myself is to employ VPW (Variable Percentage Withdrawal) https://www.bogleheads.org/wiki/Variable_percentage_withdrawal Which is withdrawing a percentage or your portfolio balance rather than an inflation adjusted amount of your initial portfolio balance. The percentage also increases as you age and does a much better job of depleting your portfolio.
VPW is also much safer than an Inflation Adjusted Initial Withdrawal Amount. Because you a withdrawing a Percentage of Portfolio Balance, it has a built in ‘self adjusting’ withdrawal amount. This produces less amounts in Market Down years and more in Market up years. This forces you to sell more assets in up years and less in down years.
Of course this means you have to have a lot of discretionary spending, so that you can adjust your spending if and when you need to in down market years. Also since VPW will never deplete your portfolio, it gives the retiree more confidence to spend more in up market years, without the fear of running out of money down the road.
Retirees already employ a VPW method in ‘Real Life’ and already are spending less when markets tank. VPW just gives you a firm plan that you can follow and bolster your spending confidence.
Kevin,
There is no substitute for actually doing it (or as I say, real knowledge comes only from experience). So your comments are meaningful.
I too have read about VPW, but have concluded that following Guyton and Klingers Withdrawal Decision Rules and Financial Guardrails get to a similar place with a fewer (and perhaps less abrupt) spending adjustments.
Did you consider following G&K’s strategy and conclude that VPW was either superior or easier to implement?
Mike
Yes, G&K was far too complex for me. And IIRC, they had you fooling with your investments along with your withdrawals. I have a Set it and forget it Portfolio of 1 Mutual Fund. I like simple. Note: – I just tried to review the G&K paper and remembered at how complex it is.
The often touted ‘Abrupt’ Spending adjustments of VPW is more controlled by Asset Allocation and other factors. I am only 30% Stocks/70% Bonds and this smooths things out greatly. Also, by delaying S.S. to age 70 provides a solid Base of spending and more smoothing as well.
Also, if you backtest VPW, you’ll see that the ‘widest swings’ were at high levels of inflation. The nominal withdrawals were very smooth. And I believe that retirees are not as subject to inflation as younger people starting out. — Buying Houses, Cars, Appliances etc. — With my A.A., S.S delayed to age 70, my Historical Downside spending is only 15% less than my Initial Withdrawal. I can do that without missing much.
Thanks Kevin for added perspective.
Having such a low equity allocation I think might shield you more from any abrupt changes in your annual WD amount, than might be the case for say someone with 50% or 60% in equities. For example, thinking about 2008, if equity lost ~40% and one had 1/2 of their retirement assets in equities, then their annual WD amount in 2009 would be 20% lower than it was in 2008 right? Isn’t that how VPW works – it’s admittedly been a year or more since I researched VPW.
I understand your comment about the apparent complexity of the G&K model. Two FPA articles of 10 and 13 pages respectively certainly is a daunting read and it takes a long while to read and re-read them before it all crystalizes in ones mind.
The way I interpret G&K’s rules (this is following their updated 2006 article) is there are really only three things to monitor:
1. The prior year inflation rate,
2. The current AWD rate and
2. The portfolio’s return in the immediately preceding year.
Using the second two tripwires, you only suspend the current year inflation increase only when “both” the prior year investment return was negative and the current AWD rate exceeds your initial year AWD rate. This is their so called “Withdrawal Decision Rule”. It’s not going to happen very often.
The only other computation to make (this is where their financial tripwires come in) is to compare the current year AWD rate to the initial year AWD rate. If the current year AWD rate exceeds or falls below the initial year AWD rate by more than 20%, you ratchet up or down, respectively, your current year AWD rate by 10% (which then becomes the new jump off point for future year inflation adjustments).
This latter adjustment should come into play infrequently as well. Thus, AWD’s should be smoother (subject to less up and down movements) as would be the case with VPW (I think).
I understand in your situation (very low equity exposure) that VPW would likely be pretty smooth. For others, maybe less so.
It would also seem to depend on the size of ones assets and how large a % of ones annual spending comes from AWD’s from ones assets versus SS (and a pension if one is lucky enough to have one). For folks where the vast majority of their annual spending is financed from their accumulated assets, the annual changes potentially created by following VPW following years with volatile investment returns might take some getting used to and would also work best for those whose discretionary spending is a sizable % of their annual spend (such that the annual changes in their total spend level is easily accommodated by ratcheting up or down some of that discretionary spend).
Again, I am not very well versed in VPW, but it seems to me that these things would be true.
Regards,
Mike
Mike, As far as your 2008-2009 example. Yes your numbers are correct, but you have to look at your Spending Plan in its entirety. For example, if a couple had a Total Spending amount of $100K, which consisted of $50K of Social Security and $50K Portfolio Withdrawal, and they had to cut back 20% (in your example) in 2009. That would only impact their Total Spending Plan by 10% (Not a big Deal).Pensions can also mitigate the Spending Budget. And for those that want more stability without pensions, could annuitize part of their portfolio as well.
But also consider this. Conventional SWR plans that take 3-4% have already been withdrawing a much reduced amount than VPW was in 2008. VPW for someone that is 65 with a lifespan to age 100, is usually taking around 4.6% in 2008, so the reduction in the entire spending plan is still probably less than someone employing a 3.5% SWR in 2009. So don’t just compare what VPW does from 2008-2009. Compare it against a Standard SWR.
Great points and discussion, Michael!
The big problem with having clients spend down their assets is more psychological than quantifiable. In addition to uneven spending patterns – more in the first 15 to 20 years and less as people age, the other side is taxes. Wealthier people hate paying RMDs.
Others become misers and live their worst nightmare. “If I spend the money in the CD, savings account, brokerage account, IRAs, (etc.), all I’ll have is Social Security and the pension.” That frequently happens when the first Social Security check is lost with the passing of the first spouse. The impact on cash flow is devastating.
PlanPrep believes it is wise to plan for a period of years for travel separate from, and on top of, the ongoing living expenses. Using lower rates of return, higher than expected personal inflation, and longer life expectancies allow for calculating a maximum spending number that the client should not exceed in any given year. Living below this figure (which typically does not vary greatly in volatile markets) is a sound practice. If this personal benchmark increases over time, then advisors know they need to help the clients plan their legacy.
Somebody is going to receive and spend the money someday, so it is best that there aren’t big surprises … which there often are.
Excellent analysis Michael. Does the range from 4-6% withdrawal rate used in discussion here include advisory fees along with fund expenses, e.g. management fees, transaction costs etc. as well?
Secondly, I have observed in my 39 years, adverse sequence of healthcare costs for young retirees who experience dementia or a stroke, or Alzheimer’s Disease care which can last 10-15 years. It would seem adverse sequence of healthcare costs (being terribly-terribly expensive to cash flow out of a retirement portfolio), along with adverse sequence of returns early in retirement, could be the type of Black Swan scenario/event which could jeopardize retirement success for many retirees. A higher withdrawal rate seems fine, so long as no adverse and long-term healthcare life event occurs in early stage of retirement.
In my RICP studies, I recall the study material data which mentioned some 28% of retirees will experience Plan failure, due to unanticipated high long term care costs.
There really is a simple method for dealing with this. What the retiree needs to know is the amount that will be available to spend each year so that principal will delete to zero at estimated date of death, say, age 100. So if the retiree has been spending 100 each year, and the annual available spend is 200, large expenditures and/or gifting programs should, at least, be considered. The computation of annual available spend is continually updated, enabling the retiree to adjust spending throughout retirement as deemed appropriate.
Prior to my retirement 10 years ago, I was involved in international legal/tax planning. When I retired I used these same financial and analytical techniques, and concluded that what I needed was to develop a model that does the above. I did develop the model and it has worked perfectly for me ever since. The model is very detailed when dealing with my financial situation involving various types of income, taxes, sourcing of withdrawals, etc. It is conservative with respect to return assumptions applied to various types of income, inflation, DOD, etc. Most importantly, it can easily accept variables so that I can judge the impact of a reasonable worst case scenario (e.g. a 60% permanent decline in equity value), or major expenditure, and consider their impact on future spending.
I have carefully studied all the alternative approaches and models, and none work for me. This approach does.
“What the retiree needs to know is the amount that will be available to spend each year so that principal will delete to zero at estimated date of death, say, age 100.”
Yes that sounds simple, until you try to add in all the assumptions needed to estimate such a number.
It is much easier than you think to come up with assumptions needed to determine a conservative base case annual available spend, and, for example, reasonable worst case scenarios. What is more difficult is making sure all cash flows and related taxes are properly computed for all future years. The most important aspect of retirement planning is assembling good data; once that is in hand, it is possible to make intelligent spending decisions throughout the course of retirement. Works for me.
And given that average life expectancy is only 80-something for most, this once again just creates an overwhelming likelihood that the majority of retirees will never enjoy most of their money by planning for a time horizon that is still highly unlikely for most. :/
– Michael
Michael, there are no fixed rules for assumptions used. If the retiree prefers an assumed joint life expectancy of age 90, he should use it. It is important to make sure all cash flows and related taxes are properly computed for all future years. Alternative scenarios using any relevant assumption changes (including reasonable worst case assumptions) should be considered. The most important element is the continual updating throughout retirement, so that actual spending can be compared to computed annual available spend. In my case, I have substantially increased my gifting in line with AAS, with appropriate contingency planning for negative scenarios.
John,
I’m not sure how you see that as being different than what’s being discussed here?
As I’ve noted here (and numerous times elsewhere in articles on this site), conservative spending rules create significant upside potential, which creates the opportunity for retirees to ratchet spending higher later. Given that the financial planning process incorporates an ongoing monitoring component, that’s automatically assumed for any financial planner who applies it (and is why Bengen, a financial planner who did the original research, didn’t otherwise explicitly mention it – because it’s assumed). In other words, the idea of “set 4% rule spending once and never change it for the next 30 years regardless of upside” never actually occurs in practice for a financial planner. See https://www.kitces.com/blog/why-does-everyone-think-safe-withdrawal-rates-are-an-autopilot-program-theyre-not/
Aside from the particular mechanism of how you calculate spending adjustments, versus a dozen or more other mechanisms out there that financial planners and academics have identified as ways to make spending adjustments (e.g., https://www.kitces.com/blog/the-ratcheting-safe-withdrawal-rate-a-more-dominant-version-of-the-4-rule/), what distinction are you trying to highlight here? To say “retirees should continually update their retirement plan based on then-current circumstances” is ALREADY standard practice.
And notably, for ANY of those mechanisms, the nature of sequence risk STILL results in the same phenomenon being illustrated in the article here, which is that the natural spending defensiveness in the early years (given sequence risk) creates a disproportionate likelihood of ending up with ‘excess unused’ wealth later that may not have been originally intended. :/
– Michael
Michael
Please pardon the rant, but I hate all formula dynamic strategies — guidelines, guardrails, ratcheting — whatever. I dislike all SWR approaches (except for ballpark analyses); and I believe all MCS models are bunk because GIGO overwhelms the science. What does it really mean to me, as a practical matter, when I hear I have an 87.53% probability of success? Simply updating garbage on a regular basis doesn’t change its nature.
I think some individuals have a tough time following my simple approach because they themselves are not retirees. For example, one young forum leader I know does some really brilliant work, but he is hopeless when it comes to practical issues relevant to retirees. As a retiree, I know how much I am actually spending. As a retiree I know how I will react to decreases in spending at various levels (some comments by others discuss these matters in detail).
When I retired I determined that what I needed to know is how much will I have available to spend each year for the rest of my life. As a CPA and tax attorney I realized that it was necessary to compute all future cash flows correctly with appropriate tax effecting ( I had def. comp, pensions, future SS and RMD, Roth and Trad. IRAs, various investments, etc.) For the last 10 years I have been able to see continually updated future annual available spends, and to compare these to my actual spending. You refer to dozens of other mechanisms; are there any that produce a specific annual available spend?
So it is the actual spending dollars that are important. I can compute a base case scenario, any sequence of returns scenario, reasonable worst case scenarios, inflation or return assumption changes, etc., and in each case I will see revised annual available spends that I can compare to actual. In my case, I initially saw a base case AAS that was significantly more than actual. I was able to compute alternate AAS scenarios, evaluate them in the context of my actual spend, and conclude how I would deal with them. The end result was a significant increase in spending (mostly gifting) and for the last 10 years I have continually reviewed updates for possible changes in assumptions or spending. AAS has cured me of “natural spending defensiveness”.
Thanks for taking an interest.
John
The main problem here is that you have no idea what returns you are going to get going forward. Maybe they are all negative for the next 15 years. You need a dynamic withdrawal plan, And you do need a plan!
Using a dynamic withdrawal plan doesn’t change the outcome/point of the article. As long as there’s an unknown-and-potentially-long-term open-ended time horizon remaining, the retiree will virtually always end out holding onto more dollars than turn out to be necessary after the fact. :/
– Michael
Agreed, there is no such thing as a ‘Perfect Withdrawal Plan’, But a dynamic, flexible plan, like VPW will probably let you spend more money. It only ratchets down spending IF and When you may actually need to. It’s the best withdrawal plan I’ve seen thus far. I am retired and actually using VPW.
John,
How is an annually/regularly recalculated “available spend” NOT a dynamic spending strategy? You update it every year for current situation/assumptions, and it gives you an updated spending number going forward? That’s effectively THE definition of a dynamic spending strategy.
Certainly, I think there’s still a LOT of room for more discussion and analysis of best practices IN dynamic spending strategies. I actually view it as the most under-researched segment of retirement spending. In large part because it’s very ‘messy’ since different people have very different views around different formulas and approaches. And also because existing tools for advisors are remarkably bad at illustrating those approaches (see https://www.kitces.com/blog/is-financial-planning-software-incapable-of-formulating-an-actual-financial-plan/ for why our planning software can’t even illustrate your very reasonable-sounding approach).
But saying “dynamic spending strategy A is better/worse than dynamic spending strategy B” is a different conversation than “dynamic spending strategies are bad, I just updated my available spending every year [which changes dynamically to my current market situation” which I’m not sure how to distinguish?
– Michael
Michael
What I said is that ” I hate all formula dynamic strategies”. The operative word is “formula”; of course I apply a dynamic spending strategy and, Kevin, of course I have dynamic spending plan. I’ll expound further tomorrow.
Michael
It appears that we have a major disconnect. You link an article, which you say shows that software can’t illustrate my approach. However, that article is about developing a formula plan, which has nothing to do with my approach. Likewise, Kevin seems to believe that without a formula plan like VPW I have no plan at all. That is the disconnect.
My entire career involved strategic financial planning. Never did I proceed according to any preconceived formula, and never did a purchase a packaged plan (that were worthless despite $million+ price tag). Each plan was ad hoc, and necessarily so because of the unique nature of each project. I also believe that each retirement situation is unique and that ad hoc retirement planning, continually updated and revised as necessary, is the only way to go.
The focus of ad hoc planning is on making sure all relevant and material issues have been identified, and that each issue is fully understood in context. Even though retirement planning is not very complex, it is still necessary to treat each situation as unique and to identify and analyze all relevant and material issues. This involves behavioral issues as well as financial issues (consider comments by MikeP and JRPower, and then think of those on the other end of the spectrum).
The Annual Available Spend scenarios, considered in the context of actual spending, are perhaps the most essential issues to be evaluated. How will the retiree deal with the AAS under various scenarios, and how will this in turn affect not only spending but also investments? The conclusions reached from such an analysis most certainly constitute a plan, but there are no formulas or preconceived rules applied. This is all about judgment in a unique setting, which does not exist in financial planning software formulas. The AAS model that I use only develops relevant and material facts that are essential to the overall analysis; it does not provide any answers.
Your comments are most appreciated.
John
John,
I’m not sure I understand the disconnect either.
As I understand it from your own prior writings, your Average Annual Spend is built from a (spreadsheet) formula that takes 5 current input variables to calculate a spend over the remaining time horizon, which is then updated each year to recalculate.
How is that NOT a dynamic spending formula? It’s a formula, the inputs change over time, spending adjusts dynamically based on circumstances as they unfold?
– Michael
Michael
The AAS model is an Excel model, which like every model is programmed to produce a specific output. Input assumptions are changed infrequently; only when deemed desirable based upon changes in facts or circumstances. My model recomputes base case AAS daily with updated market financial information, and monthly with non-market financial changes.
The disconnect, as I see it, is that my model is only programmed to produce AAS numbers under the assumptions in place when run. It produces no formulas that signal or prescribe changes in spending or investments. In other words, it only supplies dumb data and all analysis and planning is left to the judgment of the user.
Perhaps I am not reading you correctly, but every time you discuss dynamic strategies they seem to involve programming or incorporating formula adjustments such as ratcheting, guidelines, guard rails,(Kevin’s VPW), etc. My planning conclusions are entirely based upon ad hoc judgment considering AAS and other relevant and material facts. Your approach involves deriving planning conclusions by formula. I see that as a major disconnect.
Please reread my last post. Does my approach, described in detail, coincide with yours? If so perhaps there is no disconnect, except that you apparently do not find AAS an essential element of ad hoc planning as do I.
John
Well, I actually like a ‘Formula Dynamic Strategy”. Plans Work and I like Working the plan. The Plan Got me retired. And a Formula takes the ’emotion’ out of decisions.And Emotion was the biggest killer during my investing years.
Kevin, FWIW, if I were considering your spending strategy, I would plug it into my model in order to see how market decline (or increase) scenarios would affect my estate values in future years. Perhaps more importantly, I would run inflation scenarios to see the effect on my spending in future years in real terms. My model contains no formulas for deciding what, if anything, to do with this information; that would be for me to decide.
VPW has a Backtesting Tool, so that you can see actual Historical ‘Inflation Scenarios’ etc. Since the future cannot be predicted, VPW will adjust ‘Real time’ to changing market conditions no matter what returns or inflation happens to be. Do you have a link to your tool as I am not sure what you are doing?
Unless I’ve missed something in the discussion, these analyses don’t account for the progressive effect of MRD’s on withdrawls from tax-deferred accounts (where most retirees have the majority of their savings..). For a single life, the 4% rule is exceeded after age 60 and at 77, the stated historical average maximum market return of 8% is exceeded. Beginning MRD’s at the mandated age 70.5 would require an initial 6% withdrawal rate and the lucky fellow who lives to 90 would be confronted with a 20% rate! I’d like to see what effect applying MRD’s alone has on account longevity for historical 30 year rolling periods (as in the final diagram above)..
Just because you withdraw from the tax deferred accounts, doesn’t mean you are required to spend it! …. Don’t confuse RMDs with Spending.
David,
A required minimum distribution simply requires that dollars be moved from one account to another (e.g., from an IRA to a taxable account), and Uncle Sam takes a slice (that would have been taken anyway).
Whether the dollars are actually consumed and spent is an entirely separate matter.
– Michael
David,
I have written a number of articles on how to make use of the RMD (or MRD as it is sometimes called) and because it actually “adjusts” your withdrawals to the market as opposed to the 4% rule which adjusts your withdrawals based on a starting 4% number always increased in future years by inflation, this allows you to withdraw more from your account without ever running out of money – at least for a normal longevity of around 95 where the withdraw rate does get up to 11.63% for a normal table 3 IRA schedule.
Here is a recent article where I outline how I am using this strategy in my own retirement:
http://seekingalpha.com/article/3964944-dgi-vs-total-return-money-retirement
Brilliant! Now age 60 and three years into early retirement, frequently mulling these matters, your essay resonates strongly with me — and your writing is brief and lucid too. (Some of my own thoughts are here: http://silgro.com/ajs.htm#FI but not nearly as pretty.)
Beyond applause (including for many of the excellent comments below), I’ll add my observation that upon retirement there are MANY (a surprising number) of inversions that occur, similar to Slott’s model of the front nine versus back nine of the golf course (where all the rules change too). I keep having epiphanies. One in particular is how the “time value of money” seems to change. Money today is worth a lot more to me than it’s likely to be in a few decades, if I’m lucky enough to live that long. I might NEED it more down the road, say for a heart transplant, but I can ENJOY it a LOT more now than later.
y = -196.65×5 + 598.47×4 – 730.50×3 + 465.82×2 – 197.48x + 59.463
You’re welcome!
Interesting article, I think most people agree taking excess money to the grave while penny pinching along the way makes no sense. People are scared of the banks and think the stock market is rigged. People do not trust the government either. People are living below their means because, they fear running out of money is the worst thing that could happen to them. This study is an eye opener and am sure more studies will follow. There has been too much greed in the financial system, high fees. bad advice, etc. What are people to think when they have to project further returns and what the future inflation will be. Wackey world of assuming anything.
My father (born in 1924) grew up thinking the stock market was rigged. He stayed in savings accounts and funds which netted him a paltry return.
“The market” was not rigged. Short term, on a daily basis, perhaps. But long term, prices were set by long-term trends and aspects. I started buying long term in 1974, with my first real paycheck.
I bought Intel (my employer), then laser and biotech companies, Sun Microsystems, Apple. Qualcomm, etc. I retired (didn’t know it then) in 1986 at aged 34.
Stocks did very well. “The market is rigged” is silly.
–Tim May, California
I see several references to “wealthy” individuals, but I don’t find where this is defined, neither here nor in the referenced article in the Journal of Financial Planning. What is the assumed nest egg for this?
Based on wealth quintiles. The “wealthy” were the top quintile (top 20%) of wealth in the survey.
– Michael
Yes, I fit into this category. I enjoy watching my balances grow more than I enjoy spending. We have LTC insurance and government pensions. My concern is needy family that know my status. They aren’t underwater yet but I can see it coming. Wife and I have no kids and haven’t prepared a trust and don’t know how we want to leave our assets. We are both animal lovers and want to give to some no kill animal shelters and world wildlife fund. But I fear the relatives needs.
Much of this gets blown out of the water if one has long-term care expenses starting in the early retirement years…and last over 5 years…
I recall having a holiday discussion about estate planning with my sons. I coached them to expect to get nothing because I plan to spend it all and have fun. My oldest son, said something to the effect of “Knowing you, Dad, you will have every penny you have now and more, on the day that you die.”
The future is unknown and responsible people plan for unknowns. The trick is to achieve balance. There is no better time to enjoy life than while we are living, of course! ;^) And our best years are likely here and now…not later when we are older and at a future point in our inevitable decline.
I built my first net worth and retirement models when I was in my mid-20s back around 1980. I created more comprehensive models in 2000 and used them extensively. I retired three years ago. Baring an economic collapse, I’m all set and I’m spending whatever I want on whatever I want. But my son was still right…the day I die, I’ll still be planning and prepared for future unknowns…and there will be a pile left over.
I have a simplistic model for myself. I simply need to protect / maintain accumulated assets to age 70, then annuitize everything (I have no heirs). This removes the burden of planning to age 100. The common criticism that annuities do not compensate for inflation is moot in light of retiree spending declining with age. Therefore, a fixed income stream will provide more than I consume with excess going to charitable interests. Like any plan, risk is not gone. I still have the risk of hyperinflation and insurance company bankruptcy but I have removed the risk of unplanned longevity. A fast comment on MikeP’s comment–even though I did not experience the depression, the frugality of my depression-era parents is deeply embedded in my own habits. I posted a story about my Mom’s habits in retirement (under a pen name) http://bit.ly/2auVgf8
You can purchase inflation protected immediate annuities. Used to be protected for whatever inflation occurred, but now you get to pick 1, 2, or 3% maximum inflation protection.
If you’re planning to 100 from age 70, you still have 30 years of inflation to weather.
It appears these arguments are based upon steady state rates for inflation and returns. The order of returns makes a big difference so the Monte Carlo Analysis was developed in an attempt to account for worst case scenarios. The flaw in this is that this analysis uses historical data and the future may not repeat historical fact.
An interesting discussion: The 4% Rule by Todd Tressider.
Gars,
I’ve written extensively about sequence of return risk and the 4% rule on this site. Todd Tressider’s writing on this cites mine in several scenarios.
Spending according to the 4% rule actually exacerbates this situation and makes it WORSE. Because if you spend according to the 4% rule, in the overwhelming majority of scenarios you just finish with multiple times your starting wealth. See https://www.kitces.com/blog/what-happens-if-you-outlive-your-safe-withdrawal-rate-time-horizon/
– Michael
I agree. The fear of running out of retirement is completely OVERBLOWN. It’s been 5 years since I last worked, and I’ve discovered a plethora of income opportunities if I need them.
Also, we aren’t dumb robots. We adjust our spending accordingly if times are more difficult. With the real estate market and the stock market at close to record highs, the retirement generation is also the wealthiest generation. And the kids of this generation will inherit $30T+!
Time to kick back everyone! Y’all are working too hard.
Sam
I think one major flaw in the logic “that seniors spend less as they grow older” is the cost of long-term care. Long-term care can cost about $70-80,000/year in today’s dollars and can last for several years. Cost is even higher if husband & wife need the care. How does one plan for such a major spike in senior spending that is likely to occur in the last years of life?
Tim,
My approach is to assume all my travel and entertainment and other discretionary spending in my early retirement (go-go) years never trails off. This would provide a substantial sum of funds to repurpose for long-term care costs, if needed.
Mike
This fits us perfectly, we don’t want to “spend down” our savings. We want to pass most of if not the whole portfolio to future generations, thus inflation is a concern. Thanks for the insight.
A much more interesting article than most of the “4% rule” repetitious pieces.
Circumstances vary, but I spend way less than 4% of my assets per year. I quit working at a high tech company in 1986 when I was 34. Just fed up. Sat on the beach for a year. Then got interested in cryptography and things that led to Bitcoin.
My frugal habits in 1986 continued to now. My brokeraget stats say I have made about 17% per annum over some number of years.
I really can’t “spend down” my assets. Nearly all of my friends in the Bay Area seem to be in the same position. I don’t see it as a problem, but something we need to see more discussion of.
–Tim May, California
One should consider that waiting until later that having your beneficiaries receive $ that are worth way less than now, we should gift a little now while the dollar can buy more! gps invest
Do we have any “real spending data” for retirees? I understand working from assumptions, but after 20+ years at this I’ve seen spending to know that it usually begins shrinking beyond age 80. People take fewer trips, the grand children are now grown, etc. I think that might change some of your relevant factors.
I am now 81, retired 18 years, no pension, I make more than I spend. What is the problem? I am frugal and don’t spend money just to get rid of it. My idea of a fun weekend ( remember my weekends are usually not Friday or Saturday) is going to live theatre (at senior rates) or going to a lake in my RV (also at senior rates). I generally do the cooking when we are out because I simply enjoy doing it and it tastes better than most restraunt food. My children have mostly followed our frugal lifestyle and seem to enjoy life more than those who spend freely. Three of them have RVs and really enjoy using them. Frankly, I enjoy life and do it on my terms and not on what someone else thinks that I should spend. I help my grandchildren when the need arises and still invest $2-3k each month on the average. Nothing wrong with a little “surprise” for your kids when you depart this world.