The Most Important Factor in Retirement Income Planning

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This article first appeared in NerdWallet

By J.R. Robinson


As a practical matter, the factors that determine how long our accumulated nest eggs may last after we retire fall into two categories – those that we can control and those we cannot. Primary factors that are largely beyond our control include, of course, capital markets returns (sequence of returns risk) and how long we may live (longevity risk).  Factors that are, at least to some degree, within our control include:

  • Annual withdrawal amount
  • Annual withdrawal adjustment (cost of living increase)
  • Asset allocation
  • Investment expenses
  • Withdrawal strategy

While each of these has been has been explored in academic research, a review of popular financial planning applications finds that the influence of the choice of withdrawal strategy has been largely ignored at the consumer/practitioner level.  In fact, nearly all programs assume that retiree portfolios maintain a constant allocation with annual portfolio rebalancing throughout retirement.  Under these models, withdrawals from the various asset classes are typically made in proportion to their weight in the portfolio followed by portfolio rebalancing.  The unanimity with which this methodology has been applied has effectively led to the implicit assumption that constant allocation with annual rebalancing is an efficient withdrawal strategy for real world portfolios.   But is this truly the case?    

To illustrate the influence that the choice of different withdrawal strategies may have on retirement income sustainability, we consider the following reasonably realistic retirement planning scenario:

  • 30 year retirement horizon
  • $1 million initial retirement portfolio value
  • 5% ($50,000) initial withdrawal rate
  • 3% annual cost of living increase
  • 60:40 stocks:bonds allocation with equities allocated 50% large cap, 30% small/mid-cap, and 20% International.  Bonds are assumed to generate a constant 2% fixed rate of return throughout retirement (this is roughly equivalent to the current 10 year treasury yield)
  • 1%  annual investment expenses

Using these portfolio conditions, four different withdrawal strategies were tested using Nest Egg Guru’s Retirement Spending Calculator.  The results of 5,000 bootstrapping simulations for each of the four strategies tested are presented in the tables below.   The output presents remaining portfolio balances (if any) in 5 year increments  across the full range of simulations for each strategy.   It shows both the 5,000 simulations that lasted for the full time horizon as well as those that failed.   With respect to the failed simulations, the number of years until failure occurred may be particularly helpful in quantifying the risk of the  planning strategy relative to the user’s comfort level.

Table 1:  Constant allocation with annual rebalancing  

Table 1 HawaiiReporter


Successful portfolios out of 5,000 simulations = 33%


Table 2:  Spend stocks first, then bonds (decreasing equity glidepath)

Table 2 HawaiiReporter

Successful portfolios out of 5,000 simulations = 28%

Table 3:  Spend bonds first, then stocks (increasing equity glidepath)

Table 3 HawaiiReporter

Successful portfolios out of 5,000 simulations = 84%

Table 4:  Guardrail Strategy (constant allocation, don’t spend stocks after down years)*

Table 4 HawaiiReporter

Successful portfolios out of 5,000 simulations = 60%

* The guardrail strategy illustrated in involves shifting the gains, if any, from the stock and bond portions of the portfolio at the end of each year to cash and then spending down the cash, first followed by bonds and then stocks.  Under this approach equity allocations are, thus, not reduced following negative return years, until all of the cash and bond allocations have been exhausted.

The results presented in these four tables clearly illustrate that the choice of withdrawal strategy may have a dramatic effect on how long a retirement nest egg may last.  The results also show that the constant allocation withdrawal strategy with rebalancing that is commonly illustrated in retirement in many Monte Carlo simulation software applications may be sub-optimal and may lead to overly pessimistic simulation results.   As a practical matter, such results may cause retirees to be too conservative in their withdrawals (i.e., enjoy a lower standard of living in retirement and leave too many chips on the table for heirs).

While the difference between the constant allocation and  “bonds-first” withdrawal strategy is surprisingly dramatic, it is generally consistent with previously published research.   For example, in a June 2007 Journal of Financial Planning paper by SUNY professors John Spitzer and Sandeep Singh entitled, Is Rebalancing a Portfolio during Retirement Necessary, the authors demonstrated the superiority of a similar bonds-first withdrawal strategy and concluded,

While the wisdom of rebalancing in the accumulation phase of the life cycle is widely accepted, the wisdom does not appear to extend to the withdrawal phase…Rebalancing during the withdrawal phase provides no significant protection on portfolio longevity.”  

More recently, in a 2104 Journal of Financial Planning piece entitled, Reducing Retirement Risk with a Rising Equity Glide Path, noted retirement researchers, American University Professor Wade Pfau and Nerd’s Eye view blogger Michael Kitces reached a similar conclusion about the value of avoiding equity withdrawals early in retirement as a tool for ameliorating sequence of returns risk.

In summary, while this article is intended to draw attention to the fact that withdrawal strategy is an overlooked and critically important consideration in determining  income and portfolio sustainability, it is not necessarily intended to suggest that the bonds-first approach  illustrated herein is the optimal solution. Indeed, a number of papers have been published recently proposing a range of dynamic withdrawal strategies that are likely superior the ones presented in this paper. Whether these strategies are practically implementable by consumers and their financial planners is a matter for further discussion.

Additionally, all readers should understand that the output from retirement planning calculators can vary widely from one application to the next, depending upon the calculators’ inputs and methodologies. Critical thinking is required by the user in evaluating the merits and limitations of all retirement planning calculators.




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