Retirement Can't Be Pass or Fail

Anthony Watson |

We’ve always found it odd that traditional retirement planning focuses on the probability of success or failure.  The retirement planning industry has used this language and methodology for so long that most people have grown accustomed to and do not question the approach. 

How are you supposed to react if you are told you have a 90% probability of success and a 10% probability of failure if you take a certain amount of inflation-adjusted income for some assumed timeframe from an investment portfolio given a certain asset allocation between stocks and bonds?  In traditional retirement planning, this 90% probability of success measure is generally interpreted as being associated with a conservative retirement plan.  But still, can you really afford to take a 10% risk of “failing retirement”?  Is failing at retirement even an option?  Of course not.  

You Can Make Changes in Reality

One of the biggest issues we have with traditional retirement planning is that it assumes you (the current or future retiree) cannot make changes over the course of a 30+ year retirement. This extreme simplifying assumption sounds pretty absurd when you say it out loud, and we know it does not reflect reality.  In fact, often times all it takes to avoid “failing retirement” is a slight change in spending.  If this is true, shouldn’t the focus of retirement planning be on identifying when and how much of a change to your spending may be needed so that your retirement plan can always remain on track and not run the risk of failing?  Further, if your actual experience ends up being better than one of the extreme downside possible scenarios, shouldn’t you be able to increase your spending as your plan becomes less risky over time?  

"Reality-Based" Retirement Planning Answers the Right Question

By taking the same powerful Monte Carlo analysis tools and traditional retirement planning equation and changing the variable, we can instead solve for spending capacity and then determine a set of total risk-based guardrails (or spending rules).  In other words, assuming a portfolio balance, income, risk tolerance, retirement length, and asset allocation, we can answer the question of how much you can spend given a certain level of willingness and ability to make changes to that spending if required.  Further, we can find portfolio balance levels where spending can be increased or would need to be decreased to stay on track.

This “reality-based” approach to retirement income planning is probably new to you, so here is an illustrative example of how we use spending capacity and flexible spending rules in practice.  Following are the results of a hypothetical couple planning to retire in January of 2024:

Given their current portfolio balance of $2,948,000, expected income, asset allocation, risk tolerance, and time horizon, they can start by spending $23,800 monthly (after taxes).  If their portfolio climbs to $3,125,000 (+6%), their risk level reduces to a point where they can increase their spending by $1,500 to $25,300 per month.  Alternatively, if their portfolio falls to $2,352,000 (-20%), their risk level increases to a point where they need to decrease their spending by $1,200 to $22,600 monthly to bring the plan back into balance.

Conventional Retirement Planning Can Not Adapt

Traditional retirement planning makes a one-time forecast and yields a probability of success or failure.   The traditional approach makes no effort to incorporate actual data as it unfolds, nor does it tell you what action to take or when it is needed.  Our “reality-based” approach to retirement income planning instead calculates spending capacity and total risk-based spending guardrails to guide essential adjustments to spending in response to changes in the portfolio value and the realized sequence of portfolio returns.

"Reality-Based" Retirement Planning Leads to Better Economic Outcomes

Not only does utilizing flexible spending rules make sense intuitively, but they also make sense economically and lead to a more optimal outcome.  Taking a flexible (or dynamic) approach to spending (or withdrawals) allows you to start with a higher income level and tends to lead to a higher cumulative retirement income over time.  In his research article entitled “A Framework for Assessing Variable Spending Strategies,” Wade Pfau, Ph.D., CFA, RICP® concludes that variable spending strategies can dramatically increase sustainable retirement spending and further found traditional retirement planning’s constant inflation-adjusted spending until wealth depletes approach to be the worst possible strategy.

We have also written numerous articles about flexible spending rules (aka dynamic withdrawal rules) and have long felt applying dynamic withdrawal rules is one of the most powerful tools available to maximize the retirement income a client can collect during their living years.  Our latest, entitled “Quantifying the Value of Dynamic Withdrawal Rules,” is a case study that shows the quantifiable value of applying flexible spending rules to a retirement plan.

If you would like to better understand how the solutions discussed above can help you, we stand by ready to help.  To learn more, you can schedule a friendly, informal call for a date and time that is convenient for you here at this link: or contact us here at any time.