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evaluates the ongoing sustainability of person ages through the data from
Distribution Glide Path.
decreased, or stays the same based on allows for higher withdrawal rates if
an income-centric to a wealth-centric viewpoint to help
the probability of failure for the the portfolio performs well, for
them better understand how to live on their investments.
D
istribution planning research is
entering its second generation. should change as situations warrant of the current withdrawal rate to
The first generation of distribu- throughout retirement. To support benchmark data to evaluate the asso-
tion research provided answers to rela- ongoing sustainability decisions, annual ciated probability of failure rates of a
tively static questions such as what is an probability of failure of the current given portfolio mix and remaining dis-
initial safe withdrawal rate and what is withdrawal rate is presented in this tribution time.
the best (constant) allocation for a distri- paper, summarized in five-year slices The revisiting approach introduced in
bution portfolio. Recognizing that distri- through the data. this paper is simpler than some of the
bution decisions are not made only once at As a person ages, this allows for slowly complex decision rules that have been
retirement, an expanding body of research changing to higher withdrawal rates previously introduced, and is therefore
is exploring retirement as a more dynamic associated with those shorter remain- easier to implement and change as the
period, in which changes can be made as ing distribution periods. For example, a client ages and portfolio values change.
situations warrant.
This paper will explore the question,
What is a safe withdrawal rate? not only decreasing distribution periods as the client An adaptive approach to distribution
initially, but also currently. It will do so from ages, which in turn allow for (2) an increas- planning, where the withdrawal rate is fluid
an adaptive perspective, where the with- ing supportable withdrawal rate with a sim- and not constant, can dramatically improve
drawal rate is revisited annually based on ilar probability of failure rate throughout the probability of success of a distribution
the performance of the underlying portfolio retirement. The study modeled the revisits strategy. Reviewing the withdrawal rate also
or unforeseen expenditures. It will also be annually, but the data are displayed as five- allows for the withdrawal amount to be
revisited simultaneously with the effects of year slices through the data for simplifica- increased as situations warrant, which
the dynamic relationships of (1) constantly tion of reporting purposes. ensures that a retiree is maximizing his or
her lifetime income. As the client ages, his While Guytons research provides valu- Longevity Risk
or her remaining time dynamically gets able insight into distribution planning, it
shorter. The adaptive approach in this takes a very one size fits all approach to A key consideration when constructing a
study demonstrates that the withdrawal distribution planning. For example, he uses distribution portfolio is how much to allo-
rate may be slowly increased as the client a fixed 40-year period for his study. Forty cate between equities and fixed income/
ages through management of the clients years is a relatively conservative estimate cash. The long-term importance of the
exposure to probability of failure with his for the distribution period, and each allocation decision has been well docu-
or her current withdrawal rate and remain- retiree (or retired couple) will have a dis- mented by Brinson, Hood, and Beebower
ing distribution time. tribution period that is unique based on his (1986), and more recently by Tokat, Wicas,
or her unique age, health, and family his- and Kinniry (2006). The potential benefit
tory. In contrast, the analysis conducted for of non-constant equity allocations for dis-
Previous Research
this paper considers nine different time tribution portfolios has been noted by
The assumption of a constant real with- periods (10 to 50 years in 5-year incre- Blanchett (2007).
drawal amount from a portfolio is a consis- ments) and takes a simpler approach to Two key risks must be addressed when
tent theme in past distribution research. adjusting withdrawals. making the allocation decision: sequence
The sustainable withdrawal rate is typically Bengen (2001) tested a variety of risk and longevity risk. Sequence risk is the
defined as a percentage of assets where an performance-based withdrawal methodolo- risk, or really the implication, of starting
initial amount, adjusted for inflation, is gies where the distribution rate was the distribution period in a bear market (or
assumed to be taken from the portfolio for adjusted during retirement in response to a market with low or negative returns).
the entire distribution period. For example, changing portfolio conditions. One test Sequence risk will affect clients differently
a 5 percent withdrawal rate from a $1 mil- involved potentially increasing the real dis- since people retire at different times. A
lion portfolio would result in a $50,000 tribution rate by 25 percent or decreasing recent study by Watson Wyatt (Watson 2008)
withdrawal in year one. The withdrawal in it by 10 percent based on whether the found that retirees with a substantial portion
year two, though, would not be based on 5 client was in a bull or bear market. For this of their assets in defined-contribution type
percent of portfolio assets; instead the paper, the authors use a more precise investments are especially prone to
withdrawal would be $50,000 plus infla- methodology than Bengens to determine encounter sequence risk because they tend
tion. The $50,000 withdrawals, adjusted whether an adjustment is necessary. to retire during market booms (that is,
for inflation, are typically assumed to con- Bengens analysis was also limited to 55 when their 401(k)s are doing well). Market
tinue until the end of the distribution test runs due to his reliance on historical busts tend to follow market booms, which
period, where the strategy would either be time series sequence data; in contrast, this is the type of market these retirees are
judged as passing (that is, it was able to paper takes a bootstrap approach and uses likely to face shortly after they retire (think
withstand the withdrawal for the entire 100,000 runs per scenario. mean reversion).
distribution period) or failing (in other Pye (2001) addressed the probability that a Sequence risk is directly correlated to
words, it ran out of money). withdrawal amount will need to be reduced the market risk of the portfolio. Therefore,
Recognizing that distribution planning is over various periods and for various with- more conservative portfolios with lower
more dynamic than just an initial with- drawal rates. Stout and Mitchell (2006) took equity allocations will have a lower likeli-
drawal decision, a number of studies have a similar approach to Pye where the with- hood of encountering sequence risk. But
introduced logic, or decision rules, to help drawal is potentially increased or decreased more conservative allocations increase
advisors determine how and when to annually, based on the likely sustainability of longevity risk, or the risk of the outliving
adjust a withdrawal amount over time. the portfolio. Stout and Mitchells dynamic ones resources.
Guyton (2004) introduced perhaps the model employs three types of controls As life expectancies continue to
most well known study involving decision portfolio deviation thresholds, withdrawal increase, the need to create portfolios that
rules, which were tested in a follow-up adjustment rates, and absolute withdrawal can sustain 40 or more years of inflation-
paper by Guyton and Klinger (2006). rate limitsin order to prevent overreac- adjusted withdrawals is becoming increas-
Guyton employs a variety of rules, such as tions to short-term market movements. ingly important. Studies by Cooley, Hub-
the Portfolio Management Rule, the Infla- Stout and Mitchell note that downward bard, and Walz (1998); Tezel (2004);
tion Rule, the Withdrawal Rule, and the adjustments should be more immediate than Cassaday (2006); and Guyton and Klinger
Prosperity Rule, to help an advisor deter- upward adjustments, and this paper incorpo- (2006) all confirm the importance of
mine how to adjust the withdrawal over rates that concept. This paper could be seen equities in order to maintain an inflation-
time to ensure the ongoing sustainability of as an extension of Stout and Mitchells work. adjusted withdrawal over a prolonged
the portfolio. Portfolio Ruin, Balancing Sequence Risk and period. Equities are important because
they have historically increased the return equity piece of the allocation is split two- The withdrawal amount is increased by 3
of a portfolio versus cash or fixed income. thirds to domestic large equity and one- percent if the probability of failure is less
Return is a key driver of portfolio success; third to international equity, while the than 5 percent. If neither of the above con-
however, higher returns are typically cash/fixed income allocation is split evenly ditions is met, the distribution dollar
accompanied by higher variability, or between cash and fixed income. For exam- amount does not change (except for infla-
standard deviation. ple, the allocation for the 60/40 portfolio tion or deflation adjustments).
Higher equity allocations, therefore, would be 40 percent domestic large blend The target period is defined as the length
decrease longevity risk but increase equity, 20 percent international equity, 20 of the assumed distribution period (30
sequence risk. Viewed differently, if a client percent cash, and 20 percent intermediate- years, for example). As the portfolio pro-
is unlucky and encounters poor initial term bond. gresses over time, the remaining target dis-
returns (sequence risk) during the distribu- The withdrawal is revisited each year for tribution period, or planning period,
tion period, it is likely that the withdrawal this study. Based on the underlying proba- decreases. For example, if the target period
amount will need to be reduced in order for bility of failure for the portfolio, the with- is 30 years, after 4 years the target period
drawal amount can either be would be 26 years.
increased by 3 percent, To build a reference table where the
decreased by 3 percent, or withdrawal rate (as percentage of current
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Figure 2 includes a sampling of the infor- drawal, the withdrawal rate, as a percent- increased by 3 percent to $41,200 (from
mation used to create the reference table age of current assets, would be 5 percent $40,000). If, however, the portfolio value
to determine the ongoing success rates ($40,000/$800,000), which corresponds to was only $500,000, the withdrawal rate
when testing the dynamic strategies. As an a probability of failure of 2.07 percent. would be 8 percent ($40,000/$500,000).
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remaining in its target period had a value point is less than 5 percent, the withdrawal failure that is greater than 10 percent
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strategy, the withdrawal amounts at the 15. The corresponding probabilities of Revisiting, or adjusting, the withdrawal
target end dates for the 95th percentile failure for each of the scenarios is amount throughout the distribution period
(worst 1 in 20), 90th percentile (worst 1 in included in each appendix to help the reduced the probability of failure signifi-
10), 80th percentile (worst 1 in 5), 50th reader easily reference the probability of cantly. A static real withdrawal amount,
percentile (median), and 20th percentile that revisiting strategy surviving the target based on a 6 percent initial distribution (or
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$60,000 from a $1 million portfolio), had a portfolio performance. Based on the data drawal is taken regardless of the underly-
39.01 percent probability of failure at 30 used to develop Figures 3 and 4, 88.47 per- ing portfolio value.
years, while the probability of failure for cent of the runs had withdrawal amounts It is worth noting that the probability of
the revisited strategy was only 9.83 per- less than the initial $60,000 at year 5, failure actually increased for some of the
cent. Figure 5 includes the probabilities of 69.70 percent at year 10, 55.31 percent at more conservative scenarios. For example,
failure for the same scenarios in Figure 2; year 15. Reducing the withdrawal amount the probability of failure for a 4 percent
however, unlike Figure 2, the probabilities as situations warranted better enabled the distribution for a 20/80 portfolio over 25
of failure for Figure 5 incorporate the revis- portfolio to survive the entire distribution years based on the constant methodology
iting methodology where the withdrawal period if the market returns were low. was only .05 percent, yet was 3.54 percent
amount was increased, decreased, or kept Second, the dispersion of the ending based on the revisit methodology. The pri-
the same based on the ongoing probability account values was much tighter for the mary reason for the increase was that a
of success for the portfolio. The revisited revisited methodology than the constant probability of failure of less than 5 percent
strategy also had a consistently lower prob- approach. The revisiting methodology was deemed acceptable when there were
ability of failure as seen in Figure 6. ensures that the withdrawal amount is tai- ten or fewer years to the target end date
Some readers may question how it is lored to the underlying portfolio; if the when determining whether to adjust the
possible to have both a lower probability of portfolio performs well the withdrawal withdrawal. For this scenario (4 percent
failure and a higher median withdrawal increases, if the portfolio performs poorly withdrawal, 20/80 portfolio, 25 year distri-
amount when revisiting is used. This the withdrawal decreases. Contrast this bution period), the 95th percentile with-
occurs for two reasons. First, the with- dynamic approach with the constant with- drawal amount (or worst 1 in 20) at the
drawal amount was reduced with poor drawal approach, where the same with- 25th year was $52,834. The failure rate in
the 24th year of this strategy was only .01 lio values are less, which forces a higher client to have the ability to cut expen-
percent. In other words, the revisited withdrawal rate from the portfolio. ditures during poor markets. This is
approach resulted in a higher lifetime with- A second dynamic factor is the effect of difficult to explain unless the advisor
drawal amount, which is arguably each aging where distribution periods are, in has relative probability of failures of
retirees objective, and virtually every run fact, dynamically and continually shrink- the clients current withdrawal rate
that failed did so in the last withdrawal year. ing. An initial withdrawal rate for 35 years (current annual withdrawal divided by
Figure 6 compares the table data from remaining, then 34, 33, and so on, is quite the current portfolio value).
Figures 2 and 5 for the portfolio composi- different from a sustainable withdrawal Higher initial withdrawal rates result
tion 60/40 (other portfolios would yield rate when the retiree has 10 years remain- in still higher current withdrawal rates
similar figures) for the withdrawal ing. Withdrawal rates tend to be linear even when the portfolio value declines
amounts from 4 percent to 8 percent for when aligned for distribution periods from with poor markets (sequence risk).
the 20- to 50-year periods. This figure illus- 20 to 40 years (ages 55 to 75) versus para- Portfolio value volatility accentuates
trates the gap between Revisited (RV) bolic when aligned for periods under 20 the sale of more shares. The higher
withdrawal rates, which have lower proba- years (ages 76 and older). the smoothing rate over a sustainable
bility of failure rates relative to Fixed (F) rate, the more the relative number of
withdrawal rates, which is why the RV shares are needed to be sold (negative
Safety of 4 Percent and Early Versus Later
columns are to the right of the F columns. Withdrawal Strategies dollar cost averaging effect) versus the
In reality, people withdraw dollar non-smoothed rate.
amounts from their portfolios. Without Distribution planning is not a one size fits The negative dollar-cost averaging
changing those dollar amounts (except for all exercise. Each client and retiree will effect has led to the strategy of placing
increasing them for inflation), the with- have different needs that are going to influ- the first few years of distributions into
drawal rate is still constantly changing due ence the sustainable real withdrawal rate cash or more conservative portfolios/
to the dynamic factor of fluctuating portfo- decision. Past research on adaptive strate- buckets.
gies has noted that 4 percent Because the total value supporting dis-
is likely too conservative an tributions includes these conservative
estimate for an initial with- buckets, this strategy is essentially
more conservative.
ensure they are still prudent given the versus later has raised the
failure rates for different portfolio compo-
hence cut their expenses, by using a with- Market Rate data obtained from Cooley, Phillip L., Carl M. Hubbard, and
drawal rate appropriate for the time Tradetools.com (1927-1933) and the Daniel T. Walz. 1998. Retirement Sav-
remaining as well as a lower current with- St. Louis Federal Reserve (1934- ings: Choosing a Withdrawal Rate that
drawal rate relative to other rates possible 2006): http://research.stlouisfed. is Sustainable. Journal of the American
for that time frame remaining. In other org/fred2/. Association of Individual Investors 20
words, higher rates are generally possible c. Domestic large blend equity: defined (February): 1621.
for smaller distribution periods (such as 20 as the return on the Big Neutral Guyton, Jonathan T. 2004. Decision Rules
years) versus longer distribution periods portfolio based on the 23 portfolio and Portfolio Management for Retirees:
(such as 40 years). return information publicly available Is the Safe Initial Withdrawal Rate Too
on Kenneth Frenchs Web site: http:// Safe? Journal of Financial Planning 17,
mba.tuck.dartmouth.edu/pages/fac- 10 (October): 5461.
Conclusion
ulty/ken.french/data_library.html. Guyton, Jonathan T. and William J. Klinger.
Because it is impossible to predict with d. International equities: defined as the 2006. Decision Rules and Maximum
certainty the exact path each of your return on the Global Financial Data Initial Withdrawal Rates. Journal of
clients will take during retirement, an World ex-USA Return Index, data Financial Planning 19, 3 (March): 4957.
adaptive approach should be used when obtained from Global Financial Data Pye, Gordon B. 2000. Sustainable Invest-
determining the appropriate withdrawal from January 1927 to December 1969 ment Withdrawals. Journal of Portfolio
amount from a distribution portfolio. Past and the return on the MSCI EAFE Management 26, 4 (Summer): 7383.
distribution research has been based pri- Standard Core Net USD from January Stout, R. Gene and John B. Mitchell. 2006.
marily on the assumption where a con- 1970 to December 2007. Dynamic Retirement Withdrawal Plan-
stant, inflation-adjusted withdrawal is Because pure historical data is used for- ning. Financial Services Review 15, 2
taken from a portfolio for the length of the this analysis, as is common among distri- (Summer): 117131.
distribution period, regardless of the bution research, the authors would cau- Tezel, Ahmet. 2004. Sustainable Retire-
underlying portfolio. The static methodol- tion the reader that if future returns are ment Withdrawals. Journal of Financial
ogy ignores the dynamic needs of clients, lower than historical returns, the actual Planning 17, 7 (July): 5257.
market fluctuations, and client responses result of a distribution portfolio may be Tokat, Yesim, Nelson Wicas, and Francis
to those fluctuations, where the ongoing materially different from what this M. Kinniry. 2006. The Asset Allocation
value provided by advisors who regularly research suggests. Debate: A Review and Reconciliation.
meet with clients to ensure the future suc- 2. Data obtained from the Bureau of Labor Journal of Financial Planning 19, 10
cess of the distribution strategy rests with Statistics. (October): 5261.
an ability to benchmark the clients proba- Watson Wyatt 2008. Influences on Work-
bility of success or failure. Revisiting the References ers Asset Allocations in Defined Contri-
withdrawal can materially improve the bution Accounts. www.watsonwyatt.
probability of success for a distribution Bengen, William P. 2001. Conserving com/us/pubs/insider/showarticle.asp?Ar
portfolio and, therefore, is an essential Client Portfolios During Retirement, ticleID=18489.
component of any distribution plan. Part IV. Journal of Financial Planning 14,
5 (May): 110118.
Blanchett, David M. 2007. Dynamic Allo-
cation Strategies for Distribution Port-
folios: Determining the Optimal Distri-
bution Glide Path. Journal of Financial
Endnotes
Planning 20, 12 (December): 6881.
1. Data definitions: Brinson, Gary P., L. Randolph Hood, and
a. Intermediate-term bond: defined as Gilbert L. Beebower. 1986. Determi-
the return on the Moodys Seasoned nants of Portfolio Performance. Finan-
Aaa Corporate Bond Yield, assuming a cial Analysts Journal 42, 4 (July/August):
ten-year duration. Data obtained from 3944.
the St. Louis Federal Reserve: http: Cassaday, Stephan Q. 2006. DIESEL: A
//research.stlouisfed.org/fred2/. System for Generating Cash Flow
b. Cash: defined as the yield on the During Retirement. Journal of Financial
three-month Treasury bill. Secondary Planning 19, 9 (September): 6065.
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