Kitces: Making Retirement Portfolios Last by Managing a Key Risk

“For which they still made it to the end without running out along the way, but only just made it to the end and had nothing left at the end of the 30th year. So anything more than that 4% initial withdrawal rate, and they would have actually fallen short,” he explained.

It’s usually unnecessary to be that conservative, although retirees do it anyway just in case, he noted to the Schwab conference audience. Many retirees using the 4% initial withdrawal rate quadrupled their wealth over 30 years, he said.

The basic strategy calls for spending low enough so that if investors encounter the worst possible return sequence, like those retiring in 1966, they’ll be all right and can adjust if the sequence is good, Kitces said.

Dynamic Asset Allocation

Dynamic asset allocation can take several forms, including bucket strategies, Kitces said. The simplest bucket strategy looks at the investor’s near-term, intermediate-term and long-term spending needs, he explained.

The assets needed in the near term (three years) would be placed in cash or cash equivalents, representing about 12% to 15% of the portfolio. Intermediate-term assets representing about 35% of the portfolio would go into bonds, while funds needed in the last 20 years of retirement, about half the portfolio, would be in stocks.

It’s not that different from what most investors would consider a diversified portfolio, Kitces said.

There are different ways to construct buckets, he said, noting annuities, for instance, can provide an alternative to the traditional bucket strategy. Social Security benefits and an immediate annuity could cover essential expenses throughout retirement, with portfolio withdrawals covering discretionary spending and increasing over the retirement years, according to Kitces.

Advisors secure the essentials bucket with guaranteed income.

“The whole point here is you cannot outlive your essential expenses,” the planning strategist said.

If bad things happen in the portfolio and the client faces an awful returns sequence, only discretionary spending is at risk and essential expenses — food, clothing and shelter — are covered.

Other strategies include a valuation-based asset allocation approach, in which the retiree maintains a mid-range stock allocation and adjusts it when markets are overvalued or undervalued, and a “rising equity glidepath” that, contrary to conventional wisdom, boosts equity allocations throughout retirement.

Research shows that increasing the equity allocation over the years helps with retirement income, Kitces said.

Looking at stock market price-to-earnings ratios when retirement starts can help predict safe withdrawal rates, since P/E ratios highly correlate to 15-year returns, which in turn can usually predict a 30-year safe withdrawal rate, Kitces also explained. (He referred specifically to the P/E 10, which divides stock price by average earnings for the past 10 years, adjusted for inflation.)

Managing the sequence of return risks matters more in environments like the current one, with high valuations implying that 15-year returns will be below average and withdrawal rates more restrained, Kitces said.

Dynamic Spending Strategies

Dynamic spending strategies include ratcheted spending, which has retirees starting with a safe withdrawal rate and bumping up spending when they get ahead so they don’t end up with excess money 30 years in that they could have used earlier.

So if the portfolio is up more than 50% from its starting balance because the retirees built a good cushion, for example, they can give themselves a bonus 10% raise every three years, Kitces said. (Someone who retired in 1966 would never reach this point, he noted.)