Wednesday, November 20, 2013

David Blanchett Develops Simple Formulas and Spreadsheet to Approximate Dynamic Prudent Withdrawal Rate Approach

In Mr. Blanchett's recent article in the Journal of Financial Planning, SimpleFormulas to Implement Complex Withdrawal Strategies, Mr. Blanchett develops "simple" formulas that approximate the results achieved by the more complicated Monte Carlo modeling anticipated in developing Prudent Withdrawal Rates discussed in my post of September 10, 2013.  In addition, Mr. Blanchett further simplifies the process by providing an Excel spreadsheet that enables users to input a few items and develop their own simplified Prudent Withdrawal Rates.  Here is the link to his spreadsheet.

I compared withdrawal rate percentages produced by Mr. Blanchett's spreadsheet assuming 50% equities, total portfolio fees of 0.20% and a 75% Target Probability of Success with the withdrawal rates produced by the Excluding Social Security 2.0 spreadsheet on this site for payment periods of 10, 15, 20, 25 and 30 years (using the recommended assumptons for investment return and inflation), and the results were very close (within .03 percentage points) for payment periods of 30, 25 and 20 and relatively close for payment periods of 15 years and 10 years. 

As mentioned in my September 10 post, I support the dynamic "actuarial" approach proposed by Messrs. Frank Sr., Mitchell and Blanchett, and I believe that Mr. Blanchett's simplification is a very useful addition to make their approach more accessible to financial planners and other users.  

I will point out that Mr. Blanchett's spreadsheet is most useful to a retiree who has no other sources of retirement income or bequest motives as it does not coordinate with other sources of retirement income, such as annuities, and it does not provide for leaving a specific amount to heirs.  To reflect such items, you may have to use their more complicated model, or the simple spreadsheet set forth in this website. 

Saturday, November 16, 2013

Vanguard Introduces Its Modification of the 4% Withdrawal Rule

Readers of this blog will note that I devote a fair amount of energy ranting against the 4% Withdrawal Rule (and other "Safe" withdrawal rates) as retirement decumulation strategies.  In addition, I'm generally not all that impressed with proposed modifications to the 4% Rule designed to somehow make it more workable.  Vanguard recently announced its proposed modifications in a paper entitled, "A More Dynamic Approach toSpending for Investors in Retirement."  They suggest a two-step process for determining an annual spendable amount payable from accumulated savings:  Step 1:  Take X% of end-of-the-previous-year accumulated savings.  Step 2:  Subject the result of Step 1 to a corridor, the ceiling of which is (1+Y%) of the spendable amount from the previous year and the floor of which is (1-Z%) of the spendable amount from the previous year, where "X" depends on the "planning horizon" and investment philosophy and "Y" and "Z" are arbitrarily chosen upper and lower limits (they suggest a value of 5 for Y and 2.5 for Z).  Readers of the paper who get as far as Appendix 3 will note that the example set forth in this appendix describes a slightly different approach than the approach described in the body of the paper, which I am assuming is an error).

While the Vanguard modification of the 4% Rule does make the approach more dynamic (i.e., it reflects actual investment experience to some degree), I believe this approach to be inferior to the actuarial approach suggested in this website for the following reasons:

As is the case for most "safe" withdrawal rate strategies, it defines success as not outliving accumulated assets.  It does not adequately address the risk of under spending.

It doesn't attempt to provide constant real dollar spendable income in retirement.

It doesn't coordinate with other forms of retirement income such as immediate or deferred annuities and it doesn't reflect bequest motives. 

With all the adjustments required for different planning horizons and investment philosophies, it is not appreciably simpler than the actuarial approach set forth in this website (particularly if you use the assumptions and algorithm I recommended several posts ago).