Saturday, March 1, 2014

JP Morgan's Dynamic Withdrawal Strategy

JP Morgan has recently released its research on dynamic retirement income withdrawal strategies entitled, "Breaking the 4%Rule". 

As someone who has frequently ranted on this website against the 4% Rule and encouraged the use of a dynamic retirement income withdrawal strategy, I recommend this paper to readers of this blog.  In many ways, the expressed goals of the JP Morgan withdrawal strategy are similar to the goals of the withdrawal strategy suggested in this website.  The JP Morgan paper also combines its withdrawal strategy with an investment allocation strategy, which I do not address in this website as I have no investment expertise.

In addition to attempting to carefully balance lifestyle risk and longevity risk, JP Morgan also attempts to "maximize how much utility value investors receive from their withdrawals."  This utility value maximization is also not something that I address in my recommended withdrawal strategy.

Some concerns I have with the JP Morgan Strategy:

The withdrawal schedule is significantly more aggressive than withdrawal rates recommended in this website.  For example, JP Morgan specifies an initial 5.9% withdrawal rate for a 65 year old with $1,000,000 in accumulated savings and $50,000 in "lifetime income".  Based on the assumptions recommended in thiswebsite and zero bequest, I get a withdrawal rate of 3.45% using the Excluding Social Security 2.0 spreadsheet if I assume $30,000 of the $50,000 of lifetime income is in the form of a fixed immediate annuity (with the remaining $20,000 payable from Social Security).  The main reasons the JP Morgan withdrawal rate is so much higher is that their model assumes higher future investment returns, lower future inflation, a shorter payout period and does not anticipate using accumulated assets to provide for future inflation adjustments to fixed payment "lifetime income."  If comparable assumptions are used for both models, I would anticipate results to be very similar for the initial year's withdrawal.

Additionally, the JP Morgan strategy does not appear to have relatively constant inflation adjusted retirement income as a goal.  Therefore, all things being equal, their withdrawal strategy would be expected to be more volatile from year to year than the approach recommended in this website when measured in inflation adjusted dollars.

Because the JP Morgan paper was critical of the performance of the 4% Rule in volatile markets, "especially when a portfolio loses significant value during the early years of retirement" I decided to calculate spending budgets and remaining assets under the JP Morgan strategy and the Steiner Actuarial Approach (using recommended assumptions and smoothing methodology) for a hypothetical retiree where asset returns are somewhat unfavorable.  The two graphs below  compare retirement spending budgets (withdrawals from accumulated savings + Social Security + fixed pension) and remaining assets under the JP Morgan Dynamic Strategy with the Steiner Actuarial Approach for someone retiring at age 65 with $1,000,000 in assets, $20,000 in annual Social Security and $30,000 in fixed pension/life annuity income (for a total of $50K) of "lifetime income". 

I assumed about a 0% average annual rate of return for this hypothetical retiree's first five years of retirement with the following randomly chosen rates of investment return:  year 1: -15%,  year 2: 2%, year 3: 5%, year 4: -5% and year 5: 15%.  I also assumed 3% inflation each year.  I used the withdrawal rate table included in the JP Morgan article to determine withdrawal rates and I interpolated between relevant wealth and age factors.  I ignored the fact that inflation increases in the retirees Social Security benefit would increase the retirees "lifetime income" and thus perhaps slightly increase the retiree's withdrawal rate under the JP Morgan approach.  I also assumed that the JP Morgan withdrawal rate tables (and the Steiner recommended assumptions) would remain unchanged for the entire 5 year period.  For each approach, I assumed that the annual budgeted amount determined under the relevant approach would be spent during the year.

Comparison of Budget Amounts In Inflation-Adjusted Dollars

Comparison of Remaining Asset Amounts

The graphs show that based on this assumed investment experience,  the JP Morgan strategy produces a spending budget that is somewhat more volatile (when measured in inflation adjusted dollars) than the Steiner Actuarial Approach.  Because it is more aggressive than the approach in this website (based on recommended assumptions), it produces higher spending budgets each year and therefore lower remaining assets at the end of the five year period.  Is the JP Morgan strategy better than the Steiner Actuarial Approach?  I don't believe its use of Monte Carlo simulations or utility value maximization necessarily make the JPMorgan strategy superior.  If comparable assumptions are used, results under the two methods can be comparable, and the smoothing algorithm in the Steiner Actuarial Approach results in more real dollar stability in the retiree's spending budget from year to year.   The Steiner approach is also readily available on this website.