A little more than ten years ago, the Financial Analysts Journal released “The Only Spending Rule You Will Ever Need” by M. Barton Warning and Laurence Siegel. Recently, Stefan Sharkansky has updated and changed the Strategic Withdrawal Plan (SWP) set forth in Waring and Siegel’s article with a different SWP in an article entitled, “The Only Other Spending Rule Article You Will Ever Need.”
Mr. Sharkansky’s primary update/change is to specify how a retired household’s portfolio should be invested. Specifically, he proposes that anticipated essential expenses should be funded by a TIPS ladder and future discretionary expenses should be funded by investment of the remaining household assets in an equity indexed fund. Readers of our blog will recognize that Mr. Sharkansky’s proposed investment approach is quite consistent with ours in that we encourage funding the present value of essential expenses with non-risky investments/assets and the present value of discretionary expenses with risky assets, so we have no problem with the two-asset investment approach anticipated by Mr. Sharkansky.
We will not be addressing in this post whether we believe TIPS constitute a better non-risky investment than life annuities or vice versa. TIPs have a clear advantage when it comes to addressing inflation risk in retirement while life annuities enjoy a clear advantage when it comes to addressing longevity risk, particularly for those who plan on living longer than their life expectancy. Some experts argue that because TIPS enjoy the full faith and credit backing of the U.S. government, they are more secure than annuity promises made by insurance companies. However, some worry that we might be a little too close to testing this faith. In any event, we would not consider an investment strategy that contained both a TIPs ladder and life annuities (in addition to Social Security) for funding of essential expenses to be unreasonable.
We agree with Mr. Sharkansky’s conclusion that
“Even if a retiree chooses to decumulate their risky assets using an approach other than ARVA, incorporating a TIPS ladder into their retirement plan merits serious consideration—especially at this writing when real yields are above their historical average, and a 30-year constant ladder delivers a higher rate of real income than the 4% Rule.”
What we don’t particularly like about Mr. Sharkansky’s proposal is that it is not a Strategic Spending Plan but rather it is a Strategic Withdrawal Plan. Therefore, we disagree with the title of his article.
SWPs generally provide an algorithm for determining how much of your portfolio you can withdraw each year. This amount is determined without regard to the existence of other household assets and is generally the same real dollar amount each year with possible adjustments for deviations between actual and assumed investment experience or (in some instances) actual withdrawal experience.
The basic problem with SWPs is that many sources of income and many household expenses are not linear in the real world. They can and do vary from year to year.
If you have non-linear sources of income, such as
- Deferred Social Security benefits for one or both members of the household
- Fixed dollar immediate or deferred lifetime annuities
- Death benefits or other life insurance proceeds
- Personal loan repayments
- Rental income
- Employment income
- Non-lifetime distributions from defined contribution plans
- Proceeds from asset sales
Or you have non-linear planned or unplanned expenses, such as
- Mortgage repayments
- Pre-Medicare health insurance
- Planned vacations until a specified age
- New automobile purchases
- Assistance with grandchildren education
- Unexpected or expected medical or dental costs
- Long-term care costs
- Family support
- Home remodeling
Then using a SWP like the 4% Rule (or one of its many variations), the RMD approach or Mr. Sharkansky’s two-asset approach as a source of “lifetime income” to supplement your Social Security benefits will likely be inconsistent with your spending goals. If instead, you are looking for a robust Strategic Spending Plan that can handle these non-linear sources of income and expenses and will help you manage your spending and your risks during retirement, you have found it here with the Actuarial Approach.
