Nice to see two more recent articles in the retirement income press discussing the advantages of dynamic retirement approaches like ours that use guardrails to adjust spending in retirement. These two articles are:
- “Why Guyton-Klinger Guardrails Are Too Risky For Most Retirees (And How Risk-Based Guardrails Can Help)” and
- ‘Probability of Success’ Doesn’t Mean What Your Clients Think It Means
In the first article, the authors say:
“We think including spending adjustments in retirement planning is a major step forward.”
In the second article, the author says”:
“Retirement planning that rejects success/failure framing can help clients understand that a realistic retirement journey involves not failure, but adjustments.
Advisors can help clients plan for those adjustments by establishing a “spend more” guardrail that tells clients when their risk of underspending and regret is too high, and so they can afford to live a little and spend more. It also means setting a “spend less” guardrail that tells clients when their risk of overspending is too high, so they should find a way to tighten the belt or adjust their goals to bring that risk down.”
We agree.
As discussed in previous posts we recommend applying the “spend less” guardrail when your Funded Status falls below 95%. We are less concerned about application of the “spend more” guardrail, but suggest that you may wish to consider its application when your Funded Status exceeds 125%.
In this post, we will use an example to show how easy it is to apply our recommended guardrails to estimate:
- How much your risky investments need to decrease to trigger a reduction in your discretionary spending, and
- The percentage change in your discretionary spending if one of the spending guardrails kicks in
Example
Let’s assume that Bill and Susie’s actuarial balance sheet looks like this as of the beginning of the year:
Bill and Susie’s Actuarial Balance Sheet as of January 1, 2024
Assets | Liabilities | ||
Floor Portfolio | $1,150,074 | PV Essential Expenses | $1,145,266 |
Upside Portfolio | $730,000 | PV Discretionary Expenses | $345,212 |
Rainy-Day Fund | $389,595 | ||
Total | $1,880,074 | Total | $1,880,074 |
Funded Status | 126.14% |
Bill and Susie’s Funded Status is determined by dividing the present value of their assets by the present value of their spending liabilities (ignoring the Rainy-Day Fund), or
($1,150,074 + $730,000) / ($1,145,266 + $345,212) = 1.2614
We use a little algebra to solve for how much their Upside Portfolio needs to drop in order to trigger a reduction in their discretionary spending, assuming they use 95% as the “spend less” guardrail.
($1,150,074 + X ($730,000) / ($1,145,266 + $345,212) = .95
Solving for X, we get .364, or a 63.6% drop in their Upside Portfolio would reduce the couple’s current 126.14% Funded Status to the “spend less” guardrail of 95%.
If they wanted to increase their discretionary spending, what percentage could they increase discretionary spending by to reduce their Funded Status to 125%?
Again, using a little algebra and solving for Y, we get 1.039 or a 3.9% increase in their discretionary spending to reduce the couple’s Funded Status of 126.14% to the “spend more” guardrail of 125%.
($1,150,074 + 730,000) / ($1,145,266 + Y (345,212) = 1.25
Bill and Susie determine that even though their risky assets have increased since the beginning of the year, they are happy with their current spending budget at this time, but they will continue to monitor their Funded Status from year to year to see if future changes may be appropriate.
They note that the current Shiller PE Ratio for the S&P 500 is 34.57 and believe that it is certainly possible that equities may currently be close to bubble territory. Therefore, they are pleased to know that even a decrease of more than 60% would not require them to cut back on their discretionary spending based on their plan.
Conclusion
This post demonstrates how easy it is to apply the guardrails in the Actuarial Approach to manage spending in retirement. It is not necessary to run thousand of simulations and perform complicated Monte Carlo model probabilities. You may wish to go through the same exercise that Bill and Susie went through in this post to develop your own “spend less” and “spend more” guardrails based on your balance sheet numbers. This exercise may also help you target a Funded Status (presumably inside your range) with which you are most comfortable on an ongoing basis.
Happy Planning!
