Wednesday, October 24, 2012

M. Ray Grubbs on Retirement Planning with an Unknown Safe Withdrawal Rate

In a recent post, "What is a Safe Withdrawal Rate?" I described how I am working to build retirement income strategies that do not rely on a safe withdrawal rate, because I don't know how to determine the safe withdrawal rate from a portfolio of volatile assets. In a comment, Bill asked how to plan for retirement income withdrawals without knowing an appropriate safe withdrawal rate. My short answer was a bit underwhelming, but fortunately Dr. M. Ray Grubbs stepped up to the plate with a much better answer. Professor Grubbs teaches in the Else School of Management at Millsaps College in Jackson, Mississippi. Along with financial planner Jason Branning, CFP, of Branning Wealth Management, they developed a retirement income framework called Modern Retirement Theory. They've published two articles about Modern Retirement Theory in the Journal of Financial Planning, and Professor Grubbs comment from that blog post explains how to plan a retirement income strategy in a world where a safe withdrawal rate is an unknowable quantity:

Kudos to Wade as he continues to present some of the best thinking in the retirement planning industry. I have come to appreciate those around us who offer ways to think differently about the issues surrounding retirement funding toward the ends of greater certainty and quality of life.

This article is a significant advance in thinking about two questions he proposes to be solved simultaneously; (1) to meet as well as possible one’s lifestyle spending needs and (2) to preserve a buffer of financial assets to manage risks regarding unexpected expenses. He says “forget about success rates, failure rates, safe withdrawal rates, etc.,” and remain focused on these two questions. I hope he continues this line of research and writing as it seems to present a realistic alternative for retirees as they think about a sustainable retirement.

However, Wade’s response to Bill Comb’s comment may be found less than informative and helpful, much like advice given to retirees for years: work longer, save more, or die early. This advice is often given when the negative impact of a SWR comes down on a retiree. The retiree questions their advisor, “What now?” Often this question comes at a time when alternatives may be severely constrained by low or negative market returns. The retiree alone will experience the full weight.

Bill, I’d offer an approach which conforms to some of the research Wade has published. First, take a deep dive into your budget. Seek to understand in detail what it costs you to live, i.e. your basic living expenses, now, and as best as you can determine, in retirement. These are expenses that will not go away in retirement, like utilities, housing, clothing, food – and any other expenses you consider to be basic living necessities. Once these are categorized as base expenses, develop sources of net cash flow monthly that are simultaneously stable, secure and sustainable. These are not expenses that you can depend on the market and its statistical vagaries to fund for you.

Next, seek to understand your unique unknowns. How can one understand the unknown? This is the second question that Wade seeks to address with a buffer of financial assets to manage risks regarding unexpected expenses and is essentially a question of risk mitigation – therefore a question of insurance. Not insurance products necessarily, but a question of insurance – a critical distinction. Wade also mentioned in his response to you that “it is hard” to predict the future”. I would respectfully press Wade on degree – it is not hard to predict, it is impossible to predict the future for the individual. But with this impossibility to predict comes choices that each individual must make to mitigate risk of the unexpected that could wreck an individual retirement plan.

After decisions are put in place for basic expenses and contingencies, there are lifestyle questions. What would you like to do in retirement should you have the resources to do so? Define these and invest accordingly, with understanding that these expenses are discretionary and can be delayed or deferred if circumstances warrant. I think these discretionary expenses confirm to what Wade refers to when he advises you to stay flexible. Discretionary expenses are lifestyle necessities, but decisions can remain flexible since, by definition, they are not absolutely necessary to live.

Finally, consider leaving a legacy if funding permits. If your resources permit this, leaving a legacy may be something to consider but not at the expense of basic living expenses, mitigating contingencies and lifestyle necessities.

Bill, with Wade, I congratulate you on your forthcoming retirement. May you have health and happiness. I encourage you to stop looking for a single number – it just does not exist in the form you wish it to exist. Rather, keep doing your retirement homework by thinking in structured, systematic ways about what you need and develop your own sense of how to best move forward.


  1. Dr. Pfau,
    I would like to thank you for responding to my earlier question and for your level of concern as shown by asking Dr. Grubbs to respond. I certainly appreciate the advice that he has given. I perhaps should have explained my situation somewhat fuller in my earlier post. My problem, as I see it, is that I have enough saved in a 60/40 diversified index fund portfolio, so that if I follow the 4% rule, that along with social security will allow my wife and I to live at the same, what I would call modest, level in retirement that we live at now. I think modest is a generally accurate description. We are not taking any vacations to Europe, or anywhere else for that matter. We could cut back but it would mean a more frugal lifestyle, which we could do, but it would not be enjoyable at all. So if the 4% rule would work out, then we will be in fine shape. But, as you say, we cannot know the future. What concerns me is idea that we are in a new economic reality and that future stock returns may be lower (I believe John Bogle recently made some comments along these lines). My inclination is to start by following the 4% rule. Then, I suppose, if it looks like things are not going well, I could reduce my withdrawal rate based on conditions at the time. In other words, I guess I have to be flexible. Obviously, I could start my retirement withdrawing less than 4%, but, as I say, that would result in a lifestyle that would be disappointing. I do have one thing going for me. Given my wife's and my ages, I think we only need to plan for about 25 years of lifespan, and we have no children. I am much interested in Dr. Pfau's research because of the possibility of SPIAs producing a better outcome. Thanks again to both of you.

    1. Bill,

      It is a tough problem, spending more now to meet your lifestyle goals, but understanding that this could force you to make bigger cut backs later. Given the way you describe things, I wouldn't think that you should necessarily start with a more frugal lifestyle now by spending less than 4%.

      And you may be a good candidate for partial annuitization with SPIAs. I don't recall if you mentioned your ages, but a joint SPIA for a couple without inflation-adjustments could provide between 5% and 6%. Until inflation erodes away enough at the value of that income, this would help provide relief so that you don't have to withdraw as much from the rest of your portfolio, which would give you more chance to see how things are playing out.

      And if it is not too late, think about delaying Social Security, as it is the best inflation-adjusted SPIA available.

  2. Great thread. I think it is important to note that the SWR is the worst case scenario. Most of the time, an investor could withdraw much more and still be sustainable. The problem is the investor doeen't know in advance whether the return sequence will allow for higher withdrawals.

    Investors need a mechanism for making decisions through time. The retirement income problem has two possible errors. Spend too much, enjoy life, and run out of money OR spend less than you could have, be needlessly frugal and miss out on a better lifestyle. Longevity risk versus lifestyle risk. In order to make adjustments so you can spend close to the realizable sustainable rate for the investor's actual sequence of returns, and investor needs to be able to make adjustments. To make these adjustments, investors need a goals based benchmark to signal when to make these adjustments.

    The Critical Path is a goals-based benchmark we developed to drive the decision making process. Essentially we take the financial plan and turn it into the benchmark. Then depending on how the markets are cooperating, the investor can make adjustments to improve thier chances of success or increase their expenditures and live a fuller lifestyle.

    Branning and Grubb's Modern Retirement Theory concept brings a lot more granularity to the planning discussion. Instead of one amorphous retirement spending target, MRT creates the opportunity for multiple layers of spending needs and helps the client prioritize the importance. It also delineates which assets are tasked with funding each spending need.

    Combining the Critical Path and MRT creates an opportunity for an investor to more closely track their actual SWR real time amd make adustments that allow them to enjoy as much in retirement as they can afford while reducing the chances that they run out of money.


    1. Brent,

      Thank you for sharing. I remember reading about the critical path concept in your Asset Dedication book. But from the sound of things, you've added a lot to that concept since your book was published in 2004. Do you have some other readings you can suggest?

  3. Great article. I have a related post on my finance site titled "thoughts on the 4 percent withdrawal rate" that breaks down the withdrawal rate into two types of income sources that is designed to match up to three types of spending accounts.

    1. Thanks for sharing. Yes, you are basically describing a framework for matching assets and liabilities along the lines that pair up their risk characteristics. This is also a key focus on Modern Retirement Theory.