Friday, December 14, 2012

Jonathan Guyton on Combining Dynamic Withdrawals and Dynamic Asset Allocation

Two brief notes before starting:

-My December column at Advisor Perspectives is now available. It is on the role of income guarantee riders to support retirement income. This finishes my three-part series on income guarantee riders.

-My second column as a MarketWatch RetireMentor is out, called "Depleting Assets May be a Good Strategy." Subsequently, a very interesting discussion about the column took place at the Bogleheads Forum.

At the FPA Experience 2012 conference, I enjoyed an opportunity to hear Jonathan Guyton speak on the topic, “Volatility and Volatility-in-Advice: Applying Behavioral and Analytical Stress Tests to Safe Withdrawal Policies and Practices.” His talk was quite detailed, and I would like to focus on part of it. This part introduces a new avenue for research. Let me back up a minute to explain what that is.

The classic retirement income strategy put under the test for the 4% rule is to withdraw constant inflation-adjusted amounts for as long as possible until wealth is depleted. It isn’t a particularly realistic strategy, though it probably never was meant to be either. Real people will make adjustments throughout retirement. After big market changes, there are two key ways in which one could respond:

-Change the spending amount (up when markets do well, down when they drop)

-Change the asset allocation (have different asset allocations in mind for different market valuation levels)

Both of these types of strategies have been tested quite a bit by researchers. Jonathan Guyton, in particular, made his name by developing a series of decision rules which would support a higher initial withdrawal rate with the understanding that one will make cutbacks to spending when certain events take place.

What Jonathan Guyton is the first to do in this presentation (as far as I know) is to combine these two dynamic possibilities: adjust both spending and asset allocation at the same time. Past researchers have treated each separately. 

He finds some intriguing results when applying this to the case of someone retiring at the start of 2000.

The decision rules for dynamic withdrawal amounts which he uses include:

-if the current withdrawal rate (in a given year) is within 20% of its initial withdrawal rate, then increase the prior year withdrawal amount by inflation

-if the prior year’s portfolio return is negative, do not make any inflation adjustment

-if the current withdrawal rate exceeds the initial withdrawal rate by 20%, reduce the spending amount by 10% (Capital Preservation Rule)

-if the current withdrawal rate falls below the initial withdrawal rate by 20%, increase the spending amount by 10% (Prosperity Rule)

And for the dynamic asset allocation, the total stock allocation will be either 50%, 65%, or 80 depending on the market valuation level. He didn’t explain the specific rule for this, but he noted that asset allocation changes happened in 2000, 2009, and 2011. I’d be willing to guess that the allocation is 50% for 2000-2008, 65% for 2009-2010, and 50% since 2011. This is compared to a static stock allocation case of 60%.

Consider a retiree on January 1, 2000, who has saved $1.2 million. This is what Jonathan found:

                           Static          Dynamic
January 1, 2000

Initial Portfolio Value    $1.2 million     $1.2 million
Initial Withdrawal Rate    4%               5%
Initial Withdrawal Amount  $48,000          $60,000

January 1, 2012
Portfolio Value            $1.041 million   $1.078 million
Current Withdrawal Rate    6.2%             5.8%
Current Withdrawal Amount  $64,400          $62,300

This is interesting. In the dynamic case, withdrawals could not keep up with inflation, but it would be hard to argue that the dynamic person is worse off. Their initial spending started 25% higher, and after 12 years it is roughly the same as the static case. The dynamic case has been able to enjoy more total spending thus far in their retirement. As well, the current value of remaining assets is still slightly larger for the dynamic case as well.

I’d say that this is definitely an area deserving of more research focus. 


  1. What I find interesting about this summary is that the retiree with the static asset allocation still has 86% of her portfolio left 11 years into retirement. The first 11 retirement years included two severe market downturns and what has been called the "worst decade ever" for investors. To be 11 years into retirement in that environment with 86% of the original portfolio left seems pretty good to me. Of course, no one knows how the next 19 years (assuming a 30 year retirement) will be for the retiree but it seems that she is in pretty good shape.

    The rules for dynamic withdrawals described make sense but it is hard to tell how much that impacted the remaining assets 12 years into retirement as opposed to the dynamic asset allocation. The problem with the dynamic asset allocation, from the perspective of an average retirement investor rather than a researcher or investment professional, is that it is a form of market timing that could be hit or miss in terms of helping to preserve assets. As an average investor, I think I prefer the static allocation unless there is more information about the triggers for re-allocating and some research to indicate how successful it is and how likely it is to make the portfolio value lower over time (because of bad timing decisions).

    1. Hi, thanks for sharing.

      About the dynamic asset allocation, I did write an article on this topic, related to how it impacts retirement withdrawal rates. You might like to have a look:

  2. Thank you, Wade. I read it. I have to say that, as your articles go, the one in the link above was more of a challenge for me than many of your other articles. I still think that as a researcher you can be objective but as an average investor, I worry about emotion taking over once I decide on a dynamic asset allocation. I'm sticking with fixed. Given the example above, however, I see the potential value. A 5.8% withdrawal rate seems much safer than a 6.2% withdrawal rate.

    I also keep in mind that the 2000 retiree was in a somewhat unique position at retirement in terms of portfolio growth just prior to retirement. I favor your safe savings rate approach where the focus is on saving enough to likely meet the income replacement goal under most circumstances because being blessed by a bull market just prior to retirement is no guarantee there will not be bear markets during the retirement years.

    As always, thanks for your work. It provides valuable information to people who really need it.

    1. Thanks for the nice comments. Certainly, you have to stick with an asset allocation strategy you feel comfortable with. Best wishes.