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.