A good article by Wade Pfau, PhD, CFA, RICP® that in part states that variable spending can reduce sequence-of-return risk and increase, on average, withdraw rates:
Constant spending from a volatile portfolio amplifies sequence-of-return risk. But that can be partially alleviated by reducing spending when the portfolio value drops. Reducing spending in the event of a market decline provides a release valve for sequence-of-return risk that can allow the initial withdrawal rate to increase. This is because the current withdrawal rate does not have to be increased by as much when the portfolio loses value, allowing for less assets to be sold at a loss and more to remain available in the investment portfolio to benefit from any subsequent market recovery. Reducing sequence-of-return risk in this manner develops synergies, making it possible to spend at a higher average level than a constant inflation-adjusted strategy without any flexibility, while maintaining the same overall risk of portfolio depletion.
A key word is in that first sentence "from a volatile portfolio." I have a better idea - don't have a "volatile portfolio." Sequence risk can be mitigated by having two years of cash needs in high-yield savings, and another 3-5 years in safe bonds/fixed income (US treasuries/TIPS, laddered CDs, etc). Example: annual spending projected at $60k. $40k comes from Social Security. That leaves $20k/year from the nest egg. So then $40k in cash/money market, $60-$100k in bonds/fixed income.
Poof, no sequence risk. You can ride out 5-7 years without ever touching stocks that are down. Sequence risk is a fear tactic used to push annuities, but it is a real thing for people that don't know this stuff, or enter retirement with only balanced funds or target date funds, where you can't take just bonds vs equities.
Constant spending strategies like the 4% rule are also pretty bogus, because newly retired folks tend to be healthier and more active, and want to spend more. They should do that, because when they're older, they won't be capable and by nature expenses tend to drop in many categories.
That said, Pfau is correct that folks should keep an eye on economic conditions, but should NOT freak just because their overall portfolio is down, and sacrifice the enjoyment of their retirement. It's a natural cycle. I worry that advice like this cause people to be overly and unnecessarily stressed and over-reactive during their retirement. ("Hey, I have a solution to that - annuity!" NO!)
Essentially, that's why we use Pralana, right? Each year, retirees should do an update with the new version, which contains important tax/legislative updates, as well as any changes in their goals/situation, and updated account balances. Pralana will tell them if they're still good to go. No need to do much else until next year, same time, same channel. It's good to have a plan, and a great tool to execute it.
Good points 😆. Just need to make sure you have enough retirement funds to fill the 3 buckets before you retire 😉.
@pizzaman That's a good point also. For example, if you have low savings, after placing the cash and bond buckets there might not be much left for the stock bucket. That means you might run out of money, missing out on that long-term growth in equities! You have to correlate the buckets to an asset allocation and make sure it's still sane and reasonable. In the other case, tons of nest egg, the AA might be overly aggressive with a huge stock/equity bucket, and cause undue stress and risk in market volatile times. It's important to do the exercise. Trinity Study/Bengen/4% rule are built on an assumption of between 60% stocks/40% fixed income and 50/50, and of course not getting bled out by advisor fees, fund fees, commissions.
@hines202 There has been and probably will be an ongoing debate about bucketing. I use an asset liability approach which is similar to bucketing, but I am not sure either approach reduces portfolio volatility. A 60/30/10 portfolio with a starting value of one million at the start of 2022, ended at about $850,000 not including living expenses. Granted, in either case you did not need to sell equities or bonds and that may work out depending on what equities and bonds do going forward. Here are a couple of articles that you may find interesting. I was a big supporter of bucketing before retiring, but I am not so sure now. I have decided to take my pensions as a monthly benefit to mitigate the sequence of return risk. Just a different approach - not to say it is any better than yours.
https://blog.iese.edu/jestrada/files/2019/04/AP-Does-the-Bucket-Approach-Destroy-Wealth.pdf
It seems that based on the PRC survey results the most common asset allocation is 60/30/10 (give or take). Well, is that not a 3 bucket approach without saying it out loud? I think the question is how many years does each bucket cover, not how much money is in each bucket. That of course depends on your standard of living. So putting a name to it (Bucket approach) doesn't really mean much in terms of a successful retirement, but that's just me 😉. (Notice the use of emoji to show playfulness in my comments 😋).
Part two of Wade Pfau's, PhD, CFA, RICP® article on variable spending:
