Joe Tomlinson on Variable Withdrawal and Improving Retirement Outcomes

I might have linked to this article before but Joe Tomlinson, in a recent article at Advisor Perspectives (How Variable Withdrawals Improve Retirement Outcomes, Joe Tomlinson. 10/17/16), had a nice distillation of his recent thinking and research on variable withdrawals, asset allocation, and the use of annuities to improve retiree outcomes in terms of consumption, shortfall risk, and legacy planning. I thought I'd add a little personal commentary.  It is a short article that is easy enough to read and it probably does not require a set of bullet point extracts but here they are anyway:

• Optimal asset allocations for variable withdrawal strategies are quite different from the research findings and rules of thumb based on fixed strategies. Indeed, the implications go beyond asset allocation and show, for example, that equity glide paths in retirement are relatively unimportant. 
• Although the 4% rule has been popular with researchers, practitioners recognize that good planning cannot ignore what is happening with the investment portfolio; spending adjustments will need to be made during retirement. 
• The bottom line result is that, with variable withdrawals, we move from 30% to 75% stock allocation recommendation to a range of 50% to 110% – a significant increase in the upper end of the range.  
• We can improve results further by using a portion of savings to purchase a SPIA and fill in the income gap between the $30,000 of Social Security and $50,000 of essential expenses…This amount of SPIA purchase completely eliminates the shortfall risk, so we can concentrate on the CE as the primary performance measure. Testing reveals that a 140% stock allocation produces the highest CE…It is clear that adding a SPIA improves things, both in terms of eliminating shortfall risk and increasing the CE.
• Glide paths are an interesting topic when optimal stock allocations are in the 30% to 75% range as has been the case for research based on fixed withdrawal strategies. But when financially optimal results are produced with stock allocations above 100%, as I have demonstrated for variable withdrawals, glide-path analysis has little practical significance.

• Once a retiree secures funding for essential spending needs, the remaining assets are “liberated” and can be invested more aggressively.

My Comments: 

I think this article is an interesting and useful contribution to retirement research and commentary.  While > 100% allocations to stocks can be a shocking concept for retirees, it depends on how you look at it.  By that I mean that if you look closely at the article, he is in effect, if I understand him correctly, putting two filters over a retiree scenario not too dissimilar to the way I sometimes look at it.  For example, if 40% of a portfolio happens to be dedicated to retirement income by way of stuff like bonds, dividend payers and maybe even riskier things like MLPs, REITs, etc. and that 40% were to cover retirement consumption then you can technically say you are 100% allocated to stocks in the 60% portion that is not totally committed to the "floor."  So it's kinda dual: one is both 60/40 and 100% allocated depending on the point of view.  

And I think he is correct in his approach.  I personally believe that a "floor" of income -- from sources like part time work, Social Security, annuities, bonds, and selected income-producing risk assets -- dedicated to funding expected retirement consumption has, even if it's not 100% coverage, a relatively high probability of reducing not only sequence of returns risk but also some, if not all of it in it's entirety, shortfall risk.  Given that, it is easy to see that the remainder of the portfolio can take on quite a bit of risk including the possibility of leverage to get over a 100% allocation for that above-the-floor portion of the portfolio.  That risk part of the portfolio, as he says, has been "liberated."  

When looked at this way, it feels like this is similar to what I try to do on my better days: create and protect a "floor" and then be willing to take -- on the margin but not all of the time -- levered risk when it makes sense.  That levered part sounds risky but it's not as bad as it looks. Systematic rules-based alternative risk, for example, can mitigate some of the behavioral-bias risk and reduce (but not eliminate) the potential for harm when it is used in small amounts over short-ish time frames. No proof offered  here but you get the general point.

Regarding his discussion on SPIAs, I also convinced myself in my post An Amateur's Hack To Figure Out How Much Spending Might Be Increased By Hedging Out Longevity Risk With An Annuity.  June 25 2016, a point of view that I've seen confirmed in several recent research papers and reinforced in Joe's article, that retirement outcomes can in fact be enhanced by the judicious use of simple annuities.  He uses SPIAs, I like DIAs as more efficient way to do it but it's a horse-a-piece either way for this post.  Note that I have not actually purchased an annuity yet so it remains to be seen if I can jump over my own "annuity paradox."  Time will tell. 

I think the discussion of "glide path" in the article is a little bit of sleight-of-hand.  When looked at the way that Joe looks at it in the article and as I mentioned above, he is probably right: equity allocations take on less importance especially if we talk about 100% and greater allocations.  On the other hand when we look at the retiree balance sheet in it's entirety at a meta level that includes the income assets presented as actuarial present value and we include them in an overall "meta risk allocation" then yes there probably is an equity glide path and it's not just all up or all down.  I offer no proof or charts here but it would likely look like a smile where a 25 year old might have 100% equity exposure, a 97 year might have a 100% equity exposure, and a 58 year old might have a 40/60 stock/bond allocation, at least for a while.  And that's before we think about including a PV factor or a valuation for human capital...or annuities or social security or pensions.  My point is that there is a time in life when shortfall risk and sequence risk matter more than others and it is then that the risk needs to be managed by whatever means are available at the time.