How Not to Leave Money on the Table

Today we’re going to talk an extremely important, yet rarely addressed topic – how do you maximise your retirement income, without substantially increasing the likelihood of depleting your assets? For a long time, finding an answer to this problem could be compared to finding the Holy Grail of financial planning. Worry not, as I might have good news today.

During most of this article, I will avoid diving into the details and technicalities, as my goal while writing this article is for it to be readable by the ‘average individual’ as much as possible. Furthermore, I always thought that the intricacies of financial planning and investing to be more appealing to financial planners, like myself, and that clients like simplicity – the more, the merrier. It’s also worth noting that the only reason why we’ll be using US data is that there’s more information readily available. We’ve done some testing, and the results are pretty reliable across different countries.

From a retiree perspective, I find that their goal is simple, and it usually manifests itself in four simple questions:

  • Do I have enough to retire?
  • How much is enough?
  • Will my income be able to keep up with a rising cost of living (inflation)?
  • If the market were to fall by, say, 30% tomorrow? How would that change my situation?

For simplicity reasons, throughout this article, we will be tackling the all-encompassing question ‘What’s the maximum amount I can safely withdraw from my fund every year?’ while occasionally addressing some of the individual questions above.

The first formal attempt at answering this question is attributed to William Bengen, CFP ®, and it’s known as “The Four Percent Rule”. Prior to Bengen (1994), interest rates were a lot higher and as a consequence, the default ‘retirement drawdown strategy’ was to invest in bonds and live off the interest… Those days are long gone, sadly.


Source: Bloomberg Data, Abacus Wealth Management

Bengen conducted an exhaustive study of historical returns, focusing heavily on the severe market downturns of the 1930s and early 1970s. He concluded that, even during untenable markets, no historical case existed in which a four per cent annual withdrawal exhausted a diversified retirement portfolio in less than 33 years (in line with an average life expectancy of an average retiree at the time). In simple English: If you had assets totalling $250,000 and you invested in a medium risk portfolio (60% stocks, 40% bonds), Bengen argued that you could safely withdraw $10,000 per year, and maybe increase that by 3.5% (in line with inflation) every year. In 25 years, this inflation-adjusted increase would amount to an annual income of $23,632.45.

Now let’s think together for a moment: we know that 1) financial markets are volatile, 2) that investing carries risk, 3) I know 4% is the safe rate at which I can withdraw money in retirement, but what I really want my advisor to tell me is what is the MAXIMUM I can withdraw, and safely. Does 4% per year compensate me adequately for the risk I’m taking when investing?

Fortunately for us, we aren’t alone in asking this question. In 2004 & 2006, Jonathan Guyton, CFP®, published two research articles showing that by opting to take a fixed withdrawal rate during good times and bad times alike, the retiree would be ‘leaving money on the table’. In time, he would eventually look back at his retirement and be frustrated when contemplating the better lifestyle he could have had, had he decided to spend more money.

Instead of a fixed withdrawal rate approach, Guyton made a case for rules-based dynamic management of income in retirement: withdrawing more money during market good times, and protecting the pension by reducing withdrawals during bad periods in the market. Guyton’s suggestions were based on research showing that retirees tend to reduce consumption during challenging economic times (the COVID-19 pandemic has proved this to be the case, although for different reasons). As such, the ‘pain’ of having to reduce withdrawals to protect the pension wouldn’t be significant. Guyton and other authors’ findings back Abacus Wealth Management’s strategy for managing income drawdown in retirement. We can see a table summarising Guyton’s results below:

Source: “Decision Rules and Maximum Initial Withdrawal Rates”, Guyton & Klinger, 2006

Let’s translate this to English and use an example: Jane has a total pension pot worth £650,000, and she needs an annual income of £26,000 (4% withdrawal rate). If she lives for 30 years, she will have an accumulated real retirement income of £780,000 (not including inflation-linked increases). What if we told Jane that she could instead take £35,750 (5.5% withdrawal rate)? During the same 30 years, Jane stands to receive an accumulated real retirement income of £1,072,500. She could enjoy an ‘extra’ £292,500 (38% more)! When you work with a financial advisor worth its salt, you pay more, but you also get more.

What I find the most empowering about this knowledge, is that we can reverse it to answer the perennial question “Do I have enough to retire/When can I retire safely?”. If I want an annual income of £30,000, and I know that I can use a 5% withdrawal rate in retirement, I’ll need a fund totalling £30,000/5% = £600,000. If I could only get a 4% withdrawal rate, I would instead need £30,000/4% = £750,000. This approach removes the guessing work.

If you find that the concept of dynamically increasing or reducing your income based on a set of rules to be difficult to grasp, at Abacus Wealth Management we try to explain it in a straightforward and visually appealing manner. We named the rule that would enable you to increase your income as ‘Upper Guardrail’, and the rule that would suggest you reduce your income as ‘Lower Guardrail’:

So far so good but something important is missing from the above analysis: the impact of fees. For a retiree, it doesn’t matter how much is portfolio is gaining or losing every year, but how much is the retiree’s account growing or falling by, net of all applicable fees (net return). We intend to be fully transparent and fair with our fees, and we employ a soft target of a 1.5% maximum cap on ongoing fees - funds, adviser and wrapper ALL included. To include the impact of fees into your calculation, add them to your withdrawal rate for simplicity. I.e: a 4% net withdrawal rate is equivalent to a 5.5% gross withdrawal rate. From our research, the typical actively managed funds being recommended by other wealth managers charge more than 1.5% alone. This means that total charges for the client are actually closer to 2.5% - 3% per annum. We’ve discussed above the outsized impact a simple 1.5% can have over a retiree’s lifespan.

If you’ve enjoyed reading this article and noticed that you or your financial advisor’s strategy relies on ‘hope’ as a strategy, more than on historical data, academic research and scenario analysis, feel free to get in touch and book a free discovery meeting with an Abacus Wealth Management’s advisor.

João Feliciano Martins,
Wealth Manager

Source: Bloomberg Data, Abacus Wealth Management

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