Overcoming the fear of running out of money in retirement

I agree with the key points made by the article: a “total return” approach is appropriate, investment risk reduction can be reduced by diversification, and it is important to set a sustainable spending rate.
I must admit that I once suggested (during a meeting of my investment club) that I could see why it might be easier for retirees to focus on the income rather than on the capital component of returns - but I was slapped down hilariously by one of the club’s founders, who said that he’d never yet been asked at the Woolies checkout whether he was paying for his groceries out of income or out of capital!!). And I have accepted his point.
But can I comment on one interesting aspect of the concept of “withdrawal rate”? In Bengen’s famous and influential work that came up with the 4% rule, the sustainable spend is defined as 4% of the funds AT RETIREMENT DATE, and thereafter spending is simply linked to inflation. To me, that approach can’t be optimal: if asset values increase (or decrease) significantly in a sustained manner, then surely it must be optimal to reflect that increase (or decrease) in increased (decreased) retirement spending.
But the opposite approach is to set your spending every year as being the “sustainable spending rate” multiplied by the beginning of year value of financial assets. But here we encounter another problem: if we are substantially invested in growth assets, then the value of those assets will fluctuate from year to year and so our real spending will also vary somewhat erratically.
The point I would like to make is that there is a way between these two extremes. A possible path is to take a weighted average of (say) last year’s spending (adjusted for inflation) and the “sustainable spending rate” applied to the current net financial assets. That’s what my wife and I do, and we got the idea from some leading US University endowment funds. There is a great article on the subject in Firstlinks here:
https://www.firstlinks.com.au/spending-guidelines-for-retirees-and-endowments
The result is a smoothed variation of the “sustainable drawdown rate” that doesn’t fluctuate too wildly from year to year, even if asset values are a bit volatile. So this approach is supportive of a somewhat “higher risk, higher return” asset allocation.

"optimal":

Where optimum = Least Risk of Running Out, retirement is after Age Pension eligibility age and expenditure [including depreciation] is not more than Age Pension. = 'Never' Run Out while alive.

Where optimum = Largest Net Present Value Withdrawals Over Investment Term then
= PMT((1 + TotalNetYield%) / (1 + Inflation%) - 1, (AgeTo - AgeFrom), -PresentValueInvested, FutureValueInflationDiscounted, 0)

Future values are wild guesses. Repeat calculation as future rushes toward.

Academic economists define “optimal” (intelligently, in my opinion) to mean that the present value of “utility” of consumption is maximised. In practice that is likely to be MUCH closer to the second of your approaches than the first. However one possible concern with your (broadly sensible) second approach is that if your asset allocation is strongly oriented to higher-returning growth assets, then your asset values will be potentially volatile, and the consequent variability in spending may not maximise “utility” because the utility from extra spending when markets are “high” won’t offset the shortfall in utility when markets are “low”. But smoothing the drawdown addresses this issue and that is exactly what the US Endowment Funds do; that was the key point of my post. We can learn from them, those guys (as you might expect!) are pretty smart!

"smoothing the drawdown":

I imagine that most do that to some degree by keeping a 'float' of personal bank deposits. "Two years essential expenses and minimum required withdrawals of capital from Disbursement ('pension') Accounts."

The fluctuations which result from future looking guesses can result in suggestion of 'reduced or negative spending' - of increased investment - where guessed future return rate is less than future inflation discounted capital growth rate:

Return 5%, Inflation 3%, to 85, from 65, present value 1, capital gain rate 4%:
= PMT((1 + 5%) / (1 + 3%) - 1, (85 - 65), -1, (1 + 4%) ^ (85 - 65), 0)
= --2.99%% / y (- = invest)
Such investment would come from slower growth assets such as a cash buffer.

Real withdrawal rate depends on capital deposits / withdrawals in as well as returns and inflation.
Capital loss / gain rate must be included to get the overall real total return rate.

Capital gain rate 5%, Return rate 4%, Inflation 3%, To 85, From 65, Capital -1 (= - invested):

No change in quantity of assets (eg same number of shares), increase in value of assets expressed in capital gain rate 5%
Future value discounted for capital gain and inflation 1:
= PMT(((1 + 5%) * (1 + 4%) / (1 + 3%) - 1), (85 - 65), -1, 1, 0)
= 6.0194%
= ((1 + 5%) * (1 + 4%) / (1 + 3%) - 1)

Where assets have been sold or bought, a change in quantity of assets, future value (discounted for capital gain and inflation to present value) is not the same as present value:

Quantity of assets halved (capital withdrawn):
= PMT(((1 + 5%) * (1 + 4%) / (1 + 3%) - 1), (85 - 65), -1, 0.5, 0)
= 7.3758%

Quantity of assets doubled (capital deposited):
= PMT(((1 + 5%) * (1 + 4%) / (1 + 3%) - 1), (85 - 65), -1, 2, 0)
= 3.3066%

Including the capital gain rate in the total return rate and using the future value discounted for capital gain and inflation to present value allows decrease / increase of assets by sale and withdrawal or deposit and purchase to be reflected in the withdrawal rate.

When I'm 60 TBC might be $2.2M

I'm working on a 5% withdrawal rate from day 1, not 4%

Just because I've taken 5% doesn't mean I have to spend it all, though likely will. I expect to spend more in the first decade of retirement than the 2nd.

3rd if I make it will likely have aged care costs.

Inflation has more impact on your fixed items like utilities etc because as too does the CPI basket of goods change, so does your spending habits/choices in higher inflationary times.

Bananas are too expensive this year, you buy apples instead. Beef is too expensive you'll be lamb or pork or chicken. Move these around to suit.

I’m sympathetic to drawdown rates higher than 4%. Bengen’s Rule was devised using a 50/50 asset allocation to large cap stocks and 5-year bonds. Large Australian “balanced” super funds tend to invest more like 70/30 between “growth” and “defensive” assets, and to use a lot more diversification than Bengen assumed. Also Bengen assumed totally rigid indexation of spending to inflation from the day you retire: if, in reality you can endure a bit of a reduction in your drawdown amount when markets are low, that’s a second justification for targeting a higher starting drawdown rate.

John, I always enjoy your comments and think that I can add some thoughts in this thread.

RE your point that the sustainable drawdown will vary somewhat erratically as the value of financial assets largely invested in growth assets fluctuates from year to year. That may be the case if one doesn’t account for mean reversion of misvalued assets.

For example, when I include the impact of deviations of equity market PE from some long term average on my return generating parameters (in Monte Carlo simulations or my closed form solution), the sustainable spending dollars are more stable. For example, if you are in the drawdown phase AND markets fall well below average, then future valuation reversion leads to higher future returns over the valuation reversion period resulting in a lower decrease in the revised sustainable drawdown estimate after the market fall.

BTW, a material outcome after including valuation reversion is that long term volatility reduces (it grows at less than annual volatility X Sqrt(time)), and as you may conclude, this results in higher sustainable drawdowns.

It's late 2027 before I'm of preservation age.

Whatever the TBC is then, I'll leave in Super for the tax free benefits, drawing 5% a year.

The extra in my Super will go towards buying a PPoR, new car, new motorbike.

About $400K in banks, depending on interest rates. Use the tax free threshold for income to take the interest.

Furniture for the new place, traveling.

Unfortunately the $3M TSB will likely be in play before I reach preservation age.

If you have trouble with the maths (as I do), a quick Google search "annuity calculator" throws up a number of excellent free tools , eg calculator.net.

A growing or graduated annuity calculator:
https://www.omnicalculator.com/finance/growing-annuity

For where deposits or withdrawals are decreasing or increasing (growing).

Err, that calculator has these errors:
. The Future Value used is nominal not real.
. Initial withdrawal at year 1 is not inflated from year 0.

The correct year 0 value is:
= PMT((1 + 5%) / (1 + 3%) - 1, (85 - 65), -2000000, 1000000)
= $80,230.94 / y
When inflated from year 0 to first withdrawal at year 1:
= 1.03 * 80,230.94
= $82,637.87 / y

After 20 years:
. nominal balance = $1,806,111.23
. real balance = $1,000,000.00

Re: growing or graduated annuity calculator inputs:
Annuity amount (cash flows), annuity frequency yearly, type ordinary, compounding frequency yearly, Initial deposit 2000000, final balance = ((1 + 3%) ^ 20) *1000000 = 1806111.23, length 20, Return 5%, Annual growth rate 3%:
https://www.omnicalculator.com/finance/growing-annuity

Differences can be resolved:

"Final balance" is in nominal value to be calculated and entered as:
= ((1 + 3%) ^ 20) * 1000000
= $1,806,111.23
Better if entered as "Real balance" and displayed as 'Nominal or final balance' to eliminate confusion.

"Yearly withdrawal $82,637.87 initially":
Is the first withdrawal for an ordinary annuity at start of year 1.
Inflated from year 0 to first withdrawal at start of year 1:
= (1 + 3%) * 80,230.94
= $82,637.87 / y

Good first step. But "As long as total return drawn down doesn’t exceed their sustainable spending rate over the long term, . . ."
- should be REAL total return AFTER FEES & TAXES. in order for withdrawals to maintain real purchasing power after inflation, etc. This is much tougher than just nominal total returns.
Ashley

Most people, like myself, are not interested in all the fancy words and calculations! For many years I have been using a self designed Excel worksheet, projected for at least 10 years ahead, which shows me year by year where my financial situation, by asset class and income type, is likely to be. At the end of each financial year I insert the actual position and project forward from there. I can vary inflation, interest, capital gain and spend rates at any time based upon my view of the economic situation at that time. It is incredibly accurate with the biggest problem being unexpected capital gains or losses caused by events like Covid. Friends laugh at me when I tell them, but it works for me. Perhaps I am lucky to be able to work with numbers, which not everyone can do?

Geoff: thank you. I too have a fairly simple spreadsheet which has been accurate and on track for at least 8 years. I dont see why it wont serve me well in the years ahead

A relevant 'one liner':
Total return 5%, inflation 3%, to 85, from 65, present value invested 2000000, future value 1000000,
Withdrawal rate:
= PMT((1 + 5%) / (1 + 3%) - 1, (85 - 65), -2000000, 1000000)
= $80,230.94 / y

Me too. I like playing around with numbers, so I've had 3 spreadsheets for a number of years.
1. A detailed budget which covers current year's spending plus a forecast over the 4 years ahead
2. A 5 year cash flow forecast and
3. A 25 year allocated pension income/drawdown forecast ( optimistic as I'm now 77 )
Bearing in mind of course that all forecasts are invariably wrong, I can play around with the variables at will.
Works well for me.

Geoff - point well made - your retirement is "yours alone" and a well constructed spreadsheet can cover multiple variables inside and outside Super - cost of living, assets and liabilities, "what ifs" mkt drop by 10% or 20%, tax exposure, impact of "Death Tax" and the list goes on! Mine goes out to age 100 - won't get there but has a line of "pull all Super at 85!!"

Aidan - you graduated in 1996 so guess that puts you a little over 50. By the time you are 75 you might have a different perspective!!

I fail to relate a total return approach to eliminating a FOMO pandemic. Logically such a recommendation is akin to solving COVID through lockdown, in that it solves the bell curve consolidation, rather than building resilience in evidence-based practice. But FOMO is a matter of fear, anxiety, unknown.

So long that we insist on single root cause of FOMO we'll continue to promote incremental total return solutions. In reality, if a member/ client falls ill and endures endless unexpected and unaffordable health expenses (insurance, out of pocket, etc.) total return solution strategy goes out the window.

The reality is that the lack of confidence is a product of longevity risk AND health risk. A solutions that can separately solve each of those, and bring them together, will shift the paradigm of retirement spending - with confidence.

I heartily agree with the sentiments in this article. Too often I have to remind myself to not just look at my portfolio return, but also to realise that the portfolio itself is a source of drawdown income. By looking at the full picture, my potential annual drawings increase by 50% pa over a 20 year retirement period.

The focus on total returns rather than income returns is good. Aidan's mention of the long-term is good but then he refers to risk as if it is short to medium term volatility. This will guarantee lesser long-term returns and lesser drawdowns for lifestyle needs and wants.

FOTO; Fear of Timing Out: dying with too much.

total return 5%, marginal tax rate 31.5%, inflation 3.6%, expenditure 1, capital present value multiple of expenditure 100, future value 0:
= NPER((1 + 5% * (1 - 31.5%)) / (1 + 3.6%) - 1, 1, -100, 0)
= 92 y.
= Age 65 + 92 = 157 y.
FOTOers won't live long enough to get the Age Pension.