Kicking the bucket strategy

Certain retirement strategies have major flaws.

July 25, 2013 | Last updated on July 25, 2013
4 min read
Each “knot” of the income carpet shows the level of income received at a given age and starting year, as a percentage of total income required in real, inflation-adjusted dollars. Different colors indicate different ranges of percentages as indicated in the legend to the right of the chart. In a nutshell, green is good, red is bad.

The aftcast shows there’s a 23% chance Bob and Jane run out of income by age 97. This doesn’t meet our design criteria. “How can this happen?” you might ask. “We have a 4.5% initial withdrawal rate, and the plan is still inadequate?”

Yes. The major studies on sustainable withdrawal rates are based on calculated historical returns, but they miss the cost factor. Portfolio management costs, advisor fees, trading costs and all other expenses to hold and manage the portfolio increase the probability of failure. For this reason, we believe the famous “4% rule” is too optimistic. In our aftcast, we account for these costs to generate more realistic results.

Another factor that affects the outcome: we use a 32-year retirement time horizon, while the 4% rule uses a 30-year timeframe.

Scenario 2: Single bucket with age-based asset allocation

This is a variation of the buy-and-hold strategy we saw in Scenario 1. Some think they can reduce the risk of running out of money during retirement by holding more fixed income as they get older. For example, instead of holding 50% equity in the portfolio for the rest of their lives, Bob and Jane hold a percentage of equity that is equal to 100 minus their age. So, they hold 35% equity at age 65, 20% equity at age 80, and so on.

In this case the probability of depletion at age 97 is 32%—worse than our base scenario.

Scenario 3: Single bucket with a 5-year asset dedication

This is the same as Scenario 1, except we have a new rule about asset allocation. Bob and Jane’s asset mix is still 50% equities and 50% fixed income and cash. However, we never allow the fixed income and cash portion of the portfolio to hold less than five years of income required from the portfolio.

The aftcast says the probability of depletion at age 97 is 27%—worse than our base scenario.

Keep an eye on cecorner.ca for my analysis of multiple-bucket strategies and a chance to earn Continuing Education credits.