KEEPING YOUR WITS IN STORMY SEAS: CONFIDENTLY ADVISING CLIENTS ON SUSTAINABLE WITHDRAWALS WHEN ALL...

KEEPING YOUR WITSIN STORMY SEAS:

CONFIDENTLY ADVISING CLIENTS

ON SUSTAINABLE WITHDRAWALS

WHEN ALL HELL BREAKS LOOSE

FPA of the Philadelphia Tri-State

AreaJonathan T. Guyton, CFP®

Principal

© 2004 Cornerstone Wealth Advisors, Inc. All rights reserved.

A Humble Boldness …

God …Grant me the serenity to accept

the things I cannot change,The courage to change the things

I can,And the wisdom to know the

difference.

~ Serenity Prayer


Outline for Today’s Session

Synthesizing Withdrawal Rate Research

Client Conversations and Withdrawal Policies

Real-Time Decisions: You Make the Call

BUT FIRST …

CHECK IN WITHYOUR OWN BELIEFS


Decision-Making Believe-It-Or-Nots

A severe market decline is the most significant risk to the long-term sustainability of ongoing distributions from an investment portfolio.



Since withdrawal rates vary throughout the distribution period, they need to be kept low during bear markets but can be allowed to rise during bull markets.



The primary purpose of portfolio re-balancing (and the measure of its effectiveness) is to maximize the expected rate of return and, hence, the expected future value.



Relative to the impact of investment policy decision-making, withdrawal policy (mid-course adjustment) decision-making has little impact on the size and long-term sustainability of the initial withdrawal rate.



The retirement planning software you use models the effect of the strategic mid-course withdrawal adjustments you would make to a client during their distribution period.



Skillful decision-making in times of both emotional and economic stress requires skills that call on both the financial planner’s left-brain and right-brain, both the head and the heart.

SYNTHESIZING

WITHDRAWAL RATE

RESEARCH


Withdrawal Rate Research

Static Withdrawal Policy Behavioral auto-pilot Inflation-adjusted withdrawals (WDs) …

regardless Research Version 1.X

Dynamic Withdrawal Policies Behavioral flexibility during withdrawal

period Mid-course adjustments … when triggered

by quantifiable pre-determined criteria Research Version 2.X


Version 1.X: Static Withdrawal Policy Historically-based studies sought to maximize IWRs without failure in any 30-year rolling period Stochastic studies sought to maximize IWRs that would achieve a 99-100% probability of success over 30 or 40-year WD periods Their results essentially assume that every retiree begins withdrawals in an over-valued market environment with a ‘perfect storm’ soon to follow. The maximum prescribed IWR is the same even if: Withdrawals begin somewhere in a ‘bear

market’ cycle Withdrawals begin in a fairly-valued market


Version 1.X: Static Withdrawal Policy

William J. Bengen, CFP (1994, 1996, 1997) 4.1% - 4.4% initial withdrawal rate (IWR) over

a 30-year WD period, depending on asset classes employed

Asset allocation impacts maximum IWR by ~½%

Trinity Study (Cooley 1998) 4.0% IWR over 30-year WD periods: 1926 –

1995 Equity assets are exclusively S&P 500

Additional studies by academics and financial services companies using similar methodologies have generated the same 4-4½% maximum IWR using a 30-year WD period


Version 1.X: Static Withdrawal Policy

Ongoing Withdrawal Rates Change! 1/1 WD 60/40 12/31 Value WD Rate Return Value CPI

’73 $100k $4,300 4.3% - 7.5% $89k 8.8%

’74 $89k $4,678 5.3% -14.2% $72k 12.2%

’75 $72k $5,249 7.3%


Version 1.X: Static Withdrawal Policy 30-year withdrawal periods that succeed will display a wide range of yearly withdrawal rates The ability to discern ‘safe’ from ‘dangerous’ withdrawal rates within this wide range is a critical ongoing advisory decision Michael Kitces, CFP, …………………………….. (2008) 4.5% - 5.5% safe IWR based on initial market

valuation level (‘P/E10’) over a 30-year WD period ‘Over-valued’ market: 4.5% IWR (ala Bengen et al) ‘Fairly-valued’ market: 5.0% IWR ‘Under-valued’ market: 5.5% IWR Baseline IWRs add reality of initial market

conditions Equity assets are exclusively S&P 500


Version 2.X: Dynamic WD Policies

The introduction of dynamic withdrawal policies advances the findings of Version 1.X research Behavioral flexibility during the withdrawal period Mid-course WD adjustments … when triggered by

quantifiable pre-determined criteria … increase maximum IWRs by ½ - 1%

Additional enhancements from dynamic allocation changes??

There is no free lunch here! Trade-offs between Dynamic WD Policies and the lower –

but constant – inflation-adjusted WDs of Version 1.X Disregarding the Dynamic WD policies will impact the

high probabilities of success (99-100%) that they produce In some scenarios, long-term purchasing power is

impacted In extreme scenarios, Dynamic WD Policies will reduce

the higher WDs to be similar to the lower Version 1.X WD amounts

Comparing results for 30-year and 40-year WD periods



Guyton and Klinger (2006) 40 years WD policies (WDs +/-10%) when WD rate

rises/falls 20% support ~5.5% WD rate at 99+% confidence

Portfolio Mgt. Rule can reduce failures by 15-20% Policies/Guardrails apply to ongoing withdrawals Similar results when S&P 500 is only equity asset

Bengen (2006) 30 years Applying ‘floor-and-ceiling’ WD flexibility (+/- 5%

from initial real WD amount) raises IWR to 4.9% Applies to ongoing withdrawals

Klinger (2007) 40 years Findings support Guyton/Klinger (06) conclusions


Retirement Distribution Policies

Decision Rules for decision-making

Portfolio Management Decision Rule

Withdrawal Decision Rule

Capital Preservation Decision Rule

Prosperity Decision Rule


Decision Rules and Decision-Making



Dynamic Withdrawal Policy Summary

Condition: Action:Current WD Rate is within 20% of IWR

Increase Prior Year WD by CPI

Prior Year’s Return is Negative Freeze income (WD Rule)

Current WD Rate > IWR by 20%

Reduce real WD by 10% (CPR)

Current WD Rate < IWR by 20%

Increase real WD by 10% (PR)


Confidence Standards – 50% Equities

Confidence

Standard

IWR Success

Rate

Cuts/Freezes/Raises

Total PP

Year 40 PP

%

99% 4.6%

100% 2 / 5 / 6 99%

103%

95% 4.8%

100% 2 / 5 / 5 97%

101%

90% 5.1%

100% 2 / 5 / 5 92%

90%

Multi-Class Equities – 40 Years



Confidence

Standard

IWR Success

Rate

Cuts/Freezes/Raises

Total PP

Year 40 PP

%

99% 5.3%

100% 2 / 6 / 7 100%

106%

95% 5.5%

99% 3 / 6 / 7 96%

98%

90% 5.8%

99% 3 / 7 / 6 92%

90%




Confidence

Standard

IWR Success

Rate

Cuts/Freezes/Raises

Total PP

Year 40

PP%

99% 5.6%

99% 3/7/9 101%

113%

95% 6.2%

95% 4/7/8 96% 96%

90% 6.3%

94% 4/7/8 93% 93%



Synthesizing WD Policy Research

INITIAL Withdrawal Rates (IWR)

4.5% - 5.5% Static, Valuation –based

+ 0.5% - 1.0% Dynamic Withdrawal Policy

5.0% - 6.5% Version 2.X IWR


Withdrawal Policies in Real Life

1/1 WD Rate of 12/31 Value WD Rate Return Value CPI

’04 $800k$44.0k 5.5% +14% $862k 3.3%

’05 $862k$45.5k 5.3% +13% $923k 3.4%

’06 $923k$47.0k 5.1% +13% $989k 2.5%

’07 $989k $48.2k 4.9% 6% $998k 4.0%


Withdrawal Policies in Real Life

1/1 WD Rate of 12/31 Value WD Rate Return Value CPI

’08 $998k$50.1k 5.0% -26% $701k 0.0%

’09 $701k$50.1k 7.1% (intended) ****** CPR triggered as WD Rate > IWR (5.5%) by

20%CPR lowers ’09 WD by 10% from intended amount

’09 $701k $45.1k 6.4% +25% $820k 2.7%

’10 $820k $46.3k 5.6%


Version 2.X: Summary

Dynamic Withdrawal Policies add 50-100bps to Version 1.X Static Safe WD RatesDynamic Allocation Policies add 30-60bps to Version 1.X Static Safe WD RatesQuestion for future research:

To what degree does the combinedapplication of these dynamic policiesimpact the Version 1.X Static SWRs?

CLIENT CONVERSATIONS

and

WITHDRAWAL POLICIES


Client Conversations

The Retirement Income Holy Grail

Maintain lifestyle – and maximize withdrawal rates – especially early in retirementEliminate the chance of running out of moneyMaintain purchasing powerAvoid undesired changes to after-tax incomePreserve capital for future legacy



Trade-offs and Choices What to pay/give up for just a bit more Flexibility and Mid-Course Corrections Policies and Products

Myths & Realities: Connecting the Wrong Dots

The Present/Future Balancing Act

Discipline and ‘One-Time Wants’



Stories Clients Tell Themselves

“If my portfolio value has fallen significantly, then all my investments must be down significantly.”“If my portfolio value has fallen significantly and I’m taking withdrawals, I must be funding them by selling assets at depressed prices.”“We can’t enjoy life today without risking tomorrow’s financial security. One or us is going to have to give in.”



Being Present With Clients

Meeting clients right there in their story Who are they in their story? What is the fear … REALLY? Meeting them in their fear and not absorbing it Acknowledging where they are and calling out

the noise The power of suggestion

Telling YOUR story: Analogy, Metaphor and Humor The ship at sea in the (perfect) storm A cancer in the system


Client ConversationsStart of 2008 $1 million total value; $50,000 WD (5.0%) 66% equity, 28% Fixed, 6% Cash/ST

Start of 2009 $703k total value; $45,000 WD (6.4% after

CPR) 55% equity, 40% Fixed, 5% Cash/ST

Vertical and Horizontal Risk Current portfolio has $316k in Fixed/Cash Stock dividends are $10k annually $45k WD sustainable 11 years with

Divs./Int./Fixed

When do clients NEED their portfolio to recover?


Planning Policies

Bridge between client goals and the steps needed to sustain progress toward themCharacteristics of Planning Policies: Broad enough to encompass new or

unexpected events Specific enough to be rarely in doubt

about the action to take in response

(Yeske and Buie, 2006 Journal of Financial Planning)


Withdrawal Policy Statement

Income goals to be met Assets to which the policy applies (“Core”)Initial withdrawal rateSources of each year’s withdrawalMethod for re-balancingTrigger points for mid-course adjustments Type and size of WD adjustments when triggered (freezes, raises, cuts)


Those One-Time Wants and Needs

The Discretionary Fund Can relieve tension between ‘live

for today’ and ‘making sure the money lasts’

Not covered by Withdrawal Policies 2% - 10% of retirement portfolio Ideally non-qualified assets Encourage or facilitate client

conversation about policies for Discretionary Fund use

POLICIES IN ACTION:

A 39-Year Look BackAt A Perfect Storm


Withdrawal Policies in Action

Scenario 1 Static, inflation-adjusted withdrawal

policy Portfolio management rule for re-

balancing

Scenario 2 Dynamic policy: WD rule, CPR,

Prosperity rule Portfolio management rule for re-

balancing


WD Policies in Action – Scenario 1Start of WD Amount 1/1 Value WD Rate

Year 1 $42,000 $1,000,000 4.2%

Year 3 $51,300 $ 640,000 8.0%

Year 5 $61,400 $ 842,000 7.3%

Year 11 $96,500 $1,102,000 8.8%

Year 16 $113,600 $1,534,000 7.4%


WD Policies in Action – Scenario 2Start of WD Amount1/1 Value WD Rate

Year 1 $55,000 $1,000,000 5.5%

Year 3 $54,400 $ 609,000 8.9% **

Year 5 $58,600 $ 812,000 7.2%

Year 11 $92,100 $1,068,000 8.6%

Year 16 $108,400 $1,497,000 7.2% ** (CPR 10% real cuts in Years 2, 3,

4)



Year 21 $140,300 $1,795,000 7.8%

Year 26 $160,500 $2,247,000 7.1%

Year 31 $180,200 $1,732,000 10.4%

Year 39 $218,300 $ 780,000 28.0%

WD Total $5.159MM $1.638MM(1973 $s)



Year 21 $127,100 $1,779,000 7.1% **

Year 26 $141,700 $2,371,000 6.0% **

Year 31 $152,900 $2,001,000 7.6% **

Year 39 $185,300 $1,921,000 9.6% ** ** (WD Rule freezes in Years 19, 23, 29,

36)WD Total $4.642MM $1.520MM (1973 $s)


The 21st Century Advisor

A Renaissance ProfessionalKnowledge Technical Relational

Skills Communication Sound judgment in a complex

world

The Financial Lewis & Clark


Conclusions

Applying a few powerful Decision Rules significantly increases Initial WD RatesDecision rules shift key risk from “running out of money” to maintaining purchasing powerWD policies can tell us when we need to adjust … and when we don’tDiscretionary Funds provide balance and harmonyEnhanced knowledge and skills are neededA trusted advisory relationship is key!


… And Concluding Thoughts…

Make decisions boldly and humbly Synthesize current knowledge Be clear on what you believe/know

… and don’t Call out poor thinking

Employ planning policies before ad-libing


… And Concluding Thoughts…Embrace not-knowing Articulate what you don’t know Explore what you don’t know Play with what you don’t know

Stay with clients when they struggle Tell the truth with courage and

compassion

Our work is a good science … and a great art!

KEEPING YOUR WITSIN STORMY SEAS:

CONFIDENTLY ADVISING CLIENTS

ON SUSTAINABLE WITHDRAWALS

WHEN ALL HELL BREAKS LOOSE

Financial Planning AssociationJonathan T. Guyton, CFP®Principal

KEEPING YOUR WITS IN STORMY SEAS: CONFIDENTLY ADVISING CLIENTS ON SUSTAINABLE WITHDRAWALS WHEN ALL...

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