Evaluating Retirement Withdrawal Strategies with Christine Benz (EP.141)

0:28We all need to make smart decisions with our money. and I invited Christine today to share insights from a fascinating paper she co-authored titled The State of Retirement Income. This episode delves into the critical aspects of retirement planning, especially focusing in on sustainable withdrawal rates that ensure retirees don't outlive their savings. So join us as we explore the motivations behind their research, the nuances of the 4 % rule, and the implications for retirement spending strategies. As always, you can find links to the research and all the resources mentioned during the show at thelongterminvestor.com.

1:08Now, here is my conversation with Christine Benz.

1:15Christine Benz, welcome to The Long-Term Investor. Hi, Peter. So great to see you. I'm so glad that you're here with me today because I reached out at the end of 2023 when you and two others from Morningstar co-authored a paper. Your co-authors, Amy Arnott and John Reckenthaler, called the State of Retirement Income 2023. I thought that'd be a nice starting point. Can you just explain the motivation behind this research and how you hope people use it? Yeah, it's our third year doing this research. We published the first paper in 2021. And the motivation for doing the research was that this is one of the mission-critical aspects of retirement planning, figuring out how much someone can reasonably spend each year.

2:00And so a lot of the research that had been done looks at historical returns and embeds historical returns into the assumptions about how the market will behave over someone's retirement time horizon. We thought, well, it's super important to kind of think about where we are in a given market cycle if you're sort of forecasting how much someone can reasonably spend. And especially if yields are really low and valuations are high, as was the case in sort of the late 2021 period, that would argue for someone being a little bit cautious in terms of their portfolio withdrawals. Whereas if things are looking better from the standpoint of yields and or stock valuations, well, you could potentially take a little bit more.

2:46So our research attempts to incorporate starting conditions, and we use our team at Morningstar Investment Management's forecast for equity returns and bond returns over the next 30 years in our calculations. But we're trying to be forward-looking, and I suppose that's one of the key differences versus some of the research that's been done on this topic historically. That's a great transition because Bill Bengen did some research back in 1994 that revolved around this 4 % withdrawal rate that I feel like just about everybody talks about these days. And it's only been more recently that people have started pointing out some of the weaknesses within it, including Bill himself.

3:29Can you talk a little bit about that 4 % withdrawal rate that we're always referencing? Yeah, it is interesting when you talk to Bill Bengen, he is somewhat eager to distance himself from that research because the main thing is, and I'm sure financial advisors who might be listening to this know, the assumptions that he used in terms of thinking about how the retiree might spend really are kind of a straw man. They're not how people spend in retirement. So specifically, he assumes that people want sort of a paycheck equivalent in retirement. They want something that is just a fixed real amount year after year after year.

4:07And when we look at the data on how retirees actually spend, we see that while people actually tend to spend a little bit less as the years go by throughout their retirement life cycle, they're not taking the same amount out year after year. And then we also know that real life comes into play, that actual spending can be lumpy, that you have good spending years where maybe you're taking the family on a big trip. You have unexpected unwelcome expenses, maybe big home repairs, whatever. We know that people's spending can be lumpy. And this is something that happened in their working years and it persists throughout their retirement years.

4:45So that's one of the shortcomings of the Bengen method. But basically, he arrived at this idea that if you incorporate historical returns and you attempt to look at what would have been sustainable over the vast majority of 30-year horizons in market history, that a 4 % initial expenditure with that dollar amount inflation adjusted thereafter throughout the 30-year horizon, well, that was sustainable in a lot of different market scenarios. And it's a really helpful, I think, rule of thumb. I sometimes think about this research that Fidelity did several years ago where they asked consumers how much they could reasonably spend in retirement.

5:27The answer was, you know, some people were coming out with 10%, 12%, not a good number, right? You need to be lower and people need to be thinking about some basic rules of thumb so that they're on board with whatever the spending plan is. That's a really great point. And I appreciate the way you described some of the background there because these withdrawal rate discussions that we're going to get into as well as this sort of rule of thumb number, really, I think as an advisor, or if you're just doing it yourself should serve just as a starting point. It's not necessarily this one size fits all answer, but you guys did do a lot of work.

6:04And I would love for you to share some of the key variables that impact what you think this ideal withdrawal rate is. And one of the things that you pointed out that Bill himself and others have said about the 4 % rule is the assumptions being used weren't necessarily ideal. So could you talk a little bit about just those key variables that are impacting the ideal withdrawal rate and just maybe give the audience an overview of how you go about arriving at whatever that safe withdrawal rate is. Yeah. So there are a lot of variables in the mix. The retiree's desire to have kind of a steady paycheck, I think, would be a real starting point for any discussion where the retiree should have some introspection about, well, how much do I want that?

6:45And I would say from my personal experience, I'm someone who has worked in the context of like an employer, you know, getting a paycheck all the time. I've not been a commission-based person. I haven't had that lumpiness in my salary. I really like a steady paycheck. So I'm someone who would prioritize that. Other people might say, no, I'm really comfortable varying my withdrawals if it means that potentially I can take more initially, and then maybe I can spend more of my portfolio over my time horizon. So I think getting your arms around that question is a key input. Desire for bequests is another key component.

7:22So in our base case that we use in our research, we're assuming that someone doesn't really care about that, that they don't have a strong preference for leftovers. Well, some retirees may say, no, that's absolutely my priority. I'm okay if the spending rate that I have to stick with is lower, but I have a very strong likelihood of having leftovers for my heirs or charity or whatever the case might be. Some people might state a very strong preference there. And of course, the retirees own asset allocation is in the mix as well. So what's the complexion of the investment portfolio? Some retirees might have a preference for a more conservative leaning portfolio, which would tend to point to a somewhat more conservative starting withdrawal rate.

8:08So a lot of different discussion points for advisors and also for individuals to kind of introspect on as they think about what the right retirement withdrawal system is. In terms of the assumptions that we make for our base case and how we do our research, you have to make some assumptions about what the retirees' preferences are. So we do use kind of a Bangin-style spending system. So we're assuming that whatever withdrawal rate we come up with, in the case of the 2023 research, it was that a 4 % starting withdrawal was safe over a variety of time horizons. We assume that we're just taking out, say, 4 % of a portfolio balance initially, then inflation adjusting that amount thereafter.

8:51So if it's a million-dollar portfolio, I get$40 ,000 in year one. If inflation runs at 3%, I get$41 ,000 and change in year two and on the line. So we're assuming that someone wants a fairly stable paycheck. We're also assuming that they want a high probability of success. And we define success to mean that in 90 of 100 trials, the retiree would not run out of funds. So we're looking for a 90 % success rate. The fact is, if you're willing to reduce that success rate even a little bit, and in doing so, you're sort of saying, well, that would mean that I might have to adjust my spending. I'll kind of pay attention to what the success rate looks like and adjust as the years go by.

9:38If you're willing to settle for a slightly lower success rate, you can spend more, but we assume a 90 % success rate. And as I said, no preference for bequests at the end. So we put that all into Monte Carlo simulations in 2023. As I said, we came out with a 4 % starting safe withdrawal in 2022. The number was 3.8%. And then when we did the same research back in 2021, when conditions were really quite bad for retirees just embarking on retirement because yields were really low and equity valuations were pretty high, we pointed to a 3.3 % starting withdrawal rate being sustainable with those same basic assumptions in place.

10:26So that's kind of our base case. Thank you for the explanation. for people who are interested in seeing these numbers in the tables. I think the research is just so easy to consume and I'll be sure to link to it in the show notes at the longterminvestor.com. And Christine, I also appreciate that explanation of the 90 % success rate with no bequest preference, because when we go through financial planning models, Monte Carlo analysis with clients, and we say, Hey, there's a 90 % chance you won't run out of money. Really? What you're saying is there's a 90 % chance you won't have to make a change to the plan.

11:00And I think it's important for people to understand as they're looking at these different withdrawal rates. Sure, you can take a bigger withdrawal rate. It increases the probability that you'll have to make a change to your spending plan. And that's okay. And I think that you call that out is really important. I also really love that you mentioned that there's no bequest request or no bequest preference. Because one of the things that really stood out to me is that when you're testing these withdrawal rates, the balances at the end of the 30-year time period were noticeable. And you actually wrote a separate article just about retirement spending in November, shortly after this paper was published, that highlighted these residual balances at the end of life, which isn't necessarily a bad thing, but it does raise the point of whether retirees should be rethinking the way they spend or use their capital in retirement.

11:51So I know you even shared some personal stories in that article. Do you mind talking a little bit about that trend and how it all ties together? No, not at all. And I will say I was influenced by my friend, Mike Piper, who has written a great book called More Than Enough about people who do have more than enough for their own retirement spending and are maybe thinking more broadly about how can I use my money to make a difference to people I love, to charities I love, whatever the case might be. So talking to Mike about all this really influenced me to write that article. And Mike's point in the book is that the way a lot of people do it is that they perhaps underspend during their lifetime and they leave funds to their children often when the children are in their 50s or even 60s.

12:40and it's not a great life stage for someone to inherit money because by that time in your life, your fortune is kind of already determined. Your financial circumstances are pretty well underway and inheriting a couple hundred thousand dollars, I don't know what the typical inheritance is today, but it's maybe in that range, is probably not going to make a big difference in your life. It'll make some difference, certainly, if you have very little, but for a lot of us, it'll make less of a difference. So the story I shared in the article, kind of encouraging people to think about giving to their kids at a younger age, related to my husband and I on a quest to purchase our first home in the Chicago suburbs back in the 90s when interest rates were really high.

13:26I remember we got an eight and three quarter percent interest rate and we were lucky to get it, but we were looking at houses and we went and looked at a house in a nearby suburb one day, right near where my mom and dad lived. The house was a little bit out of our price range, not a lot, but a little bit. And I remember my dad saying, well, how about if we gave you a little bit of money for your down payment to help you get into a house where you wouldn't have to be immediately shelling out funds to fix it up? And so we did take advantage of their gift and it made just such a huge difference in our lives.

14:00We got to live where we wanted to live, the suburb where I grew up. We got to eventually live just a couple blocks away from where my parents lived, and we were able to help them age in place in their house. And the best news is that we, you know, I think we kind of had our financial footing at that point, but we never asked for anything again. And so it was just, I think my parents would agree that it was just a great use of funds. I know we offered to pay them back many times over, over the years, and they wouldn't hear of it because I think it had been a pretty good use of their capital as well.

14:34So the purpose of that story was just to share about how smaller gifts to help with a home down payment or maybe student loan pay down, whatever the case may be, while your kids are kind of getting launched, that can be more impactful than that even larger gift later in life. And we did have a larger inheritance from my mom and dad later in life. And it was really that first gift that made a bigger difference to us. I think that very last thing you said is probably what caught my attention most in your article that you had written about this experience is that that first gift, even if smaller, made a bigger impact than the gift that you inherited at death.

15:17And there's nothing wrong with feeling insecure about parting with money. I do think that comes into play from time to time, particularly if you're very frugal and have a very disciplined savers mentality where you're struggling to spend money on yourself, no less on others. But, you know, I think it's something to think about as you age, as you look at those around you, family, friend, and obviously charitable gifting comes up as well. I had a conversation with Mayor Stattman a few months ago where he has the line where it's better to gift with a warm hand than a cold one. And I think it's just coming up more and more in client conversations these days.

15:54I think we're seeing the baby boomer generation in particular having more and more of these conversations. So I appreciate you sharing that within the context of these withdrawal rates, which as I kind of transition back that direction, we've really been focused on fixed withdrawal rates. And you've sort of pointed out why they're not necessarily a great fit for everyone in real life. Things aren't really operating that way. But your paper explores several different dynamic spending strategies. So could you share some of the benefits of a flexible spending approach as compared to a fixed withdrawal rate, as well as any disadvantages, if there are some you'd like to share there as well?

16:31Yeah. So we did want to explore some of these more variable strategies, because certainly if you talk to retirement researchers, academics who work on this topic, I think that you'd probably hear almost universal sentiment that being somewhat variable, being somewhat flexible, rather than sort of rigidly spending the same fixed real amount is the way to go about it. And the key reason is that it helps protect you if after a market downturn, you can take a little bit less from the portfolio. It helps leave more of the portfolio in place to repair itself and recover when the market eventually does.

17:08And then it also helps you kind of maximize your consumption during your own lifetime. So if you're someone where that's the primary goal is to just make sure that you are spending in line with what you could actually spend, you can also take upward adjustments after a good market environment. So as we've done in the past few years, we've explored a variety of variable strategies ranging from like really simple tweaks to a fixed real withdrawal system to systems that are a little bit more elaborate, like the guardrails system. So in the category of a simple tweak, one that we have looked at a couple of years running, is just if the portfolio has encountered a loss, the year after that loss, the retiree doesn't get that raise for inflation.

17:57So 2022 is kind of a good slash bad example of that because we had bad bond market returns, bad equity market returns. Most portfolios had losses. So after 2022, the idea would be, sorry, no inflation raise in a year when inflation had really gone up a lot. But that's the basic sort of tweak to a fixed real withdrawal system, that you would not be able to take that inflation raise. And then when the portfolio recovered and again had gains, you could go back onto sort of taking the increase in line with inflation. So the nice thing is, is that that simple adjustment, which I think is pretty easy for individual investors to pull off, does result in a decent little bump up in terms of starting safe withdrawal amounts.

18:47not a lot, but a little, and maybe something that would be kind of a livable adjustment, certainly easy to calculate, easy to sort of incorporate into your retirement spending plan. Then we looked at spending in line with required minimum distributions. So using some sort of system that incorporates, well, how did the portfolio behave, which is what you do when you calculate your RMDs. You have to look back to whatever your balance was at the end of the year prior. So incorporating portfolio balance slash behavior, as well as your age. So you get to take a little bit more as you age because your time horizon due to your life expectancy is shrinking a little bit.

19:29So that strategy, there's a lot to like about it in terms of kind of maximizing consumption. So ensuring that the retiree is spending as much as he or she possibly could over his or her life cycle. We find that that's not a super livable sort of spending system. It might be okay for people who have a lot of other living expenses coming from other sort of non-portfolio income sources. So like the person with a pension, for example, who also has a retirement portfolio. Well, maybe it would work for them where if they're using the RMD system to calculate their withdrawals. That's not their core spending.

20:09But for a lot of us where our portfolio will supply a lot of our living expenses, it just might tend to jostle us around a little bit more than would be ideal. Another thing that we measure is kind of the standard deviation of those portfolio withdrawals. If you're seeing a lot of volatility in the withdrawals, it might mean that a system isn't super livable. And then the guardrail system, I would say, is probably my favorite system of thinking about withdrawals. And the basic idea is that you are very much plugging into whatever the portfolio's balance is. You're revisiting that annually, but the guardrails kick in to protect you from having to go too low in a bad year, from being able to take too much in a very good year.

20:57So it's a more complicated system. I know Jonathan Guyton would kind of push back on that and say, well, it's not that complicated, but you do need to read the fine print about how to incorporate it. But that delivers a really nice boost to starting withdrawal percentages, especially for portfolios that are more equity heavy. So it's, I think, ideal for a consumption-minded retiree. It's a really elegant system, I think. So that's, I would say, probably my favorite. When I think about my own retirement portfolio plan, I'll probably use something akin to that. Well, and it seems like that's the one of the different options that's going to maximize your spending the most and maybe prioritize it even over bequesting.

21:43And one of the things, again, I can't emphasize enough, this paper is so easy to read the tables you've made. And I'm going to link to it in the show notes, because if you're listening to Christine, there are some bullet points on the pros, the cons, and then who this is generally best for, for these different dynamic spending models. I'll tell you it's exhibit 15 in the paper. But again, I will link to it in the show notes at the longterminvestor.com. It's really tempting to actually dive in a little deeper on those. But prior to you coming on the show, about a week ago, you had announced that you have a new book coming out called How to Retire, 20 Lessons for a Happy, Successful, and Wealthy Retirement.

22:21Tell me a little bit about that project. Yeah, it's been a really fun project, Peter. One of the things that got me interested in working on an interview-style book was that I do a podcast myself. And what I've realized through that whole process is that there are these pockets of deep thought leadership and a lot of different aspects of retirement planning. And so each chapter is a lesson about some aspect of retirement effectively taught by one of these thought leaders, college professors, financial advisors who I know, authors, people like that. So it's financial and non-financial lessons about how to maximize your financial allocations and also what I call your time on earth allocations.

23:10So it's about all of that. Well, to me, that sounds fascinating. And maybe it's because of my everyday role that I feel like the nuts and bolts of investing and personal finance have somewhat been figured out. That doesn't mean it's easy behaviorally to do, and it's not all perfectly black and white, but there's a lot of things that we know are definitely optimal or increase your probability of success or living the life you want to live. And I'm noticing a trend of more people exploring these ideas. And I'm so appreciative that you shared with me a really early peek at what you're doing. Two chapters in particular caught my eye from Carolyn McClanahan and Lauren Carstensen on longevity, as well as just thinking about health care and long term care.

23:54You don't have to go deep into the details, but just to give listeners a sense of the difference in topics beyond. I mean, you also have people covering some of that technical stuff like Bill Bernstein. But maybe just give us a sense of some of these different topics, things that people might learn and be surprised by. Yeah. The more I have focused on retirement planning, the more it's become clear to me that the decision about whether and when to retire is way less than half financial. If you don't have the money, you don't have the money and you can't retire. But for a lot of folks, it's sort of like, well, when should I retire and so forth?

24:30So I am trying to address some of these non-financial aspects of retirement. Laura Carstensen is one of my favorite people to interview. She discussed with me the role of relationships in retirement, relationships throughout our lives, but the importance of relationships. They're like everything, it turns out. And one interesting finding that she has identified in her research is that our social networks shrink as we age, which you might think, well, that's inherently bad. You've got people maybe getting sick, dying, moving away, whatever. But her point is that our social networks do shrink, but a lot of that is by choice, that we might have these more robust social networks when we are younger.

25:14But then as we age, we do become a little bit more selective. We hone our network to be the people we really care about and the people we really spend time on. So I discussed all the different aspects of social networks and relationships with her and how introverts aren't necessarily doomed to be less happy. In fact, if they have kind of a carefully called network of friends, that's just as valuable as the person with a more diverse social network. One interesting finding, though, is that diversifying our social network is really important, like across the age spectrum. It's better to not just, you know, quite intuitively better to not just stick with people in your same age cohort as you age.

25:58You're better off trying to find some younger friends, too. So Laura and I discussed all of that stuff. Carolyn, who I know you know, Peter, is just a dynamo on all aspects of retirement and health care. She's an MD and a financial advisor and just so thoughtful and so realistic about all aspects of healthcare. And so we talked about how to manage our health for greater longevity, how to manage our healthcare needs, how to manage the cost of healthcare, which is one of the biggest line items in many retiree budgets. So those would both be in kind of the category of mostly non-financial discussions.

26:38With Bill Bernstein, we looked at the optimal asset allocation for a retirement portfolio. Bill, of course, is the author of several seminal books on asset allocation and finance. And so we discussed, well, what should retirees' portfolios look like in terms of their asset allocations and just went deep and geeked out on that topic with bill. So it's a fun and I think broad ranging book. I hope people find it helpful. I hope financial advisors find it helpful because I think they'll recognize a lot of the people who I am lucky enough to be able to interview for the book. Well, I appreciate a little bit of the tease as I look at the chapters and the people that you are interviewing.

27:20I agree both financial advisors, people who are currently retired or approaching retirement, planning for retirement are going to absolutely love and benefit from a lot of these lessons. Christine, I always put everything in the show notes, including we'll make sure to get a link for pre-orders of that book that comes out in the fall in the show notes at the longterminvestor.com. And for those who aren't familiar with you, where else can they find you? They can find me on morningstar.com where I write articles, do videos. I'm there almost every day in some fashion. I'm also on Twitter or X, I guess.