Although there are many challenges to the 20-year-old “4% sustainable withdrawal rule” — including from yours truly — parallel debates are taking place on how best to implement a chosen withdrawal strategy.

Two recent but different research papers on the mechanics of withdrawal strategies find some common ground against the conventional wisdom while sharing some aspects of the popular “bucket” strategy, in which assets are segmented by certain categories.

> Bonds And Leverage. In “The Floor-Leverage Rule for Retirement,” published in the September/October 2013 issue of the Financial Analysts Journal, Jason Scott and John Watson write that drawing a fixed amount from a portfolio with a stable asset mix runs a high risk of depleting the portfolio prematurely. They reason that such strategies force the sale of securities when prices are down, creating an unrecoverable loss.

The antidote prescribed in the article is to identify a minimum or floor cash-flow target, then set aside assets in guaranteed investments to cover this spending floor. Generally, the authors peg this floor at 85% of the portfolio value. The remaining 15% of assets — i.e., the “surplus portfolio” — then should be allocated to an equities-based exchange-traded fund that offers three times leverage exposure. The use of this type of fund is important to create a more balanced, effective asset mix while limiting losses in the leveraged portion to the cash invested.

If the surplus portfolio value accounts for more than 15% of the total at the end of the year, the excess should be sold to buy additional guaranteed investments. The idea is to assure that the floor spending is fully funded, regardless of what happens to stocks. The resulting asset mix is similar to that proposed in another recent paper.

> Rising Equity Allocation. In a draft paper released in September, American financial planner Michael Kitces and professor Wade Pfau also argue against a stable asset mix throughout the withdrawal years. Their paper, entitled Reducing Retirement Risk with a Rising Equity Glidepath, argues that investors should start with a higher fixed-income allocation — from which withdrawals are made — and allow equities to grow over time. This strategy was found to be successful, not because equities aren’t touched in down markets but because the stock allocation grows over time.

This approach differs markedly from the Scott and Watson article and the popular bucket approach, in which subportfolios are created based on specific needs over varying time frames. Bucketing would sell stocks periodically to replenish spendable cash. Instead, Kitces and Pfau suggest that cash and bonds should be “spent” but not replenished regularly.

They found, for example, that regularly withdrawing from a portfolio with a constant 60% in stocks had a 93% probability of success based on historical returns. But a portfolio that began with 30% in equities and finished at 70% actually would have succeeded in 95% of past scenarios tested — despite a (lower) 50% average equities allocation.

The authors’ view that starting a withdrawal strategy with a lower equities allocation increases the chances of success makes sense. Interest income’s highly taxed nature is an unavoidable trade-off for peace of mind.

Although each paper adds solid insight into the young body of withdrawal research, neither discredits the bucket strategy with infrequent rebalancing and smart tax planning. IE


Dan Hallett, CFA, CFP, is vice president and principal at Oakville, Ont.-based HighView Financial Group, which designs portfolio solutions for affluent families and institutions.