Advisers may want to use multiple withdrawal rates to match different client needs: for example, one withdrawal rate for a “medium-term” bucket for the next 10 years, and a different withdrawal rate for a long-term bucket for the subsequent 15 years. While advisers may use cash flow planning tools to map out future spending plans and milestones, selecting the right withdrawal rate for different stages of the retirement plan is key to ensuring good client outcomes.
2. What is capacity for loss?
For clients in accumulation, a focus on risk profile is appropriate with due regard to attitude to risk. For clients in decumulation, a focus on the withdrawal profile is appropriate with due regard to capacity for loss. Assessing suitability means considering the risk a client is willing and able to take with their investments. Whereas attitude to risk is a measure of emotional willingness, capacity for loss is a measure of economic capacity. Attitude to risk is measured by perceptions around risk and return. Capacity for loss is measured by economic values such as age, wealth levels, and future withdrawal requirements. Attitude to risk is more important in accumulation. Capacity for loss is more important in decumulation.
3. What is a withdrawal rate?
While adopting a “4 per cent rule” is a helpful rule of thumb, it is a simplistic approach based on financial adviser William Bengen’s famous paper that was itself based on a set of assumptions modelling the retirement needs of an average US saver in the early 1990s invested in a 50/50 US equity/US bond portfolio, based on average US life expectancy. If that describes your client, then read no further. Mr Bengen’s conceptual and mathematical framework are helpful, but the assumptions are not. For each client, advisers need to answer three questions to determine the right withdrawal rate:
- What is the potential range of outcomes for a given asset allocation strategy (dispersion of returns)?
- What is the time horizon that the funds are required to last (durability)?
- What level of confidence does my client need that their retirement fund will last the course (confidence)?
The range of potential outcomes will differ for each asset allocation. Rather than using a mean-variance approach, a vigorous scenario analysis provides a more realistic range of potential outcomes.
In broad terms, the range of potential outcomes will be widest for high variance strategies (e.g. global equities), and lowest for low variance strategies (e.g. cash). But this measure alone is not enough as we need to know whether the investments will last.
