Michael Kitces Blog: How DO You Measure Which Retirement Income Strategy is Best?

[jdmorton]

Michael Kitces published this blog article yesterday which some might find interesting (or confirm their thoughts on the subject): https://www.kitces.com/blog/best-ret...o-you-measure/.

Here is the introduction at the beginning of the article:

"Given the myriad of products and services available to today’s prospective retirees, there are a lot of choices to consider about which retirement income strategy to pursue, from portfolio-based withdrawal strategies to annuities with income guarantees and more.

Yet as it turns out, what seems like a relatively simple question – which retirement income strategy is the best – is actually remarkably difficult to determine. Because as it turns out, which is “best” depends heavily on how you measure what “best” really means in the first place.

For instance, when evaluates by what produces the most wealth, the best retirement strategy is generally to just not spend very much (and ideally invest for growth along the way, too)! If the goal is to maximize retirement spending, then the “best” strategy is the invest as aggressively as possible, to maximize the portfolio growth that will substantiate that spending. Yet portfolios with maximal growth can also produce the greatest catastrophes, which means a risk-averse retiree may not want that approach, even if it would otherwise have increased retirement spending!

What all of this ultimately means is that in framing different retirement income strategies – and the trade-offs they might entail – it’s important to give serious consideration to the measuring stick that will be used to evaluate the potential retirement outcomes. Because the “best” retirement income strategy may be very different depending on whether you measure based on wealth, spending, probabilities of success, magnitudes of failure, or utility functions that weigh both the upside and downside risks!"

For me, it seems rather intuitive that my "best" retirement income strategy is probably different from yours simple because our needs and eventual outcome is probably different - I might need more money at the beginning of retirement and not worry about leaving much of an inheritance (sorry kids). You might want to leave more to your kids or favorite charity.

There is an active discussion on this article over at bogleheads.org.

[Gone4Good]

Yup, one size does not fit all.

It starts with the fact that we each have an individual "hierarchy of needs" we want to provide for.

First we need to cover necessary expenses for survival
Second is a level of spending that is not necessary but highly desirable
Third is spending that is pure luxury

Somewhere between category two and possibly four falls the desire to leave an inheritance.

Set against those "needs" are the resources we have to meet them. Someone with ample resources can fully fund all four possible levels of "need" without having to incur any risk at all.

As retirement resources fall short of our needs, though, the we can try to compensate by taking on more risk. Portfolio risk increases. Withdrawal rates increase. Complicated withdrawal strategies and "life cycle spending" arguments start to seem more attractive.

Ultimately our tolerance for risk runs up against our hierarchy of needs. If the two are in a comfortable balance, we can retire. If they are out of balance, we can't retire unless we adjust our needs downward, move our risk tolerance upward, or find some other way to increase our resources.

That's an off-the-top-of-my-head conceptualization of how each of us determines the right retirement income strategy for our personal situation and preferences.

[DrRoy]

The options really require you to assess your risk tolerance first. What is best for someone will depend significantly on that.

[Options]

Quote:

Originally Posted by DrRoy The options really require you to assess your risk tolerance first. What is best for someone will depend significantly on that.

+1
This was my first thought. Kitces does a nice job of illustrating the alternatives for measurement.

[unclemick]

I think with hindsight at 22 going on 23 years of ER I followed all the wrong strategies even though hand grenade wise it was 'enough' to paraphrase Mr Bogle. I think the historical period played a big role also combined with my views of the future at each point in time.

Cutting expenses in early ER big time. Using some temp. work, selling and consuming some real estate proceeds and nailing fixed income(in lieu of annuities) with early age 55 pension(small) and SS age 62 to allow portfolio to grow to 70 1/2 turned out to be overly aggressive starting in 1993 going on age 50. Plan wise I was going to croak at precisely 84.6 which I think was an IRS number back then.

heh heh heh - Plan A, backup plan B and emergency plan C all of which will be wrong with hindsight but stay flexible and have fun. How wrong was I? At age 73 with new Wife we will jump several tax brackets up. But who is whining?

[daylatedollarshort]

He left off a liability matching portfolio for the risk averse, which can be structured to be more diversified and inflation protected than purchasing a single annuity.

[unclemick]

Another thing - although my spending has drifted up over time, expenses were aggressively changed mainly down after a market drop and then back up after a few years with lumps(sometimes unplanned) taken out periodically for things like Katrina, death, moving, remodeling , replace truck, etc.

I didn't do an emergency reserve like some do.

heh heh heh - expenses can be moved unlike Mr Market although sometimes it is painful.

[donheff]

Quote:

Originally Posted by unclemick . heh heh heh - Plan A, backup plan B and emergency plan C all of which will be wrong with hindsight but stay flexible and have fun. How wrong was I? At age 73 with new Wife we will jump several tax brackets up. But who is whining?

I would view that situation as a primary goal.

[CoolChange]

Quote:

Originally Posted by donheff I would view that situation as a primary goal.

If this were my primary goal, I would never R, let alone ER, since that income strategy would give me the best shot at jumping tax brackets.

Of course, this may unconsciously be my primary goal since I seem to be suffering from chronic OMY syndrome.

[DEC-1982]

A great article. It shows the critical need to understand one's capacity/tolerance and willingness/ability to adjust before one can decide what's best for oneself.