Tuesday, April 15, 2014

When “Probably” Isn't Good Enough

Financial planners have long discussed whether we should pay off the mortgage, or keep a mortgage and invest that capital in the stock market.

The naive argument is that one can borrow a mortgage at say, 4%, and invest the money for a 10% return in the stock market, netting 6% on the “arbitrage”. But paying off a 4% mortgage is risk-free. (It is not a function of stock market returns.) The 10% market return in this example has a standard deviation of 20%, far from risk-free, based on historical market returns since 1926.

If you could find a risk-free 10% and keep the mortgage, that would be a certain 6% net and true arbitrage. But, that ain't gonna happen.

You would, in fact, earn the 6% difference in the years in which you receive the expected market return of 10%, but half of annual market returns are expected to be more than 10% and half less.

The meaning of “10% expected return with a standard deviation of 20%” is that in about two out of three years the returns will fall within the range of a 10% loss to a 30% gain (+ or - one standard deviation from the mean). That means the net return after the 4% mortgage payments will fall between a 16% loss and a 26% gain two out of three years. In 2007 to 2009, market returns fell way over to the wrong side of two-thirds of returns.

The worst financial mistake I have made in retirement (I should add “so far”) was taking the advice of a well-known financial planner in Washington before I retired in 2005. I could have bought my retirement home with cash, but he convinced me to hold a mortgage and leave that cash in the market. He gave me this advice because he thought the market would probably return about 10% a year on average over the life of the mortgage. But probably isn't the same as certainly and average isn't the same as annually.

Two years later, in 2007, the stock market crashed. Had I paid for the house with cash, I would have had hundreds of thousands fewer dollars exposed to the stock market.

The housing market crashed, too, but I don't plan on selling my home for a very long time, so that wasn't painful. Even the stock market crash was tolerable because I held a quite large helping of bonds. But it bugged the hell out of me that I had borrowed money against my home and paid a lot of interest for the privilege of losing that borrowed money in the stock market and that I was advised to do so by someone I trusted.

Fortunately, I could handle the losses. The former home of a good friend remains empty to this day after that housing and stock market crash. I see it every day, falling into disrepair. His mortgage was foreclosed, which brings up the most important reason I know to not borrow a mortgage to buy stocks. If you buy stocks on margin and the market crashes, you may have to sell some of your stocks and take a loss. If you buy stocks margined with your home and the market crashes, you can lose your home.

My friend had a lot of money going into 2007. It didn't seem at all likely that he would lose his home within a year.

Losing my home is high on my list of unacceptable outcomes.

I just found a 2011 article by Michael Kitces entitled Why Is It Risky To Buy Stocks On Margin But Prudent To Buy Them "On Mortgage"? This column and the comments adequately vet the issues, so I'm not going to repeat it or start a similar thread here. The issue I actually want to bring up is one of the magnitude and probability of risks.

The Retirement Income Industry Association  (RIAA) describes this in perhaps the most stilted prose you can encounter. I include it here for your literary amusement:
“The diverging opinions about the value of flooring in practice may derive from the range of opinions – that cannot be proven a priori – about a practitioner’s (or a client’s) view of the primacy of the probability of failure vs. the magnitude of failure. Some believe that the probability of failure looms greater in people's minds than the magnitude of failure. Others believe that consequences always trump the odds. There is no way to tell, a-priori, who is right and who is wrong for a specific set of circumstances whose resolution and outcomes are yet ahead of us.”
There. Got that?

What they're trying to say, sort of, is that at some point the consequences of failing are so horrible that “probably won't happen” is no longer good enough for some people. This is an ongoing struggle in financial planning with the “probabilities” group arguing that you can invest in stocks and you probably won't go broke and the “safety first” group countering that you should first make sure that nothing really bad is going to happen and invest what's left over in stocks.

Note that neither group says that you can't lose a whole lot of money. One side merely argues that you probably won't. The other side agrees but argues that “probably” isn't good enough when it comes to losing your standard of living in old age.

I lean toward the safety-first school. My tendency is to first take the unacceptable outcomes off the table and as I mentioned, I consider losing my home an unacceptable outcome.

I'm not against people taking financial risk in retirement. Given the difficulty involved in funding a retirement with our current system, there is no risk-free way to achieve it. I'm only against people taking risks they don't understand.

I've talked with many people who lost their homes or fortunes and not one was able to say, "I understood the risks when I took them and, if I had it to do over, I would make the same bet."

My former neighbor was a business school graduate and he could probably explain the details of his mortgage and his foreclosure risks. I'm just not sure he ever internalized that risk until it was too late.

My point isn't specifically about mortgages, or stock investments, or when to combine the two. It's about risk, both its probability and magnitude. Don't dismiss a potentially catastrophic outcome because the probability of it happening is very low.

You might go broke with a systematic withdrawals strategy, but you probably won't.

You might lose your home if you take a large mortgage and invest it in stocks, but you probably won't.

You could come up short if you claim Social Security benefits early and live to 90, but you probably won't.

The question you have to answer is when “probably won't” is good enough for you.






Saturday, April 12, 2014

Retirement Advice for People Who Aren't Rich

I write a retirement finance blog primarily to help people who don't have enough money to attract the interest of a good financial planner. (Hence, the tag line above.)

In reality, retirement planners are effective for a relatively small group of people who have enough money to be profitable for their planners but not so much that they don't need a retirement planner. Bill Gates doesn't need a retirement plan (though he certainly needs tax plans, estate plans, insurance plans, etc.) and households with no retirement savings probably won't find good, inexpensive planning help — except for my blog, of course!

There are ways that people who couldn't save enough money for retirement can improve their situations, by postponing Social Security benefits as long as they can work, for example, and I try to cover those in my blog.

Ron Lieber wrote a column in the New York Times entitled Retirement Advice for People Who Aren't Rich identifying some new services that may also provide retirement planning help for the "unwealthy". Betterment, Wealthfront, WiseBanyan and LearnVest are such services. Though they are all young and unproven companies, they sound interesting enough to consider.

A big caveat here, I have not vetted or used any of these services, so I can only recommend that you research them. I cannot recommend that you actually use them, though I will try them out in the near future. No one knows if these companies will flourish or fail.

The company I feel much better about is Vanguard. I am a longtime Vanguard customer. I love the company and its investment offerings. (I thoroughly dislike their banking services, however, and recommend you consider Charles Schwab if you are looking for a top quality investment company with outstanding and inexpensive banking services. I love Schwab Bank.)

According to Lieber, "Vanguard’s full-service offering, called Personal Advisor Services, costs 0.3 percent annually of the assets it’s managing. For now, customers need $100,000 in accounts there to join, but the company plans to drop the minimum to $50,000 at some point soon. An existing Vanguard service that resembles the new one costs 0.7 percent annually on the first $1 million and requires at least $500,000 on balance."

Vanguard is certainly not a start-up, and their entry into this market suggests that the smaller companies are on to something.

If you have any experience with any of these companies, or similar services, I'm sure my readers would love to hear from you.

Tuesday, April 1, 2014

The Chicken and the Pig

In the mid-nineties, I began an intensive study of retirement finances. I wanted to retire early. The Tech Bubble was just getting into full swing and dollar signs were flashing before me, none so brightly as the largest "terminal portfolio values" generated by Monte Carlo simulations of safe withdrawal rate strategies.
You know those best of the best-case scenarios where you retire with a million bucks, fund 30 years of retirement, spend $45,000 a year and then leave your kids a portfolio worth nearly eight mil? Never mind that those numbers are inflated dollars 30 years in the future or that they happen once in a blue moon. In the late nineties, everyone with a sock puppet was going to be rich.

I couldn't figure out exactly how that was going to work, so I built my own Monte Carlo simulator to learn the details. (I started my career as a software developer.) Then I really couldn't understand how that was going to work. Constant dollar withdrawals just made no sense to me but, hey, Money magazine was on board so there had to be something there.

(I think today, particularly after the Great Recession, most people have abandoned the constant dollar withdrawal folly and realize that they can spend more when their stock portfolio grows, but they will have to spend less if it shrinks.)

I was a big fan of systematic withdrawal (SW) strategies back then.

Then something happened in my life that caused the financial equivalent of a paradigm shift. You know "paradigm shifts" in science, right? Like when Copernicus explained that the earth revolves around the sun and not the opposite and everyone was like, "Whoa, Dude! This changes everything!"

I had one of those.

I retired.

When my mother-in-law retired from teaching she had said, "You can't imagine what it feels like to realize that you will never receive another paycheck."

I finally understood. Then I looked at my retirement savings and realized that I would also no longer contribute more earnings to that pile of money and, in fact, I would be spending from it every year. In effect, I would be swimming against the portfolio growth tide. When the market gave me 8%, I would be spending half of that, not contributing another 4% of my paycheck.

I had to make that money last an awfully long time to support my family. Three decades, maybe.

Suddenly, "There's a 90% to 95% chance that your portfolio will last 30 years" started to sound more like "there's a 5% to 10% chance that you'll go broke before you die".

Bam! Paradigm shift.

I could stop the story here with ". . . and that's how I became a safety-first guy", except that isn't the end of the story and I'm not a diehard safety-first guy. (But, I'm close.)

The sudden scarcity of paychecks after retiring wasn't the only shock. In 2000, a friend who was heavily invested in tech stocks lost his entire $4M nest egg just a few years before retiring. Literally dozens of my coworkers who held on to their company stock too long lost millions in paper profits that year and likely will never be even paper millionaires again. And those were just the people I knew. At just one of the tech companies.

Having a secure source of money to at least meet my non-discretionary spending needs began to sound pretty important.

Retirement funding is far more complex than systematic withdrawals versus floor-and-upside. Many factors come into play in selecting a strategy. Like, how much wealth you have.

A few of my former colleagues and Tech Bubble survivors escaped the carnage with tens or even hundreds of millions of dollars. They don't much need retirement plans. They can build a diversified portfolio and be pretty sure that even their grandchildren won't need a plan.

More than 90% of Americans, though, have not been able to save nearly enough for retirement. They probably shouldn't be risking anything in the stock market. Other factors that play into strategy selection include whether or not you are married and whether you have heirs. Your health is a factor. It isn't simply a matter of your risk tolerance.

I view retirement strategies as a continuous spectrum from life annuities and certificates of deposit (my mother-in-law's preferred investment) on the conservative end of the spectrum to systematic withdrawals on the riskier end. You can choose fairly precisely how much safety you want at the appropriate point along that spectrum. As a financial planner, I think my job is to place clients at the right point along that spectrum depending on their unique, current financial situations.

Sometimes, things will happen as we age to suggest moving that point along the spectrum in one direction or the other. Pulling the trigger on retirement may be one of those times. It may, as my mother-in-law tried to explain, significantly change how you view the world.

There's a fable about a chicken, a pig and a plate of ham and eggs. The chicken is involved but the pig is committed.

Most people seem like chickens to me before they retire. I was. Same goes for retirement planners who are still working. Chickens think more about spending than risk. When we retire, risk takes center stage.

Retirees are committed.

Monday, March 31, 2014

Where There's A Will

One of the first things any good financial adviser will ask is if you have a will.

Thinking about death and wills and life insurance is never fun, so many people put it off as long as possible. If you can force yourself to think about it for a few minutes, it helps to have some structure. People who don't want to hire a financial adviser to provide that structure can get it from websites and workbooks.

I recently looked at a website called Everplans that offers a number of services for free, but charges for additional services like more storage and more "deputies" to access your plan. It provides a good place to store your key information online, like the location of your legal documents or even copies of your legal documents if you wish.

The user interface is very friendly. Walking through the process will let you identify what planning steps you have completed and what more you need to do.

There are many alternatives to Everplans, like AfterSteps.com and Principled Heart. A few are mentioned in this New York Times article.

These services are meant to help you organize your affairs and not to create wills or other legal documents. There are websites that do, but this is something I have always felt too important to trust to anyone other than a qualified attorney.

If you prefer to go old school, check out The What if. . . Workbook by Gwen Morgan.

Sometimes we just don't know what it is that we need to know and services and products like these can help.



Thursday, March 27, 2014

Long Term Care

In my last post, The Thing That's Missing, I used long term care risk as an example of retirement risks that aren't really addressed by retirement spending strategies, but need to be considered in a comprehensive retirement plan. Nonetheless, the possible need for long term care late in life is on the minds of most retirees.

Medicare doesn't cover long term care expenses. Medicaid will, but only after the patient's assets are depleted. Medicaid is a jointly-administered program by state governments and the Federal government, so the rules vary by state.

Depleted means that most savings has been spent and property has been sold. Some assets and income are excluded from Medicaid eligibility calculations. Surviving spouses are afforded some protections, including postponing the sale of the patient's home, so long as the patient or spouse still live in it. Again, these rules vary by state.

A retiree who relies on Medicaid to pay for long term care will have little left to bequeath to heirs. It is this risk of losing all one's wealth at the end of life, and a concern for the quality of long term care the patient will be able to afford, that drives retirees' fears. Retirees without heirs and a surviving spouse could presumably be less concerned. According to HHS, less than 15% of nursing home patients have a surviving spouse.

As I wrote in Long Term Care Insurance some time ago, the LTC insurance industry states some pretty scary facts in their advertising, like “nearly two-thirds of Americans over the age of 65 will require long-term care” and “long-term care can cost over $75,000 a year.” Both statements are correct, if misleading.

According to a Genworth report, $75,000 a year is a good current estimate for North Carolina, but $125,000 a year would be closer for New York. Many patients, however, have stays shorter than one year.

I mentioned in that post that studies show about 43% of retirees are likely to have no long term care needs, at all. Another 19% will be in long term care for short periods and the cost, less than $10,000, will be manageable out of pocket. That's 62% of retirees who won't have a big LTC problem.

Another 8% will have costs between $10,000 and $25,000, possibly also a manageable amount.

About 30% of retirees, though, will have costs exceeding $25,000 and some will pay a lot more. Care for an injury like the one sustained by Christopher Reeve is estimated to cost $1M the first year and nearly $2M each subsequent year. Put this all together and LTC costs can range from zero to millions of dollars a year and can occur at any time (about a third of long-term care patients are under the age of 65).

Or never.

Risks like that are difficult to plan for.

There are four basic ways to deal with risk. We can avoid it — we can avoid the risk of riding motorcycles, for instance, by not riding motorcycles. This isn't an option for LTC risks.

We can mitigate the risk, for instance, by wearing a helmet when we ride a motorcycle. I'm not sure there's an effective way to mitigate LTC risk.

We can insure risks, if insurance is available and affordable, by paying an insurer to assume the risk for us. When something bad happens to 38% of a class of persons who might purchase insurance, though, insurance will rarely be affordable, and that's the case with LTC insurance. It is expensive and doesn't work well.

(NOLO provides a fair and unbiased, I think, summary of the current state of LTC insurance.)

Lastly, we can accept the risk. That can mean we believe we can pay for the risk if it is incurred (we self-insure), or it can mean that we don't believe we can pay for it but have no reasonable alternatives. The first is a financial decision and the second is a fact of life.

The best way to deal with long term care (LTC) risk depends in large part on the retiree's wealth. For retirees without much wealth, LTC insurance will be unaffordable and the only realistic option will be to accept the risk and go the Medicaid route. 

For wealthy retirees, those with perhaps a million dollars or more (two million for a couple), accepting the risk by self-insuring may be a better option than buying expensive insurance. Wealthy retires also have the ability to buy insurance, of course. The difficulty is for retirees who fall in between these levels of wealth.

The in-betweeners must decide how much they value secure annual income versus how badly they wish to avoid the possibility of spending all their wealth at the end of life. Retirees may change their minds as they age and conditions change.

The question you have to answer is how much of your wealth are you willing to dedicate at this time to support normal spending and how much to protect end-of-life wealth?

One option for the retiree is to reduce "normal" spending in order to purchase LTC insurance. In that case, LTC premiums can be considered non-discretionary spending and included in the portion of the spending plan that covers those expenses (the floor). 

The downside of this approach, in my opinion, is that the LTC insurance industry is still trying to figure out its risks. Some carriers have stopped offering the insurance and some have dramatically raised premiums. Retirees who can't pay for premium increases may have to let their policies lapse and premiums they previously paid will have been paid for naught. They might find acceptable ways to decrease their coverage to make the new cost affordable.

An upside of LTC insurance is that it can pay expenses far greater than most retirees can pay from savings. 

Saving is another approach some retirees consider in anticipation of experiencing LTC costs. This is a difficult proposition, akin to saving to replace a destroyed house instead of purchasing homeowners insurance. The LTC costs may present themselves long before the retiree has saved enough to cover them. If the amount to be saved annually is roughly the same as insurance premiums, the latter would better cover large expenses. It will be nearly impossible for most retirees to save enough to cover the top 16% of expenses in the chart above.

Another benefit of LTC insurance is that it will pay those expenses the day after you buy it, while saving for the expense assumes that you will have time to save. Exacerbating this problem of inadequate time to save is the fact that younger LTC patients tend to have longer and more expensive nursing home stays. One study showed that for every year of age when entering a nursing home after age 85, the average length of stay declines about 35 days, and with it the cost. Your potential LTC expenses are greatest when your savings will be smallest.

If you're going to try the savings approach, I'd recommend a separate portfolio for LTC liabilities, for reasons I explained in The Thing That's Missing.

Be aware that you might reduce your retirement spending in order to save for LTC expenses and never incur catastrophic expenses. Conversely, you might reduce retirement spending and save a large but inadequate amount of money to pay for long term care. If it's inadequate and you eventually rely on Medicaid, you will be forced to spend that savings on your care before Medicaid will begin to cover costs, in which case you would have been better off spending that money throughout retirement.

Another alternative is to buy a longevity annuity that begins paying at age 80 to 85. Forbes magazine's William Baldwin believes this approach is better than LTC insurance in three ways. First, with the annuity, you can spend the money any way you want, not just for LTC-covered expenses. Second, annuity providers can't change the terms after you buy a policy, like LTC insurers can and do. And thirdly, you won't have to prove to an annuity provider that you're owed the payments.

On the other hand, you wouldn't be covered if your LTC expenses occurred before you're in your eighties. Since a third of LTC patients need this care even before age 65, there is a good chance that you will need the money before a longevity annuity would pay.

Most retirees won't be able to afford long term care insurance as it is currently structured. If you can afford the premiums, you need to understand that you have two quite different goals, which most people will value differently, competing for your resources, maximizing annual spending and protecting end-of-life wealth. The challenge is deciding how much of your assets you wish to dedicate to each goal.

To tie this back to retirement income strategies, any strategy except Life Annuities would probably have some funds left in the spending portfolio to help pay long term care expenses. Which of the other strategies would do this best depends on future market returns and interest rates, which is to say it's unpredictable.

I wish I had a happier solution to long term care risk, but unless and until LTC insurance becomes much more affordable, I don't think there is one.

Monday, March 24, 2014

The Thing That's Missing

After recently writing about four major retirement spending strategies, Life Annuities, Time-Segmentation, Floor-and-Upside and Systematic Withdrawals, I received a number of comments at this blog and at Wade Pfau's Retirement Research Blog that began with, "The thing that's missing from this discussion is. . ."

Some mentioned that the topic of Required Minimum Distributions was missing. Others mentioned the risk of high long term care expenses late in life wasn't discussed. Truthfully, many risks are omitted from the discussion of retirement spending strategies.

There's a risk of very high but uncovered medical costs. A reader recently told me that he needs medication that needs to be prescribed off-label and will costs five figures a month that will not be covered by insurance. There is a risk of financially-debilitating divorce. There is liability risk. There is a risk that your children or grandchildren will need financial help. And, yes, there is a chance that you will have high long term care costs late in life. (The risk may not be as great as you have been led to believe, but that's another topic.)

(Wade Pfau just posted two excellent pieces on retirement risk. In my opinion, we spend way too much time talking about income and not enough about risk.)

The reason these risks weren't discussed is that the spending strategies I reviewed are intended primarily to mitigate only longevity risk, or the risk that you will run out of money before you die. A retirement plan should address all identifiable financial risks of retirement, but these four strategies aren't retirement plans, they're potential pieces of a comprehensive retirement plan.

I think this gets a little confused by systematic withdrawal strategies that lump all future liabilities into one pile and attempt to mitigate all risks by creating a large enough pile of money to address whatever pops up. That may be the most efficient way to create a lot of wealth, but it might not be the most effective way to prioritize, manage and meet liabilities. Many economists prefer to match resources with future liabilities so each can be addressed in he best way.

Let's take the LTC cost liability, for example, and assume that you want to save money to offset those potential costs. (I'm not sure that's a great approach for most people, but let's go with it for the moment.)

LTC costs, as I showed in a post about Long Term Care Insurance a while back, will be near zero for about 40% of retirees, manageable out of pocket for more, and catastrophic for a few. The spinal injury Christopher Reeve suffered, however, is estimated to cost about a million dollars for the first year of the injury and nearly $2M annually for subsequent years, according to the Christopher and Dana Reeve Foundation. That's an enormous range, from zero to $2M a year. And your LTC costs, if you experience them at all, may be decades in the future.

Hardly anyone can set aside millions of dollars "just in case".

In contrast, we can estimate annual "normal" retirement income needs relatively accurately and we know for certain that we will have those costs. The only real question is for how long. That is a very different animal than LTC cost risk and I prefer to address each with its own portfolio.

"Why do you recommend a separate portfolio?" one of my readers responded. "Why not just change your asset allocation?" another wondered.

Glad you asked.

First, because you need to decide what portion of your financial resources you are willing to dedicate to each goal. Most people can't secure their retirement income needs and save another several hundred thousand dollars to address a large liability they might never have. Building two portfolios forces you to decide how to allocate your investments. If forced to choose, I suspect most people will value sustainable retirement income more than avoiding spending the last of their wealth at the end of life.

Second, you need to decide on a portfolio asset allocation. If you want to minimize longevity risk, allocate something like 30% to 50% to stocks. That will dampen portfolio volatility and reduce the chances of depleting your portfolio, according to William Bengen in Conserving Client Portfolios During Retirement.

To have the best chance of growing a very large amount of money to cover large LTC costs 20 to 30 years in the future, you would want a much higher stock allocation, maybe 70% to 80% stocks. You can't do both with a single portfolio. A compromise might not meet either goal.

Third, we sell stocks and spend from a retirement income portfolio, but presumably not within an LTC savings portfolio, at least not for many years. A single portfolio would unnecessarily introduce sequence of returns risk into our LTC investments.

As you can see, the goals and risk and reward characteristics of a retirement income portfolio are different in many ways from those of a portfolio intended to save for a large, uncertain, future liability. And, that's why I would recommend separate portfolios.

Ultimately, what's important is how much money you have and not how many portfolios or accounts you divide it into. Your net worth will be a function of the weighted allocation of all your portfolios.

Instead of having two portfolios, one with 90% of your total assets invested in 60% stocks and 40% bonds and a second with 10% of your assets allocated 80% to stocks and 20% to bonds, for instance, you could have one portfolio with 62% stocks and 38% bonds (the weighted average allocation). Your expected returns would be the same in either case, as would your net worth's volatility.

But the same argument could be made for budgeting: why not just divide everything into "income" or "expense"? The reason is that you can't manage your finances very well that way.

Like putting all of your bills in a single pile and considering only their sum, by creating a single portfolio to address all liabilities, you would have difficulty understanding where you stood at any point in time in meeting your individual liabilities and which might be at risk. That's an important thing to know unless you value all of your liabilities equally.

Also, any actions you took within your single portfolio would have an equal effect on all of your goals, whether or not that is what you intended. It's a personal financial management issue.

So, why didn't I include LTC cost and other risks in the discussion of spending strategies? Because those risks are different than the longevity risk we try to mitigate with spending strategies. Spending strategies are about maximizing the amount of money you can spend each year and minimizing the risk that you will run out of savings prematurely. An LTC saving strategy would be about paying for a potentially very large, uncertain expense near the end of life.

LTC cost risk is just one example of a retirement risk that isn't addressed by a spending strategy, so I guess "the thing that's missing" from those strategies would be the rest of the plan.

Thursday, March 20, 2014

Spend More Today vs. Spend More Tomorrow

My two previous blogs, The Downside of Upside and Diminishing Returns, initiated a fun conversation with Wade Pfau that he used yesterday to spur a discussion at Wade Pfau's Retirement Research Blog.

In those two posts, I expressed the opinion that investing in equities in order to increase a retiree's spending throughout retirement isn't terribly appealing because a) retirees typically — though not always — spend less as they get older and, b) by the time he earns the additional spending with stock market gains the retiree might well be too old to enjoy spending them.

Wade's response was, and I paraphrase here, "Well, yes, but retirees don't invest in equities to increase their spending if their portfolio grows."

Wade explained that he believes retirees are attracted to systematic withdrawal (SW) strategies primarily by the probability of greater spending than is attainable through investing in safer alternatives (albeit with risks of the opposite outcome). He believes that potentially increasing one's standard of living beyond the initial spending suggested by SW is merely a side-effect of the SW strategy, not a major consideration by retirees or one promoted by advisers.

I completely agree with the first part of that statement: the primary attraction of SW is the possibility of greater spending than with safer investment alternatives.

I argue, however, that it is not the only SW benefit marketed to retirees or expected by them. I believe there are three:
  • The potential to support more spending than with annuities or bond ladders
  • The potential to support the initial withdrawal amount annually for 30 years and leave a large legacy portfolio, and
  • The potential to improve one's standard of living throughout retirement if the portfolio grows.

The risk, of course, is that none of these potentials will be realized.

I would point out that with SW strategies, spending can increase over time, or decrease if the portfolio shrinks. As Michael Kitces pointed out in his critique of "The 4% Rule - At What Price?" by Scott, Watson and Sharpe, SW strategies are seldom implemented in the precise way depicted in that (and other) papers.

After portfolios grow significantly, advisers encourage retirees to spend more (increase their standard of living), according to Kitces, rather than stick with their initial withdrawal amount. I trust they would recommend the opposite should the portfolio contract significantly.

If this is truly the way SW is implemented, then the retiree would increase her spending contemporaneously with the growth of wealth (and decrease spending similarly if the portfolio contracted).

Wade and I actually disagree on very little here. We agree that increasing spending throughout retirement isn't the best reason to invest in equities after retiring. The question Wade and I are asking is this. Is the promise of continually improving your standard of living as retirement progresses a significant incentive for you to invest in equities after you retire?

We would both appreciate your thoughts below or at Wade's blog. And if you're an adviser, please let us know.