The statement, “we don’t want to run out of money in retirement” is closely followed by the question, “how much can we spend through retirement?”. Most people view things in the context of today; their wealth, spending requirements, according to what they see and understand today. In determining spending, there can be a bias for a fixed dollar amount per annum and often then an inflation adjustment. There are other factors to incorporate, such as risk preference, utility preference, life expectancy and importantly, variability in returns. Here we explore how investees can approach this question with confidence.

Messrs Haghani and White¹ have recently considered and analysed this subject (amongst an array of others) in their seminal book “The Missing Billionaires – A Guide to Better Financial Decisions”. In simple terms, they demonstrate through proper analysis that ignoring investment returns from year to year (together with your risk and utility preference) and drawing fixed annual spending sums potentially puts you on the road to wealth oblivion. Ignoring your portfolio performance from year to year and with it your individual preferences, is likely a recipe to prematurely exhaust your retirement pool. This need not be the case.   

For example, lets say you had a 60% exposure to market risk equities (expected return = 9% pa) and 40% exposure to short term government debt (expected return = 4% pa). Your time horizon is 20 years and your average tax rate is 20% with a moderate risk tolerance. Based on different approaches to spending, the outcomes would be:

• Spend fixed 5% per annum adjusted for inflation: this would likely see capital exhausted at the end of 19 years.

• Set spending each year by reference to the value of your portfolio based on risk and utility preference: this would see surplus capital and confidence that your capital wouldn’t be exhausted, whilst ensuring your spending would match your risk appetite.

We can see this tabled below. 

In 1999, equity markets were in the peak of the Dotcom boom. For the next three subsequent years, market returns were negative. The key point here, is that if you started investing in 1999, you then went on to experience three consecutive years of negative returns. 

By regularly reviewing and establishing your optimal level of spending and combining this with dynamic adjustment to asset allocation, (Is a 60/40 allocation boring or simply optimum solution?), the client, whether a retiree, endowment or not-for-profit, is able to optimise their spending. 

There are various reasons why wealth doesn’t survive, particularly from generation to generation. Spending and the failure to operate an optimal & dynamic spending program, or conversely, just spending too much with an overconfident, straight line approach to expected returns, are some of the key determinants to wealth dissipation. 

Cameron Harrison utilises dynamic asset allocation and annual spending review and recalibration tools. In terms of achieving effective wealth outcomes (irrespective of risk tolerance), the desired outcome is an optimal result, not a maximising ‘dream’. Investors ignore this at their very great peril.

Cameron Harrison client investors can avail themselves to our:

• Wealth planning methodology

• Wealth Pilot® Modeller

• Risk Pool analysis