Though it is important for retirement industry professionals to confront the possibility that their clients could run short of money during life after work, it's equally important for them to assuage overblown fears that can lead to unneeded sacrifices in one's standard of living.
This is the central message shared by PGIM's David Blanchett in a LinkedIn post published in response to a recent Wall Street Journal article that warns of the potential for "financial ruin" in retirement when savers follow the "tried-and-true 60/40 portfolio and 4% withdrawal rate."
As evidence for concern, the article points to the significant market volatility experienced by investors during 2022 and early 2023, when both stocks and bonds posted notable losses. Investors who followed the 4% rule of thumb, the article suggests, may have put themselves at a heightened risk of bankruptcy later in life, per standard Monte Carlo projection practices.
While it is true that sequence of returns risk presents a big challenge for retirees, Blanchett's work has shown time and again that focusing on binary success and failure metrics is an overly simplistic approach to the "decumulation challenge." And yet, many news articles do just that.
The reason why this approach falls short? Monte Carlo "failures" aren't like plane crashes.
"Falling a dollar short in the 35th (or 30th or 40th) year of retirement is not 'failure' (i.e., financial ruin) because retirement is not binary," Blanchett wrote. "The idea that you can only either pass or fail a financial goal, like retirement, is an incredibly incomplete perspective that can lead to wildly suboptimal advice."
What Is 'Failure,' Anyway?
As Blanchett's post contends, even if a portfolio "fails" in a standard Monte Carlo projection that assumes a spending rate of 4% for a retirement period between 30 and 40 years, a real-world retiree is still likely going to have other sources of income, which could be more than enough to fund necessary consumption.
Many Americans receive some type of guaranteed lifetime pension benefit, such as Social Security, which provides a minimum standard of living. This means a retiree's portfolio is generating income in addition to these guaranteed sources, thereby providing a safety net that might allow for a different portfolio withdrawal rate.
"Portfolio-only metrics like success rates mask this," Blanchett warns. "For the typical retirement scenario, lasting 30 years, where the portfolio is funding a blend of essential and flexible expenses, I think 5% is more reasonable."
Another important point about projected failures is that very few — if any — retirees actually follow completely rigid spending frameworks like the 4% rule. As Blanchett wrote in a ThinkAdvisor article published in May, traditional models commonly don't include the desire or ability to adjust spending during retirement, since withdrawals are assumed to change only by the rate of inflation.
"Retirees have an ability to adjust spending based on real-life needs and circumstances," Blanchett emphasized, "which can significantly affect spending rates."
Unfortunately, many financial planning tools continue to determine safe withdrawal rates by focusing on whether the goal is accomplished in its entirety, and they ignore the magnitude of failure. News articles often do the same, resulting in scary headlines and factoids that may not reflect the retirement reality many Americans really face.
