Rules for flexible spending

A retirement planning tool is only as good as its assumptions and inputs. Share your thoughts or ask questions about the internals of the simulation, built in planner assumptions, or planner inputs.
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lbhough
Posts: 10
Joined: Tue Dec 02, 2014 8:40 am

Rules for flexible spending

Post by lbhough »

Morning ! I love this tool, and posted a question a few weeks ago. Since no one answered it, I thought I would try it again in a different category. (I put it under someone else's question about retirement spending). So here goes:

As you have suggested in other posts, after setting up my basic expenses, income and portfolio, I ran a 'doomsday' scenario in which I simulated a 25% drop in returns during the first year of retirement. Using 'fixed' rules for spending, I don't like the outcomes very much ! but using the flexible spending rules, things still look great !

I understand that you can set the flexible spending limits (the default here looks to be 25% of planned expenses), but I am looking hard now at how those spending rules are coded. It would help me to understand how I would 'translate' these flexible rules into spending plans.

Obviously, I could spend 100% of my spending limit during down years and still not run out of money for ten years. So I'm asking how does the program 'decide' to spend less ? For example, does it decide to spend less in 2017 based on 2016 returns ? Does it only spend the full amount when the returns of previous year exceed the spending limit for the following year ? Maybe spending is cut whenever returns are below average ?

I would like to understand the flexible spending algorithm so that in down years in my own retirement I would have some reasonable plans.

Since I'm new to the forum i wasn't sure if this question belonged in this category, so feel free to move it. Thanks for any additional info related to flexible spending rules/guidelines.

jimr
Posts: 577
Joined: Thu Feb 28, 2008 6:48 pm

Re: Rules for flexible spending

Post by jimr »

First, sorry I missed your earlier post. Despite phpbb's anti-spam bot measures, the forum gets lots of spam and when I see an old thread resurrected, my first instinct is to assume it's spam.

The Spending Policies page of the documentation takes a crack at describing exactly how the spending policy algorithms work.

With the conservative and flexible spending policies, the percent of desired expenses that gets funded is reduced in years where 1) the portfolio declines in value and 2) the value of the portfolio is lower than it was at the start of retirement.

You can see how this plays out in a simulation run by clicking on the details tab and viewing the year-by-year results after you run the simulation. Keep in mind that these results are median results from all 10,000 simulation iterations. Even though these results may not show cases where spending was reduced to the lowest level, if the plan's probability of success is less than 100%, you can be sure that in several of the simulation iterations, spending was reduced to the minimum level to preserve capital.

The settings windows has some controls for the spending policy algorithm. The spending policy multiplier setting allows you to control how fast changes are made to the percent of desired spending that gets funded. Setting the multiplier to .5 reduces the algorithm's impact by a factor of 2, while setting the multiplier to 2 increases its impact.

Next, there's a minimum and maximum percent of expenses to fund. This sets a floor and ceiling on the impact of the spending policy rules. As you mention the default minimum is 75% of desired spending. Setting the minimum to 80% or even 90% is a safer bet if you're concerned about having to reduce spending by 25% in the case of very bad portfolio returns during your retirement. Usually setting the maximum level to a lower value doesn't improve the probability of success. However it usually does cause the ending portfolio value to be higher.

Please don't hesitate to post a followup if you have more questions.

Jim

lbhough
Posts: 10
Joined: Tue Dec 02, 2014 8:40 am

Re: Rules for flexible spending

Post by lbhough »

Jim - That's a big help. I will look at the spending policies page in detail before posting further.

But just for clarification, you gave two ways in which spending would decrease referencing portfolio value.

Does spending adjust in the SAME year that portfolio returns go down, or does year 2017 spending reflect 2016 returns/values.

Thanks ! Lindsay Hough

jimr
Posts: 577
Joined: Thu Feb 28, 2008 6:48 pm

Re: Rules for flexible spending

Post by jimr »

Spending adjusts in the next year. Expenses are funded before portfolio returns are calculated. Logically you could think of expenses hitting on Jan 1 and portfolio returns hitting on Dec 31.

The way the algorithm works is that there's a running variable called 'percent of expenses to fund' that starts at 100% and is adjusted each year based on 1) the sign of the change in portfolio value and 2) whether the portfolio is smaller than it was at retirement.

If the portfolio is smaller than retirement and portfolio return was negative, the 'percent of expenses to fund' variable is reduced by the inflation rate. For example, if it was 100%, it'll be changed to 97%. In the next year, expenses will be funded at 97% of the specified level. If the portfolio drops again that year, the 'percent of expenses to fund' variable will be adjusted to 94% and the next year only 94% of expenses will be funded. This continues on until either the portfolio recovers above its starting value or the spending floor percent is reached. If the portfolio value goes up above its starting value, the 'percent of expenses to fund' variable gets increased by the inflation rate each year that portfolio returns are positive.

lbhough
Posts: 10
Joined: Tue Dec 02, 2014 8:40 am

Re: Rules for flexible spending

Post by lbhough »

thanks for the clarification jim. I'm definitely going to take a deeper look into this.

somewhere you indicated the easiest way to get the FRP standalone outputs into excel. unfortunately, I didnt' document how to do this.

I will look back through your online documentation. it's a terrific program and thanks for the help and support. LBH

jimr
Posts: 577
Joined: Thu Feb 28, 2008 6:48 pm

Re: Rules for flexible spending

Post by jimr »

The trick for exporting to excel is to click the right-mouse with the mouse pointer positioned over any cell on the detailed output table. Most tables in the planner support a right-mouse menu that includes an export option. If you accidentally click on the table column headers instead of a table cell, you'll get a different menu that allows you to show/hide columns.

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