Seeking specificity around Flexible spending policy

[ochotona]

Hi Jim, I need some help in determining how to set spending budgets after the first year of retirement is over. From you language below, it's clear that if the portfolio has a lean year (negative growth), then you don't get the COLA the next year. A good year is a year of positive growth.

But the language below is unclear; do you mean greater or less than in nominal terms or real terms? The portfolio might have growth in nominal terms, but not in real terms. Or it might be 2x larger in nominal terms, but unchanged in real terms.

"If the portfolio is growing, but is smaller than it was at the start of retirement"

"when the portfolio has a balance that’s greater than the starting balance"

"If the portfolio is at least two times the size it was when retirement started, spending percentage is increased by the inflation rate. If the portfolio is between one and two times the original size (at retirement start), an increase of 1/4 of the inflation rate is given."

Thank you.

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"Next, the Flexible spending policy extends the conservative policy by allowing the retiree to spend more than originally specified in the plan if their portfolio does well. In lean years, this policy mimics the conservative policy by withholding the COLA when the portfolio is shrinking and the balance is smaller than it was at the start of retirement. If the portfolio is growing, but is smaller than it was at the start of retirement, the percent of expenses funded remains constant (retiree gets a cola, but that’s it). However, following good years when the portfolio has a balance that’s greater than the starting balance, the flexible policy allows the percentage of expenses funded to grow well above 100%. The amount of spending growth depends on the relative size of the portfolio compared to the balance at the start of retirement. If the portfolio is at least two times the size it was when retirement started, spending percentage is increased by the inflation rate. If the portfolio is between one and two times the original size (at retirement start), an increase of 1/4 of the inflation rate is given. These thresholds were chosen somewhat arbitrarily and is still subject to further adjustment. However, simulation results aren’t hugely sensitive to small changes in these variables in otherwise successful plans."

[jimr]

do you mean greater or less than in nominal terms or real terms? The portfolio might have growth in nominal terms, but not in real terms. Or it might be 2x larger in nominal terms, but unchanged in real terms.

The comparisons are all made using real values.

[ochotona]

Thanks, Jim.

I'm confused by this language too:

" However, following good years when the portfolio has a balance that’s greater than the starting balance, the flexible policy allows the percentage of expenses funded to grow well above 100%."

When I look at my plan, percent of expenses funded is pegged at 100% for the entire plan duration. Does that mean in year two, if the plan is up in real terms, that I can increase 100% by CPI/4? Let's say CPI = 4%, so then does percent of expenses funded increase to 101% for year two, so my spend increases 1% in real terms?

[jimr]

When I look at my plan, percent of expenses funded is pegged at 100% for the entire plan duration.

It's a bit unusual for the percent of expenses funded to be pegged at 100% for the whole plan unless the spending policy is set to stable or conservative or you've set a ceiling value of 100% in settings.

Does that mean in year two, if the plan is up in real terms, that I can increase 100% by CPI/4? Let's say CPI = 4%, so then does percent of expenses funded increase to 101% for year two, so my spend increases 1% in real terms?

That's what should happen in general. As I said before, usually you'd see the "percent of expenses funded" go up to 101% or higher in that case rather than staying pegged at 100% the whole time.

[ochotona]

OK, I think the toggle was set to Stable. Now it's on Flexible, and I see different % Expenses Funded, percentages below 100%, going down to 90% which is my floor.

So let me test my understanding. I'm going to retire on my 65th birthday, and I'm going to define my fiscal year as beginning every year on my birthday.

As far as I have tested, after you run the Planner, the top line of the Detailed View table, in the % of Expenses Funded column, that one looks like it's always 100%, and then there are lower numbers for later years.

So let's say on my 72nd birthday, I run the planner, and the prior year was a growth year for the portfolio, and the portfolio is up in real terms since the beginning of the plan (but not yet 2x greater in real terms), and inflation is 4%. Therefore, the new % Expenses Funded = 101% = 100% + INFLATION/4. The original Planned Expenses were let's say $150,000. The new Planned Expenses are then $150,000 * 1.01 = $151,500. Then I carry that new spending $151,500 into the Summary View and replace the old $150,000 value. Is that the workflow?

I understand the Planner is trying to mimic how people are likely to behave, and that it's not strictly prescriptive, yet I think it's necessary for me to think and act like the Planner to some degree, or else the plan and reality won't match up well.

I'm wondering if the easier and simpler way to do it is just HOLD nominal spending constant after drawdown years, and then after a positive year just re-run the Planner again, find the desired amount for your Prob(success), and spend the amount from the top row of Detailed View, and forget about having a complicated external spreadsheet. Having two places where computations are done just seems like an invitation to tracking errors.

[jimr]

I understand the Planner is trying to mimic how people are likely to behave, and that it's not strictly prescriptive, yet I think it's necessary for me to think and act like the Planner to some degree, or else the plan and reality won't match up well.

It sounds like you have a good understanding of how this all works, so this ultimately comes down to personal preference and risk tolerance and how you actually want to run your own retirement. The simplification you described above sounds reasonable, but really I'm not in the business of giving financial planning advice to individuals.

What I do personally is just run the planner each year and recheck where things stand to see if the current spending amount still appears to be roughly reasonable.

[ochotona]

I'm a person who likes to see decision rules in a table. Is this a correct representation of the flexible spending policy? Thank you.

[jimr]

It looks like the image didn't post correctly, but that's likely something to do with the phpbb software than anything you did.

It might be easier to move this to email if you need to send images. You can email using info@flexibleretirementplanner.com

Jim

[ochotona]

OK the image of the table didn't post... I'm just checking to make sure all of my budgeting rules are OK. Thanks.

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Portfolio grew last year (real), Portfolio grew since inception (real), Budget for next year

YES, YES >= 2, Get 2 x COLA

YES, YES < 2, Get 1.25 x COLA

NO, YES, Restore previously lost purchasing power

NO, NO, No COLA

[jimr]

That looks good. Although for the NO, YES case I'd probably just say "Get 1x COLA"