A Framework for Assessing Variable Spending Strategies

This is part one of a two-part series.

Being flexible with spending matters. My analysis shows that variable spending strategies – including floor-and-ceiling, guardrail, actuarial and other methods – can dramatically increase sustainable retirement spending.

In this article, I provide the background and history behind variable spending strategies, followed by a framework for evaluating the effectiveness of those strategies. I then use that framework to evaluate a well-known strategy – constant inflation-adjusted spending. In part two, which will appear next week, I evaluate a series of other strategies.

In 1994, William Bengen introduced the concept of the 4% rule for retirement withdrawals. He defined the sustainable spending rate as the percentage of initial retirement portfolio that can be withdrawn after adjusting for inflation in subsequent years. Using U.S. historical data, he found that a retirement portfolio will not deplete for at least 30 years with an allocation of at least 50% to stocks. Bengen’s rule adjusts spending annually for inflation and maintains constant inflation-adjusted spending until the portfolio depletes. Spending does not respond to the investment performance of the portfolio, other than facing the necessity that spending falls to zero if the portfolio depletes.

While this assumption may reflect the preferences of many retirees to smooth their spending as much as possible, retirees will inevitably adjust their spending over time in response to the performance of their portfolio. Retirees will not generally play an implied game of chicken by keeping their real spending constant as their portfolios plummet toward zero.