Monitoring Decision Rules

During retirement, it is fundamental that you monitor your cash flow continuously to insure that you maintain a safe initial withdrawal rate, and therefore you maintain your financial security. 

We have adopted eight rules that define specific actions which are triggered in response to particular events that may affect your cash flow.  These rules introduce discipline to the management of your cash flow and that’s why they are so effective.  They were first published in the following journal article:

“Decision Rules and Portfolio Management for Retirees: Is the Safe Initial Withdrawal Rate Too Safe?” FPA Journal, Sept. 2004, by Jonathan T. Guyton

The implementation of these rules is a very important to safeguard your financial security throughout retirement.  They are explained below.

1. Portfolio Performance

You should calculate your portfolio’s internal rate of return, or a time weighted rate of return, on a regular basis.  Otherwise, how will you know if your investments match the rate of return required to sustain your withdrawal rate throughout retirement?

2. Burn Rate

If you do not want to deplete your capital, your burn rate should be zero.  The higher the burn rate, the faster you will deplete your capital.  The burn rate is calculated as follows:

• The rate at which next year's withdrawal rate will exceed this year's rate of return.

3. Funding Ratio

Funding ratio should always be 100% or higher.  The ratio is determined as follows:

• Market value of portfolio divided by the present value of future income needs

4. Portfolio management rule

Determines the source of each year’s withdrawal in positive years

• Following years where an asset class has a positive return that produced a weighting exceeding its target allocation, the excess allocation is sold and the proceeds invested in cash to meet future withdrawal requirements

Determines the order of withdrawals.  Portfolio withdrawals are funded as follows:

• Overweighting in equity asset classes from the prior year end
• Overweighting in fixed income from the prior year end
• Cash
• Withdrawals from remaining fixed income assets
• Withdrawals from remaining equity asset in order of the prior year’s performance

Determines the source of withdrawal in negative years

• No withdrawals are taken from any equity following a year with a negative return if cash or fixed income assets are sufficient to fund the required withdrawal

5. Inflation Rule

Determines the size of the yearly withdrawal increase

• Yearly withdrawals increase by the annual rate of inflation as measured by the CPI except when the withdrawal rule freezes the withdrawals
• The maximum inflation increase is 6%
• There is no “make-up” for a “capped” inflation adjustment

6. Withdrawal Rule

Determines the conditions when portfolio withdrawals are frozen from one year to the next

• Withdrawals increase from year to year in accordance with the inflation rule, except that there is no increase following a year where the portfolio’s total return is negative and when that year’s withdrawal rate would be greater than the initial withdrawal rate
• There is no “make-up” for a missed increase.