A flexible spending and withdrawal strategy is better than a rigid one, concludes a Vanguard study. Pegging withdrawals to a specified amount, such as strictly following the 4% rule, can lead to spending too little and dying with greater-than-anticipated wealth. Pegging withdrawals to a fixed percentage of the portfolio value can lead to wide swings in spending.

Vanguard’s dynamic spending rule is a hybrid of the two more rigid rules. A retiree starts with a reasonable withdrawal rate (e.g., between 3.5% and 5.5%). At the beginning of each year, the retiree calculates the planned percentage withdrawal based on the prior year-end’s real (inflation-adjusted) balance. Then a maximum increase (the ceiling) and decrease (floor) is calculated. These could be, for instance, a 5% increase and a 2.5% decrease. The actual withdrawal amount is then adjusted downward to stay below the ceiling or upward to stay above the floor.

An advantage to this approach is that it smooths out the annual volatility of withdrawals relative to taking a set percentage of portfolio value. It also adjusts withdrawals relative to market conditions, something the 4% rule and similar strategies do not do. Thus, withdrawals are tempered during good market years to help support spending in bad market years.

The authors of the study found that the 5% ceiling and the 2.5% floor had an 85% success rate over a 35-year period. In other words, the portfolio did not fail—meaning deplete to $0—the vast majority of the time.

Vanguard is not the only entity to suggest a flexible approach. What makes the firm’s analysis interesting is its explanation of why a flexible approach works. The success of the strategy is directly tied to a retiree’s ability to cut back on spending. “The more flexibility retirees have in their floor…the higher their success rate—meaning, the lower the chance that they will deplete their portfolio or be required to significantly reduce their spending before the end of their planning horizon. In fact, retirees’ ability to accept changes in their floor helps their portfolio more than increasing their ceiling hurts it,” write the study’s authors.

Source: “From assets to income: A goals-based approach to retirement spending,” Colleen Jaconetti, Michael DiJoseph, Zoe Odenwalder and Francis M. Kinniry Jr., Vanguard, September 2016.