Decumulation: BWFA’s Approach

An important issue that sneaks up on people as they approach retirement is how to cope with the hairs that are popping out of strange places. Another one is how to fund retirement from your savings. Living off your “nest egg” is called decumulation. It is this second issue I would like to examine here.

Three widely held beliefs about decumulation are:

  • The decumulation phase can be handled on autopilot.
  • Investing heavily in bonds will produce the income you need.
  • Risk management is not as relevant during decumulation as it was in growing the nest egg.

These assumptions are incorrect, and mismanaging assets during decumulation can cause serious financial surprises.


On Autopilot
Many retirees built their nest egg on autopilot. They selected some funds within their 401k and then went back to work. A fixed amount came out of each paycheck and was allocated according to their instructions. Although the worry meter rose whenever markets dropped, these periods were actually beneficial because the investor could buy more mutual fund shares at lower dollar prices. As markets rose over recent decades, dollar cost averaging paid off handsomely.

Because autopilot worked so well building the nest egg, it is natural to expect it to work well during decumulation. Unfortunately, when markets drop you will have to sell more shares to produce a given monthly withdrawal to meet living expenses. And then there’s a smaller nest egg to generate returns in the future. Dollar cost averaging works against you during decumulation. You need a new strategy.

Bond Allocations There’s a rule of thumb that retirees should have a bond allocation equal to their age (a 70-year-old retiree should be 70% in bonds). For someone retiring this year with a portfolio of bonds that produces $60,000 in interest each year, this appears to be a good income. However, this type of reasoning can be disastrous because retirees today live longer and therefore face a long period of inflation which will dramatically increase their expenses.

One way to appreciate the folly of focusing on a fixed income is to talk to today’s retirees who are in their mid-eighties. An income of $30,000 per year was viewed as sufficient in 1985. Today it doesn’t go far, especially for retirees facing escalating medical costs. The bottom line is retirees need their assets to grow.

BWFA’s Approach
BWFA has developed an optimal strategy for the decumulation phase. This strategy recognizes the need to continue to grow the nest egg even in retirement years through diversified investment in various asset classes and a disciplined approach to managing risk.

» Portfolio Structure
BWFA structures retiree portfolios so that interest and dividends generate 60%–80% of monthly income needs. This income remains fairly constant even when the portfolio value fluctuates. In addition, a significant portion of the portfolio will be invested for growth so retirees can keep pace with inflation.

» Reserve Fund
To meet retiree income needs, BWFA establishes a reserve fund that contains at least six months of living expenses. Each month a set amount is transferred to the client’s checking account. Every six months, BWFA refills the reserve fund using the accumulated income plus the strategic sale of selected securities in the portfolio.

» Individual Equities
To fully exploit this strategy, we utilize individual securities whenever possible. Selling shares in a mutual fund amounts to selling the average holding; you sell the good with the bad. We selectively choose what and when to sell, which lessens the debilitating impact of reverse dollar cost averaging described above.

» Risk Management
Last and perhaps most important is the need to manage risk and use discipline. BWFA uses investment models that specify how much should be invested in various asset classes. The discipline is in keeping each asset class within a target range. For those familiar with the dot-com bust, this is familiar ground.

To get the full perspective on our approach to funding your retirement years, contact us for an initial consultation.