Thursday, May 15, 2014

The two main criticisms of Annual Available Spend

The two main criticisms of this methodology are: 1) this is nothing new.  Most everyone does the initial information gathering and analysis using Excel models or the like; and 2) the methodology does not come up with a safe withdrawal rate or similar plan for withdrawals.

            Routine information gathering, or something more?

The main premise of the AAS methodology is that information gathering is the most important aspect of retirement planning.  Everyone does something in this regard, but often not enough for effective planning.  If there is a complete understanding of the retiree's specific facts, the planning will be centered on those facts and not simply follow one of the many formula's currently in use.  So do most gather information in a manner comparable to AAS?  The answer is yes if the answers to the following three questions are yes:
           
            1.  Do you know your base case AAS:  The after-tax amount received from all sources that will be available for you to spend each year until your assumed year of death (age 100 or ?) when investments reach zero?

            2.  Do you know your AAS computed under a reasonable worst case:  For example, equity value permanently declining by 60% (or more or less severe market decline, or high inflation); or whatever you consider to be a reasonable worst case as applicable to your specific situation?

            3.  Have you compared your base and worst case AAS to your best estimate of expected future annual spending needs?

As the article demonstrates the computations of best and worst case AAS and spending needs are prepared in great detail to make sure all of the retiree's specific information is properly taken into account.  It is my understanding that information gathering generally does not include computing base and worst case AAS, and spending needs may or may not be thoroughly evaluated, e.g., they may not obtain the retiree's detailed view on how he might practically and psychologically deal with various negative scenarios.

In cases such as retirement planning, when analysis and problem solving involve matters of uncertainty, information gathering is more than half the battle.  So after we have this information, what do we do?  That brings us to the second criticism.

            So where is the method for determining investments or SWR?

Once the information gathering is completed, there is no specific investment or withdrawal plan that fits all.  The facts will lead to the best approach using solid reasoning and judgment. The base and worst case AAS are compared to spending needs and that is where the important analysis lies.  Is the retiree more like Joe, Bill, or Al in the article?  Of course, no two individuals are alike and it is impossible to generalize.  Are the AAS scenarios more or less than spending needs?  To what extent can the retiree manage shortfalls or a worst case?  What is the psychological position of the retiree?  Etc. 

Changes in investments can be tested in the AAS best and worst case models -- fixed/equity allocations, annuities, TIPS ladders, etc.  Each of these will change the base case and worst case AAS, which can then be compared to actual spending needs.  Various withdrawal plans or SWR plans can also be tested and compared.  There are many systems involving various SWR rates, value timing, buckets, reservoirs, etc.  If any of these might be helpful, test them in the models, but there is no best system or formula; it is all dependent upon evaluating the AAS model outcomes.


One additional point that must be reemphasized.  It is essential to continually update and monitor the model output.  The model can easily and automatically update the base case AAS.  In the short term there should be very little change in the AAS, and this might lend comfort to the retiree.  However, some changes are inevitable over the years (hopefully for the good), and adjustments can be made as appropriate.

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