The Original Retirement Spending Decision Rules
The next decision rule approach provides the name for this category of methods. The Guyton and Klinger spending decision rules derive from work by Jonathan Guyton in 2004 and the team of Jonathan Guyton and William Klinger in 2006.
The modern form of the rules, as they are generally understood and implemented today, is found in the latter article. In it, they use Monte Carlo simulations based on the underlying data from 1973 to 2004, and 1928 to 2004 to analyze three retirement asset allocations—50%, 65%, and 80% stocks—over forty-year retirement spending horizons.
Four decision rules comprise this approach. They allow spending to increase faster than inflation when markets are doing well and to drop, even in nominal terms, when the portfolio is losing value.
- Portfolio management rule: This rule addresses where withdrawals are taken from, and is not something I model in my simulations. With this rule, a cash reserve is created to cover spending needs. Following years with negative returns, asset allocation can change as withdrawals from equities are avoided if sufficient assets remain in cash and fixed income to cover withdrawals.
- Withdrawal rule: Annual spending increases with inflation except in years after the portfolio experienced a negative return. After negative return years, spending stays the same. There is no make-up in subsequent years for a missed spending increase. This rule is only applied if the year’s withdrawal rate (current spending divided by remaining assets) is higher than the initial retirement date withdrawal rate.
- Capital preservation rule: Spending is cut 10% if the current withdrawal rate rises to 20% more than its initial level and the planning age is still more than fifteen years away. So for a thirty-year horizon, the rule only applies for the first fifteen years of retirement. For example, if the initial withdrawal rate is 5%, then a spending cut would take place whenever the current withdrawal rate exceeds 6% of remaining assets in the first fifteen years of retirement.
- Prosperity rule: Spending is increased 10% in any year that the current withdrawal rate falls to 20% below its initial level. For example, if the initial withdrawal rate is 5%, a spending increase would take place whenever the current withdrawal rate falls below 4% of remaining assets.
The modern version of their rules drops Guyton’s original inflation rule, which capped spending increases at 6% when inflation exceeded that amount. It also adjusted the withdrawal rule to prevent spending freezes when the current withdrawal rate falls below the initial withdrawal rate.
Exhibit 1 illustrates the historical performance of the withdrawal, capital preservation, and prosperity rules using a 50/50 asset allocation.
Exhibit 1: Time Path of Real Spending and Wealth
Guyton and Klinger’s Decision Rules
For 4% Initial Spending Rate, 50/50 Asset Allocation, Rolling 30-Year Retirements
Using SBBI Data, 1926-2015, S&P 500 and Intermediate-Term Government Bonds