- Dr. Wade Pfau, who holds a Ph.D in economics from Princeton University, offers advice for retirees trying to mitigate sequence risk in retirement.
- He says that fluctuating spending, reducing volatility at key points, and having assets that are uncorrelated to portfolio returns can help a retiree stay on track for the long term.
- Pfau says that “these small changes you can make can have a huge impact.”
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A successful retirement is something that most everyone is striving to achieve. However, with the majority of American households struggling to make ends meet, it’s easier said than done. Combine that with volatile markets, and the task at hand grows even more difficult.
Sequence risk, or the manner in which investment returns materialize, can upend a retiree if not accounted for properly. Overspend in a down year for markets, and a once-sound financial plan can start to look flimsy.
For those fortunate enough to be in a situation to not work anymore, Dr. Wade Pfau is offering advice to remove some of that risk that comes hand-in-hand with retirement.
To bring you up to speed, Pfau holds a Ph.D in economics from Princeton University, has written several books, and is also a professor of retirement income at the American College of Financial Services. In addition to those impressive accolades, Pfau has also won awards for his research and writing.
Here are four ways Pfau says investors can manage sequence of returns risk and prosper in the long term.
1. Spend less
This is Pfau’s first most instinctive and broad suggestion, so we won’t spend much time on it.
2. Fluctuate your spending
“Different advisors have proposed different types of variable spending strategies,” Pfau said. “One of my favorites is actually — Bill Bengen defined it — and he’s the one who created the 4% rule initially.”
Pfau continued: “But he talked about a floor and ceiling approach where you spend a fixed percentage of what’s left every year. But you decide you’re going to have a floor that you don’t want your spending to fall below a certain dollar amount, and then you have a ceiling where you’re not going to let your spending go above a certain dollar amount.
“So as long as you’re within that range, you just spend a fixed percent, but you apply the floor and the ceiling.”
3. Reduce volatility at key points
Pfau notes that exposure to the stock market is generally quite low when an individual enters into retirement due to the nature of a target-date funds. However, he doesn’t think it needs to stay that way in perpetuity.
“If you’re willing to start at a lower stock allocation but increase it later, that can really work as a risk management technique that doesn’t lower your spending and allows you to have a less volatile asset allocation, but still have the same amount of risk that this idea that you’re going to fund retirement just through investments can still work out for you,” he said.
Pfau refers to this idea as the “rising equity glide path.”
4. Buffer assets
“Buffer assets are assets held outside the portfolio that are not correlated with the portfolio, and that can provide a temporary resource to spend from after market downturns to avoid selling portfolio assets at a loss,” Pfau said. “Just try to give the portfolio an opportunity to recover so that you can then subsequently start taking distributions from the portfolio again.”
Pfau rattles off three potential buffer assets that can help investors in times of need:
1. Cash (Pfau has mixed feelings about cash since it just sits on the sidelines and increases your withdrawal rate.)
2. Policy loans leveraging the cash value of your life insurance policy
3. A growing line of credit on a reverse mortgage program
“These small changes you can make can have a huge impact,” he said. “Just being able to source a year of spending from a buffer asset, and leave your portfolio alone for a year can have a huge impact on helping to keep that portfolio sustainable, or helping to not deplete it.”
