Every day, I seem to have a discussion with someone regarding strategies for sustaining retirement income in a lower-return world. Investors, particularly retirees, are looking for solutions, and their frustrations are as clear as their request: Can’t someone help? While I can’t fix low interest rates on lower-risk investments (such as high-quality bonds and bond funds), perhaps I can provide some perspective and a solution. As with the old conundrum—is the glass half-full or half-empty?—the answer to the retirement income puzzle is often about perspective.

First things first

The first place to start in a low-return environment would be to minimize your investment costs, including taxes (see: Do sweat the small stuff). Every dollar paid in costs and taxes is a dollar less that you have to spend. Given the anticipation of lower rates going forward, these expenses are likely to be a larger portion of your total returns.

Next, you should review your current income sources and expenses to determine the degree of flexibility in your annual spending needs; this will help you make an informed decision around the spending strategy that’s best for you.

Retirement spending: 3 strategies

I’m not the first person to try to help with this challenging topic, and many spending rules have been suggested to help retirees who want to generate a paycheck from their portfolios. Two of the most popular are the “dollar plus inflation” and the “percentage of portfolio” rules. I’d like to offer what I consider an alternate solution: the “dynamic spending” strategy.

The dollar plus inflation strategy is just what it sounds like. Upon retirement, you select the initial dollar amount you’d like to spend each year and increase that amount annually by inflation. The well-known “4% rule” follows this approach (Bengen 1994[1]). While this strategy allows for rather stable real spending from year to year, it also requires a trade-off: a higher risk of premature portfolio depletion. The chink in the armor for this strategy is that it’s indifferent to the returns of the portfolio, which can be problematic in both bear and bull markets. The result is you could potentially run out of money (or at least have to substantially reduce your spending since you’re not likely to continue spending down to your last $1) in the event portfolio returns are negative, or you could potentially live well below your means and not enjoy retirement to its fullest if portfolio returns are much better than expected.

The percentage of portfolio strategy, on the other hand, may be too sensitive to returns, creating significant income volatility based on market movements. With this strategy, the annual spending amount is a consistent percentage of the portfolio’s value. This approach ensures that the portfolio won’t be depleted, but as the portfolio’s value rises and falls, the income amount will rise and fall as well—sometimes dramatically. Yes, it’s this last part—income falling in response to negative returns—that people often struggle with.

Compared with these two strategies, our dynamic spending strategy is a more flexible approach that moderates the other two strategies’ weaknesses, as summarized in Figure 1.



With dynamic spending, you would calculate each year’s spending in three steps:

  1. Use the percentage of portfolio approach (e.g., 5%) to calculate a spending level based on the portfolio’s value at the prior year-end.
  2. Determine a range of acceptable spending levels based on the prior year’s actual portfolio value. To find the range, increase the prior year’s spending by 5% (the ceiling) and reduce it by –2.5% (the floor).[1]
  3. Finally, compare the results. If this year’s spending amount based on the percentage of portfolio:
    • Exceeds the ceiling amount, spend the ceiling.
    • Is less than the floor amount, spend the floor.

As you can see, the dynamic spending strategy is a bit more involved and may require a little more discipline and oversight to follow compared with the other two strategies. Given that, this is certainly one area where working with a financial advisor can make a lot of sense and may even pay for itself.

Worth the extra effort

Our research[2] has shown that using the dynamic spending strategy, a retiree can capture a large part of the sustainability benefits of the percentage of portfolio strategy, but without the strategy’s considerable volatility in annual spending. Ultimately, an investor with endless flexibility would choose the percentage of portfolio approach for its 100% success rate; however, for most retirees this is simply not practical. In that case, dynamic spending can provide many of the benefits of percentage of portfolio without giving up the relatively consistent level of real annual spending.

Perfection not required

In reality, there isn’t a perfect solution, and each strategy requires trade-offs. In a perfect world, we would never need to decide whether a glass is “half full or half empty.” It would always be full, and with our beverage of choice. But neither life nor retirement spending choices require perfection to be rewarding. A dynamic spending strategy can help you negotiate the inevitable trade-offs between spending sustainability and stability, providing you with the financial and emotional resources for a comfortable retirement. Now, where’s that glass?



[1] Bengen, William P., 1994. Determining Withdrawal Rates Using Historical Data. Journal of Financial Planning (Oct.): 14–24.

[2] This assumes no inflation. See “From assets to income: A goals-based approach to retirement spending” for a detailed example, including inflation.