RETIREMENT PUZZLE
I GET DRAWN DOWN, BUT I GET UP AGAIN
As more and more of us retire without DB pensions, approaches to managing drawdowns will become increasingly important. And the stakes are high - for most of us who aren’t athletes or on oil rigs, if our pot doesn’t grow as much as we’d hoped, we can probably just retire a year or two later. But if you’ve been retired for 15 years and find yourself running out of money, that’s a harder problem. For all the complexity of the issue, drawdown investors typically only have two levers they can pull. They can change strategy, or they can change how much they drawdown. All the analysis and projections we create are ultimately to drive those two decisions - beyond that, we are on the receiving end of reality. Varying income is not always possible, but where it is an option it can help mitigate tail risk- effectively, it’s reducing the size of the problem. In the chart below you can see, reasonably intuitively, that if you can afford to cut spending when investments underperform, you can reduce the uncertainty around your pot size. The example is marginal, as
most investors will not have that much leeway to reduce drawdowns, but it can meaningfully reduce the probability of exhausting the pot and give it more chance to recover in the tails. Moreover, by spending more when investments perform well, the expected overall income can be essentially unchanged. Changing strategy can make a much larger difference than refining the withdrawals. As an extreme example to highlight this, I’ve included the central case for a 100% cash strategy on the same chart. Generally speaking, most strategy changes will either increase both risk and return, or decrease both. Visually, changing strategy tends to mean either increasing the central outcome and widening the cone of outcomes, or lowering and narrowing it. However, there is a small refinement you can make by changing strategy dynamically, which has a different type of effect. Suppose you decide that, when investments do well, and you can afford larger drawdowns, you’ll make the investments a bit safer; and when you cannot afford the drawdowns as large,
