Are Retirement Spending Strategies Different For Individuals And Institutions?

Endowment policy—a general term referring to the spending decisions facing endowment funds, foundations, family offices, and other related institutions—has confronted questions about sustainable spending for many years.

Endowment funds have shifted to the probability-based methods discussed in this chapter since the 1970s, as previous ideas about only spending interest from a fixed income portfolio were slowly abandoned for not providing enough income and inflation protection.

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Endowment spending policy is an active area of research, with the latest policies of different university endowments often guiding the way for others. It is interesting that research on endowment spending policies has evolved separately from research on spending policies for retirees.

Each area developed its own tools for balancing the tradeoff between the desire to keep spending growth consistent with inflation, while also recognizing that poor market returns might eventually trigger a need to reduce spending.

The balance to strike is how and when to reduce spending to avoid creating too much spending volatility and uncertainty, while simultaneously maintaining future potential spending and avoiding even bigger subsequent cuts. Retirees can easily apply endowment spending rules to their own personal situations.

Generally, endowment spending rules can be classified into two categories: hybrid rules and moving average rules.

First, hybrid rules provide a way to combine the constant amount and fixed percentage strategies. A simple example is illustrated in Exhibit 1. In this case, annual spending is determined as the average of constant inflation-adjusted spending based on the initial balance at retirement, and a percentage of the remaining account balance.

For a 4% withdrawal rate and a $100 initial balance, annual spending is half of $4 on an inflation-adjusted basis, and half of 4% of the remaining account balance throughout retirement.

This hybrid strikes a balance between trying to stabilize spending while allowing it to fluctuate in response to portfolio performance. Real spending drops to about $3 (a 25% decrease from the initial level) in the historical data, which is midway between a constant $4 and the $2 threshold reached with the pure fixed percentage strategy.

Similarly, wealth balances are less strained than with the constant spending rule but fall behind what is left with the pure fixed percentage strategy.

Hybrid rules lead to more stable spending than fixed percentage rules, but they increase the risk that assets can be depleted as well. For this reason, the sustainable spending rate associated with hybrid rules generally falls between the spending rates for the other two rules.

This allows income fluctuation and some response to market conditions, but not as much as with the constant percentage rule. Also, wealth can still run out, though not as soon as with the constant inflation-adjusted withdrawal rule.

Exhibit 1 Time Path of Real Spending and Wealth

Endowment Formula – Hybrid

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


Moving Average Rules

The second type of endowment policy rule bases spending on a percentage of the moving average of the remaining account balance. The most common smoothing rules for endowment spending are moving average rules.

Rather than define the spending rate only in terms of the initial year of the plan, the spending rate is a constant value over time. But rather than spending a constant percentage of the remaining portfolio balance each year—resulting in a great deal of spending volatility—moving average rules seek to spend a constant percentage of the average portfolio balance over the previous few years.

Most frequently, the average portfolio value over the previous three years or twelve quarters is multiplied by a spending rate to determine the feasible spending amount for a given year. This approach allows spending to adjust somewhat more gradually over time than with a pure fixed percentage rule.

Exhibit 2 provides an example of a 4% spending rule based on the average remaining portfolio balance during the previous three years. In practical terms, this rule ends up behaving like the fixed percentage rule. Volatility for spending will be slightly less, but a very similar overall experience can be observed in the historical data.

Exhibit 2 Time Path of Real Spending and Wealth

Endowment Formula – Three-Year Moving Average

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



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