or when they have significant erosion and a more-aggressive
approach later or when they have a significant buffer. For example,
they may manage to buffer worst-case losses to the original investment initially, then manage to a low erosion rate, splitting the
difference between worst and average losses, then a higher erosion
rate and average losses. Ultimately it is the combination of time
and position relative to the reference point that drives the risk and
cash flow allocations and facilitates the tactical decisions needed
for personalized solutions.
Additional guardrails include never increasing cash flow any year
during the first five in which the portfolio has a negative return,
delaying increases as long as possible, and establishing an alternate
source of withdrawals such as a line of credit to be used in any
year the portfolio has a negative return that is greater than the cost
Conclusion: Don’t Be Blind
Retirees want to maximize initial cash flow, maintain their standard of living, and minimize both cash-flow risk and erosion risk.
They face multiple risks such as longevity, lifestyle, market, and
healthcare risks, and they have a smaller margin for error. Their
decision-making is driven by multiple biases, but they are likely to
be focused short-term, hypersensitive to losses, worried about the
worst case, and uncomfortable with uncertainty. They want personalized plans that are comprehensive yet simple to understand
and they want choices. Finally, goals, risks, behaviors, and wants
change over time across markets that are constantly changing.
Managing all these pieces requires innovation and adaptability
rather than old assumptions, static portfolios, systematic withdrawals, or feeling lucky.
Perhaps the most important way that managing the distribution of
wealth is different from managing its accumulation is that the help
of an advisor takes on greater importance. In the debate between
advocates of active versus passive portfolio management, retirement income is one area where there should be no debate.
Autopilot approaches are inefficient and dangerous, and actively
managing risk and cash flow can significantly improve portfolio
longevity. The butterfly effect makes even small mistakes important
and there are no second chances. Because it is easier to recognize
the mistakes of others than one’s own (Kahneman 2011a), an advisor who understands the risk and psychology of retirement income
is vital for helping retirees avoid mistakes. Furthermore, optimal
decision-making may require going against conventional wisdom,
and it is much easier to be a minority of two than one (Asch 1955).
Managing retirement income is no more difficult or complex than
accumulating wealth; it is simply different financially and psychologically and calls for different solutions. It does not require complex calculations, simply a masterful grasp of the obvious.
James B. Sandidge, JD, is principal of The Sandidge Group LLC.
Contact him at firstname.lastname@example.org.
1. See, for example, Blanchett (2013), Banerjee (2014), and Roy and Carson (2015).
2. The increase in overall spending at age 90+ for the 90th and 95th percentiles is driven
by healthcare spending.
3. Unless noted otherwise, in this article stocks always are listed first, investors retire
with $1 million, and all investments include a 1.5-percent annual fee; also, “stocks”
are S&P 500 Total Return Index, “bonds” are an equal weighting of Treasury bills and
Barclays Long Government Bond Index; all data are from Thomson Financial and all
analyses are by The Sandidge Group.
4. For example, corporate health plans typically have higher participation rates than
retirement plans. This is because the short-term risk of getting sick and needing
health insurance is more salient than the long-term risk of retiring without enough
5. According to the Insurance Institute for Highway Safety, 32,719 people died in U.S.
auto accidents in 2013, approximately ten times the number of deaths from the
9/11 attacks. But because the auto deaths were spread across 30,057 crashes
over twelve months, they represent chronic risk, which tends to be less vivid than
6. In 2008, the Wall Street Journal ranked Hamel the world’s most influential business
thinker (White 2008).