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Retirement Planning > Spending in Retirement

The Retirement Spending Assumption Dave Ramsey, and Most Advisors, Aren't Talking About

By Jim Sandidge

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What You Need to Know

  • Systematically increasing cash flow every year is not the best spending plan for every retiree, no matter the initial withdrawal rate.
  • Retirees have four main goals tied to cash flow, and they prioritize them differently.
  • With the right long-term strategy, it is possible to start taking from a $1 million portfolio at an 8% rate and not go broke.

One aspect of the Dave Ramsey-”Supernerd” throwdown no one has mentioned is the fact that delivering innovative, comprehensive, personalized cash flow in retirement requires more creative thinking than the financial services industry has shown to date.

Ramsey’s suggestion that retirees can withdraw 8% initially is not black and white because retirement income is a nonlinear process, and nonlinear problems have multiple solutions that require nonlinear thinking, sometimes called “creative thinking.”

Challenging assumptions is the genesis of creative thinking; however, most people are more prone to make assumptions, and doing so limits creativity. For example, Monte-Carlo-based research typically assumes you systematically increase cash flow by some amount that approximates the inflation rate.  

The Four M’s

To understand how this assumption regarding systematic increases in cash flow limits creativity, one needs to consider the four cash flow goals of retirees that I call the four M’s. Retirees want to maximize cash flow in the early years (M1), maintain their standard of living, which is about enough cash flow in the later years (M2), minimize cash flow shocks (M3), and minimize principal erosion (M4).

Delivering personalized solutions means recognizing not everyone values each goal the same. Because many people reduce consumption in retirement, they don’t need cash flow to increase at the rate of inflation as Monte Carlo typically assumes and can afford to emphasize one or more of the other goals.

In the chart below I assumed two people each retire with $1 million at the start of 2000, a horrendous year to retire. Consistent cash flow (M3) is important to one, so they withdraw $50,000 each year (red line) while the other (blue line) wants to maximize cash flow in the early years so they withdraw 10% the first year, then reduce cash flow to a sustainable level based on decision rules I wrote.  

Cash flow chart

The result is the variable cash flow paid more each of the first seven years and the same amount in the eighth year, maximizing early cash flow (M1) by distributing $547,000 over the first eight years compared to $400,000 for the fixed cash flow.

The fixed total cash flow did not equal the variable until after 16 years, with both portfolios distributing approximately $800,000 through the 16th year, and the two portfolios each had $562,000 remaining after 21 years (M4). 

Thus, because it was more consistent, the fixed cash flow was optimal for M3 (cash flow shocks), but the variable was optimal for M1 (early cash flow), and the two were equally optimal for M4 (principal erosion).

It is debatable which was optimal for M3 (standard of living) as the variable flow eventually fell below the fixed after eight years, but they distributed the same amount of cash through 16 years and finished the 21st year with the same amount of principal, which should sustain an equal amount of cash flow from that point on.

And here’s another result not pictured on this chart: Taking a 5% initial withdrawal and increasing that dollar amount 3% annually (the type of systematic approach designed to maximize M2 at the expense of the other goals and typical of Monte Carlo analysis) depleted the principal in the 21st year, making it suboptimal for M4 (minimizing principal erosion) relative to the two strategies shown.

Those whose knee-jerk reaction to the prospect of withdrawing 8% initially is to yell “heresy” because they immediately assume systematic increases in cash flow for everyone illustrate linear thinking (one solution) in a nonlinear retirement income world (multiple solutions). As Keynes noted, “the difficulty lies not so much in developing new ideas as in escaping from old ones.”

Challenging the assumption of systematic increases in cash flow is the type of creative thinking needed for advisors to deliver innovative, comprehensive, personalized solutions, and the key to creating a personal brand as a creative thinker, something neuroscientists have shown consumers highly value.

James Sandidge is an advisor, attorney and principal at the Sandidge Group. His research on retirement income planning and chaos theory has been featured by the Social Science Research Network and other publications. Sandidge’s paper “Chaos and Retirement Income” earned him the 2020 Investments and Wealth Institute Journal Research Award.

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