Theory to Practice: Siegel and Waring on Retirement Spending Rules

The CFA Institute Seminar for Global Investors, formerly known as the Financial Analysts Seminar, offers engaging lectures, small classroom discussions, and interactive case studies on a wide range of timely investment topics. The 2019 seminar will be held in Chicago on 22–25 July. Learn more about the agenda and speaker details on our website.

Retirement portfolios can fail us in two ways: living cautiously might “leave too much on the table” when our money outlasts us, but spending too much can mean running out of money before we run out of life.

Wealth managers can help their clients structure investment programs to avoid these unwanted outcomes by undertaking the careful work of balancing risks, returns, and spending.

At the 2016 Financial Analysts Seminar, Laurence B. Siegel and M. Barton Waring presented a way to balance an investor’s portfolio concerns, outlined in their paper, “The Only Spending Rule Article You Will Ever Need.” Siegel and Waring suggest a personal annuity structure, created by relating an asset portfolio’s value to a stream of annual spending over a term related to the remaining lifespan of the investor.

The innovation in Siegel and Waring’s approach is to call for yearly recalculation of the personal annuity — they call it an “Annually Recalculated Virtual Annuity” — and to limit spending in each year to the newly calculated annuity amount, reflecting updated values of assets and real rates of returns. After a year of strong investment returns, the next year’s spending can increase; this reflects the changed annuity relationship between the newly calculated accumulated asset value and the remaining investment term. After a tough year in the markets, the following year’s spending is adjusted down similarly.

By recalculating the annuity every year (a trivial calculation using a program like Excel) and adjusting the new year’s spending, the investor remains prepared to fund spending over the required term, avoiding the ruin of running out of money.

Investors, of course, need comfort over the likelihood of their annuity “allowance” varying every year. But the beauty of the Siegel–Waring approach is that variability in that spending allowance can be directly related to variability of the portfolio assets’ value, giving life to the notion of risk tolerance and its relationship to investment policy and allocation to risk assets.

By actively considering their spending needs, investors gain clearer insight into the implications of starting their retirement with a particular value of accumulated assets. And investors who diligently perform the annual annuity recalculation will not court disaster by deferring their spending adjustments when assets have diminished due to periods of disappointing investment returns.

Siegel and Waring concede that practical implementation of this technique is challenged by selecting the right annuity term. Living beyond 100 may be unlikely, but not so remote that we’d want to risk running out of money prematurely. One solution is to “shape” spending to allow for more spending in earlier, more active years of retirement (allowing for diminished spending over the far reaches of our most optimistic life expectancy). Alternatively, longevity risk can be shifted to commercial insurers through deferred life annuities that kick in at a ripe old age, supplementing the personal annuity structure in later years.

Maybe the work of Siegel and Waring is indeed “the only spending rule article you’ll ever need,” drawing together as it does the relevant considerations of risks, returns, and spending — it received the 2015 Graham and Dodd Award of Excellence for best paper from the CFA Institute Financial Analysts Journal. At the very least, it is a terrific example of applying theory to practice, offering practitioners a framework that can be genuinely useful and insightful for their clients.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

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