The combination of variable withdrawals and dynamic equity allocation leads to a surprising gain in the total income from a retirement portfolio. Good news for income challenged retirees.

Prior generations of retirees have been blessed with a combination of defined benefit pension plans and strong investment returns from their personal retirement assets. Consequently, one third of retirees recently surveyed have seen an increase in retirement assets (Blackrock, 2021) and avoided the risks associated with managing a shrinking retirement nest egg. This is expected to change for current and future generations of retirees. In our paper (Westmacott et al, 2021) we discuss how to optimise portfolio withdrawals in retirement while minimizing the risk of an income shortfall.

We introduce expected shortfall as a dollar measure of the risk of running out of money prematurely. We find that allowing some variation in the annual withdrawal, within a minimum and maximum withdrawal, improves the total expected withdrawal. We consider the case of a Canadian male who retires with $1 million and withdraws between $30,000 and $80,000 annually, indexed to inflation. The total expected withdrawal increases by 50% when compared with a constant $40,000 annual withdrawal and the same expected shortfall.

Retirees must not only decide how much they can withdraw annually but also how best to split their investment assets between risky assets (equities) and less risky bonds.  A conventional approach is to have the equity allocation diminish with age, according to a predefined rule. An example would be a rule that has a retiree entirely in bonds by age 100. These pre-defined rules are shown to underperform a more dynamic approach that considers the retiree’s age but also their current wealth and future income requirements. We call this strategy stochastic dynamic optimisation.

By allowing the equity allocation to adapt we find further improvements in total expected income. We consider two scenarios. The first scenario uses the familiar 4% withdrawal rule which equates to a withdrawal of $40,000 annually from initial savings of $1 million. The equity allocation is constant and chosen to minimise the expected shortfall.  The second scenario optimises the equity allocation while imposing a minimum withdrawal also of $40,000 and with the same expected shortfall. Rather surprisingly, the second scenario, with dynamic optimisation yields 25% greater expected total withdrawals for the same shortfall risk.

The combination of flexible withdrawals and flexible equity allocation provides a powerful tool for enhancing the retirement income available from retirement assets.  This is a continuous process, so a retiree’s withdrawals and optimal equity allocation is updated every year. By considering the retiree’s age, portfolio value and income needs annually, this approach is tailored to the individual’s retirement journey. With dynamic optimisation, each equity value is the best choice possible, given the model constraints. An example from our paper shows a map of the optimal choice of equity allocation. The idea of a constant equity allocation or a pre-determined glide path is replaced with a tool that guides retires through the uncertain terrain of future markets.


Optimal equity allocation from scenario in (Forsyth et al, 2021). Authors’ calculations.