Financial advisors have a wide range of strategies at their disposal to create financial plans for their clients. And when it comes to retirement planning, one popular technique is the use of ‘guardrails’, which set an initial monthly withdrawal rate that can be later adjusted as the size of the client’s portfolio changes. This strategy is valuable because it generally allows for higher initial withdrawal rates than more static approaches that don’t accommodate clients willing to adjust their spending in retirement. However, given the technical nature of the guardrails approach, advisors can find it challenging to explain to prospective and current clients how it will work in practice.
To start, it is typically preferable to explain guardrails to prospects and clients in dollars rather than in percentage terms (e.g., telling the client they can safely withdraw $4,500 each month rather than saying they will have a 5.4% annual withdrawal rate). Further, given that a client’s monthly distributions will almost certainly change at some point when implementing a guardrails strategy, they must understand what this means in practical terms. To help them do so, advisors can explain that when market returns are strong, they can take larger distributions each month (in dollar terms), but when an inevitable bear market arrives, they may need to cut back on their monthly income until things get better. In addition to explaining withdrawals in dollar terms, advisors can also present a client’s asset allocation in dollar terms (instead of the more usual approach of explaining the allocation in percentages) by framing it as the number of years of income that would be protected from stock market fluctuations (e.g., setting aside a ‘war chest’ of cash and fixed income balances to provide 5 years’ worth of income).
While most clients will have no problem accepting a larger monthly income, tightening their belts will be more challenging. One way to prepare clients for a potential reduction of their monthly income is to give advance warning that a cut might be necessary if their portfolio declines further (and to encourage them to consider where they would cut back if needed). In the case of a market downturn, advisors can wait an agreed amount of time (e.g., 2 quarters) after the client’s portfolio balance falls below the lower guardrail before implementing an income reduction, as this can give the market time to recover and preclude the need to make any adjustment at all (and is still more conservative than the annual review prescribed in the initial guardrails research). If the portfolio balance declines due to excess distributions (e.g., a lump-sum withdrawal to buy a new car), advisors can advise clients on whether withdrawals will bring them closer to (or even dip below) the lower guardrail and the implications for their future monthly income.
Ultimately, the key point is that while a guardrails strategy can help clients maintain sustainable withdrawal rates throughout retirement, ensuring that clients understand how the strategy applies to them – in practical terms – is essential for success. Advisors can do this by explaining withdrawal rates, guardrails, and potential future changes in spending and income, all in dollar (rather than percentage) terms. Furthermore, by giving clients advance warning of potential changes, advisors can help clients feel confident about the guardrails strategy and, perhaps more importantly, in their advisor’s ability to implement it!
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