You may not have heard of the “guardrails approach,” but this investing tool for retirement planning is worth considering, especially in a volatile market. That’s because one of the biggest challenges for many people in retirement is ensuring their retirement investments last for the rest of their lives, yet leave a bequest to heirs. It’s a tough knot to untangle.
Part of the problem is that assets such as stocks and bonds are prone to be volatile. Some years offer solid double-digit returns and others are distinctly poor with tremendous losses. For instance, in 2022 the SPDR S&P 500 exchange-traded fund, which tracks the performance of the large-cap stocks, fell 18%. That same year, the bond market also declined, with U.S. 10-year Treasuries also falling 18%, according to data from New York University. Yet inflation spiked.
So, what can you do? Jonathan Guyton and William Klinger, a financial planner and computer whiz, respectively, developed an investment methodology known as the “guardrails approach.” It’s designed to lower the risk of retirees running out of money.
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What is the ‘guardrails approach’?
“Guardrails focuses on lifetime spending,” says Amy Arnott, portfolio strategist for Morningstar. “And it means you are able to spend more money during your lifetime.” And it’s also likely to ensure that significant assets will be left over for bequests to family and charities. She estimates that someone starting with a $1 million portfolio — taking 4%, or $40,000, income initially and following the guardrails approach — will likely have a portfolio of $1.3 million when they die.
In the simplest terms, the amount you take out of your retirement pot each year will rise and fall based on the annual swings of the portfolio’s value and inflation.
If the portfolio grows by 40% to $1.4 million at the end of the first year, then the retiree gets to withdraw $45,021, according to Morningstar. If at the end of the first year the portfolio drops by 30% to $672,000, the retiree gets to withdraw $36,835.
“It can be challenging to understand the ins and outs of the actual guardrails calculations,” Arnott says. However, financial advisers should be able to help crunch the numbers.
How to use the ‘guardrails approach’
The guardrails approach is a good one, but it has flaws, says Richard Rosso, director of financial planning at Real Investment Advice. He notes that the amount of money required in retirement is not static. It tends to begin with increased spending at the beginning of retirement when people take overseas trips. After the trips, spending falls for a while, sometimes to as much as one-fourth of what it was the first year of retirement, he says. And the money not spent could then remain in the portfolio.
Eventually, many retirees see their financial needs increase as their health deteriorates and they need more medical care. “Everyone’s spending varies,” Rosso says.
Rosso also recommends that those using the guardrails approach evaluate the portfolio every quarter, rather than annually. He says most clients understand the need to spend less when the markets are falling. “This dynamic system of guardrails is not a bad thing,” he says. “It’s a good way for clients to see what’s going on with the portfolio and the spending.”
Another challenge not commonly understood is the impact of life expectancy (longevity risk), which is not included in the guardrails approach, says Nick Nefouse, global head of retirement solutions and head of LifePath at BlackRock.
At birth, Americans are expected to live to age 77 on average, according to Social Security Administration data. However, that doesn’t mean someone who is 76 only has a year to live; at that age a man can expect to live another 10 years while a woman has almost 12. That’s why Nefouse includes mortality assumptions in BlackRock’s retirement planning tools. Whatever approach is taken, it’s usually advisable to have a chat with a financial adviser, he says.
Note: This item first appeared in Kiplinger Retirement Report, our popular monthly periodical that covers key concerns of affluent older Americans who are retired or preparing for retirement. Subscribe for retirement advice that’s right on the money.
