Floor-Leverage Rule Spending Simulation1

Total assets in individual retirement accounts and defined contribution plans have grown more than 400% over the last 18 years from $3 trillion in 1995 to $12.4 trillion in 2013 according to Investment Company Institute (2014)2. More importantly, these assets as a percentage of the total retirement market have grown to 54%, which indicates that the responsibility of managing investments is shifting towards individual investors. The need to assist these individuals with managing their retirement assets is growing.
The 4% rule3 and the mental accounting strategy4 are two of the well-known retirement planning strategies. The 4% strategy, originally proposed by William Bengen in 1994, invests in a 50/50 stocks/bonds portfolio with the first year withdrawal rate set to 4% and then adjusts for inflation in subsequent years. The mental accounting strategy divides the retirement portfolio into multiple “accounts,” one for each objective. For example, the account for short-term needs and essential spending would be invested in a conservative portfolio. The account for long-term needs and discretional spending would be invested in an aggressive portfolio.
When planning for retirement, there are numerous strategies to choose from. Keep in mind that it is impossible for any strategy to account for all scenarios, since unexpected personal events, market volatility, inflation, longevity, etc. can all impact retirement spending.
The chart above is a great example of how the timing of retirement can have a dramatic impact on a retiree’s spending. The chart shows the simulated spending rates for six hypothetical retirees based on the floor-leverage rule5 proposed by Scott and Watson (2013). The spending rate of the 1950 retiree increased steadily over the 20-year retirement period because market returns were strong during that time. The spending rate for the 2000 Retiree was flat during the retirement period because the internet bubble in 2000 and financial crisis in 2008 wiped out most of the equity portion of the portfolio.
Despite the uncertainties, there are many things that you can help clients control.

  • Cost. Bogle (2014) found that the total wealth accumulated over a 40-year period by a low-cost index fund investor is 65% higher than a high-cost active fund investor6 .
  • Diversification. A diversified portfolio that invests in multiple asset classes with dissimilar returns can help reduce overall portfolio risk.
  • Goals and Risk Tolerance. Help clients understand their investment objectives, liquidity requirements and how much risk they can tolerate and then build a portfolio that meets those needs. Work closely with your clients to help them stay invested for the long term.
  • Rebalance. Rebalancing a portfolio periodically can help investors stay on track with their investment goals and risk tolerance.

Since there is no such thing as one-plan-fits-all, use your resources and experience in portfolio management to create a custom-tailored retirement plan that’s right for each client.
All investments involve risk, including the loss of principal and cannot be guaranteed against loss by a bank, custodian, or any other financial institution.
Diversification neither assures a profit nor guarantees against loss in a declining market.
The buying and selling of securities for the purpose of rebalancing may have adverse tax consequences.


IRN R 14-301 (Exp 6/16)

1 Scott, Jason S and John G. Watson. 2013. “The Floor-Leverage Rule for Retirement.” Financial Analysts Journal, Vol. 69, No. 5:45-60.
2 2014 Investment Company Fact Book – A Review of Trends and Activities in the U.S. Investment Company Industry, 54th edition, Investment Company Institute.
3 Bengen, William P. 1994. “Determining Withdrawal Rates Using Historical Data.” Journal of Financial Planning, vol. 7, No. 4 (October):171–180.
4 Das, Sanjiv Ranjan, Harry Markowitz, Jonathan Scheid, and Meir Statman. 2010. “Portfolio Optimization with Mental Accounts.” Journal of Financial and Quantitative Analysis, vol. 45, No. 2 (April):311–334.
5 The floor-leveraged rule is based on the mental accounting concept with the long term account invested in a 3x leveraged equity portfolio.
6 Bogle, John C. 2014. “The Arithmetic of “All-In” Investment Expenses. Financial Analysts Journal, Vol 70, Number 1: 13- 21.