Optimal control of the decumulation of a retirement portfolio with variable spending and dynamic asset allocation

TL;DR

This paper develops a dynamic asset allocation strategy combined with a modified ARVA spending rule to optimize retirement decumulation, improving efficiency and reducing risk compared to static strategies.

Contribution

It introduces a novel approach that jointly optimizes withdrawal rules and dynamic asset allocation, enhancing retirement portfolio decumulation strategies.

Findings

Dynamic strategies outperform static ones in efficiency.

Allowing variable withdrawals improves outcomes.

Incorporating dynamic asset allocation yields significant benefits.

Abstract

We extend the Annually Recalculated Virtual Annuity (ARVA) spending rule for retirement savings decumulation to include a cap and a floor on withdrawals. With a minimum withdrawal constraint, the ARVA strategy runs the risk of depleting the investment portfolio. We determine the dynamic asset allocation strategy which maximizes a weighted combination of expected total withdrawals (EW) and expected shortfall (ES), defined as the average of the worst five per cent of the outcomes of real terminal wealth. We compare the performance of our dynamic strategy to simpler alternatives which maintain constant asset allocation weights over time accompanied by either our same modified ARVA spending rule or withdrawals that are constant over time in real terms. Tests are carried out using both a parametric model of historical asset returns as well as bootstrap resampling of historical data. Consistent with previous literature that has used different measures of reward and risk than EW and ES, we find that allowing some variability in withdrawals leads to large improvements in efficiency. However, unlike the prior literature, we also demonstrate that further significant enhancements are possible through incorporating a dynamic asset allocation strategy rather than simply keeping asset allocation weights constant throughout retirement.