Accumulation, Distribution, and Decumulation

We thought that a discussion of the above concepts would shed some light on the issues surrounding investing and retirement income planning. To start let’s define the terms:

• Accumulation. This refers to the net acquisition of assets prior to their specific use to fund retirement. When we invest for the future without removal of gains (i.e., income, dividends, capital gains), then we are said to be accumulating wealth.
• Distribution. This stage occurs when we are looking for a “sustainable income” from our accumulated assets. The notion here is that this is for your lifetime, or the lifetime of your survivors in certain cases, at a prescribed rate. The focus is on the longevity of the income stream across challenging market and economic conditions. A term used to describe this stream is SWR (sustainable withdrawal rate) which expresses the acceptable percentage of income that can be derived from the asset base for lifetime income. If you take too much out of your portfolio then you are forced to contend with the final phase.
• Decumulation. By our definition, this occurs when the asset base shrinks by such a degree that future income streams are uncertain. This may have occurred because of poor returns, too great of a portfolio withdrawal rate, or some combination of the two. Mathematically, the smaller the asset base, the higher the withdrawal rate, assuming no changes to income requirements.

Ok, we now have some working vocabulary, but what does this mean to me, and how can this be applied to a straightforward assessment of my potential life in retirement? A couple of important distinctions can be drawn from a deeper analysis here:

• The sequence of returns (i.e. positive years, negative years, and flat years) does not impact the SWR in an accumulation portfolio because no money is being withdrawn. Arguably, one can wait out the storm, or continue to add funds in market downturns, while accumulating assets. You may experience a shrinking capital base, but given enough time, these effects tend to be temporary.[1]
• When we enter the distribution phase, the sequence of these returns and the variability in inflation can force us into permanent decumulation. In other words, a few bad years of return, and a miscalculation of inflation, could punch holes in your portfolio and impair your ability to generate a lifelong income. Ouch!

Here’s where we turn to some practical advice to triage our fears. We are never powerless to make a change to the betterment of our financial lives. Three ideas come to mind:

• Save more than needed. If you don’t want to cut your future lifestyle expenditures, and who really does?, then build some robustness into your current savings. Create a buffer of 5-10% over your required savings, or make sure you are increasing your annual savings based on inflation, but with no less than a 2% increase per year.
• Cut your expenses. I know I wrote that no one wants to do this, but you may have little choice if you are deep into the distribution phase. Trim expenses that aren’t essential, or modify your budget based on the variability of your portfolio returns at a bare minimum. You need to preserve your SWR, and not go beyond, or you are placing your future in the “luck” of a favourable outcome.
• Manage your volatility in distribution. Volatility is the friend of accumulators and the enemy of distributors! The next tech-innovator may be a great portfolio addition for an accumulator 5-10 years away from retirement, but rarely would this be suitable for someone looking for sustainable income streams. As volatility is a necessary component for return, it cannot be removed entirely, but its negative impact can be managed through thoughtful planning.

Clearly, the transition from saving to spending one’s investments is not a simple as switching on-and-off a light switch. It requires a proper review, a realistic assessment of the variables of return, and a sensitivity to a SWR. This is where a financial professional can help you navigate the obvious pitfalls involved, and steer you away from a scenario that leads to unwanted decumulation.[2]

[1] The average breakeven timeframe since 1928 for the US markets is 26 months or just over 2 years. See Ben Carlson’s methodology here: https://awealthofcommonsense.com/2020/03/how-long-does-it-take-to-make-your-money-back-after-a-bear-market/

[2] We are just scratching the surface here, and exceptions do occur, for individuals or corporations who need to pay out assets at an accelerated rate. My observations are based on some of the ground-breaking work of Jim Otar on retirement planning. Further detail can be found at his website: http://retirementoptimizer.com/

The enclosed article expresses the opinions of writer, Patrick A. Choquette, and not necessarily those of Raymond James Ltd. (“RJL”). Statistics, factual data and other information are from sources believed to be reliable but accuracy cannot be guaranteed. It is furnished on the basis and understanding that Raymond James Ltd. is to be under no liability whatsoever in respect thereof. It is for information purposes only and is not to be construed as an offer or solicitation for the sale or purchase of securities.Raymond James Ltd. is a Member - Canadian Investor Protection Fund.

Raymond James Ltd. is a Member - Canadian Investor Protection Fund.