Barron's took on the 4% rule for retirement withdrawals and looked at ways to tweak it to be more flexible. That may not be a great description, read it for yourself but there was a useful question that I think is becoming more relevant. With more years available to study 4% withdrawal outcomes, the odds of getting to the end and leaving a lot of money unspent that could have otherwise made for a better quality of life are quite high.
I'm a long time believer in the 4% rule so I guess am I questioning whether that number is too stingy. Regardless of where this goes, I believe thoroughly understanding the 4% rule and why odds of favorable outcomes are so high is crucial. This is something I've been saying forever. Once you do fully understand it, you are better able to make an informed decision if you decide on a larger withdrawal rate.
When I first started blogging about the 4% rule, almost 20 years ago, the success rate for money lasting for 30 years (the original Bengen study) was something like 93% and for a 5% withdrawal rate it was something like 88%. With now many more years of success, I imagine the odds have improved. So this made me curious about 6% and I sort of found it. The following is from Bengen's paper.
You can see a lot of instances where a 6% withdrawal only lasted 20 years but in case it's not obvious, quite a few of those failures where skewed by the Great Depression and the 1970's. As I eyeball it, 6% lasted for at least 30 years in 21 out of 51 instances so that is not great on the surface.
As we've talked about though, administering the 4% rule includes increasing from 4% at the rate of inflation. 4% would really only apply to the first year or maybe the first two. So it is with 6%, pretty quickly you'd be withdrawing quite a bit more.
Growth in the portfolio addresses inflation. Odds are pretty good that the portion allocated to equities, whatever percentage you think is right for yourself, that portion will grow faster than the rate of inflation.
In looking at alternative ideas to the 4% rule as designed by Bengen (so including the inflation bump). Barron's made the suggestion that I have been making forever, whatever you got, 4% which means the amount available to take out will fluctuate. If the portfolio drops one year, your portfolio income would drop too. If the portfolio went up (that is likely more often than not), then you've have more available to take out.
I think this is what I simulated through Portfoliovisualizer. Starting with $1 million, I assumed 60% US equities and 40% in the 10 year US Treasury and assumed a 6% withdrawal rate for 35 years. Here's a closeup of the results.
Not sure why the image is fuzzy but we can probably weed out the best and worst case and figure most outcomes would land closer to the middle. The 25th percentile seems reasonably conservative for this exercise. Whatever you got, 6% for 35 years and this person is left with 70% more than what they started with.
Where is too much then? I'm pretty sure an advisor would get in trouble saying "10% should work." A client can of course do whatever they want with their money, I'm just saying that an advisor might have to work with that but should not greenlight it. I have one client who has been taking more than 10% for the 18 years we've been working together. I imagine most advisors have one or two doing the same.
So should we greenlight 6%? Clearly odds of failure increase. The thing with any of these numbers is the focus on income needs. You have $900,000, you plan to start with $45,000 of income, 5%. You're chugging along taking a 5% income stream and then a few years in, something very expensive needs to be paid for and maybe you have just the one pool of capital to draw from. A lower withdrawal rate from my perspective is about increased resiliency in the face of something negative happening that is very expensive.
One common path for retirement withdrawals that several clients did was that they started with some monthly number, $3000 or $4000 or whatever, based loosely on 4-5% and they stuck with that number for an extended period and then based on need they'll bump it up. This is after several years. One approach I've never encountered IRL is "CPI was 2.3% last year so raise my withdrawal from 4.41% to 4.51% (4.41x1.023)."
I still don't know where I am headed with this and while having money in the bank is optionality and piece of mind, it is certainly reasonable to have mixed emotions over living a $50,000 lifestyle for 30 years and making it to 95 with $5 million unspent.
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3 comments:
When you add in Social Security (or whatever that becomes in the future), it seems to me that if you have savings of 900k to 1M staying in the 4 to 6% range should work. Didn't notice you mentioning the SS aspect, and that will change but whatever it is, the GOV will come up with something. The key is saving and staying invested in your younger, working years, making it a priority.
@RS
I think of SS as a completely different income stream. Whatever the number, $30k, $60k, that is one stream with no real planning, just understanding what it will be and how it works.
Someone then might be trying plan how much of an income stream to take from their retirement savings to add to SS to have a complete picture.
Two different households, each getting $50k from SS and each one with $900,000 in savings. One household might be able to comfortably meet their needs only taking 3%, $27k, whereas the other household in this example might have a tough time on 5%, $45k, not due to lifestyle preferences but maybe spending on a health issue or they have a child who will always need help.
Good notes. As a fellow FA, my five biggest concerns:
Straight up that markets don't return as much. In the first few years of retirement, this can be devastating. From the same starting amount, someone made far more by under performing the market by 5% in the 80s than outperforming by 5% in the 70s. We don't get up choose our decades.
If the small-cap premium has been sucked out by VC and PE.
If AI will only bring benefit to a few, private companies. Amazon and Meta has shown that legislators and regulators are pretty placid on having market power and buying and killing competitors, and a few companies can strangle broad economic productivity gains by pulling out all the profit.
Demographics - when native and immigrant working age population are barely replacing, and the only other place to grow the economy is efficiency (see above) could we see lower returns?
Lower interest rates keeping returns, especially dividends, down.
Public debt choking off private investment. Someone that is 55 can have the hard questions about SS solvency and debt politics hit right when they are considering retirement (2033-2035).
The political blindspots, such as the always avoided link between lower immigration and inflation) that can lead to incredible anger without possibility of solution.
Any and all of the above leading to higher volatility, which reduces the geometric returns, and especially accelerates the "dollar cost ravaging" during withdrawals.
I like to think these are all plausible concerns, and it only takes one or two to upset the assumptions of long-term averages. Please know that I'm usually upbeat, and there has never been (and probably never will) be a better producer of mass-affluent wealth in the world than the stock markets. There's no better place for someone to put the money they want to grow for the long term, but it doesn't mean it will grow at rates necessary for 4% return.
Maybe a better approach is to flip it and ask what the geometric return over a 30+ year retirement has to be to support those withdrawal rates, and then review potential average volatility over those time frames to come up with two variables to help clients "choose their own adventure". Clients love when I talk like that. But like you said, our job is to use history and provide future scenarios that help clients make the best possible choices with the best information in an uncertain world.
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