The answer unfortunately is NO. Someone looking to take money out for 30 or 40 years, say 7% or $35,000 of an initial nest egg of $500,000 and adjusting upwards for inflation every year, will most likely have no portfolio left long before then. One big problem is inflation: the real after-inflation return on equities was 5.9% and on bonds only 2.1%. The other significant reason is that several bad years of returns in row, such as happened in the 1970s and in 2001-2003, especially when they occur at the beginning of the drawdown period, so diminish the portfolio that it never recovers, even if strong returns follow.
Sustainable (Safe) Withdrawal Rate
A sustainable rate is around 4%. Many researchers and planners have taken different approaches and assumptions to estimating this rate, often also called the safe withdrawal rate. The range of estimates varies from as low as 3% up to about 6%. Such a big range is obviously of interest since it can mean double the income. Thankfully some of the factors involved are under the control of the investor, unlike future market returns. What are the factors affecting the sustainable withdrawal rate?
- Flexibility in the annual withdrawal amount - instead of rigidly taking out the same inflation-adjusted amount year after year, which means annual increases, freezing the withdrawal (no inflation increase) after a year of negative returns (e.g. 2008) can allow 0.8% more, or when combined with a rule that inflation increases would never exceed 6% up to 1.4% more - i.e. a total of 5.4% annually - per Jonathan Guyton's Withdrawal Rules: Squeezing More from Your Retirement Portfolio at the American Association of Individual Investors. Paul Merriman's popular book Live It Up Without Outliving Your Money proposes rules that boost withdrawals down or up depending on portfolio success which would have supported eventual on-going rates of 6% using historical data from 1970 to 2007. To carry out such a strategy it helps for retirees to have a budget which differentiates between essential living spending and nice-to-have extras to see how much wiggle room there is.
- Diversification of a portfolio using different asset classes such as foreign equities and bonds, real return bonds, REITs, value and small cap stocks reduce portfolio volatility. Reducing the downward jolts is crucial. Diversification then allows a higher withdrawal rate. Guyton's article shows about a 0.4% increase in a successful withdrawal rate in the more effective portfolio.
- Lessening the duration of withdrawals by delaying the start of drawdowns, one obvious way being to work longer and retire later. Funding a 20 year retirement obviously costs less than a 25 year retirement. Table 3 in the famous Trinity study by Phillip Cooley, Daniel Hubbard and Daniel Walz shows how the probability of success rises with shorter payout periods. For example, a 10 year reduction in payout period (25 to 15 years) allows an increase in withdrawal rates from 4% to 5% for a portfolio split 50-50 between stocks and bonds.
Resources:
Bogleheads' Safe Withdrawal Rate summarizes and links to US research
ByloSelhi's annotated links on Sustainable Withdrawal including Canadian content, fund companies, media, government, calculators
No comments:
Post a Comment