|Source: Capital Pixel|
So what's the right rate? How can we die broke? Actually there is a way by going the annuity route; but that gives up control of assets and, though that might be a partial solution, we do need access to some of our assets in case of an emergency.
One good thing is we have a rule-of-thumb that basically gives us a minimum. This is William Bengen's 4% rule. He found that, over widely varying 30-year periods, a conservative portfolio drawn down at an inflation adjusted 4% rate would outlast retirees. This is the starting and ending point for many retirees. Unfortunately this could leave a lot left over.
So others have improved on this. Guyton has found that, throwing in some flexibility by foregoing the inflation adjustment in down markets, the rate of withdrawal can be raised as high as 5.5%. If you are only going to read one article on this subject, read How Retirees Can Spend Enough, But Not Too Much by Lieber. Lieber describes Guyton's findings.
The difference between 4% and 5.5% draw down rate is obviously significant. On $1.0 million, it is $55,000/year versus $40,000!
Others argue that even more considerations should be taken into account. For example, what is the market's P/E ratio when you start. A lower-than-average P/E ratio would suggest a bit higher withdrawal rate based on the idea that the longer term prospects for the market are relatively positive. Conversely, a higher P/E (think year 2000 and dot.com bubble) and the withdrawal rate should be a bit muted. Kitces has done valuable work in this area.
It's interesting to contemplate that we are still in the infancy of this line of research. Throwing in some data on life expectancy (the big unknown) can refine the analysis. In fact, we have sites today (this is for retirees who find they have too much time on their hands!) where we can actually get a prediction on what date we will no longer be concerned with such mundane questions as maximum withdrawal rate. Now the biggest hurdle is market performance on the path we go down ;)! But this has gotten me into the weeds.
To get a feel for the issues involved here, let's go back to my favorite investment planning tool - the BlackRock Asset Class Returns chart. The chart shows 20 years of returns, on an annual basis, for several asset classes and for a diversified portfolio. This time I want to look at the diversified portfolio which is easily replicated using low-cost, well diversified funds. It is basically 65% stocks and 35% fixed income.
Assume a person retired in 1990 at age 65 and withdrew 4% of his $1.0 million portfolio on the first day of each year and he was invested in line with the diversified portfolio - this produces the "return" column. The withdrawal was adjusted each year for 2% inflation as shown in the "income" column.
As shown in the table, the retiree, at the end of the 20 years ended 2009, had a portfolio valued at $2.69 million. Junior, in the basement, is cheering wildly and spends the day eyeing exotic cars. Our retiree is kicking himself for not taking that extra cruise a year and continually driving his car into the ground!
|Return data from BlackRock|
This, of course, was a good period, despite the sharp downturn in 2008 and early 2009.
As it turns out, each of us will go down a particular path. This should be kept in mind when we examine research results presented by many studies (based on Monte Carlo studies) that average numerous paths and present probabilities. The message is that retirees need to examine portfolios on a dynamic basis and that adjustments can and should be made.
Clearly the reiree in the table, who is now 85 years old, has the capacity to step up consumption if so desired. In fact, he could convert part of the portfolio to an immediate pay annuity and get a very attractive payout for the rest of his life.
To gain a bit more perspective, it is worthwhile looking at a person who retired in 2000 with $1.0 million. This, of course, was at the height of the dot.com bubble when portfolios were robust. Sadly, many got caught up (as is usual) in the hype and weren't well diversified - but what about those who were? How did they stand at the end of 2009? This is shown in the following table, again, assuming they invested according to the diversified portfolio and had an inflation adjusted 4% drawdown:
|YEAR||ASSETS (1/1)||INCOME||PORTFOLIO||RETURN||ASSETS (12/31)|
The retiree still has over 80% of his portfolio and is in decent shape. This despite starting the period with the negative market and experiencing an historically sharp drop in 2008. To me, it is a great illustration of the value of sticking with a portfolio plan and avoiding the shifting of assets on the basis of emotions.
Again, at age 75, he would be in great position to buy an immediate pay annuity. Also, if in great health, he might even consider putting a small sum towards a deferred annuity to pay at age 85.
The point here is that we will all go down a dynamic path and that our position should be examined on an ongoing basis.
The analyses here show how easy it is to examine questions the reader might have given a bit of playing around with Excel. For example, it would be easy to collect CD rates, for example, or Treasury rates and see how a retiree would have done putting all of their assets in those particular assets. I'm going back and doing the analysis using a 5.5% withdrawal rate.
Disclosure: The information here is for educational purposes only. Individuals should do their own research or consult a professional before investing.