New article: 4 Percent Withdrawal Rate May Be Too High for Today's Retirees

[smjsl]

Sorry if I missed a thread on this... apparently there is a new study, The August 2011 issue of the Journal of Financial Planning included the paper, "Can We Predict the Sustainable Withdrawal Rate for New Retirees", by Wade D. Pfau, Ph.D., questioning 4-percent rule...

4-percent-withdrawal-rate-high-retirees-moneywatch: Personal Finance News from Yahoo! Finance:

The paper goes on to predict safe withdrawal amounts for retirements beginning after 1980 (we won't know the safe withdrawal rate for 30-year retirements until the 30 years are up). The model described in this paper predicts safe withdrawal rates of 2.7 percent for retirements beginning in 2000, 1.5 percent for retirements beginning in 2008, and 1.8 percent for retirements beginning in 2010.
The paper then examined the periods for which low safe withdrawal rates were required, and found some patterns. The lowest safe withdrawal rates occurred for retirements beginning when interest rates on bonds were at historical lows, when dividend yields on stocks were below average, and price/earnings ratios on stocks were at or above historical averages. These three situations describe the current economic circumstances.
When you think about it, this only makes sense. Your retirement savings can generate only three types of retirement income: interest and dividends, appreciation in your retirement investments, and withdrawals of principal. If current economic conditions are such that the first two items are expected to be below historical averages, it only follows that your total retirement income will be below historical averages.

 

[clifp]

Sorry if I missed a thread on this... apparently there is a new study, The August 2011 issue of the Journal of Financial Planning included the paper, "Can We Predict the Sustainable Withdrawal Rate for New Retirees", by Wade D. Pfau, Ph.D., questioning 4-percent rule...

4-percent-withdrawal-rate-high-retirees-moneywatch: Personal Finance News from Yahoo! Finance:

Excellent paper, although the math can be a bit much. As 99/2000 retiree I was particularly interested in his analysis. It seems entirely reasonable, as Bogle suggests, to look at the the underlying economic conditions to predict future withdrawals rates as well as paying attention to the timing of retirement. I.E. retiring at the end of bull market (in 99) is going to let you accumulate a lot more than someone who retired in say 2009.

If we assume some regression to the means than the SWR for the 99 retiree needs to be lower than the 2009 retiree.

The truly depressing was to look at his simple spreadsheet (linked at the end). I found using current P/E10 and 10 year dividend yield average (I had to guesstimate this number) and the 10 year treasury bond that the SWR for a portfolio of 70/30 stocks was only 2% and for a 50/50 portfolio it was 1%!. Now I am not convinced this numbers are all that accurate but plugging in the historical averages gives a SWR of near 6% for most portfolios which is consistent with other studies.

 

[MasterBlaster]

clearly, if there is no growth in the economy and no growth in the markets. With 2 percent dividends and 0 percent (real) interest on savings.

Then a 4 percent withdrawal rate would not be sustainable.

Without growth financing a long retirement becomes problematic.

 

[ziggy29]

clearly, if there is no growth in the economy and no growth in the markets. With 2 percent dividends and 0 percent (real) interest on savings.

Then a 4 percent withdrawal rate would not be sustainable.

Without growth financing a long retirement becomes problematic.

And whether or not "this time it's different" is left as an exercise for the reader...

 

[MasterBlaster]

And whether or not "this time it's different" is left as an exercise for the reader...

The assumption in much fianancial planning is that the future will behave kind of like the past has. ie., Past is Prologue.

If that isn't so valid then just perhaps a 4% withdrawal rate isn't so realistic.

 

[ERD50]

And whether or not "this time it's different" is left as an exercise for the reader...

But there will be a quiz on Oct 5, 2041.

-ERD50

 

[harley]

I'll be there, if I can remember at age 95.

 

[Animorph]

This concept has surfaced here a couple of times. While it indicates possible p/e-caused gains or losses for the future, seems like inflation variability might need to be considered as well. 3.33% WR will last 30 years with no growth as long as there is no inflation. And inflation should be low if all we get is a series of recessions and no growth. I'm really leary of anything that comes in below 2%.

 

[Meadbh]

Good article, thanks for posting. Worrisome, though!

 

[clifp]

This concept has surfaced here a couple of times. While it indicates possible p/e-caused gains or losses for the future, seems like inflation variability might need to be considered as well. 3.33% WR will last 30 years with no growth as long as there is no inflation. And inflation should be low if all we get is a series of recessions and no growth. I'm really leary of anything that comes in below 2%.

I was thinking of that also. Right now you can 10 year TIPs with basically a 0% coupon, so that eliminates inflation risk. It seems to me if you are ok with running out of money after 30 years, you have a SWR of 3.3%, although year 31 will be tough.

As ERD points the vast majority of FIRECalc runs even at 4% or 5% withdrawal rate end up with a lot more when you die than you retire. Still the demand for capital (and labor) is uncommonly poor right now which doesn't bode well for current retirees.

 

[teejayevans]

We should have a poll on what withdrawal rate everyone is using. I plan on starting at 3%, I can always increase it if I have "too much" money, buying one of these should do it: Ferrari 458 Italia - Wikipedia, the free encyclopedia
TJ

 

[obgyn65]

+1. My planned SWR is 3.32%, and I expect it to keep decreasing over the next few years. It's one of the reasons why I am now planning to continue to work part time in 2012 instead of fully retire.

If that isn't so valid then just perhaps a 4% withdrawal rate isn't so realistic.

 

[chinaco]

I was thinking of that also. Right now you can 10 year TIPs with basically a 0% coupon, so that eliminates inflation risk. It seems to me if you are ok with running out of money after 30 years, you have a SWR of 3.3%, although year 31 will be tough.

...

Pfau suggest this in his conclusion of that article. He also cites the use of other securities and derivatives as well as annuities.

Another interesting observation is that his extrapolated 2008 and 2010 (prediction of MWR) is very near (but below) the S&P 500 div yield in those periods.

 

[rescueme]

We should have a poll on what withdrawal rate everyone is using.

I would assume that for an ER type, it would be variable. That's because for most, not all income streams are yet active such as SS, age 65 pensions, married couple SS income "techniques", etc.

While I retired at 59 (certainly not ER, in my mind - but close enough), I/DW have seven different income streams starting/stopping between the ages of 59 to age 70 (when my SS starts).

Any withdrawl recommendation is just that - a recommendation and IMHO only applies at "normal retirement age" (whatever that is), with all income sources "on-line"...

If not, you need to be a bit flexible in planning and realize that during the early years of retirement, WD rates will surely vary.

 

[travelover]

I wonder what rate Andy Rooney is gonna use.

 

[pb4uski]

I'm wondering how I should think abut SWR.

According to my projections if I retire now at age 56, my withdrawal rate will be roughly 5.0% until I am 60 (the sweet spot to start my pension) at which point it will decline to 4.4% until I begin taking SS at age 70. At that point my pension and SS will cover most of my living expenses and my withdrawal rate will be 0.7%.

Should I be concerned that the withdrawal rate is higher than 4% in the first 14 years given it is so low once I begin to draw SS?

Above is based on 6% average investment earnings rate (60/40 equity/bond mix) and 3% inflation rate (but 5% for medical costs).

 

[MichaelB]

I'm wondering how I should think abut SWR.

According to my projections if I retire now at age 56, my withdrawal rate will be roughly 5.0% until I am 60 (the sweet spot to start my pension) at which point it will decline to 4.4% until I begin taking SS at age 70. At that point my pension and SS will cover most of my living expenses and my withdrawal rate will be 0.7%.

Should I be concerned that the withdrawal rate is higher than 4% in the first 14 years given it is so low once I begin to draw SS?

Above is based on 6% average investment earnings rate (60/40 equity/bond mix) and 3% inflation rate (but 5% for medical costs).

Have you run your numbers through Firecalc? They seem pretty solid to me. The 4% is intended make a portfolio last 30 years, while you need only 14 before another income source kicks in.

 

[2B]

I'm wondering how I should think abut SWR.

According to my projections if I retire now at age 56, my withdrawal rate will be roughly 5.0% until I am 60 (the sweet spot to start my pension) at which point it will decline to 4.4% until I begin taking SS at age 70. At that point my pension and SS will cover most of my living expenses and my withdrawal rate will be 0.7%.

Should I be concerned that the withdrawal rate is higher than 4% in the first 14 years given it is so low once I begin to draw SS?

Above is based on 6% average investment earnings rate (60/40 equity/bond mix) and 3% inflation rate (but 5% for medical costs).

Your analysis parallels mine although I would start with a much higher withdrawl rate between now and age 65 (Medicare) and then falling again at age 70 to almost nothing.

Being cynical, I assume the financial planning industry focuses on ways for make the average individual work until they die trying to save up enough for the retirement they can never afford. That and buying annuities.

 

[chinaco]

I'm wondering how I should think abut SWR.

...

Many others are doing the same... including the authors of all of those studies.

 

[pb4uski]

Have you run your numbers through Firecalc? They seem pretty solid to me. The 4% is intended make a portfolio last 30 years, while you need only 14 before another income source kicks in.

Yes, I have run Firecalc (not recently, but a while ago) and Financial Engines (through my Vanguard account) and both have very low failure scenarios.

I see your point is that the 4% that we kick around assumes 4% withdrawals for 30 years to fund expenses in excess of pension and SS, so the fact that initial years exceed 4% are not so alarming for me now.

Thanks for the input.

 

[chinaco]

Here is another article (this month) by Pfau that focuses on accumulation for retirement.

Getting on Track for a Sustainable Retirement: A Reality Check on Savings and Work

 

[2B]

pb4uski,

There are so many unknown variables in the mix that you really need to decide when the time is right and then live with the risk. William Bernstein talks about some of this in his Investor's Manifesto book.

Wars, revolutions, coups, major disasters have reguarly swept the world. We have one of the few financial markets in the world with over a hundred years of unbroken history. Think of the people that lost their wealth and maybe their lives in the Russian Revolution, Nazi Germany, French Revolution, etc.

People talk about 2008 as a "black swan" but it's not. That type of market collapse is normal or, at least, seems to happen every so often. A true "black swan" would be something like nationalization of American industries, cancellation of all debt, losing a war, etc.

Bottom line -- you have to buy your ticket and take your chances. Don't worry. You won't get out of this life alive anyway.

 

[CyclingInvestor]

Here is some historical perspective on the recent stock market declines :

 

[Animorph]

We'll be at 8% WR for another couple of years and then start tapering down to 1% as college costs and last DS disappear, other income streams come online, and the mortgage winds down. If DW actually retires soon. We'll spend the majority of that time in the 3% to 4% range. Until then I try to be careful to raise cash early for near-term expenses and let DW know she can w*rk as long as she feels like.

 

[Lsbcal]

A few mitigating ideas:
1) We've already been through some big declines including the last 2 months which were quite bad historically. So looking at your portfolio right now (assuming a healthy equity percentage), you should not assume a 1966 scenario going forward. I think that is adding too many bad periods together. No guarantees of course.

2) Adding some international (maybe not right now though) and emerging markets could help in the growth area. I'm talking about broad international + EM to really spread the risk.

3) We may well have low real rate periods going forward. My own studies indicate one could have achieved modest real yields over the 1954 to 1971 period even though 5yr Treasuries yields went up by around 3.7%.

4) If we are heading into a rising rate period (and rising taxes) then deferring Social Security until you really need it (to get the max benefits) might be a good idea for some.