Weekly Insight: The Sustainable Withdrawal Rate

Occasionally, I teach a retirement planning course at local community colleges. I pose this scenario to the attendees: Consider an investor with two accounts that each average an 8% rate of return over a 25-year period. Account (A) had good years in the beginning and poor results at the end. Account (B) had the opposite sequence of returns—poor results in the beginning and good results at the end. (Remember, they both averaged an 8% rate of return over the 25-year period.) Which account ends up with more money? Most people think that Account (A), which had good returns in the beginning, would end up with the most money. The answer is they end up with exactly the same ending balance (see graphic below):


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However, what if this investor was retired and taking withdrawals from the portfolio to supplement his/her retirement income? Would the account still have the same ending balance after 25 years of withdrawals? The answer is a big NO!

The account that had good years early (A) may have much more than it started with, even after 25 years of distributions. The account with the poor years in the beginning (B) may have been totally depleted. Look at what happens to our previous results for the two accounts (using the same returns) when we incorporate a 5% initial withdrawal rate and increase our withdrawal by 3% each year for inflation. Can you say “disaster”?


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Financial advisors have studied this problem for a long time. The challenge is you cannot predict or control the “sequence of returns.” The one thing retirees can control is how much they withdraw each year.

William Bengen became a bit of a celebrity in financial planning circles after publishing his landmark study in 1994 that became known as the 4% rule. He found that a balanced portfolio (60% stocks/40% bonds) coupled with a 4% initial withdrawal rate, adjusted for inflation each year, would have supported every 30-year period in history. This means that if you have $1 million, you can withdraw $40,000 the first year, $41,200 in year 2, and so on for 30 years without depleting the account. The 4% withdrawal rate worked even if you began retirement during the Great Depression. Most historical 30-year retirement periods (in retrospect) would have supported a higher withdrawal rate, some as high as 8 or 9%. This means that your portfolio value would grow considerably if you had decent market returns and stuck with the original 4% inflation-adjusted withdrawals. In fact, a retiree would have ended up with the same or more than his or her original starting principal in 103 of the 115 rolling 30-year time periods from 1871 to present, after a lifetime of inflation-adjusted spending (starting at a 4% initial withdrawal rate).

Numerous offshoots of the 4% rule have been proposed with the goal of determining what factors would allow us to start retirement safely with a higher withdrawal rate. The options include using a shorter retirement time horizon, using decision rules that govern the rebalancing rules of the investment portfolio, and dynamic withdrawal strategies that increase or decrease the withdrawal based on the account balance.

Let’s face it, “Just withdraw less money” is a lazy answer and unsatisfying solution. It’s like asking for dieting advice and getting, “Just consume fewer calories.” Technically, it may be good advice, but we try to provide a bit more insight in this column. On that note, further insights on this topic are coming in next week’s post, which will be entitled: Investing for Retirement Income.

Until then…have a great week!
 

Jeremy A. Kisner, CFP®, CPWA® is a Senior Wealth Advisor at Surevest Wealth Management and author of book: A Good Financial Adviser Will Tell You.
Weekly Insight: The Sustainable Withdrawal Rate was published: by
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