sustainable withdrawal rates
TRANSCRIPT
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Sustainable Withdrawal Rates &
“The 4% Rule”
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In the beginning… (1994)Peter Lynch, the Law of Averages and Sequencing
Source: Moshe A. Milevsky, “Retirement Ruin & the Sequencing of Returns” http://www.ifid.ca/pdf_newsletters/pfa_2006feb_sequencing.pdf February 2006
Looking Back… (1994)Portfolio Sustainability Given Various Withdrawal Rates
1926
1928
1930
1932
1934
1936
1938
1940
1942
1944
1946
1948
1950
1952
1954
1956
1958
1960
1962
1964
1966
1968
1970
1972
1974
1976
05
101520253035404550
5%
50/50 Allocation, year end portfolio withdrawals beginning from 1926-1976
5% 4% 3%
Source: William P. Bengen, “Determining Withdrawal Rates Using Historical Data” http://www.retailinvestor.org/pdf/Bengen1.pdf Oct 1994
Looking Back… (1994)Portfolio Sustainability Given Various Withdrawal Rates& Equities Allocations
1% 2% 3% 4% 5% 6% 7% 8%05
101520253035404550
50
36
2117
1412 12
8
50 50
39
23
1814
1210
50 50 50
34
20
1512
10
50 50 50
32
19
1310
8
50 50 50
24
1613
8 7
Variable equities Allocations & withdrawal rates, minimum portfolio duration from 1926-1976
0% 25% 50% 75% 100%
Source: William P. Bengen, “Determining Withdrawal Rates Using Historical Data” http://www.retailinvestor.org/pdf/Bengen1.pdf Oct 1994
Safe Withdrawal Rates w/ Allocation Shifts (1996)(63% Stocks originally, reduced annually as follows)
None 0.50% 1% 1.50% 2% 2.50% 3%
4.14% 4.11% 4.08% 4.05%3.81%
3.55%3.29%
Annual Stock Phase-Down
1.5% 8.0% 20.5%
Source: William P. Bengen, “Asset Allocation For a Lifetime” http://www.simonemariotti.com/downloads/Papers%20finanziari/Bengen%2096.pdf Aug 1996
Determining a Starting Allocation (1996)
Source: William P. Bengen, “Asset Allocation For a Lifetime” http://www.simonemariotti.com/downloads/Papers%20finanziari/Bengen%2096.pdf Aug 1996
The Power Of DiversificationThe effect of small cap stocks on probability of success
4.25% 4.50% 4.75% 5.00% 5.25% 5.50% 5.75% 6.00% 6.25% 6.50%
92%88%
78%71%
57% 55%49%
41%37% 35%
100%96%
92% 90%82%
75%71%
61%53%
49%
(63% Stock, 37% Bonds, 1% Phase-Down, 30-Year Periods)
0% Small Cap 30% Small Cap
The addition of this second “asset class” increases the sustainable withdrawal rate to 4.3%
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The Power Of Diversification?The 4% Rule in Other Countries
Lowest Safe Withdrawal
RateUnited States 4.15%Canada 3.66%United Kingdom 3.05%Germany 0.84%France 0.93%Japan 0.25%
Source: Wade Pfau “Does International Diversification Improve Withdrawal Rates?” http://www.advisorperspectives.com/newsletters14/Does_International_Diversification_Improve_Safe_Withdrawal_Rates.php March 2014
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Diversified PortfoliosTEIC Model Portfolios – Historical Results
Mapping Out Probability of Failure
12%
11%
10% 0-5%
9% 5-20%
8% 20-50%
7% 50-80%
6% 80-95%
5% 95-100%
4%
3%
50 45 40 35 30 25 20 15 10
Initial withdrawa
l rate
Time Horizon
P(Failure)
The Pitfalls of Valuation…
It is possible to use dynamic allocation rules to bypass valuation concerns, but with the caveat that “markets can remain irrational longer than you can remain solvent”
The Pitfalls of Valuation… and Fees!
It goes without saying that fee reduction should be a major priority for retirees!
A Simple Model for Generating Expected Returns
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The Building Blocks for Equity Return Forecasts
Source: Bloomberg * Data as of February 18th, 2015
Beginning Dividend Yield*
10-YEAR Implied
Inflation*Real GDP Growth
Expected Return
Expected Real
Return
Canadian Equities 2.78% 1.72% 2.21% 6.71% 4.99%
US Equities 1.94% 1.67% 1.94% 5.55% 3.88%
International Equities 3.18% 1.37% 1.23% 5.78% 4.41%
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Cash & Fixed Income Forecasts
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Our Expected Returns from a Historical Perspective
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This tool is available at: http://www.flexibleretirementplanner.com/wp/
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Model Assumptions
Monte Carlo simulations assume returns are normally distributed.Inflation variations are not tied to portfolio performance.Model assumes gains in taxable account are not deferred (i.e. 100% annual turnover).Withdrawals first come from taxable account, then the RRSP, then the TFSA.Required Minimum Withdrawals as determined by the IRS at Age 70.Any model has “model risk” (GIGO). Continuous updates required based on changing market environments.
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Crunching the Numbers…For a 30 year retirement horizon, a client would have the following probability of success for a given asset allocation / withdrawal rate
Rate Con. Balanced BalancedGrowth
Balanced3% 80% 87% 89%4% 34% 49% 57%5% 8% 16% 23%6% 1% 4% 7%
This analysis readily demonstrates that in a lower return environment, it is essential to counsel clients about the risks inherent in excessive withdrawals!
Annual Withdrawal AdjustmentsCPI vs. Floor & Ceiling Rules
4.25% 4.50% 4.75% 5.00% 5.25% 5.50% 5.75% 6.00% 6.25% 6.50%
92%88%
78%71%
57% 55%49%
41%37% 35%
100% 100%95%
91%
80% 77%
67%63%
59%55%
(63% Stock, 37% Bonds, 1% Phase-Down, 30-Year Periods)
CPI Floor & Ceiling
The addition of a set of simple “spending rules” can increase the sustainable withdrawal rate as high as 5.3%
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Crunching the Numbers…For a 30 year retirement horizon, a client would have the following probability of success for a given asset allocation / withdrawal rate
Rate Con. Balanced BalancedGrowth
Balanced3% 95% 97% 97%4% 62% 73% 78%5% 21% 34% 42%6% 3% 9% 14%
Rate Con. Balanced BalancedGrowth
Balanced3% 80% 87% 89%4% 34% 49% 57%5% 8% 16% 23%6% 1% 4% 7%
Conservative Spending Policy (no COLA, down to max of 75% of Original Spending Rate)
Mapping Out Probability of Failure(With an asset allocation overlay)
Allocation to Stocks (x)
Time Horizon
(y)
10% P(Failure) 25% P(Failure)
40 2.5% 2.8% 2.9% 2.8% 2.8% 2.8%
35 2.9% 3.1% 3.1% 3.1% 3.1% 3.0%
30 3.3% 3.5% 3.5% 3.4% 3.4% 3.3%
25 3.8% 4.1% 4.1% 3.9% 4.0% 3.7%
20 4.6% 4.9% 4.8% 4.6% 4.7% 4.6%
0 20 40 60 80 100
40 2.8% 3.1% 3.2% 3.3% 3.4% 3.5%
35 3.2% 3.4% 3.5% 3.6% 3.7% 3.7%
30 3.6% 3.8% 4.0% 4.0% 4.1% 4.0%
25 4.2% 4.4% 4.5% 4.5% 4.7% 4.5%
20 5.0% 5.3% 5.3% 5.3% 5.4% 5.3%
0 20 40 60 80 100
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Crunching the Numbers…For a 30 year retirement horizon, a client would have the following probability of success for a given asset allocation / withdrawal rate
Rate Con. Balanced BalancedGrowth
Balanced3% 97% 98% 97%4% 69% 82% 73%5% 27% 44% 34%6% 6% 13% 9%
Rate Con. Balanced BalancedGrowth
Balanced3% 80% 87% 89%4% 34% 49% 57%5% 8% 16% 23%6% 1% 4% 7%
Better Returns After Initial Decade, Conservative Spending Policy (no COLA, down to max of 75% of Original Spending Rate)
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Crunching the Numbers…For a 30 year retirement horizon, a client would have the following probability of success for a given asset allocation / withdrawal rate
Rate Con. Balanced BalancedGrowth
Balanced3% 95% 97% 97%4% 62% 73% 78%5% 21% 34% 42%6% 3% 9% 14%
Conservative Spending Policy (no COLA, down to max of 75% of Original Spending Rate)
Rate BalancedGrowth
Balanced3% 96% 96%4% 69% 69%5% 28% 31%6% 6% 8%
Conservative Spending Policy and Moving to Conservative Balanced Portfolio at Age 76
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Summary There is no static spending rule – sustainable
income in retirement is specific to each client and time-frame.
True risk is outliving assets, not periodic volatility.
Shorter time horizons favour bonds and cash (a Conservative Balanced Model) while normal or longer time horizons favour equities (Balanced or Growth Balanced models)
In most cases, maintaining a 60/40 portfolio throughout retirement is better than aggressively shifting to more conservative asset allocations.
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Further Reading“20 Years of Withdrawal Rate Research” The Kitces Reporthttp://www.aicpa.org/interestareas/personalfinancialplanning/resources/retirementplanning/downloadabledocuments/kitcesreport-march2012.pdf
“A More Dynamic Approach to Spending for Investors in Retirement” Vanguard Researchhttps://pressroom.vanguard.com/content/nonindexed/2013.10.23_A_more_dynamic_approach_to_spending.pdf
“The Only Spending Rule Article You Will Ever Need” Waring & Siegalhttps://larrysiegeldotorg.files.wordpress.com/2014/09/siegel_waring_only-spending-rule-article-youll-ever-need.pdf