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What’s A Sustainable Portfolio Withdrawal Rate?

  • There is no single answer to the question, “How much income can my retirement portfolio provide?”, but history might provide some context for setting reasonable targets for most retirees and investors.
  • When we analyze a wide range of rolling 30-periods back to 1926, including very negative market environments, we find that a 4% withdrawal rate (generally accepted as a decent “rule of thumb” in financial planning) runs a very low risk of depleting a retiree’s portfolio assets, except in periods of unusually high inflation.
  • Investors should be wary of ignoring a second major component of their retirement sustainability – inflation, or the growth of their cost of living.
  • High inflation has a major impact on the sustainability of a retirement portfolio, in some cases equal to or greater than the impact of the initial withdrawal rate.
  • Investors facing retirement would also be well served to look beyond a purely income-based approach to providing cash flow in retirement, and build a diversified portfolio designed to generate a “total return,” including both capital growth and income, to keep pace with spending and inflation.

Introduction

In contemplating retirement, perhaps the most important question investors wrestle with is how much money they can afford to draw from their retirement nest egg. What withdrawal rate is sustainable, without knowing how long that spending may need to be maintained? No retiree wants to exhaust his savings while he is still alive, and many aspire to leave a legacy to their children, grandchildren, or to worthy causes. Financial planners call this longevity risk, and as life expectancies rise, it’s a growing problem for many individuals and families as they chart their financial futures. In this paper, we will discuss withdrawal rates, along with the related issue of how portfolios may be designed to generate annual income – differentiating between the investor’s need for cash flow and the yield an investment generates.

An appropriate (that is, reasonably sustainable) withdrawal rate will obviously differ based on a number of variables – someone who is 65 years old may plan for a retirement of 30 years or more, and need to be more conservative in her spending than a retiree who is already in her 80s. In addition to disparities in the personal needs of specific individuals, in discussing the withdrawals a portfolio can maintain we must also account for the vagaries of the markets – no years, or decades, are identical. While a “bull” market with multiple years of high returns might allow for a high level of spending with little risk of depleting a portfolio, we believe that a more conservative approach, which accounts for the inherent risk of retiring into a down market, is far more reasonable. While determining a single “correct” withdrawal rate is not possible without being able to predict the future, in this paper we will apply historical data and a range of possible scenarios to a simulated “balanced” portfolio to try to determine what an investor might use as a starting point.

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Gerstein Fisher
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