Safe Withdrawal Rates
November 8, 2011
We are excited to announce that Wade Pfau has agreed to write a monthly column for Advisor Perspectives covering key developments in research surrounding safe withdrawal rates. His first article will appear in next week. In the meantime, here is a never-before-published article he originally wrote last December. It summarizes his research article from the December 2010 Journal of Financial Planning.
Prospective retirees must consider whether they are comfortable basing retirement decisions on the impressive but perhaps anomalous numbers found in historical US data. What has been safe for US retirees in the past has been far less secure for their foreign counterparts.
Conventional wisdom states that, when it comes to retirement planning, the 4% “safe withdrawal rate” (SWR) rule is the platinum standard. That rule, dating back to William Bengen’s 1994 article in Journal of Financial Planning, says that a new retiree can safely withdraw 4% of their savings in the first year of retirement and adjust this amount for inflation in subsequent years. Bengen found that this strategy is safe in the sense that the strategy will not lead the retiree to exhaust all of his or her remaining assets for at least 30 years.
The 4% rule has been widely adopted by the popular press and financial planners as an appropriate general rule of thumb for retirees. Since Bengen’s paper, numerous researchers have developed strategies to allow retirees to safely exceed a 4% withdrawal rate. Though the SWR fluctuates a bit from study to study, depending on the dataset and assumptions used for its calculation, my own research suggests a safe withdrawal rate for the US of 4.02%. That was the highest amount that could be sustained in the worst-case retirement year. I find that using the Dimson, Marsh, Staunton Global Returns Data for 17 developed market countries since 1900.
The problem with SWR research based on historical data, however, is that most every study has been based on the same Ibbotson Associates dataset on US financial market returns since 1926. The time period covered by such data may have been a particularly fortuitous one for the United States that will produce dangerously overinflated SWRs if asset returns fail to be so stunning in the future.
Indeed, over the time period in question the US consistently enjoyed among the highest inflation-adjusted returns and lowest volatilities for stocks, bonds, bills and inflation. For stocks, only three countries enjoyed higher returns, and the only four countries experienced less volatility in stock returns. This combination of high returns and low volatility is remarkable for the US and helps to support higher withdrawal rates. The story is similar for bonds, bills, and inflation as well. For bonds, only three countries enjoyed higher real returns, and only two countries enjoyed less volatility for those returns. Only two countries experienced lower average inflation than the 2.98% we enjoyed in the US.
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