What's A Sustainable Withdrawal Rate For A Retirement Portfolio?

by: Gerstein Fisher
Summary

When we analyze rolling 30-year periods back to 1926, we find that a 4% withdrawal rate runs a low risk of depleting a retiree's portfolio.

Inflation has a significant impact on the sustainability of a retirement portfolio.

We prefer a total return over an income-oriented approach to generate cash flow from a retirement portfolio.

When saving and investing for retirement, perhaps the most important questions are two related ones: how large a nest egg is required and what’s a sustainable portfolio withdrawal rate during your golden years. The difficulty of such questions is brought into relief by some current market trends—inflation is creeping up; volatility has returned to equity markets, which have relatively low expected returns due to high valuations; interest rates are rising, and bond returns this year are negative (the Bloomberg Barclays Aggregate Bond Index declined 2.5% year-to-date to April 26). Adding longevity risk—people are living longer—to the mix makes the retirement portfolio equation even harder to solve.

With these elements in mind, we decided to conduct research on the perennial question of what’s a sustainable portfolio withdrawal rate. We analyzed all 63 30-year rolling period from 1926 to 2017, assumed a 50/50 portfolio (50% stocks, as measured by the S&P 500 Index, 40% US bonds*, 10% cash), and tested withdrawal rates ranging from 3% to 7%.

The Intersection of Withdrawal and Inflation

Here’s the methodology we used: we assume the investor retires with a $1 million portfolio and seeks to fund living expenses for 30 years (e.g., from age 65 to 95). He withdraws a percentage of the initial portfolio every year and adjusts the amount each year according to inflation. For example, with a 4% withdrawal and inflation-rate scenario, the retiree would withdraw $40,000 from the nest egg the first year, $41,600 the second year, $43,264 the third year, and so on. Exhibit 1 provides some indication of how much even a one percentage point increase in the cost of living can impact a portfolio at different rates of withdrawal.

Total Withdrawals from $1M Portfolio Over 30 Years

When surveying all 30-year periods, we can see that starting years make a big difference—which underscores the importance of prudent, conservative planning. The 50/50 portfolio averaged an annualized return of 8% to 9% but varied from just 6% to nearly double that rate of return. Exhibit 2 compares three 30-year periods and assumes a 4% withdrawal rate and 3% inflation. As you can see, the portfolio is depleted for the period commencing in 1929, on the eve of the Great Depression, despite the modest assumptions for inflation and withdrawal rates, while retirees fortunate enough to start drawing from their nest egg in 1975 saw their portfolio values multiply in 30 years of retirement.

*40% bond portfolio consists of 20% 5-Year Treasury Notes and 20% Long-Term Government Bond Index (Source: Morningstar)

Portfolio Values Over Time

Let’s now consider how a wide range of withdrawal and inflation rates would have fared during all 30-year periods over the past 90 years. As demonstrated in Exhibit 3, a 3% withdrawal rate was sustainable in nearly every period, even with elevated inflation. A 4% withdrawal rate, often cited as a benchmark in financial planning, was successful except in cases where inflation creeps above 5%. Withdrawal rates of 5% or higher appear to be fundamentally risky, even when inflation is a fairly modest 4%.

Ratio of Failed Scenarios Across Withdrawal and Inflation Rates

Obviously, there is no magic number that is right for everyone; an appropriate withdrawal rate depends on numerous factors such as size of portfolio and an individual’s age, lifestyle, spending and health. I have related above some of the results from our extensive research. I invite you to review our full study (https://gersteinfisher.com/gf_article/whats-a-sustainable-portfolio-withdrawal-rate/), in which we also take up the important question of how to invest the retirement portfolio and generate enough income to meet monthly withdrawals (hint: we much prefer a total return approach vs. a focus on interest and dividend income and particularly eschew reaching for yield in this low interest-rate environment).

Conclusion

Determining the appropriate withdrawal rate from a portfolio to cover living expenses in retirement is a crucial but challenging exercise. Our research points to 4% as being a reasonable starting point, though actual inflation rates and individual-specific issues could alter the equation.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Disclosure
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Gerstein Fisher), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from Gerstein Fisher. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Gerstein Fisher is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of the Gerstein Fisher current written disclosure statement discussing our advisory services and fees is available for review upon request.
G Gerstein Fisher, is a division of People’s United Advisors, Inc., a registered investment adviser. People’s United Advisors, Inc. is a wholly-owned subsidiary of People’s United Bank, N.A.

Investment products and services are:
• Not insured by the FDIC or any other government agency
• Not deposits or other obligations of, or guaranteed by, People’s United Bank, N.A.
• Subject to investment risks, including possible loss of principal.