It’s an age-old question.
How much can I withdraw from my portfolio each year and not run out of money?
For almost three decades, the typical answer was “four percent,” the resulting rule of thumb from Bill Bengen’s 1990s research.
But there’s been a slight disturbance in the force of late on the withdrawal rate front.
A New Hope?
The so-called inventor of the 4% rule, Bengen has been back in the news suggesting he now believes a sustainable withdrawal rate to be 4.5%, based on updates to his model.
For some retirees, this might seem like cause for rejoicing. More money to live on with better assurance their nest egg won’t run out? Yes, please.
But others, like those whose greatest fear is running out of money, might eye the revised figure with suspicion.
What’s the real story? Does Bengen’s new rule of thumb change the game for retirees wanting to make the most of their savings?
A Dynamic Approach
We’ve long advised clients a safe withdrawal rate is closer to 5%.
While it may seem we’re splitting hairs here—4%, 4.5%, 5%—a higher withdrawal rate could mean the difference between living watchful of every dollar spent and living not only with confidence a nest egg will last but with a real sense of financial flexibility and independence.
Let’s say, for example, you have a $2M portfolio and plan to withdraw 4% each year, adjusted for inflation annually to maintain purchasing power. In the first year, you’d withdraw $80,000; in the second year, $82,400, and so on. Over 30 years, the sum total of annual withdrawals would exceed $3.8 million.
Applying a 5% withdrawal rate to the same $2M portfolio would mean a first-year withdrawal of $100,000, with annual inflation adjustments after that. Over 30 years, annual withdrawals would total more than $4.75 million—nearly $1,000,000 more than under the 4% withdrawal method.
What accounts for the small but significant differences in safe retirement withdrawal rates between the Bengen and Vista approaches?
It boils down to two primary factors.
Static vs. Dynamic Approach
When Bengen introduced his research in 1994, he sought 100% certainty his withdrawal rate would maintain a nest egg across 30 years.
Perhaps influenced by the prior 30-year period which included a long bear market for U.S. stocks, as well as crushing inflation, Bengen sought the level of spending that would allow a portfolio to survive even that “worst case” scenario.
While historical data proved a static 4% withdrawal rate never resulted in portfolio depletion, it often left money on the table at the end of the 30-year period. In other words, investors could have spent more. The 4% rule prioritized certainty over maximum total spending.
Vista’s approach seeks to prioritize maximizing lifetime spending while still providing confidence a portfolio will last. We’ve found the question most retirees ask is, How much can I withdraw from a portfolio without facing undue risk of running out of money?
Provided retirees are flexible, a withdrawal rate of 5% is often the answer. Flexibility means an ability to either spend less, or willingness to suspend annual inflation adjustments, should that worst-case scenario—low returns, high inflation—occur early in retirement.
Our experience guiding retirees through challenging bear markets suggests most investors are flexible. During the tech crash of the early 2000s and 2008/2009 financial crisis, many clients expressed a desire to lower their withdrawals, even though our analysis indicated such cutbacks were rarely required.
After all, their portfolios had been designed from the outset with difficult times in mind.
When Bengen first established the 4% rule, he tested it against a 50/50 stock/bond portfolio comprised of the S&P 500 Index and U.S. Treasury bonds. Years later, he added small cap stocks to the mix and found a 4.5% withdrawal rate would have worked.
Since we opened our doors in 2001, the typical Vista portfolio not only has included large cap stocks and small cap stocks, but also international and emerging market stocks, as well as real estate investment trusts.
Just as in Bengen’s study, U.S. Treasuries anchor the bond side of our portfolios. But in addition to Treasury bonds, we invest in high-quality diversifiers such as Treasury inflation-protected bonds and international government bonds—each of which was not readily investable when Bengen published his analysis.
In other words, the more broadly diversified portfolios we build for clients would have resulted in better outcomes for retirees than the simple portfolio mix to which Bengen applied his 4% rule.
A Nest Egg That Lasts
Determining retirement withdrawal rates is a complex process in which optimal decisions require consideration of several unknowns, such as future investment returns, the sequence of those returns, actual inflation, and a retiree’s projected life span.
Add to that an individual investor’s willingness to assume stock market risk, planned future portfolio injections (sale of a business, downsizing a home, or start of social security), and any legacy and philanthropic goals, and you can see there’s no “one-size-fits-all” solution to determining the “right” withdrawal rate.
Vista’s work is all about understanding your unique circumstances and translating your goals into clear and candid advice designed to sustain your nest egg for the duration of your retirement.
Our approach is all about making things easy to understand, implement, and maintain—and flexible enough to maximize lifetime income.