Sustainable Withdrawal Rates for New Retirees in 2015

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over 4% of their retirement date assets and sustain this spending level over 30 years. That was the worstcase scenario from the U.S. historical record. Naturally, Bengen could use many simplifying assumptions in his research, since his aim was to show how sequence risk should temper client expectations downward from loftier numbers like 7%. But the idea of the 4% rule took hold in the popular consciousness for advisors and consumers alike. // THE 4% RULE IS OVER-SIMPLIFIED FOR RESEARCH PURPOSES, AND MAY NOT REFLECT REALITY. The 4% rule is really just meant to be a simplification for research purposes which should be separated from real-world practice. It includes a number of overly simplified assumptions which do not reflect reality: // International market data suggests there is no reason to believe that the U.S. experience can provide confidence about what is a true worst-case scenario. // The low interest rate and high stock market valuation levels facing today’s retirees are extremely rare in the U.S. historical record, lending further credence to the previous point. // Real world investors must unavoidably pay investment management fees which can be expected to lower their net returns. // As longevity continues to improve, 30 years is no longer a conservative planning horizon for 65-year old couples working with financial advisory firms. After explaining more about how these previous points impact sustainable spending rates, we use Monte Carlo simulations to estimate sustainable spending rates for retirements beginning in January 2015. In doing so, this article draws from elements from my previously published research articles in order to create a more comprehensive and consolidated analysis of sustainable retirement spending rates. It is the first to include fees for both financial advice and fund management, while also incorporating the heightened sequence of returns risk facing retirees in the current low-yield world and the reality that 30 years is increasingly not a conservative planning horizon for 65 year olds. The simulations will reflect the current market environment at the start of retirement, while also providing mechanisms for market returns to gravitate, on average, toward their historical averages over the retirement horizon. This is also a more realistic approach to Monte Carlo simulations, which moves beyond the capabilities of most commercially available financial planning software packages. These simulations will include realistic fees to cover the expenses related to working with a financial advisor and to pay underlying mutual fund expenses, and we also show the differences in sustainable spending rates over 30 and 40 year horizons. As a preview of the findings, we estimate that a 40% stock allocation and a 30-year planning horizon would support a 2.1% sustainable initial spending rate, provided one is willing to accept a 10% chance for failure [with a volatile investment portfolio, there is no such thing as a guaranteed spending rate]. Extending the horizon to 40 years, with the same asset allocation and acceptable failure probability, drops the sustainable spending rate to 1.49%. A more realistic assessment of sustainable spending from a volatile investment portfolio does suggest that the 4% rule-of-thumb for retirement spending is considerably more risky than many realize. These numbers may seem low, and it is true that there is still upside potential for these strategies to end up doing better with the investments in the volatile portfolio, but this is the reality for clients self-managing market and longevity risks, paying fees, and entering retirement in the current market environment. Bengen’s historical simulations do not fully reflect the risks currently associated with the strategy. 5 FOR FINANCIAL PROFESSIONAL USE ONLY - NOT FOR USE WITH THE GENERAL PUBLIC
OUR LIMITED HISTORICAL EXPERIENCE The U.S. historical experience does not provide Table 1 summarizes the international experience a broad enough set of potential outcomes to be on the topic of “safe withdrawal rates.” The table confident about 4% as a worst-case spending rate. provides historical success rates for the 4% rule using This time period is when the U.S. grew to become the financial market data for 20 countries since 1900. world’s leading superpower, and it is not pessimistic Results can vary when using different datasets and to consider that future financial market outcomes asset allocations. In this case, with a fixed allocation might become more muted and more aligned with of 60% stocks and 40% bonds, the 4% rule worked the past international experience. The 4% rule has in 95% of the rolling historical periods with the U.S. not worked nearly as well in most other developed data. Success rates were also over 90% for the local market countries for which we have sufficient stock and bonds data in Canada, Denmark, New financial market data to create such a test (Pfau, Zealand, and South Africa. In the other 15 countries, 2010). While it seems reasonable to focus on U.S. results varied dramatically. The historical success historical data, who is to say whether the future rates for the 4% rule were as low as 28% for Italy, experience of American retirees will be similar to our 41% for France, and 46% for Belgium and Germany. past or whether it will be more reflective of situations This is an important point for advisors to reflect upon experienced in other countries? when advising clients on sustainable spending rates from volatile investment portfolios. // TABLE 1: INTERNATIONAL 1: SUCCESS SUCCESS RATES FOR RATES THE 4% RULE FOR THE 4% RULE For a 60/40 Asset Allocation to Stocks & Bonds For a 60/40 Asset Allocation to Stocks & Bonds ITALY FRANCE GERMANY BELGIUM NORWAY 28% 41% 46% 46% 49% AUSTRIA SPAIN FINLAND JAPAN IRELAND 55% 56% 61% 64% 64% SWITZERLAND NETHERLANDS UNITED KINGDOM SWEDEN AUSTRALIA 74% 76% 78% 84% 87% SOUTH AFRICA DENMARK UNITED STATES NEW ZEALAND CANADA 94% 95% 95% 96% 99% NOTE: Note: Assumptions Assumptions include a 30-year include retirement a 30-year duration, no retirement administrative fees, duration, constant inflation-adjusted no administrative withdrawal amounts, fees, and constant annual rebalancing. inflation-adjusted withdrawal Source: Own calculations amounts, from Dimson, and annual Marsh, and rebalancing.SOURCE: Staunton (1900 - 2013) Global Returns Own Data. calculations from Dimson, Marsh, and Staunton (1900 - 2013) Global Returns Data. FOR FINANCIAL PROFESSIONAL USE ONLY - NOT FOR USE WITH THE GENERAL PUBLIC 6
Page 1 and 2: Sustainable Withdrawal Rates for Ne
Page 3: INTRODUCTION Retirement income plan
Page 7 and 8: Table 2 demonstrates how today’s
Page 9 and 10: SIMULATING SUSTAINABLE SPENDING RAT
Page 11 and 12: CONCLUSION The dual impacts of sequ
Page 13 and 14: With the correlated error terms, in

Sustainable Withdrawal Rates for New Retirees in 2015

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