Safe Withdrawal Rates

From Bogleheads

1 Safe Withdrawal Rate
2 Studies and papers:
- 2.1 Trinity Study:
- 2.2 Papers
3 Tools/Calculators:
4 Links/further study:
5 Additional Papers
6 See also
7 References:

Safe Withdrawal Rate

Defined: The quantity of money, expressed as a percentage of the initial investment, which can be withdrawn per year for a given quantity of time, including adjustments for inflation, and not lead to portfolio failure; failure being defined as a 95% probability of depletion to zero at any time within the specified period.

Usage: Typically, SWR is utilized as an approximation of the probability that a given portfolio can support a given annual spending component for a required period, with a reasonable confidence. To do this, variables such as the allocation of assets within a model portfolio, the beginning balance, and/or the number of years expected in retirement are varied, a model is applied, and results of these alterations in the variables are observed and compared, in order to optimize for the maximum.

Controversy: Unfortunately, the term "Safe Withdrawal Rate" is necessarily an ambiguous term. This is because initial methods utilized historical data to statically determine what would have been safe given the actual results that past portfolios would have generated with the variables given. The next logical step, of course, was to use that information to predict future SWRs. Either use is technically correct, but one should always be sure to be clear whether the use is in reference to past or projected SWRs, so that unnecessary argument can be prevented.

Studies and papers:

Figure 1: Trinity Study portfolio success rates, 1926-1995

Figure 2: Trinity Study portfolio success rates, 1946-1995

Figure 3: Trinity Study portfolio success rates, 1926-1995, adjusted for inflation and deflation

Trinity Study:

In what has become known as the Trinity Study, three professors from Trinity University in San Antonio, Texas, Philip Cooley, Carl Hubbard, and Daniel Walz, studied actual historical stock and bond returns from 1926 through 1995 to determine sustainable withdrawal rates. The study was published in the February 1998 issue of the Association of American Individual Investors (AAII) Journal in an article entitled * "Retirement Savings: Choosing a Withdrawal Rate That Is Sustainable." The study has gained renewed significance in light of recent turbulent economy.

Using all of the historical data, the professors looked at five possible portfolio compositions, from 100 percent stocks to 100 percent bonds - the three other portfolios were: 75 percent stocks/25 percent bonds, 50/50 stocks and bonds, and 25/75 stocks and bonds - and evaluated the impact of fixed annual withdrawals ranging from three percent to twelve percent. Stocks were represented by the S&P 500, while long-term high grade domestic bonds were used for the bond portfolios.

Payout periods were in five-year intervals, from 15 to 30 years. In the study, the professors considered a portfolio successful if it ended a particular withdrawal period with a positive (non-zero, non-negative) value.

The study produced a number of conclusions, including:

Withdrawal periods longer than 15 years dramatically reduced the probability of success at withdrawal rates exceeding five percent.

Bonds increase the success rate for lower to mid level withdrawal rates, but most retirees would benefit with at least a 50 percent allocation to stocks.

Retirees who desire inflation-adjusted withdrawals must anticipate a substantially reduced withdrawal rate from the initial portfolio.

Stock-dominated portfolios using a 3 to 4 percent withdrawal rate may create rich heirs at the expense of the retiree's current standard of living.

For a payout of 15 years or less, a withdrawal rate of 8 to 9 percent from a stock-dominated portfolio appears sustainable.[1] [2]

The Trinity Study numbers

Figure 1 shows the success rate of various portfolios for different time periods measured against the full time span of the studied data, 1926-1995.
Figure 2 shows the success rate of various portfolios for different time periods measured against the post-World War II markets, 1946-1995.
Figure 3 shows the success rate of various portfolios for different time periods measured against the full time span of the studied data, 1926-1995. However, unlike Figure 1 which covers the same time period, this data is adjusted for inflation & deflation.

Papers

Oct 1994

Determining Withdrawal Rates Using Historical Data by William P. Bengen

The paper

"...employs graphical interpretations of the data to determine the maximum safe withdrawal rate (as a percentage of initial portfolio value), and establishes a range of stock and bond asset allocations that is optimal for virtually all retirement portfolios..."

Original article

November 2000

Making the Money Last Maximum Safe Withdrawal Rates http://www.fa-mag.com/past_issues.php?idArticle=127&idPastIssue=42

March 1998

John Greaney What's the "safe" withdrawal rate in retirement ? http://www.retireearlyhomepage.com/safewith.html

June 2000

The Retire Early study on safe withdrawal rates. The Retire Early website recently conducted a similar study to Trinity using an alternative database spanning the years 1871 through 1998. It generally confirms the Trinity Study results.[2] http://www.retireearlyhomepage.com/restud1.html

1998 - 2001

William J. Bernstein

The Retirement Calculator From Hell http://www.efficientfrontier.com/ef/998/hell.htm

The Retirement Calculator From Hell - Part II http://www.efficientfrontier.com/ef/101/hell101.htm

The Retirement Calculator from Hell, Part III: Eat, Drink, and Be Merry http://www.efficientfrontier.com/ef/901/hell3.htm

November 2006

Geoff Considine Seeking Alpha Safe Portfolio Withdrawal Rates: Beyond The 4% Solution http://seekingalpha.com/article/21334-safe-portfolio-withdrawal-rates-beyond-the-4-solution

January 2007

Jonathan Clements How to Survive Retirement -- Even if You Are Short on Savings

(Quoting Bernstein:) "Two percent is bullet-proof, 3% is probably safe, 4% is pushing it and, at 5%, you're eating Alpo in your old age," reckons William Bernstein, an investment adviser in North Bend, Ore. "If you take out 5% and you live into your 90s, there's a 50% chance you will run out of money."
(Clements said:) "[Using a two-act retirement plan] if you're short on savings... will give you a fair amount of income, your heirs will inherit a decent sum if you die before age 85 and, if you live longer than that, you should be comfortable enough."

Aug 2007

Scott Burns Will the real safe withdrawal rate please stand up? http://assetbuilder.com/blogs/scott_burns/archive/2007/08/29/will-the-real-safe-withdrawal-rate-please-stand-up.aspx

Oct 2007

Scott Burns Why We’re All Confused about “Safe” Withdrawal Rates http://assetbuilder.com/blogs/scott_burns/archive/2007/10/10/why-we-re-all-confused-about-safe-withdrawal-rates.aspx

Oct 2007

John J. Spitzer, Ph.D., Jeffrey C. Strieter, Ph.D., and Sandeep Singh, Ph.D., CFA, An article in the October 2007 issue of the Journal of Financial Planning, published monthly by the Financial Planning Association® (FPA®)

provides a more robust calculation of “safe” withdrawal rates for retirement and provides a graphic method for better understanding the interrelationship among withdrawal strategies, risk tolerance, and asset allocation.

April 2008

Jason S. Scott, William Sharpe, and John G.Watson

The 4% rule is the advice most often given to retirees for managing spending and investing. This rule and its variants finance a constant, non-volatile spending plan using a risky, volatile investment strategy. As a result, retirees accumulate unspent surpluses when markets outperform and face spending shortfalls when markets underperform. The previous work on this subject has focused on the probability of short falls and optimal portfolio mixes. We will focus on the rule’s inefficiencies—the price paid for funding its unspent surpluses and the overpayments made to purchase its spending policy. We show that a typical rule allocates 10%-20% of a retiree’s initial wealth to surpluses and an additional 2%-4% to overpayments. Further, we argue that even if retirees were to recoup these costs, the 4% rule’s spending plan often remains wasteful, since many retirees may actually prefer a different, cheaper spending plan.

Available at http://www.stanford.edu/~wfsharpe/retecon/4percent.pdf

May 2008

David Aston MoneySense magazine Retirement: A number you can live with

If history is any guide, a 4% withdrawal rate means your portfolio will be able to withstand a market meltdown of the worst magnitude we’ve experienced in the last 80 years as well as support you for an exceptionally long life. William Bengen, a U.S. researcher, has back-tested a 4% withdrawal rate with a balanced portfolio of U.S. stocks and government bonds earning overall market returns and found that you would have been able to safely withdraw 4% of your portfolio over any 30-year period since 1926.

http://www.canadianbusiness.com/my_money/planning/article.jsp?content=20080521_144419_6236

June 2008

Jonathan Guyton Withdrawal Rules: Squeezing More From Your Retirement Portfolio

"...most [SWR] research has centered on withdrawal rules that are quite static... yet most retirees have the ability to modify their annual spending, at least to some degree. Would the ability to make small systematic modifications if investment performance is poor increase the safety of an investment portfolio and allow for slightly higher withdrawal rates?

http://www.aaii.com/commentary/articles/200508_portstrategies.cfm