You will be afraid to spend!!! (Part 1 of many)


By Tom Wall


How much can a retiree safely begin taking out of a volatile investment portfolio and have that portfolio last for 30 years?

Financial advisor William Bengen set out to determine this in his 1994 foundational research published in the Journal of Financial Planning, titled “Determining withdrawal rates using historical data.” His research had slightly different assumptions than mine, but was based upon the same data set and found that the worst case dating back to 1926 was just over 4%. This resulted in what’s now commonly known as the “4% rule,” although creating such a rule was never his intention. For example, this meant if you retired with $1,000,000 at any point in the US after 1926, you could have started with $40,000 of income, increased it with inflation each year, and had money left at the end of 30 years in all scenarios.

As a retiree, the problem with this approach is that history does not repeat itself, and many smart people say the safe rate going forward could be much less. Today’s high stock valuations, low interest rates, and rising inflation all contribute to a gloomy outlook. That said, one can clearly see the median success rate was almost 6% over the period studied, and in many cases much higher. In those cases, a retiree starting out using a very low “safe” withdrawal rate would have gotten wealthier in retirement but dramatically under-spent their potential. What a bummer.

Investment portfolios alone cannot efficiently provide retirement income, because a prudent retiree would always be afraid of overspending. Millions of retirees are under-enjoying their retirements because they’re afraid of what happens if they live a very long time, require expensive care, or need access to their principal. They’re living scared and hoarding wealth to ensure they don’t outlive it. And with interest rates so low, “living off the interest” like our grandparents did isn’t feasible either.

The better solution is adding actuarial science (life insurance and annuities) to the mix, giving these people freedom spend, certainty that their loved ones will be taken care of, and the ability to stay more fully invested.

What do you think about safe withdrawal rates today? LOTS more to come on this…