All but the wealthiest retirees or those with minimal spending needs require a strategy that will increase the likelihood of their nest egg outliving them. In general, every retiree wants a comfortable lifestyle and no worries about running out of money. This requires building a sufficient nest egg and carefully managing the withdrawal rate.
Readers may be familiar with the 1998 study that arrived at a 4% guideline as a safe withdrawal rate (SWR). That is, withdraw 4% of the initial balance at retirement and increase the amount annually by inflation. They concluded that this rule gives retirees a reasonable chance of their nest egg lasting 30 years if their nest egg is about 50% in stocks.
Unfortunately, the data this study is based on is now stale. Then, interest rates on government bonds were in the 5% range and stock valuations as measured by P/E ratios were lower. Recent indications from the Federal Reserve suggest interest rates that are now in the 3-4% range will increase only a bit more and then stabilize before decreasing. The S&P 500's P/E ratio in the mid-1990s was around 15; recently it was around 18.
Some recent studies came to uncomfortable conclusions. One concluded no matter what the asset allocation, there is no static inflation-adjusted withdrawal rate that will allow most retirees to have both a comfortable retirement with no risk of running out of money. Another study by Wade Pfau concluded that for moderate risk investors, 2.4% was a SWR.
Unfortunately, many retirees believe they can safely significantly exceed the 4% guideline. One study by Fidelity discovered that 38% of respondents thought they could annually withdraw at least 7% and half of those thought 10-15% and still have their money last a lifetime.
However, taking account of mortality provides for better scenarios. The 4% guideline and many other studies ignore it. Consider, of 100,000 65-year-old men only about 6,000 will live 30 years in retirement. That means 94,000 men potentially had a less desirable lifestyle because of using any of the preceding withdrawal rates.
Research indicates taking mortality into account allows for higher withdrawal rates with similar risk. One study shows an inflation-adjusted 5% withdrawal rate has about a 20% failure rate when success is measured by lasting 30 years. However, the failure rate for a 65-year-old man with a 5% withdrawal rate is less than 10% when success is simply the nest egg outliving the retiree.
Other research suggests another way to partially mitigate the empty nest egg problem, a dynamic withdrawal rate. For example, forgo inflation-adjustment for the withdrawal rate is whenever the market increase does not exceed the inflation rate.
For retirees expecting a normal lifespan that are risk-averse and want a simple guideline for a SWR, 3.5% and ignoring inflation-adjustment as just mentioned is not unreasonable. Additionally, the older the retiree, the higher can be the withdrawal rate. A 90-year-old man has little concern about what will happen 30 years later.
Robert Stepleman can be reached c/o Dow Wealth Management, 8205 Nature's Way, Lakewood Ranch, FL 34202 or at [email protected]. He offers advisory services through Bolton Global Asset Management, an SEC-registered investment adviser and is associated Dow Wealth Management, LLC.