Friday, November 11, 2011

What is a good withdrawal rate?

I received this question through email:


I read your abstract on withdrawal rates and was very interested.

However, I am trying to ascertain what I may withdraw from my portfolio if the 4% rate, as you seem to think is inaccurate.

I am 70 years old.

Here is my answer, which unfortunately doesn't provide a specific number:

It is a great and important question.  But it is hard to answer though, without knowing more information.

For example, are you married, and if so, how old is your wife? Because, the 4% rule refers to a 30 year period.  It can be higher or lower if you are planning for a shorter or longer period.

What is your asset allocation? What fees are deducted? This question might be harder to answer, but have your investments been performing as well or worse than the benchmark indices for stocks and bonds used in the withdrawal rate research?

What other income sources do you have?  Social Security? Any pensions? Any annuities? Because the more income you have from other sources, the less tragic it would be if you run out of wealth, and so that allows for a higher withdrawal rate as well.

Relatedly, how flexible are you to decrease your spending later if markets perform poorly?  In that regard, how much value would you get from spending more now?  Is it worth it to spend more now, if the consequence is that  cutting back more later may be necessary?

Does the assumption of the 4% rule, which is that you always will keep spending the same inflation-adjusted amount in the future, apply to you?  Or is it likely that you will spend less in the coming years for unrelated reasons?

How is your health insurance situation?

Do you have any desires to leave an inheritance?

I think one needs to think about all of these questions (and perhaps more, I might add to the list later if I think of something else) when deciding how much to withdraw.  I am concerned that the 4% rule will not work for recent retirees over a 30-year period.  But that doesn't necessarily mean that someone shouldn't spend more than 4%.  The purpose is to maximize one's lifetime satisfaction, balancing between how much to spend now, and what that might mean for cutting back on spending later.

Update: Dan Moisand's December 15, 2010, column, "A Little More To It" at Financial Advisor Magazine does a good job of also explaining the issue I was grappling with in trying to answer this question: the real world isn't always so clear and pristine as what we assume in the research about safe withdrawal rates. Real life gets in the way.