[Introductory note: Part III of William Bernstein's classic 5-part "Retirement Calculator from Hell" series provides particularly relevant background reading for this post.]
An argument
made in support of the 4% rule is that despite what I argued before, post-1926 U.S.
history did include a number of calamitous market events, such as the Great
Depression and the Great Stagnation of the 1970s. As such, it is hard to
imagine an even more dire situation awaiting future retirees. The historical
success of the 4% rule suggests that we can reasonably plan for its continued
success in the future.
My first foray
into researching about personal retirement planning was a study about the
sustainability of the 4% rule in other developed market countries. Here I will provide
further perspective about the results described in my article, “An International Perspective on Safe Withdrawal Rates: The Demise of the 4% Rule?”
from the December 2010 Journal of Financial
Planning.
From an international perspective, a 4% withdrawal
rate has been problematic. In the original article, to avoid claims of bias
that I choose an asset allocation which exaggerates the risk of the 4% rule, I
used a rather generous and unrealistic “perfect-foresight assumption.” For each
country and in each retirement year, I used the asset allocation (between
stocks, bonds, and bills) which supported the highest withdrawal rate. Though
not always, in many cases this meant using 100% stocks. With the
perfect-foresight assumption and an updated dataset which includes two more
countries, the calculated SAFEMAX (this is the maximum sustainable withdrawal rate over 30-years in the worst-case scenario from a country's history) exceeds 4% in Canada (4.4%), New Zealand
(4.1%), Sweden (4.1%), Denmark (4.1%), the GDP-weighted world portfolio (4.1%),
and the US (4%).
The perfect foresight assumption is quite
unrealistic, though, and here I will focus on a more plausible 50/50 retirement
asset allocation. In terms of the SAFEMAX, 50% stocks and 50% bills generally
outperforms 50% stocks and 50% bonds. For this reason, I will further consider
results for the stocks and bills case. Though not shown here, I do also note
that stock allocations below 50% support lower SAFEMAXs in all countries except
Switzerland and Sweden. The results for 50/50 are in Table 3.2.
With a 50/50 asset allocation, the 4% rule did not
survive in any country, though it came close in the U.S. and Canada, with
support for 29 years of expenditures and a SAFEMAX just below 4%. Even allowing
for a 10% failure rate, 4% made the cut only in Canada, the US, New Zealand, Denmark,
and the GDP-weighted world portfolio. In 10 of 19 countries, the SAFEMAX fell
below 3%. World War II era Japan, in particular, faced the sort of crisis
suggested by William Bernstein, as the SAFEMAX was only 0.26% for 1937
retirees. The 4% rule would have supported expenditures for only 3 years.
Shockingly, the 4% rule would have failed more than half of the time for
countries including Spain, Belgium, Germany, France, and Italy. Italians
attempting to use the 4% rule would have actually faced failure in 80.5% of cases. The
table also shows results for a 5% withdrawal rate, and failures rates are
substantially higher than for 4%. Even if the 4% rule could somehow be deemed
as safe, there is clearly not much room for error when seeing how quickly
failure rates rise for 5% withdrawals. I do not use hyperbole when suggesting
that the results in this table do not portray the 4% rule in a positive light.
To expand the previous table further, Figure 3.2
shows a boxplot of the distribution of withdrawal rates for each country,
ranked by order of their SAFEMAX from smallest to largest. For each country,
the red central marker is the median, the edges of the box are the 25th and
75th percentiles, and the whiskers extend to the most extreme datapoints not
defined as outliers. Outliers are plotted individually. This figure does provide
a broader view about the range of outcomes for each country.
Figure 3.3, meanwhile, shows the distribution of
withdrawal rates across countries for each retirement year. From this figure,
we can see the contemporaneous correlation of withdrawal rates across countries
and also observe general historic trends. In recent years, those who have
challenged the 4% rule are sometimes accused of falling victim to recency bias,
placing too much weight on the poor financial market conditions of the recent
past. However, Figure 3.3 suggests that recency bias may instead be responsible
for too much faith in 4%. Across countries, the median sustainable withdrawal
rate was under 4% in many cases prior to about 1945. Since World War II,
however, the median outcome never fell below 4%, and in only a few cases did
the 25th percentile fall below 4%. Indeed, in recent years the
performance of the 4% rule across countries was much stronger than the earlier
part of the historical period. While some of the worst outcomes can be connected
with World Wars I and II, given the broader view of history suggested by
William Bernstein, is it appropriate to ignore those cases? Whether there are
important structural changes which might explain why the earlier period is less
relevant to today’s environment is an exercise to be left for the reader’s
interpretation.
Keep in mind also that I am only
looking at the 19 developed market countries in the dataset, with data going
back to 1900. Travel back in time to 1900, though, and ask people to put
together a list of 19 developed market countries for the 20th
century, and you would probably find frequent mention of countries like Argentina,
Russia, and China, among others. As those countries never made the dataset,
even the results I describe here include survivorship bias.
From the perspective of a U.S. retiree, the issue is
whether the future will provide the same asset return patterns as in the past,
or whether Americans should expect mean reversion that would lower asset
returns to levels more in line with what many other countries have experienced.
And for international readers, do keep in mind that the 4% rule is based on
U.S. historical data, and mileage may vary quite dramatically in other
countries.
It may be
tempting to hope that asset returns in the 21st century United
States will continue to be as spectacular as in the last century, but John Bogle
cautioned his readers in his 2009 book Enough,
“Please, please, please: Don’t count on it.”
Wade,
ReplyDeleteThe images are too big to fit in the main div of your post. Can you please scale them down? Normally people scale down images to fit, and then make them bigger if people click on them.
Thanks, I made that change. Usually I do as you suggest at the start, but I thought the figures were too hard to see in a smaller form.
DeleteGlad I found your site. The numbers are pretty alarming, gotta learn more about this whole retirement system...
DeleteHello Wade. Are you aware of a study done by the Trinity U authors on adding foreign stocks to the portfolio to enhance withdrawals? I believe it was in The Journal of Financial Planning (whose archives I can't access). In any event I recall the foreign stocks had little effect (MSCI-EAFE) on the withdrawal rate in the long run. More grist for the mill. Fred
ReplyDeleteHi,
ReplyDeleteYes, that was a Monte Carlo study based on EAFE data since 1970. Since the results here show the US was quite near the top in the international rankings, we shouldn't expect too much benefit for the US in the past. But that could change in the future.
Hi Wade,
ReplyDeleteI am more attracted by the variable income provided by dividing total assetts each year by the number of years left to withdraw. I will retire at age 60 and withdraw 1/30 th of my pot in year 1, 1/29 th in year 2 etc
However I do have the security of an index linked ovcupational pension as my main source of income. Do you think my method is sound?
Cliff UK
Hi Cliff,
DeleteThough I'm not sure about your exact choices, what you are describing is related to the optimal approaches for drawing down assets. If you are risk averse, you may want to build a sufficient floor of guaranteed income sources to make sure your basic needs are met, but otherwise I do not see a problem with what you are describing. Please realize that spending may fall below your desired level as time passes. Also, do not you probably won't ever want to spend more than 1/5 of remaining assets as you reach very old ages.