Taking Retirement Withdrawals From a Fund Portfolio
Charles Rotblut will speak at the 2015 AAII Investor Conference this fall; go to www.aaii.com/conference for more details.
Retirees are commonly told they can safely withdraw 4% of their savings, adjusted for inflation, without running out of money.
Often this advice is presented with return data based on stock and bond market indexes. What is sometimes lacking, however, is an example of implementing the withdrawal strategy with a real-world portfolio.
Since I created a hypothetical portfolio for analyzing the effect of rebalancing (discussed in the article “Portfolio Rebalancing: Observations from 25 Years of Data,” April 2013 AAII Journal), I have the data to walk through the process and show where potential pitfalls may lie. The portfolios use actual funds that were available to investors over the time period studied, so the results presented should be close to what an investor could have actually realized on a pretax basis during the past 25 years. In other words, rather than relying on theory, these portfolios provide close to a real-world example.
Though I used mutual funds for my analysis, exchange-traded fundscould be directly substituted without any significant changes. Investors holding individual stocks and bonds should group their holdings by asset class to follow the examples provided.
In this article
- The Mechanics of Adjusting Withdrawal Rates
- Portfolio Withdrawal Options
- The Funds
- Incorporating Periodic Rebalancing
- The Results
- What About Withdrawing More Than 4%?
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One change I made from the example shown in my April article was to incorporate an accelerating withdrawal rate. Each year, I increased the percentage withdrawn by the reported Consumer Price Indexfor the year as an inflation adjustment. Factoring in inflation raised the annual withdrawal rate from 4.00% of the portfolio’s value at the end of 1988 to 7.65% of the portfolio’s value at the end of 2012. The inflation escalator was included since retirees will need to increase the amount of their portfolio withdrawals to cover rising expenses.
The good news is that a person who retired at age 65 in 1988 and turned 90 in 2012 would not have incurred longevity risk—the risk of outliving one’s savings—by adhering to the 4% withdrawal rate over that time period. This was the case even though AAII’s moderate portfolio allocation model, which uses a 70% allocation to stocks, was followed. The bad news is that the dollar size of the annual withdrawals did not increase every year and, if rebalancing is not employed, the allocation shifts to nearly 90% domestic stocks after 25 years.
The Mechanics of Adjusting Withdrawal Rates
The 4% rule recommends investors base their retirement withdrawal rates on the value of their portfolio at the start of retirement. In the analysis used for this article, the starting portfolio value is $100,000. I chose this number for its ease of calculation and analysis. It can easily be scaled upward or downward. Plus, any cumulative dollar changes can be quickly estimated through simple multiplication. (A $1 million portfolio would have had dollar amounts that were 10 times larger than the amounts shown in this article.)
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