How Much Can You Withdraw From a Portfolio and Not Outlive It?

The biggest risk any investor faces is running out of money. From the standpoint of retirement savings, this is known as longevity risk. It is the risk of living longer than your savings can support you. Longevity risk is why millennials are encouraged to put most of their savings into stocks and why retired investors should keep withdrawals to a reasonable level.

What defines a reasonable level is the subject of an article I wrote for this month’s AAII Journal. I’ll share one of the conclusions here: If you are using a systematic approach like the 4% rule, don’t plan on using a withdrawal rate greater than 5% as your base. This is a handy rule of thumb even for those who aren’t retired. For any amount saved, a person can quickly estimate how much income their portfolio will provide in the first year of retirement. No fancy calculator needed; simply multiply what you have saved by 5%. The total will be the base amount of dollars you can withdraw. (Those of you with many years until retirement should keep in mind the boost that additional savings and market returns will have on the actual future amount of dollars you will be able to withdraw.)

The longer one’s expected life-span in retirement is, the smaller the withdrawal rate should be. While a 5% inflation-adjusted withdrawal rate holds up fairly well over periods of up to 25 years (an 82% success rate of not outliving your money with a 60% large-cap stock/40% intermediate-term government bond allocation), its odds of success fall at 30-year and 35-year periods (71% and 58% success rates, respectively). Going down to 4% is better (98% and 93% success rates at 30 years and 35 years). A middle ground not covered in the article is to diversify slightly more and use a 4.5% withdrawal rate.

The idea comes from retired financial planner William (“Bill”) Bengen. Bengen created the original 4% withdrawal rule. In subsequent research, he found an initial 4.5% of retirement savings could be withdrawn and subsequently increased by the rate of inflation if small-cap stocks were included.

I took Bengen’s suggested allocation of 35% large-cap stock, 20% small-cap stock, 35% intermediate-term bond and 10% cash and tested it over 30-year and 35-year periods using a 4.5% withdrawal rate. The success rates (meaning the odds of not outliving one’s money) were good. For retirements lasting 30 years, the portfolio only ran out of money three times out of all actual 30-year rolling periods (1928–1957, 1967–1996 and 1968–1997)—a 95% success rate. At 35 years, the portfolio failed just four times (1928–1962, 1936–1970, 1967–2001 and 1968–2002)—a 93% success rate. Not perfect, but quite high.

When the portfolios did fail, a down year for stocks occurred early in retirement. Examples include the years of 1931, 1937 and 1969. The value of the equity holdings fell at the same time withdrawals were being taken. To the extent that a retiree could have avoided withdrawing from their equity holdings and/or cut back on withdrawals, the greater the likelihood of success would have been.

Those who are years away from retirement should realize that without withdrawals taken, the portfolios would have never run out of money. It is the size of the withdrawals combined with the sequence in which returns occur that matters. As such, it makes sense to take risks when younger and to incorporate a cash bucket and/or sources of guaranteed income (pensions, Social Security, annuities, etc.) when older.