The most common method of producing retirement income is the SWIP (Systematic Withdrawal Plan). It appeals to consumers because it is driven by the underlying desire of people to ‘have their cake and eat it, too’…or at least the hope that you can. Psychologically, when a person has acquired something, they tend to want to keep it. This is also why the vast majority of research centers around the question: How much can I safely withdraw from my retirement portfolio?
As a general rule, the research is testing how long the portfolio will last before it runs out of money. It also tests the probability of having any cake left over and if so how much. If I were to summarize my observation of a theme of all the research for SWIPs, it is this: How much can I spend with the hopes of having something left?
To me there are better options for having your cake and eating it too, but they involve the use of a combination of financial tools to support retirement income. That subject is for another day. Today’s message focuses on the sinking withdrawal rates we have seen over the past two and a half decades.
William Bengen, CFP set the stage for the research on this topic in 1994 where he first announced the safe withdrawal amount with a balanced portfolio of stocks and bonds. He called this the “Safemax“. We know it as the “4% Rule”. The 4% Rule says you can safely withdraw 4% annually and increase it by 3% per year to compensate for inflation, and you can do this for 30 years. This means a 1 million dollar portfolio would produce $40,000 of retirement income the first year.
Through 1998 to 2009, we saw additional research on this topic from others like Cooley, Hubbard, Walz ,Huxley, Burns, Guyton, Klinger and Otar. They tested all kinds of things…things like liability matching, using different asset allocations, the use of guide-rules to adjust withdrawal amounts along the way, and the cost of the time value of fluctuations. All of this seems like someone is trying to come up with a magic formula for people to eat more of their cake and still keep it. When we ask a portfolio to produce an income and leave some cake at the end of the day,, we are asking it to do two things and it cannot do them both well.
Early on, the research found ways to push the withdrawal rate to as high as 6%, but it came with a lot of “ifs”. As a general rule, the research proved to us how difficult it is to get much more income using the SWIP approach. Then something happened in 2008. I’m sure I don’t need to remind you that we had a market adjustment. What it did to the research is that it forced us to start asking some additional questions…questions like: What if a retiree faces a perfect storm like 2008 and what if U.S. markets perform more like other markets around the world moving forward? What if a retiree is still alive after 30 years? Should we evaluate longer time frames? And my all-time favorite: What if we factor in costs to invest? By the time the next decade concluded (2010-2020), the research forced us to accept the reality of the low interest rate environment we are living in. During this time period, we see the research of Dr. Wade Pfau enter the scene.
In March of this year, Blanchett and Finke published an article in Advisor Perspective titled, The False Promise of U.S. Historical Returns. Factoring in their forecast of how they believe U.S. markets will perform moving forward, current low bond yields and a desire for a 90% probably of a SWIP working, the retiree could withdraw 2.2% safely. That is $22,000 the first year of retirement with a 1 million dollar portfolio. That is a long way from what the first research told us.
This is how I would summarize what the last decade of research has told us: safe withdraw rates have sunk. There has been a steady decline in the amount we can eat off our portfolio. Because there are so many variables researched, I will share with you a range of safe withdrawal rates. That range falls between 1.5% and 3%. That means the research predicts that moving forward, a 1 million dollar portfolio might be able to produce a sustainable inflation adjusted income with the first year of retirement income being somewhere between $15,000 and $30,000. From my perspective, that isn’t a lot of cake-eating each year moving forward. These are discouraging levels of income, given how hard it is to accumulate a retirement portfolio.
Perhaps it is time we get more focused on using a variety of methods to produce income and how to effectively combine them so people can enjoy the wealth they have accumulated. It also drives home the point of how important it is to get positioned to use a variety of techniques to produce retirement income.
Oh, by the way, radio financial entertainer, Dave Ramsey, who has millions of fans/cult followers has never admitted that the safe withdrawal rate he started promoting in 1985 is unrealistic. His examples then and now still demonstrate an 8% withdraw rate. The sad part of this is that if you reverse engineer his advice, it is still predicated on this assumption. To be fair, I have seen one of the men that he has brought alongside, Chris Hogan, use 6%. We must ask ourselves: How can this be supported? At some point, we must stop listening to entertainment and to the financial institutions who are pushing their products and learn about realities and what we can do now.
If you want to learn more about combining tools, check out Incisic.com
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