GOOD READ---especially note the last paragraph! The 4 Percent Rule Is Not Safe in a Low-Yield World by Michael Finke, Ph.D., CFP®; Wade D. Pfau, Ph.D., CFA; and David M. Blanchett, CFP®, CFA Executive Summary The safety of a 4 percent initial withdrawal strategy depends on asset return assumptions. Using historical averages to guide simulations for failure rates for retirees spending an inflation-adjusted 4 percent of retirement date assets over 30 years results in an estimated failure rate of about 6 percent. This modest projected failure rate rises sharply if real returns decline. As of January 2013, intermediate-term real interest rates were about 4 percent less than the historical average used in previous simulations. Calibrating bond returns to the January 2013 yields offered on five-year TIPS to match the duration of bond investments used in previous simulations, while maintaining the historical equity premium, causes the projected failure rate for retirement account withdrawals to jump to 57 percent. Results from this analysis suggest that the 4 percent rule cannot be treated as a safe initial withdrawal rate. Some financial planners may wish to assume that today’s low interest rates are an aberration and that higher real interest rates will return in the medium-term horizon. Although there is little evidence to support this assumption, we estimate how a reversion to historical real yields will affect failure rates. Because of sequence of returns risk, portfolio withdrawals can cause the events in early retirement to have a disproportionate effect on the sustainability of an income strategy. We simulate failure rates if today’s bond rates return to their historical average after either five or 10 years and find that failure rates are much higher (18 percent and 32 percent, respectively, for a 50 percent stock allocation) than many retirees may be willing to accept. The success of the 4 percent rule in the United States may be a historical anomaly, and clients may wish to consider their retirement income strategies more broadly than relying solely on systematic withdrawals from a volatile portfolio. Michael Finke, Ph.D., CFP®, is a professor and Ph.D. coordinator in the Department of Personal Financial Planning at Texas Tech University. ([email protected]) Wade D. Pfau, Ph.D., CFA, is a professor of retirement income at the American College. (WadePfau@gmail) David M. Blanchett, CFP®, CFA, is head of retirement research at Morningstar Investment Management. (David.Blanchett@morningstar)
Posted on: Wed, 07 May 2014 15:38:53 +0000
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