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Not Just a Number

Aaron Brask

MANY PEOPLE TELL ME they need, say, $1 million or $2 million to retire, effectively equating retirement with a dollar amount. But there’s more to retirement than just the financial side. It’s a major turning point that will alter virtually all of our priorities—how we spend our days, how we interact with loved ones, what we care about and what we hope to achieve.

Even if we focus only on the financial side, we can’t sum up retirement with a single number. Many people have historically relied on the 4% rule—the so-called safe withdrawal rate (SWR). Based on William Bengen’s pioneering research, this rule says we should be able to withdraw 4% of our portfolio in the first year of retirement, and thereafter increase that dollar amount each year by the inflation rate, without running out of money. For example, if we have a $1 million nest egg, we could take out $40,000 (4% of $1 million) in the first year. If inflation is running at 2% a year, we’d withdraw $40,800 ($40,000 x 1.02) in year two, and so on.

The 4% rule was determined by figuring out what withdrawal rate would have been successful historically even in the worst markets. Since Bengen’s original 1994 study, he and others have introduced updates to his methodology that increased the SWR by improving a nest egg’s diversification.

On the other hand, studies have also highlighted the link between stock market valuations and withdrawal rates. In other words, expensive markets may require withdrawing less each year. Current bond interest rates and stock dividend yields are both near their historical lows, as you can see from the accompanying chart. This concerns me—and it may require a withdrawal rate lower than 4%.

To be fair, such caution may not be necessary for three reasons. First, for many seniors, retirement income isn’t solely a function of interest and dividends. It also involves chiseling away at principal itself. That said, relying on principal means worrying about sequence-of-return risk—the danger that market prices will be down sharply when we need to sell to fund retirement spending.

Second, low dividend yields may not be the warning sign they once were. Over the past few decades, there’s been a trend toward returning corporate cash to shareholders via stock buybacks. Combine those buybacks with cash dividend yields, and the total yield on stocks doesn’t look so alarming. Buybacks may just result in getting less dividends now, but faster dividend growth in future.

Third, inflation may remain low. Bengen has pointed to inflation as being “the retiree’s worst enemy.” If this enemy is weakened, that’s all the better for retirees. Recent headlines and bond market volatility have reflected renewed concerns about inflation. But if the multi-decade trend toward lower inflation continues, this could minimize one of the worst threats to retirees who use the 4% rule.

How am I advising my clients? It depends on someone’s age and time horizon, but I’m more likely to suggest withdrawal rates closer to 3.5%. The implication: $1 million isn’t what it used to be. For retirees, what matters isn’t the size of their nest egg, but the lifestyle it can support—and I fear $1 million won’t support the lifestyle it once did.

Aaron Brask is an investment advisor based in West Palm Beach, Florida. His practice and research focus on low-cost, tax-efficient strategies for investing and retirement. Outside of work, Aaron enjoys sports, traveling, and spending time with his wife and two young children.

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John McHugh
John McHugh
4 months ago

“Third, inflation may remain low.”

Or not.

We are in a brave new world of finance and money creation, and no one knows where it will go. I keep hearing this scary old line in my head, that markets will discover how to inflict the greatest pain.

Anything like a repeat of the 1970s would be a catastrophe. And that’s not all… but it’s enough.

I’m staying the course, but maybe a 4% of balance withdrawal rate might be the thing if this risk starts to be realized.

rayanmiller6303
rayanmiller6303
4 months ago

I hope to retire at 60 and have just north of a million, that will tide me over till I hit 67 and claim social. To keep my lifestyle I will need about 60K/year
I can foresee during good market years taking 6 or even 7% if I need it between 60-67. Once I hit 67 I can probably manage 4% or less. We own our home and could take money out of it in a pinch , the worst that could happen is when I hit 80 and the nest egg is gone I live on social security. I would rather that approach then die at 78 with 2 million.

ishabaka
ishabaka
4 months ago

Why on earth do financial advisors never mention variable withdrawals?

corrupt
corrupt
4 months ago

“I expect in our case we start with a withdrawal rate around 3-4%, but it will jump well into the high single digits once my wife retires, since we’ll retire before SS kicks in.”

Roboticus, I suggest you use the low income years between retiring and collecting SS to transfer funds from 401K/IRA’s to a Roth. I’ve done so for the last 5 years and am happy with the results.

Roboticus Aquarius
Roboticus Aquarius
4 months ago

Do you find that many people actually use the 4% rule? It was never actually a rule, as I’m sure you realize, just a rough guideline to inform people how much risk they may be carrying. Only a tiny percentage of the people I’ve asked actually use it. Also, I’m fine having a number (I actually graphed against our ages just to get an idea of how it might change over time, knowing the range of potential error is pretty high.) They are all just ballpark figures to let us know if we’re in great shape, doing ok, or need to kick it in gear.

I prefer building a cash flow model (with the biggest weakness being the returns assumption.) I’m spending some time now to make it much more flexible. I expect in our case we start with a withdrawal rate around 3-4%, but it will jump well into the high single digits once my wife retires, since we’ll retire before SS kicks in. Once SS starts we’ll see a couple point reduction. My preliminary models suggest I’m in the ballpark, but I know I need a more sophisticated look at it (and a good 5 years of savings still) before I take that leap.

parkslope
parkslope
4 months ago

This article seems to imply that stock price valuations are irrelevant for deciding on a safe withdrawal rate.

R Quinn
R Quinn
4 months ago

It drives me nuts when someone throws out $1 million dollars or any other number as a target.

You made the key point in your last sentence. There is no magic number to target, but a number that will support a lifestyle.

In addition, it needs to be pointed out that it’s a moving target. If I were 30 years old today, $1 million 35 years from now is quite meaningless.

I don’t know what the right withdrawal rate it, I’ve seen from 2.5% to 5% within the last several months. There are even “experts” saying some people are saving too much, which to my way of thing is impossible.

Guest
Guest
4 months ago

Thank you Mr. Brask. You certainly are more optimistic than me. I’m concerned the stunning market performance (especially over the past year-plus) has pulled future returns so far forward that, generally, a withdrawal rate closer to 2.5% may be more sustainable. And for my kids, well I expect they’ll need to save more annually for their own retirement as those same lower future market returns are likely to result in significantly less compounding than my wife and I benefited from.

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