Morningstar - Q2 2021 - 38

Strategies

Finding the Right Withdrawal Number
Is the 4% rule too high, too low,
or just right? It depends.
Research

41
44
47

The Turkey That Didn't Gobble
More Women, Higher-Quality Plans
Reasonable Doubts
Quant U

The Two Sides of ESG Investing
Best Ideas

Manager: Convertibles With Conviction
Passive: Thoughtful Momentum
Equity: Vast Scale

RESEARCH

Amy C. Arnott

Retirement is supposed to be a well-deserved
break after the pressures of the working
world, but that doesn't mean it's easy. One of the
toughest parts can be figuring out how much
retirees can safely spend. If they take out
too much, they risk running out of assets later in
life, especially if they're fortunate enough to
enjoy a long lifespan. If they take out too little,
they might miss out on some of the fruits of
a lifetime of savings, such as travel, dining out,
giving money to charity or family members,
or spending more on leisure activities. Pinning
down a number that's neither too high nor too low
is notoriously difficult, and the stakes are high.
Even retirement experts often disagree on the
right number for retirement withdrawals. The
4% rule-which assumes that retirees set an initial
withdrawal rate equivalent to 4% of the starting
portfolio value and adjust the previous year's
withdrawal amount each year for inflation-has
been widely adopted by financial advisors
and individual investors. But there has also been
debate about whether withdrawals should
ratchet down (to account for lower market returns)
or up (to account for lower inflation), as well
as the need for more flexible systems that don't
assume a fixed withdrawal rate.
In this article, I'll dig into the key assumptions
behind the different estimates and what they

mean for retirees. Assuming that future market
returns are lower than in the past, an
initial withdrawal rate closer to 3.5% looks like
a reasonable starting point.
The Origins of the 4% Rule
Financial planner Bill Bengen's landmark
study was notable because it stresstested withdrawal rates based on return
patterns over actual historical periods instead
of relying on average returns over time.1
He examined each 30-year period with starting
dates from 1926 through 1976, adjusting
withdrawals for each year's actual inflation
rate. Based on this data set, he concluded
that for a portfolio combining 50% stocks and
50% bonds, a 4% withdrawal rate never
fully depleted the portfolio's value, even during
some of the worst periods, such as 1928
through 1957 and the 1973-74 bear market.

However, some observers argued that because
it's based on testing worst-case scenarios,
the 4% rule could be considered overly
conservative. Financial planner Michael Kitces
looked at historical returns going back to
1871 and concluded that while a 4% withdrawal
rate worked for a 60/40 portfolio in every
scenario, actual sustainable withdrawal rates
varied significantly (from 4% to 10%, with
a median of about 6.5%) over different 30-year
periods.2 As a result, retirees relying on
the 4% rule would have often ended up with
large remaining portfolio balances at the
end of retirement.

1 Bengen, W. P. 1994. " Determining Withdrawal Rates Using Historical Data. " Journal of Financial Planning, Vol. 7, No. 4,
PP. 171-180. October.
2 Kitces, M. 2008. " Resolving the Paradox-Is the Safe Withdrawal Rate Sometimes Too Safe? " The Kitces Report, May.

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