Morningstar - Q2 2021 - 39

On the other hand, Bengen himself has expressed
the view that lower inflation should allow for
more generous withdrawal rates, suggesting
a number as high as 5.25% to 5.5%. In an October
podcast with Kitces, Bengen said that because
previous withdrawal-rate estimates were
based on worst-case scenarios, higher numbers
should be sustainable in a low-inflation
environment like we've had recently.6 In 2020,
for example, inflation was only 1.4% compared
with closer to 3% per year historically. A more
benign inflation rate has significant implications for
retirement spending. While Bengen didn't
elaborate on the return assumptions behind the
higher figures, I came up with similar numbers
by keeping stock and bond returns in line
with their historical averages, increasing the equity
allocation to 60% of assets, and reducing
inflation to 1.4% per year.

Similarly, Cornerstone Wealth Advisors' Jonathan
Guyton argued that a 65% equity weighting
combined with a more dynamic withdrawal
strategy could produce safe withdrawal rates as
high as 5.8% to 6.2%.3
Too High, Too Low, or Just Right?
In 2013, Morningstar's David Blanchett-
along with researchers Michael Finke
and Wade Pfau-published a paper arguing that
the 4% withdrawal rate is unsustainable
in an era of lower bond yields.4 Because there's
a strong correlation between bond yields
and future total returns, record low
interest rates imply significantly lower fixedincome returns.

In 2020, Pfau published another article about
the need to ratchet down withdrawals, given lower
bond yields.5 He looked at this issue using
bond yields in March 2020 as a starting point.
(At that time, the 10-year Treasury was yielding
about 0.8%.) He also assumed that stocks
maintain their historical average risk premium
of 6 percentage points per year over bonds,
which also implies lower future stock returns.
Based on these return assumptions plus
a 2% assumption for inflation, he came up with
a 2.4% estimate for sustainable withdrawal
rates for a portfolio combining 50% stocks
and 50% bonds. That would effectively reduce the
dollar amount of first-year withdrawals by
about 40% for new retirees-a $16,000 reduction
for a $1 million portfolio.

In fact, low inflation is one of the reasons a 4%
withdrawal rate would have still been sustainable
over the worst 30-year return stretch we've
experienced to date: the period from 1929 through
1958. Retirees during that period would have
watched their portfolios suffer through the
Great Depression, the bear market in 1937, and
World War II. As a result, nominal returns for
a 50/50 balanced portfolio averaged only 6.4% per
year. But inflation was also unusually kind to
retirees, averaging 1.8% over the 30-year period.
In particular, a deflationary trend toward the
beginning of the term helped offset the effects

of an adverse sequence of returns. While
the market suffered double-digit losses from 1929
through 1931, inflation also dropped below
zero. As a result, retirees adjusting their
withdrawals for inflation would have reduced
withdrawal amounts in dollar terms. If inflation
had been more normal-in line with the
2.9% historical average-the portfolio would have
been depleted after about 25 years.
Wading Into the Debate
It should be clear by this point that the only
answer to the right number for sustainable
withdrawal rates is both vague and unhelpful: It
depends. But we can make some educated
guesses to test a plausible scenario. There's no
question that lower bond yields don't bode
well for future fixed-income returns. At the
same time, high equity market valuations suggest
the possibility of lower stock-index returns.
To account for both scenarios, we used
real (inflation-adjusted) returns on stocks and
bonds as a starting point but reduced the
arithmetic averages for both asset classes by 200
basis points. That leads to average real
return assumptions of about 7% for stocks
and 0.4% for bonds.

To get a better sense of how portfolio results
might play out with different withdrawal levels, my
colleague Maciej Kowara used the real return
assumptions above as a baseline (keeping volatility
and correlation assumptions in line with
the historical averages) and tested various initial

EXHIBIT 1

Success Rates for 50/50 Portfolio Mix Our study finds that investors should start with a slightly lower withdrawal rate than 4%.
Starting Withdrawal Rate (%)
Probability of Success (%)
Average Length of Shortfall (Years)

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

100.0

99.9

99.5

98.1

93.9

86.0

74.5

61.6

47.9

34.9

23.9

15.5

1.8

3.6

4.1

4.8

5.7

6.7

8.0

9.1

10.5

11.8

Source: Morningstar.

3
4
5
6

Guyton, J.T. 2004. " Decision Rules and Portfolio Management for Retirees: Is the 'Safe' Initial Withdrawal Rate Too Safe? " FPA Journal, October.
Blanchett, D., Finke, M., & Pfau, W.D. 2013. " Low Bond Yields and Safe Portfolio Withdrawal Rates. " Morningstar White Paper. Jan. 21.
Pfau, W.D. 2020. " How Much Can Retirees Spend on March 11, 2020? It May Not Be What You Think. " Retirement Researcher.
Kitces, M. 2020. " How the Creator of the 4 Percent Rule Applied It for His Clients and His Own Retirement, With Bill Bengen. " Financial Advisor Success Podcast, Oct. 13.

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