I have always found the history of “sustainable withdrawal rates” (SWR) to be quite interesting (a fact that secures my qualifications as a geek, as if there might otherwise have been some doubt), so I enjoyed retirement researcher, Wade Pfau’s recent post, Safe Withdrawal Rates for Retirement and the Trinity Study.
As Wade's post explains, William Bengen published a seminal paper on the topic in 1994 (download PDF). The Trinity study, subsequently published in 1998 (download PDF), took a slightly different direction with important repercussions. The latter shifted focus from “the highest withdrawal rate possible in the worst-case scenario from history” to the proportion of thirty-year periods in which a portfolio would have (past perfect tense) survived.
As he also notes, both studies were based on historical market returns available in the mid to late nineties and basing a retirement plan on the assumption that future portfolio returns will equal or exceed those of the past is faulty logic. Given current capital markets, they are unlikely to, according to Pfau, Michael Finke and David Blanchett in The 4% Rule is Not Safe in a Low-Yield World.
There is another interesting piece of history regarding safe withdrawal rates that Pfau doesn’t include in his post. In the September 1995 issue of Worth magazine, Fidelity Magellan's fund manager, Peter Lynch, published an article entitled “Fear of Crashing” in which he suggested that a retiree should be able to invest her savings 100% in growth funds and safely spend 7% of the portfolio annually (damn, some days I miss the ’90s).
I apologize for not being able to provide a link to the Worth article. Apparently, 1995 was before the time that the Internet knew everything. Prehistoric, in today's world.
Scott Burns, then a financial columnist for the Dallas Morning News, published a challenge the following month, October 1995, entitled “Dangerous Advice from Peter Lynch.” Burns provided data showing that a retiree implementing Lynch’s advice would quickly have gone broke in many historical time periods.
(Timing is everything. Lynch wrote his column a year following
Bengen’s paper. Burns apparently had read Bengen’s work; Lynch
apparently had not. )
Lynch not only withdrew the “Fear of Crashing” statement, he hired Burns as a contributing editor for Worth, yesteryear's equivalent of hiring the guy who hacked you as your new security consultant, I suppose.
The story became even more interesting when, in 2010, Burns and economist Laurence Kotlikoff published “Spend 'Til the End”, in which the authors refer to the “rules of thumb”, like 80% replacement rates and 4% safe withdrawal rates that Burns had written about for so long in his columns, were better referred to as “rules of dumb.” (I recommend this book.)
SWR studies provide important insight into the portfolio survival process, but as Pfau points out, translating the results directly into a retirement plan is a risky proposition. I have concerns beyond Wade’s research showing that historical data is a poor basis for future expectations.
As I have previously pointed out on this blog, the model is based on the absurd policy that the retiree will continue spending the same amount annually even when it is clear that he is headed for ruin. As Pfau has noted, constant-dollar spending is a research strategy, not a retirement planning strategy. If your retirement plan is to spend a constant-dollar amount annually, you need a new plan.
Nonetheless, SWR studies can be enlightening and I find their history far more interesting than that of most retirement research – admittedly a low hurdle.