Financial Planning
July 26, 2019
How Much Money is Enough in Retirement?
Does a low interest rate environment blow up your retirement portfolio? 
By Lori Zager & Lisa James
To understand how much is ‘enough’ in retirement, we need to understand the amount that can be withdrawn annually from a portfolio (inflation adjusted) so we are reasonably certain the portfolio won’t go to zero before death. This concept is called the ‘Sustainable Withdrawal Rate (SWR)’.

The Sustainable Withdrawal Rate (“SWR”) will depend on the individual retiree’s situation, including:
  • Anticipated years in retirement
  • Desire for increased longevity protection
  • Desire to leave money to heirs
  • Portfolio mix (stocks, bonds, cash)
  • Risk Tolerance (desire for higher/lower success rate)
The ‘4% withdrawal rule’, which is the ability to withdraw 4% of your portfolio each year without running out of money, used to be a reasonable rule of thumb for retirement planning. This rule was based on historical studies of 50% intermediate-term U.S. Treasury notes/50% common stock portfolios over 30-year investment periods. 

In a well-known 1994 study, William Bengen found a 4% SWR survived all historical scenarios starting from 1926 to 1976. In the later Trinity Study, done in 1998, a 4% SWR had 95% success rate. This lower success rate was affected by the use of corporate bonds instead of Treasury notes (in a period with some large corporate bond defaults). 

In 2013, a study by Finke, Pfau and Blanchett calculated the SWR based on Monte Carlo simulations*, assuming 2.6% real bond returns and 8.6% real stock returns. With this new analysis, they found a 4% withdrawal rate succeeds 94% of the time with a similar 50/50 stock/bond split over a 30-year investment period.
The past success of the 4% SWR may not be as relevant in today’s interest rate environment.
Past studies include very few low interest rate periods like the one we have today. We care about low interest rates because bond yields are an excellent predictor of 10-year bond total returns AND bonds are a large part of retirement portfolios. See chart below from the Finke, Pfau and Blanchett 2013 study.
92% Correlation Between Intermediate Bond Yields and Subsequent 10-yr Bond Total Returns
Our current Treasury bond yields of 2% are far below the historical average of 5%.  If you retire today, you will likely have very low bond returns for the first 10 years of retirement. That implies lower than average returns on half of a 50/50stock/bond portfolio.  Further, returns during the first 10 years of retirement have a very large effect on future portfolio outcomes. (They explain 80% of outcomes.) Our current low yield problem means a 4% withdrawal rate has a higher risk of failure than in the past.
So, what results do we get with low bond yields at the start of retirement?
In 2018, Wayne Pfau updated the Trinity study, reflecting interest rates that started low at the beginning of the retirement period and increased over time to the historical average rate. He came up with the following results in the table below using corporate bonds (not Treasuries) in his Monte Carlo simulations. Under these circumstances, higher equity portfolios have higher success rates.  
  • A 4% withdrawal rate succeeds 75% of the time with a 100% allocation to stocks for 30 years
  • A 4% withdrawal rate succeeds 73% of the time with a 75/25 stock/bond split for 30 years
  • A 4% withdrawal rate succeeds 64% of the time with a 50/50 stock/bond split for 30 years
Strategies to consider for a low interest rate environment:
  • Delay retirement until you have a bigger retirement account.
  • Use a lower withdrawal rate.
  • Increase the equity percentage of your portfolio (more volatility).
  • Accept a lower probability of living off your portfolio until you die, or lower probability of leaving money to heirs.
  • Trade off withdrawing more now and less in thefuture
  • Increase stock allocation after a big market drop.
  • Use a ratcheting strategy: If your portfolio value increases to 50% above the beginning level, increase your spending by 10%. Revisit every 3 years.
  • Call us!
You must determine the appropriate tradeoff between your standard of living in retirement versus the risk of running out of money or leaving too much behind. While the data in the cited studies are instructive, it’s important to evaluate both interest rates and the nature of the equity market at the beginning of your retirement. Your portfolio experience will be specific to your retirement timing, it is not an average.

Here’s to a successful retirement!

*A Monte Carlo simulation performs risk analysis by building models of possible results by substituting a range of values—a probability distribution—for any factor that has inherent uncertainty. It then calculates results over and over, each time using a different set of random values from the probability functions.

Nothing contained herein is intended to be a formal research report, or as a source of any specific investment recommendations and makes no implied or express recommendations concerning the manner in which any specific accounts should be handled. Any opinions expressed in this material are only current opinions and while the information contained is believed to be reliable there is no representation that it is accurate or complete and it should not be relied upon as such. Investing involves risk, including loss of principal, and no assurance can be given that a specific investment objective will be achieved.