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# Retirement Savings: Choosing a Withdrawal Rate That Is Sustainable

## Abstract

Most investors who plan for retirement eventually confront the question of how much money they should plan to withdraw annually from their investment portfolio. The dilemma is that if they withdraw too much, they prematurely exhaust the portfolio, but if they withdraw too little, they unnecessarily lower their standard of living. Financial planners, counselors, analysts, and writers stand ready to advise investors on their dilemma, but their advice varies greatly, ranging from investing in common stocks and spending the dividend yield (roughly 3%), up to 7%, which allows for the invasion of principal. Highly risk-averse investors would likely gravitate toward the low end of the range because of their concerns about outliving their portfolio. Moreover, the larger the percentage of a retiree's total income provided by the portfolio, the more risk-averse the retiree is likely to be. In addition, some retirees wish to bequeath a large estate to their heirs, which again argues for a low withdrawal rate. In contrast, an aggressive investor without heirs might wish to plan a financial future based on a high withdrawal rate. Because of these highly personal behavioral traits, circumstances, and goals, no single withdrawal rate appears appropriate for every investor. What, then, can be done to help an investor in planning for a withdrawal rate? The word planning is emphasized because of the great uncertainties in the stock and bond markets. Mid-course corrections likely will be required, with the actual dollar amounts withdrawn adjusted downward or upward relative to the plan. The investor needs to keep in mind that selection of a withdrawal rate is not a matter of contract but rather a matter of planning. Thus, the question addressed here is: What is a reasonable withdrawal rate from a portfolio for purposes of planning retirement income? Or stated differently, what withdrawal rate is likely to be sustainable during a specified number of years? To help in the selection of a withdrawal rate, the following sections provide information on the historical success of various withdrawal rates from portfolios of stocks and bonds. If a withdrawal rate proves too high based on historical year-to-year returns, then it seems likely that the rate will not be sustainable during future periods. Conversely, historically sustainable withdrawal rates are more likely to have a high probability of success in the future.
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... Studies on safe retirement spending rates typically draw information from historical data. [1][2][3][4][5] A prime example of such a study is the commonly quoted '4% safe withdrawal rate' published in Cooley et al. 1 , where the authors used historical data over the period 1926 to 1995 to assess safe spending rates for retirees. The assumptions made in these studies are that the statistical properties of historical returns remain stable over time. ...
... Studies on safe retirement spending rates typically draw information from historical data. [1][2][3][4][5] A prime example of such a study is the commonly quoted '4% safe withdrawal rate' published in Cooley et al. 1 , where the authors used historical data over the period 1926 to 1995 to assess safe spending rates for retirees. The assumptions made in these studies are that the statistical properties of historical returns remain stable over time. ...
... In particular, it is important that these scenarios are as close as possible to the true representation of what could happen. In extension of the work presented by Cooley et al. 1,2 , Bengen 3 , and Maré 4 , the focus of this study was to improve the modelling of safe retirement spending rates by using forward-looking information rather than historical information. Many large financial institutions regularly estimate forward-looking distributions from option prices in order to gain insights into the weights investors place on different future asset prices. ...
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An important topic for retirees is determining how much they can safely withdraw from their retirement savings: draw too much from their retirement fund and risk outliving their retirement savings, or draw too little and live below their means. For retirees to decide on the appropriate withdrawal rate, retirees need to have the tools available to decide on their spending rates. There are many factors that influence withdrawal rates, such as initial wealth, asset allocations, age, life expectancy, and risk tolerances. The topic of safe withdrawal rates aims to optimise spending rates while minimising the risk of running out of retirement savings. The focus of this study was on using forward-looking moments of the risk-neutral and real-world asset distributions in determining safe withdrawal rates for South African retirees. The use of forward-looking information, typically derived from traded derivative securities (rather than historical data), is essential in optimising safe withdrawal rates for retirees. In particular, we extracted the forwardlooking risk-neutral and real-world distributions from option prices on the South African Top 40 index, and used the moments of the distributions as a signal in a simple tactical asset allocation framework. That is, when we expect the growth asset to decrease in value, we hold cash (or short the asset) and, alternatively, when we expect the growth asset to increase in value, we hold the growth asset for the period. Using this approach, we found that we can sustain withdrawal rates of up to 7% compared to the commonly quoted 4% safe withdrawal rate obtained by historical simulations.
... indices and investment strategies as alternative sources for both asset classes. For example, long-dated corporate bonds (Cooley et al. 1998) and inflation-linked government bonds (Pye 2000) are used instead of government bonds. For example, instead of the return of the entire U.S. stock market, small cap stocks are tested (Bengen 1997), the 4% rule is extended to include international diversification, and value and growth strategies are tested (Guyton 2004). ...
... The risky part of the portfolio is represented by German equities, the risk-free part by German government bonds. The concept of the study is largely adopted from the study known as the "Trinity Study" (Cooley et al. 1998). ...
... In this study, a portfolio consisting of 60% equities and 40% bonds was modeled, which generated an annual return of around 4% and compensated for inflation. Details are given in the chapter "Methodology and Model Assumptions" (Cooley et al. 1998). ...
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On account of the current low interest rate phase, which is most likely to continue in the coming years, the average yields to be achieved in the bond, time deposit and savings product sectors are declining, so that risk-averse investors in particular have few opportunities to generate return-oriented retirement provisions. This scientific article analyzes the level of a possible safe withdrawal rate for diversified pension portfolios, considering historical returns and inflation rates. Consequently, this article provides immediate practical added value for a possible retirement provision. The evaluation is based on the consideration of historical returns of the stock and bond market in Germany. To determine a safe withdrawal rate, the development of portfolios with different compositions and inflation-adjusted withdrawal rates are simulated over periods of 15 to 35 years. In this simulation, the risky part of the portfolio is represented by German equities, the low risk part by German government bonds. To sum up, the empirical results show a maximum safe withdrawal rate of 4%. The underlying portfolio is composed of 50% equities and 50% government bonds. Particularly due to the outlined demographic change in Germany as well as the ongoing low-interest phase, the empirical study can provide significant theoretical and practical insights.
... Empirical research addresses the sustainability of a constant withdrawal amount at equidistant times, given the initial investment. In Cooley et al (1998), annual withdrawals are made from portfolios consisting of US stocks and bonds, using data from 1926 to 1995. The withdrawals are made over the periods 15, 20, 25 and 30 years. ...
Preprint
Given a geometric Levy alpha-stable wealth process, a log-Levy alpha-stable lower bound is constructed for the terminal wealth of a regular investing schedule. Using a transformation, the lower bound is applied to a schedule of withdrawals occurring after an initial investment. As a result, an upper bound is described on the probability to complete a given schedule of withdrawals. For withdrawals of a constant amount at equidistant times, necessary conditions are given on the initial investment and parameters of the wealth process such that $k$ withdrawals can be made with 95% confidence. When the initial investment is in the S&P Composite Index and $2\leq k\leq 16$, then the initial investment must be at least $k$ times the amount of each withdrawal.
... The "Trinity" studies-named after the university at which all three authors, Cooley et al. (1998) taught at the time of publication-began in 1998 with an attempt to empirically test Bengen's (1994) 4% rule by modeling stock market returns via historical simulation. Specifically, the authors analyzed portfolio success rates as a function of safe withdrawal percentages while accounting for asset allocation, distribution periods, and the uncertain market returns over rolling 30-year periods using historical stock market data of the S&P500 from 1926 to 1995. ...
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Counterparty risk in the form of investment fraud damages a retiree’s nest egg. Does fraud negatively impact portfolios that are both stock and bond-heavy equally? This study uses Monte Carlo analysis within the Trinity Study framework to determine the average reduction in portfolio success of a retiree who experiences fraud. Findings suggest that each incidence of fraud results in a loss of three percentage points in retirement success. However, portfolios containing some bonds (75/25, 50/50, and 25/75) outperform all equity (and all bond) allocations, particularly when fraud is present. On average, each incident of fraud reduces the chance the victim will enjoy a successful retirement by nearly 3%. Various limitations, implications, and future research possibilities are discussed.
... To ensure comparability across 3 Note that while constructing strategies which differ across two dimensions (2×2) would result in four different strategies, we only use three of them as the combination fluctuating withdrawals and risk-free asset allocation could lead to confusion in a hypothetical choice scenario. 4 Besides its simplicity, a similar decumulation strategy was originally developed by Bengen (1994) and Cooley et al. (1998). different planning horizons, we selected the withdrawal rate w such that the default probability remains constant at 10% (i.e., a higher withdrawal amount for shorter horizons). ...
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We field a large online survey to study preferences and hypothetical product choices for phased withdrawal accounts and compare their demand to the demand of annuities. We find that most individuals prefer phased withdrawal accounts with dynamic withdrawal rates and equity-based asset allocation. Additionally, when offered the opportunity to exchange the phased withdrawal account with an annuity, most individuals decline to annuitize. Our results suggest that policymakers should consider offering combined solutions of phased withdrawals and annuities. Retirees who are averse to full annuitization could preserve some of their accumulated wealth while also acquiring protection against longevity risk.
... These, in part, demonstrate the increasingly financialised strategies of its advocates. In 1998, an academic study (Cooley et al. 1998) was published that underpins a key financial metric for FIRE participants. Known popularly as the 'Trinity Study,' it explored the question of what constitutes a sustainable or safe 'withdrawal rate' for retirees seeking to plan how much they take from their investment portfolio annually, so as to deliver a decent pension without running down the pot too quickly. ...
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The Financial Independence Retire Early (FIRE) community consists of individuals each personally dedicated to reducing consumption, so as to build up financial surpluses that are eventually adequate to live off. While it shares certain features in common with other ‘financial independence’ ideologies and self-help communities, one thing that distinguishes it is the emphasis on frugality. Freedom comes to consist not only in independence from the labour market, but also from materialism, consumerism, and consumer debt. At the same time, this freedom is predicated on passive investment in the stock market and reliance on financial techniques for representing the future. Using semi-structured interviews with leading FIRE advocates and analysis of books and blog content, this paper assesses the ambivalent moral economy of FIRE, to understand how and why individuals seek this unusual relationship to capitalism, that pursues the status of rentier through the strategic rejection of materialism.
... Cette règle de gestion est en plein essor depuis que le planificateur financier WilliamBengen (1994) a déterminé la « safe withdrawal rate ».Cette règle empirique, énonce que les retraités qui dépensent 4 % de leur portefeuille chaque année ont peu de chances de manquer d'argent au cours de leur période de retraite. Plusieurs années plus tard, « the Trinity Study » (ainsi nommée parce qu'elle a été publiée parCooley et al. (1998) professeurs à l'Université Trinity) a corroboré les conclusions de Bengen. L'étude conclut, en effet, que les retraités prélevant entre 3 % et 4 % de leur capital financier, avec des ajustements annuels fonction de l'inflation, avaient une probabilité de près de 95% de disposer d'un tel revenu pendant au moins 30 ans, en supposant une l'allocation de départ constituée de 50% d'actions et de 50% d'obligations. ...
Chapter
In retirement, a major concern is to not outlive one’s savings.
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