Let’s say you are ready to retire or planning for retirement. You are decided to save $1,000,000 (or another arbitrary number) by age 65 (or another age), and would like to start withdrawing from your portfolio every year. How much can you withdraw and not run out of money? A few factors come into play:
- Time Horizon: the longer the time in retirement, the less money you can withdraw annually
- Return: the greater the expected portfolio return, the more money you can withdraw per year
Trinity study summarized here by RBC Wealth Management outlines different asset mix scenarios (i.e. 100% percent stocks vs. 100% bonds) as well as a variety of retirement horizons in order to determine a safe withdrawal rate for a particular investor.
For simplicity, portfolio allocation was restricted between two assets (1) SP500 and (2) Government Bonds. Then the results were summarized in tables to help an investor decide his or her optimal withdrawal rate (see below table for reference)
Let’s take a typical 30 year retirement, for example (bottom left table below):
- Since 1926 an investor experienced multiple 30 year withdrawal periods. One investor may have started to withdraw in 1926 (withdrawals assumed to end in 1956). Another investor, for example, could have started withdrawing in 1950 and finished by 1980 etc.
- Safe withdrawal rate: the table below demonstrates that the safe withdrawal rate for a 30 year withdrawal period lies between 0% and 4%, assuming an investor is not willing to run out of money
- Safe Investments are not safe: safe investments do not bring about withdrawal safety.
- For example, if an investor allocated 100% of a retirement portfolio to fixed income, a 4% withdrawal rate would only result in 41% success rate (59% of investors would run out of money).
- At 5% withdrawal rate many portfolios begin to fail. This is true for all time horizons and asset allocation scenarios (although the degree of impact is different). 5% withdrawal rate is unsafe.
- Putting all your money into stocks did not work perfectly either. Assuming 4% withdrawal rate and 100% of allocation to SP500, approximately 7% of investors would go bankrupt and run out of money. And not everyone is able to withstand a 50% drawdown that can be experienced with equities.
- Ideal Asset Allocation: the safe asset allocation seems to be between 50% equities/50% fixed income and 75% equities/25% fixed income.
Everyone financial situation is different. However, for general financial planning purposes one can assume a portfolio withdrawal rate between 0% and 4%, and asset allocation of at least 50% equities.