With varying rates of withdrawal, how long does an investment portfolio actually last? That’s the question three professors from Trinity University in Texas wanted to know. They decided to examine the returns of various stocks and bonds from 1926 to 2009. Here are the five portfolios, each with different allocations, their study looked at:
For each portfolio, the researchers applied various withdrawal rates—ranging from 3% to 12%. The researchers made adjustments based on inflation during the period as well. They wanted to know, “How likely is it that an investor’s portfolio will last a lifetime?”
The Trinity study’s underlying premise, if certain withdrawal rates provide lifetime income based on historical market data and returns, then the withdrawal rate is sustainable for the future. However, there are a few problems with the study. First, there’s a danger in relying on historical data when it comes to returns. There’s no guarantee when it comes to the market’s performance for the future. Next, predicting how much a retiree can safely withdrawal yearly is difficult. Everyone’s situation is different, and there’s no single rate of withdrawal to make sure you won’t deplete your savings. Those without heirs could withdrawal more aggressively than those hoping to leave a financial legacy for future generations. Or perhaps your parents and grandparents died early, so based on your family history you think your portfolio only needs to last 20 years when it could turn out you need it to last much longer.
Most financial advisors agree that choosing a conservative withdrawal rate—typically 4 percent to 5 percent—minimizes the risk of emptying a nest egg prematurely. Of course, periodically adjusting a client’s withdrawal may be necessary, depending on circumstances. If a client decides to retire early, changing the withdrawal to a smaller amount could ensure the funds last longer. A client whose portfolio weakened during an economic downturn might make some adjustments. Perhaps they need to lower their withdrawal rate or the portfolio’s asset allocation.
As the following table illustrates, yearly withdrawals of 3 percent virtually guarantee a portfolio, no matter its investment mix, will last at least 30 years. Withdrawal rates of 4% and 5% also successfully ensured a portfolio would survive a lifetime; however, asset allocations within the portfolio were critical to this success. Once withdrawal rates reached 6 percent, the success rate began to decrease. If it reached 7 percent or higher, that posed a significant risk a lasting portfolio. The chances of running out of money during a retiree’s lifetime increase dramatically.
|Portfolio Composition / Payout Period||Withdrawal Rate as a Percent of Initial Portfolio Value|
|100% Stocks||Portfolio Success Rate|
|75% Stocks / 25% Bonds||Portfolio Success Rate|
|50% Stocks / 50% Bonds||Portfolio Success Rate|
|25% Stocks / 75% Bonds||Portfolio Success Rate|
|100% Bonds||Portfolio Success Rate|
|Cooley, Philip, Hubbard, Carl, and Walz, Daniel, “Portfolio Success Rates: Where to Draw the Line,” Journal of Financial Planning April 2011. Data for stock returns are monthly total returns to the Standard & Poor’s 500 Index, and bond returns are total monthly returns to high-grade corporate bonds. Both sets of returns data are from January 1926 to December 2009 as published in the 2010 Ibbotson SBBI Classic Yearbook by Morningstar. Inflation adjustments were calculated using annual values of the CIP-U as published by the U.S. Bureau of Labor Statistics at www.bls.gov.|
As always, don’t hesitate to contact us if you need help ensuring your nest egg is safe for years to come.