Withdrawal Rates

A reader passed along a very dense paper that attempted to transform the conversation about safe withdrawal rates into a conversation about "safe savings rates." The paper was very wordy (kettle calling the pot?) and frankly I found the term safe savings rate to be misleading--not in a deceitful way but in a poorly communicated way. I think the point was to sort of work backwards to calculate how much you need to save to have enough money such that your portfolio replaces half of your final salary without depleting.

Some of the assumptions included 30 years of accumulation followed by 30 years of "decumulation" and maintaining a 60/40 equities/fixed income target throughout. The article focused a lot on when you retire, in relation to the stock market being low or high, as going a long way toward determining safe withdrawal rates and "safe savings rates."

Of interest to me was the data show the variability in what constituted a safe withdrawal rate. About the lowest safe withdrawal rate was the familiar 4% with the higher safe withdrawal rates being between 8-10%. Again this depends when you retire which is largely a function of luck in relation to the stock market cycle. It is very likely, based on the data on this paper, that someone who retired December 31, 2008 will be able to safely withdraw a higher percentage than the person who retired one year later after the market had gone up 25%. The chart of safe withdrawal rates was very volatile.

It is important to understand what the 4% rule really is. The idea is that by sticking to 4% a retiree gives themselves the best chance of not outliving their money, it is sort of a worst case scenario strategy which I think is prudent. There is nothing that says a 10% withdrawal rate can't work, it could. It would depend on variables that are beyond ones control making 10% imprudent but it could work. The lower the withdrawal rate the better the chance for success but there are no guarantees with any withdrawal rate--realistically it would be difficult to fail with a 1.5% rate unless there was some sort of medical catastrophe that had to be paid for out of pocket.

The concept of safe saving seemed to be about figuring how much to save but if I read it correctly (and I may not have, it really was wordy) it relies on a lot of assumptions about future unknowable events but at least it called for very high savings rates (most of the time). While plenty of people will disagree with me on this I think articles showing the need for very high savings rates have a better chance for metaphorically hitting people in the face with some reality and understanding of how far behind they might be. Collectively we are woefully behind where we need to be.

You might be able to get more out of the article than I did but I would circle back to a few points I have made before that seem to often be overlooked in these types of articles. First is linear returns; the paper took actual data and derived averages based on a retirement starting every year going back to 1901 so these were real market experiences although really not real experiences of people. The assumption of linear returns can muddy the waters in terms of taking the same $40,000 out when the market is up 20% versus flat versus down 15% and of course the one off events that occur every month. Beware of assumptions of linear returns.

I would also focus on replacement of some portion of your expenses not your income. For people who live below their means (hopefully that is you) replacing expenses becomes much easier to do. If you make $10,000/month and live off of $4000 while you work, in retirement the savings rate would go down (probably to zero) and the tax bill would drop by at least $1400/month (the FICA) and maybe more depending on the circumstance. If the $4000 includes a mortgage that will be paid off then all the better. If the goal is replacing 50% of expenses then at this point the portfolio only needs to be $600,000 which is not inconsiderable but much easier than $1.25 million to replace half of a $100,000 income. Of course none of that offers a guarantee and it ignores the one-offs that come every month (examples include vet bills, car repairs, home repairs, dental incidents and so on).

For now my thoughts remain save as much as possible, live below your means, plan on working a few hours a week doing something you love after you've "retired," don't take more than 1% per quarter (or better yet take less) and because this has been a source of humor and teasing over the years; don't drink soda.

Also, don't plan on getting social security and medicare. It would be better to plan on not getting them and being wrong than to plan on getting them and be wrong about that. I'll mention my not too popular idea again of paying in the full $17,000, getting nothing out but letting me contribute to my SEP with no limits and writing off the entire contribution.

The events of the last four years hurt a lot more people than most of us have seen hurt in a single financial event. The financial crisis drew comparisons to the great depression but not everyone was seriously damaged 80 years ago and not everyone was seriously damaged over the last fours years either. While being prudent and conservative will not ensure anything I have to believe the more prudent and conservative a person was the less likely they were to be seriously damaged.