A Safer Safe Withdrawal Rate Using Various Return Distributions

Athavale, Manoj; Goebel, Joseph M.
July 2011
Journal of Financial Planning;Jul2011, Vol. 24 Issue 7, p36
Academic Journal
• A common conundrum faced by most people approaching retirement is the amount of money they can safely withdraw from their retirement portfolio without the risk of depleting the portfolio over their retirement horizon. The advice that most retirees will hear is the 4 percent rule-a retiree who faces normal retirement conditions can make an annual inflation-adjusted withdrawal equal to 4 percent of the original portfolio without risk of depleting the portfolio. • This rule of thumb has helped bring a disciplined approach to retirement withdrawal strategy. However, tests of the 4 percent rule using simulation methodology have assumed that expected returns are drawn from a lognormal distribution-an assumption that lacks empirical support. • The important question, therefore, is whether the choice of method used to represent the future affects estimates of the sustainability of a retirement portfolio. • We test the 4 percent rule by creating plausible retirement scenarios using standard methodology, but assuming that expected returns can conform to various distributions. •Our analysis indicates that a 4 percent withdrawal rate will result in portfolio failure with greater probability (18 percent) than previously believed, and the truly "safe" withdrawal rate-2.52 percent-is significantly smaller than previously believed.


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