Abstract

http://ssrn.com/abstract=2201323
 
 

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The 4 Percent Rule is Not Safe in a Low-Yield World


Michael S. Finke


Texas Tech University

Wade D. Pfau


The American College

David Blanchett


Morningstar Investment Management

January 15, 2013


Abstract:     
The safety of a 4% initial withdrawal strategy depends on asset return assumptions. Using historical averages to guide simulations for failure rates for retirees spending an inflation-adjusted 4% of retirement date assets over 30 years results in an estimated failure rate of about 6%. This modest projected failure rate rises sharply if real returns decline. As of January 2013, intermediate-term real interest rates are about 4% less than their historical average. Calibrating bond returns to the January 2013 real yields offered on 5-year TIPS, while maintaining the historical equity premium, causes the projected failure rate for retirement account withdrawals to jump to 57%. The 4% rule cannot be treated as a safe initial withdrawal rate in today’s low interest rate environment. Some planners may wish to assume that today’s low interest rates are an aberration and that higher real interest rates will return in the medium-term horizon. Although there is little evidence to support this assumption, we estimate how a reversion to historical real yields will impact failure rates. Because of sequence of returns risk, portfolio withdrawals can cause the events in early retirement to have a disproportionate effect on the sustainability of an income strategy. We simulate failure rates if today's bond rates return to their historical average after either 5 or 10 years and find that failure rates are much higher (18% and 32%, respectively for a 50% stock allocation) than many retirees may be willing to accept. The success of the 4% rule in the U.S. may be an historical anomaly, and clients may wish to consider their retirement income strategies more broadly than relying solely on systematic withdrawals from a volatile portfolio.

Number of Pages in PDF File: 15

Keywords: retirement, systematic withdrawals, 4% rule, safe withdrawal rates

JEL Classification: C15, D14, G11, G17

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Date posted: January 16, 2013 ; Last revised: January 17, 2013

Suggested Citation

Finke, Michael S. and Pfau, Wade D. and Blanchett, David, The 4 Percent Rule is Not Safe in a Low-Yield World (January 15, 2013). Available at SSRN: http://ssrn.com/abstract=2201323 or http://dx.doi.org/10.2139/ssrn.2201323

Contact Information

Michael S. Finke
Texas Tech University ( email )
2500 Broadway
Lubbock, TX 79409
United States
Wade D. Pfau (Contact Author)
The American College ( email )
Bryn Mawr, PA 19010
United States
HOME PAGE: http://www.retirementresearcher.com
David Blanchett
Morningstar Investment Management ( email )
22 W Washington
Chicago, IL 60602
United States
859-492-5637 (Phone)
HOME PAGE: http://www.davidmblanchett.com
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