An International Perspective on Safe Withdrawal Rates from Retirement Savings: The Demise of the 4 Percent Rule?

For my first blog post, I would like to share some surprising results from my recently finished paper, “An International Perspective on Safe Withdrawal Rates from Retirement Savings: The Demise of the 4 Percent Rule?”  The full paper can be downloaded in PDF form from RePEc.  It is currently under review at The Journal of Financial Planning.
This paper challenges the “conventional wisdom” that withdrawing 4% of one’s retirement savings account balance at retirement, and then adjusting this amount in each subsequent year for inflation, is safe, in the sense that the strategy will not lead you to run out of savings for at least 30 years.  The problem is that most every study about these sustainable withdrawal rates is based on the same Ibbotson Associates’ Stocks, Bonds, Bills, and Inflation (SBBI) monthly data on total returns for US financial markets since 1926.  But the time period covered by this data may have been a particularly fortuitous one for the United States that will produce misleadingly large and dangerous “safe” withdrawal rates if asset returns fail to be so stunning in the future. 
In this study, I instead used 109 years of financial market data for the 17 developed market economies in the Dimson, Marsh, and Staunton (DMS) dataset.  I do this because I think it will provide a more realistic range of possibilities about what could happen in the future for US retirees, or in this regard, for retirees from any of these countries.
The table from the paper shown below provides some of the key results.  Basically, the table shows that only in 4 of the 17 countries was the safe or sustainable withdrawal rate above 4%.  This does require some more explanation.  First, “safety” is defined in terms of William Bengen’s SAFEMAX criteria.  It is the highest withdrawal rate that would have provided a sustained real retirement income without being exhausted for 30 years during every year of the historical period for the particular country. In other words, it is the maximum sustainable withdrawal rate from the worst-case retirement year. 
More importantly, while the table does illustrate some of the potential danger of a 4% real withdrawal rate (i.e. it failed in 13 of the 17 countries), this table is still too optimistic in favor of high withdrawal rates for two reasons.  First, this table provides a best-case scenario for increasing the SAFEMAX by assuming in each year for each country that the new retiree has perfect foresight to choose the fixed asset allocation that would maximize the withdrawal rate for the subsequent 30 year period. Obviously the assumption is not realistic and artificially inflates the SAFEMAX.  Second, to be consistent with most studies, the table assumes that mutual fund companies and financial advisers do not deduct any fees from the portfolio. Looking to the future, index funds and ETFs do provide very low administrative fees, making it more reasonable to ignore them, but retirees who invest in costly mutual funds must realize the strong impact it will have on their sustainable withdrawal rate.
Perspective on Safe Withdrawal Rates from Retirement Savings
 The next table fixes one of these overly optimistic assumptions.  While there are still no administrative fees, this next table shows the results for a specific asset allocation of 50% stocks and 50% bonds, rather than using the best possible allocation which could not have been known in advance.  This table overwhelmingly shows that a 4 percent withdrawal rate is not safe when using the SAFEMAX criteria for the DMS data with the 50/50 asset allocation. Indeed, the original result from William Bengen, which is listed as “US SBBI ITGB,” is the only case out of 20 with a SAFEMAX above 4 percent. For the DMS data, Canada’s SAFEMAX of 3.94 is the highest, followed by the US and Denmark with 3.66. Even with a willingness to accept a 10 percent chance of failure, a withdrawal rate of over 4 percent was possible only in 4 countries using the DMS data. The United States just missed being one of these countries, as its 10th percentile value is 3.98.  
Perspective on Safe Withdrawal Rates from Retirement Savings
The results have shown that from an international perspective, a 4 percent withdrawal rate has been anything but safe. With the perfect foresight assumption, only 4 of 17 countries could achieve it, while the 50/50 allocation for stocks and bonds shows no successes with the 17 countries in the DMS data.

But what to make of these results? First, a few caveats are in order. For one thing, researchers have demonstrated that including more financial assets, using dynamic rules to adjust market portfolios, and changing rebalancing strategies can all serve to increase safe withdrawal rates, but these modifications have not been incorporated here. As well, some of the worst outcomes were connected with World Wars I and II, and investors who are confident that world war is a relic of the past may feel comfortable ignoring those cases, or may at least assume that enjoying a comfortable retirement would be the last thing on their minds. On the other hand, the paper does already provide two important advantages to increase the SAFEMAXs, namely the perfect foresight assumption and the lack of administrative fees.

These findings may be rather frightening. After all, who but the wealthiest could possibly save enough to live comfortably from a 0.47 percent withdrawal rate? The results assume that historical patterns in each country will prevail in the future, though from the perspective of a US retiree, the issue is whether the future US will experience the same asset return patterns as the past US, or whether Americans should expect some kind of mean reversion that could lower asset returns to levels more in line with what other countries have experienced. It may be tempting to hope that asset returns in the twenty-first century United States will continue to be as spectacular as in the last century, but Jack Bogle cautions his readers in his 2009 book Enough, “Please, please please: Don’t count on it” (page 60).

So, please have a backup plan and don’t make your retirement completely dependent on a large assumed withdrawal rate from your savings!

Update on February 23, 2011:

Hello my Canadian friends from the Canadian Financial DIY blog. This article was intended for U.S. audiences to point out how well they had things compared to other countries.  But, actually, Canada experienced even better historical withdrawal rates than the U.S.!  I’m adding a figure below which shows the historical path of maximum sustainable withdrawal rates for Canada, in case that is something you haven’t seen before.

Perspective on Safe Withdrawal Rates from Retirement Savings

McLean Asset Management Corporation (MAMC) is a SEC registered investment adviser. The content of this publication reflects the views of McLean Asset Management Corporation (MAMC) and sources deemed by MAMC to be reliable. There are many different interpretations of investment statistics and many different ideas about how to best use them. Past performance is not indicative of future performance. The information provided is for educational purposes only and does not constitute an offer to sell or a solicitation of an offer to buy or sell securities. There are no warranties, expressed or implied, as to accuracy, completeness, or results obtained from any information on this presentation. Indexes are not available for direct investment. All investments involve risk.

The information throughout this presentation, whether stock quotes, charts, articles, or any other statements regarding market or other financial information, is obtained from sources which we, and our suppliers believe to be reliable, but we do not warrant or guarantee the timeliness or accuracy of this information. Neither our information providers nor we shall be liable for any errors or inaccuracies, regardless of cause, or the lack of timeliness of, or for any delay or interruption in the transmission there of to the user. MAMC only transacts business in states where it is properly registered, or excluded or exempted from registration requirements. It does not provide tax, legal, or accounting advice. The information contained in this presentation does not take into account your particular investment objectives, financial situation, or needs, and you should, in considering this material, discuss your individual circumstances with professionals in those areas before making any decisions.