Aren't we all unique and worthy of our very own "safe withdrawal rate"? (Archived Blog)

Recently, a colleague and I were discussing “Financial Rules-of-Thumb”.  The conversation was mostly about how much we disliked the notion of rules-of-thumb and which ones we thought were the most damaging to the general public.  Near, or at the top of both our lists, was the “safe withdrawal rate of 4.5%” rule-of-thumb.


While this rule-of-thumb is a great place to start the conversation, it’s only the tip of the iceberg when it comes to retirement income planning.  With such an important topic one must also consider:      



In order to fully understand the disdain for the rule-of-thumb let’s briefly consider the actual research around safe withdrawal research itself and the all-important underlying assumptions.


In (1994), William Bengen famously coined the term “SAFEMAX” and the notion of a 4% safe withdrawal rate.  Later research, built on Bengen’s work, and included additional assumptions, such as: asset allocation of an adequately diversified portfolio, 60% in US equities and 40% in fixed income; rebalancing strategies with rules about cash set aside; and a handful of other assumptions.  With the additional research the “safe withdrawal rate” increased to 4.5%.  This seems to be where the rule-of-thumb is derived.


It’s very important to note that all of the safe withdrawal research relies heavily upon important underlying assumptions.  With regard to the research supporting the rule-of-thumb notion, the following highlights a few of those assumptions:


  • The INITIAL withdrawal from the portfolio is 4.5% and
  • Subsequent ANNUAL DRAWS REMAIN THE SAME or high, only adjusted for inflation. 
  • Portfolio is 60% in US equities and 40% in fixed income
  • Portfolio is rebalanced annually with rules about what to do with replenishing cash.


In other words it assumes a steady and relatively consistent annual draw from the portfolio.  First problem, what if you need or want a lump-sum here and there? And what if you don’t need or want to take the ‘maximum’ safe rate, can you make it up in later years, and how do you track that?


To highlight this problem, rarely do we see an even withdrawal pattern.  More often we see an uneven pattern with a higher draws early on and a lull after a few years followed by an up-tic in later years.  This makes sense when you consider the following typical spending cycle in retirement.  Very often, upon retirement people have some pent up demand for such things as extended travel plans or desire to complete a big project (such as building the cabin in the woods).


Then after some time it’s common to see activity slows a bit and the needs from the portfolio often drop as well.  Sometimes spending becomes less discretionary and more determined by necessary services, such as health care and support services.


An additional problem with the pigeonhole, rule-of-thumb is that it makes discussion about other planning opportunities, such as Social Security maximization non-existent.


The biggest problem I have with rules-of-thumb is that it creates a false sense of security or worse, it can lead people to make sacrifices they don’t need to make like skipping that dream vacation or skimping when they could otherwise be enjoying life.


The point here is that, while in some cases consistent draw from the portfolio is warranted, in many cases it is not.  The rule-of-thumb is a great conversation starter, but rarely applies to anyone.

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