or
How 5% turns out to be less than 2.5%!
or
What Scott Burns should have said.
By withdrawing a constant percentage of his portfolio's current balance (instead of automatically adjusting withdrawals to match inflation), a retiree avoids the possibility that he will run out of money.
However, the amount that he withdraws can fall to a very low level.
The Data
Here are the amounts withdrawn when one removes 5% of his portfolio's current balance after adjusting for inflation (i.e., using real dollars). These are based upon an initial balance of $100000. Expenses were set at zero.
These data were taken using the latest version of my Deluxe Calculator 1.1V08, which is a modified version of the Retire Early Safe Withdrawal Calculator, Version 1.61 dated November 7, 2002. The calculator was set up with an initial withdrawal amount equal to zero and expenses (which is the sum of the withdrawal percentage of the current balance and the actual portfolio maintenance expenses) set at 5.0%. I used TIPS with a 2% real interest rate for allocations other than stocks.
[Note: dummy values are used for stock returns after 2002. They are set for heavy losses. Thirty-year historical sequences starting in 1973-1980 include dummy data values at the end of their sequences.]
[Note: You can do a similar calculation on FIRECalc. However, all balances in FIRECalc are in nominal dollars. You have to adjust for inflation manually.]
With 50% stocks and 50% TIPS at 2% interest, these are the 5-year rolling averages of the amounts withdrawn at years 5, 10, 20 and 30. Each year's withdrawal is 5% of the current balance.
Year, 100E10/P, at year 5, at year 10, at year 20, at year 30
Code: Select all
1921 19.61 5200 6958 6451 4989
1922 15.87 5660 7359 6341 5264
1923 12.20 5623 6789 5624 5153
1924 12.35 6089 6435 5399 5314
1925 10.31 6290 5814 4997 5295
1926 8.85 5913 5018 4450 5033
1927 7.58 5892 5070 4417 5220
1928 5.32 5062 4642 3881 4730
1929 3.69 4100 4048 3280 4192
1930 4.48 3900 4145 3269 4374
1931 5.99 4080 4457 3447 4776
1932 10.75 5176 5183 4303 5959
1933 11.49 6280 5674 5198 7066
1934 7.69 5399 4588 4516 6000
1935 8.70 5911 4780 5065 6505
1936 5.85 4930 4002 4525 5528
1937 4.63 4151 3612 4268 4942
1938 7.41 4640 4294 5233 5844
1939 6.41 4322 4121 5267 5632
1940 6.10 4349 4241 5674 5704
1941 7.19 5184 4939 6843 6533
1942 9.90 5732 5470 7575 6927
1943 9.80 5417 5363 7290 6392
1944 9.01 5063 5227 6944 5779
1945 8.33 4823 5241 6731 5234
1946 6.41 4826 5728 6997 5093
1947 8.70 5382 6664 7717 5358
1948 9.62 5503 6774 7564 4937
1949 9.80 5485 6791 7262 4480
1950 9.35 5985 7370 7409 4557
1951 8.40 5746 6707 6403 4007
1952 8.00 5637 6305 5765 3577
1953 7.69 5712 6308 5531 3421
1954 8.33 6000 6439 5359 3448
1955 6.25 5336 5566 4328 2981
1956 5.46 5059 5294 3853 2828
1957 5.99 5246 5432 3771 3007
1958 7.25 5669 5733 3741 3296
1959 5.56 5020 5002 3085 2942
1960 5.46 5124 4938 3038 3046
1961 5.41 5223 4766 2982 3108
1962 4.72 5016 4430 2748 2994
1963 5.18 5299 4595 2842 3208
1964 4.63 4985 4163 2679 3072
1965 4.29 4752 3834 2641 3015
1966 4.15 4596 3667 2691 3079
1967 4.90 4849 3812 3040 3442
1968 4.65 4686 3527 3108 3532
1969 4.72 4617 3410 3251 3835
1970 5.85 4792 3653 3663 4527
1971 6.06 4595 3604 3757 4823
1972 5.78 4354 3436 3744 4884
1973 5.35 4190 3444 3888 4925
1974 7.41 4712 4106 4707 5525
1975 11.24 5270 4761 5435 5732
1976 8.93 4611 4315 4937 4515
1977 8.77 4539 4586 5193 4009
1978 10.87 5038 5402 6139 3943
1979 10.75 5290 5788 6829 3580
1980 11.24 5377 5967 7375 3116
1981 10.71 5178 5768 7404
1982 13.48 5709 6155 8030
At year 5: y = (16064/[P/E10] ) + 3923.9 and R-squared is 0.4117.
At year 10: y = (30366/[P/E10] ) + 2733.4 and R-squared is 0.4701.
At year 20: y = (47737/[P/E10] ) + 1307.6 and R-squared is 0.5244.
At year 30: y = (27716/[P/E10] ) + 2862.5 and R-squared is 0.2057.
With 80% stocks and 20% TIPS at 2% interest, these are the 5-year rolling averages of the amounts withdrawn at years 5, 10, 20 and 30. Each year's withdrawal is 5% of the current balance.
Year, 100E10/P, at year 5, at year 10, at year 20, at year 30
Code: Select all
1921 19.61 5881 10004 9772 7634
1922 15.87 6342 10125 8926 7745
1923 12.20 6171 8664 7260 7329
1924 12.35 7111 8043 6928 7812
1925 10.31 7325 6668 6027 7632
1926 8.85 6770 5441 5198 7256
1927 7.58 6596 5512 5103 7618
1928 5.32 5166 4815 4170 6548
1929 3.69 3700 3846 3197 5408
1930 4.48 3538 4127 3303 6019
1931 5.99 3873 4707 3677 7078
1932 10.75 5770 6087 5281 10214
1933 11.49 7255 6523 6585 12376
1934 7.69 5688 4713 5314 9633
1935 8.70 6566 5087 6442 11075
1936 5.85 4942 3884 5422 8650
1937 4.63 3811 3345 4993 7344
1938 7.41 4682 4510 7081 9866
1939 6.41 4174 4187 7083 9277
1940 6.10 4161 4298 7833 9363
1941 7.19 5221 5189 9988 11030
1942 9.90 6280 6210 12010 12407
1943 9.80 5864 6146 11551 11205
1944 9.01 5267 5919 10729 9610
1945 8.33 4850 5946 10222 8231
1946 6.41 4488 6304 10056 7278
1947 8.70 5578 8422 12388 8275
1948 9.62 6050 9063 12628 7597
1949 9.80 6125 9218 12073 6582
1950 9.35 6642 9873 11803 6373
1951 8.40 6341 8689 9596 5325
1952 8.00 6278 8042 8308 4555
1953 7.69 6363 7983 7744 4216
1954 8.33 6907 8319 7451 4301
1955 6.25 5743 6643 5349 3414
1956 5.46 5211 6067 4390 3090
1957 5.99 5485 6298 4207 3380
1958 7.25 6267 6960 4187 3959
1959 5.56 5210 5666 3089 3332
1960 5.46 5359 5539 2991 3502
1961 5.41 5556 5270 2925 3630
1962 4.72 5199 4678 2565 3410
1963 5.18 5664 4947 2694 3796
1964 4.63 5169 4258 2458 3552
1965 4.29 4777 3722 2375 3422
1966 4.15 4495 3429 2414 3497
1967 4.90 4894 3634 2920 4176
1968 4.65 4615 3179 3006 4334
1969 4.72 4466 2956 3189 4891
1970 5.85 4785 3316 3883 6400
1971 6.06 4518 3286 4079 7109
1972 5.78 4119 3042 4045 7187
1973 5.35 3732 2950 4157 7040
1974 7.41 4445 3876 5603 8434
1975 11.24 5523 5086 7326 9339
1976 8.93 4533 4386 6355 6454
1977 8.77 4383 4768 6821 5263
1978 10.87 5111 6114 8813 5034
1979 10.75 5369 6642 10187 4177
1980 11.24 5533 7036 11598 3357
1981 10.71 5282 6776 11809
1982 13.48 6328 7735 13743
At year 5: y = (26132/[P/E10] ) + 3397.2 and R-squared is 0.4056.
At year 10: y = (50640/[P/E10] ) + 1813.4 and R-squared is 0.4329.
At year 20: y = (92196/[P/E10] ) + 490.71 and R-squared is 0.4847.
At year 30: y = (49066/[P/E10] ) + 2950.1 and R-squared is 0.1962.
Remarks
Withdrawing a constant percentage of the current balance never causes a portfolio balance to fall to zero. The buying power of the amounts withdrawn drops quite a bit.
All initial balances were $100000 in this study.
The mid-1960s, especially 1965 and 1966, were the worst case. With 50% stocks, the buying power dropped between $2600 and $2700 at year 20 before rising later on. With 80% stocks, there was a lot of variation. But the 5-year average withdrawal amount at year 20 fell all of the way down to $2375 during the worst case (1965) sequence.
There are many examples of higher returns at year 20, but not when starting with stocks at high valuations.
If we apply the formulas directly at year 20, the amounts withdrawn are calculated to be $3012 with 50% stocks and $3783 with 80% stocks when P/E10 equals 28. The spread in the data (i.e., the amount of randomness or uncertainty) is much greater with 80% stocks than with 50% stocks. The odds are better than 50-50 that the (80%) high stock portfolio will do better than the (50%) balanced portfolio, but the Safe Withdrawal Rate of the balanced portfolio is higher. Visual projections suggest that today's Safe Withdrawal Rate is close to 1.6% to 1.7% with 80% stocks and 2.5% with 50% stocks.
The cause and effect relationship to the traditional withdrawal method is straightforward. Withdrawing 5% of the current balance at times of high valuation means higher withdrawals in the earlier years and lower withdrawals later on.
Have fun.
John R.