Retirement income
If not 4%, what’s a sustainable withdrawal rate?
December 08, 2022
A growing body of Vanguard research indicates that the old 4% rule for sustainable portfolio withdrawals in retirement is no longer feasible. But what is a more realistic figure? Our latest work suggests a range of potential rates depending on one’s desired bequest level, portfolio depletion risk, and asset allocation.
“What many might find surprising is that, among the three factors considered in our study, asset allocation will likely have the least impact on moving the dial when it comes to the sustainable withdrawal rate (SWR),” said Kevin Khang, head of active research in Vanguard Investment Strategy Group (ISG) and co-author of the paper. “A lot of past literature on SWR focuses on asset allocation, but it’s based on long-term historical returns spanning many decades. In today’s environment, the expected equity risk premium over fixed income is not as high.”
“Desired bequest levels and portfolio depletion risk are bigger factors in determining SWR,” said Vanguard Investment Strategist David Pakula, the paper’s other co-author. “In fact, because of that, most of our hypothetical scenarios focused mainly on the impact of those two factors and assumed an asset allocation of 50% stocks and 50% bonds.”
While asset allocation itself may not be as crucial, the projected return environment would clearly impact the SWR. The bar chart below indicates the optimal SWR depending on different investment and inflation scenarios further parsed by the retiree’s desired bequest level and portfolio depletion risk tolerance.
“We see SWRs approaching or exceeding the old 4% rule only in our most optimistic investment scenario and for the more risk-tolerant retirees with no desire to leave a bequest,” Khang said. “It illustrates the need for customization for each investor. Relying on old rules of thumb could mean prematurely depleting the portfolio.”
Sustainable withdrawal rates based on retiree profiles and investment scenarios
Notes: The hypothetical investor profiles are based on desired bequest level as a percentage of initial portfolio balance and the probability of not depleting a portfolio over 30 years while still meeting the desired bequest level. Investor A has a 50% bequest level and 95% probability of success, Investor B a 25% bequest and 85% probability, Investor C no bequest and 85% probability, and Investor D no bequest and 70% probability. Investment scenarios are based on future expected returns for a balanced portfolio (50% U.S. stocks and 50% U.S. bonds) and future inflation rates. The downside scenario assumes returns in the bottom 25th percentile in the distribution of potential returns and inflation in the top 25th percentile in the distribution of potential rates, the baseline scenario assumes median returns and median inflation, and the upside scenario assumes returns in the top 25th percentile and inflation in the bottom 25th percentile. For more details, please refer to the paper.
Source: Vanguard calculations, using data from Vanguard Capital Markets Model® (VCMM).
IMPORTANT: The projections and other information generated by the VCMM regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Distribution of return outcomes from the VCMM are derived from 10,000 simulations for each modeled asset class. Simulations are as of March 31, 2022. Results from the model may vary with each use and over time. For more information, please see the Notes near the bottom of this web page.
For more details on the impact of each factor on SWR, please refer to the paper.
Related links:
- Sustainable withdrawal rates by return environment: A time-varying Bayesian analysis (article in The Journal of Retirement, issued November 2022)
- When inflation volatility spikes: Setting a realistic withdrawal rate (article, issued April 2022)
- What can new retirees withdraw from a portfolio? A scenario analysis (6-page research paper, issued April 2022)
- Assessing plans for retirement and beyond (compendium of retirement-related articles, most issued in October 2022)
Notes:
All investing is subject to risk, including the possible loss of the money you invest. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income. Diversification does not ensure a profit or protect against a loss.
Bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer’s ability to make payments.
IMPORTANT: The projections and other information generated by the Vanguard Capital Markets Model regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. VCMM results will vary with each use and over time.
The VCMM projections are based on a statistical analysis of historical data. Future returns may behave differently from the historical patterns captured in the VCMM. More important, the VCMM may be underestimating extreme negative scenarios unobserved in the historical period on which the model estimation is based.
The Vanguard Capital Markets Model® is a proprietary financial simulation tool developed and maintained by Vanguard’s primary investment research and advice teams. The model forecasts distributions of future returns for a wide array of broad asset classes. Those asset classes include U.S. and international equity markets, several maturities of the U.S. Treasury and corporate fixed income markets, international fixed income markets, U.S. money markets, commodities, and certain alternative investment strategies. The theoretical and empirical foundation for the Vanguard Capital Markets Model is that the returns of various asset classes reflect the compensation investors require for bearing different types of systematic risk (beta). At the core of the model are estimates of the dynamic statistical relationship between risk factors and asset returns, obtained from statistical analysis based on available monthly financial and economic data from as early as 1960. Using a system of estimated equations, the model then applies a Monte Carlo simulation method to project the estimated interrelationships among risk factors and asset classes as well as uncertainty and randomness over time. The model generates a large set of simulated outcomes for each asset class over several time horizons. Forecasts are obtained by computing measures of central tendency in these simulations. Results produced by the tool will vary with each use and over time.
Contributors
David Pakula
Vanguard Information and Insights
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