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Splurging in retirement?

By Barbara Whelehan ·
Friday, February 11, 2011
Posted: 4 pm ET

At a recent editorial meeting here at Bankrate, one of my colleagues suggested we run a story challenging the rule that retirees withdraw no more than 4 percent from their portfolios during retirement. It seemed to him that the rule was too rigid and not applicable in every situation. For example, if a retiree's portfolio had strong capital gains one year, why not take out some extra money and use it for a major purchase, like a car, instead of taking out a car loan?

That argument flew in the face of everything I'd read over the years in the Journal of Financial Planning and elsewhere. I piped up that scores of studies have shown that 4 percent to 5 percent was the most retirees dared to withdraw from their portfolios if they wanted retirement income to last for 30 years. Those precious flush market gains help investors get through the tough times, I said. Furthermore, T. Rowe Price just published a study showing that, over the previous decade, when investors experienced two nasty bear markets, retirees would have fared better if they'd reduced their withdrawals for a period of three years after each market bottom.

Maybe I've been brainwashed. Or maybe my colleague is too cavalier about retirement planning.

The study's findings

Let's go back in time for a moment to Jan. 1, 2000. It would have seemed like an ideal time to retire. Over the previous two decades, stock market investors enjoyed outsized double-digit gains (on an annualized basis, nearly 18 percent), culminating in 20 percent-plus returns in each of the five years from 1995 through 1999. It all seemed like sunny days would be ahead. But in hindsight, the sunny days were behind us. The following decade produced violent storms.

The study examined the effects of market turbulence on a portfolio worth $500,000 on Jan. 1, 2000. The retiree -- let's call him Sam -- planned to withdraw 4 percent, or $20,000, the first year, increasing that annual withdrawal amount each year by 3 percent, in line with expected inflation. Sam's portfolio had 55 percent invested in stocks and 45 percent in bonds. At the outset, this portfolio's odds of success in generating enough income for 30 years were pretty good at 89 percent, according to the study.

The table below shows how much that $500,000 portfolio would be worth as of Dec. 31, 2010, under four different scenarios.

Portfolio outcomes after a tough decade
Account status Portfolio value Monthly withdrawal amount Odds of success*
At retirement on Jan. 1, 2000 $500,000 $1,667 89%
Results as of Dec. 31, 2010, assuming four different strategies:
OPTION 1: Continue withdrawals as planned $334,578 $2,307 29%
OPTION No. 2: Reduced withdrawals by 25% for three years after each bear market bottom $386,113 $1,493 84%
OPTION No. 3: Take no annual inflation adjustments for three years after each bear market bottom $352,367 $1,990 69%
OPTION No. 4: Switched to 100% bond portfolio after first bear market bottom on Oct. 1, 2002 $270,669 $2,307 0%
Source: T. Rowe Price Associates.
*Represents the percentage of total simulations in which the investor does not run out of money during a 30-year retirement period. The odds of success on January 1, 2000, reflect the initial investment and withdrawal assumptions. The odds of success at the various stages of the options reflect historical return data and any changes in the investment or withdrawal assumptions and projections thereafter. For historical returns, the S&P 500 Index is used for stocks and the Barclays Capital U.S. Aggregate Index is used for bonds. For simulations, stocks are expected to return 10% overall with a standard deviation of 15% and fees of 1.211%; bonds are expected to return 6.5% with a standard deviation of 5% and fees of 0.726%. Portfolios are rebalanced monthly, and withdrawals are made monthly. This example does not take into account taxes or required minimum distributions from retirement plans.


If Sam had taken his withdrawals as planned, his portfolio would have dwindled to a dangerously low level -- and his odds of success in having enough money for another 20 years would be 29 percent. That's not good. If, at the end of the bear market in September 2002, Sam had bailed out of stocks and switched to a 100 percent bond position, his portfolio would be seriously decimated. The study gives him a zero percent chance of having enough money for retirement, using Monte Carlo simulations -- which are sophisticated projections of 10,000 possible future market scenarios. Zero percent is, well, really bad. Let's face it, 10 years into retirement, it's tough to think about putting together a resume and pounding the pavement.

The best outcome occurred if Sam had reduced withdrawals by 25 percent for three years after the market hit bottom in September 2002. His chances of making it another 20 years would be 84 percent -- not fantastic, but pretty good. If he'd continued taking 4 percent withdrawals without the extra money for inflation, his chances of success would be 69 percent.

Christine Fahlund, a senior financial planner with T. Rowe Price, notes in the study that retirees need to pay attention rather than take a passive approach as they take withdrawals. And selling equities at the market bottom is a bad move since investors miss out on a subsequent rebound, she notes.

What if a retiree enjoys big market gains one year? Should the 4 percent withdrawal rule prevent him or her from splurging on a big-ticket purchase? "One year of robust cap gains is not a reason to spend that money on a car," says Fahlund. "You need up years to offset the down years."

I'd love to hear how retirees managed their portfolios through the last decade. What do you think of the 4 percent rule? How did you get through the tough times? Share your insights.


Check out Bankrate's Retirement Realities series. We'll be adding stories to it throughout the year.

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Wade Pfau
February 28, 2011 at 1:53 am

Dear Barbara,

I just posted this comment on your colleague's newest blog entry:

"Thank you for writing about my new article. I think you did a great job representing it here.

I would like to just add one comment. When you mention about the concerns with withdrawing 5% or more, I do share those concerns. An implication of my research is that sometimes it is okay to withdraw much more than 4%, such as for a new retiree in 1982, for example.

But for recent retirees since about 1995, I am much more concerned about 4% being too high rather than too low. In this regard, I share the concern of your colleague Barbara Whelehan that now is not the time to be discussing higher withdrawal rates.

An implication of my "safe savings rates" is that retirees should have saved enough that they can meet their desired retirement expenses using a withdrawal rate below 4%. Because of the concern I just mentioned, I don't think that 4% can be considered as a safe withdrawal rate for recent retirees.

Thank you again and best wishes, Wade Pfau"

Dear Patricia:

Your comment is a little frightening because I did some research on this very topic. When you say that you've been withdrawing 7% each year, do you mean 7% of your remaining portfolio balance, or 7% of your initial $2 million. If it's the latter, my research suggest that you may be on the path to running out of wealth in the not-too-distant future. If you are interested, please see my paper:

"Will 2000-Era Retirees Experience the Worst Retirement Outcomes in U.S. History? A Progress Report after 10 Years."

February 21, 2011 at 10:37 pm

I entered 2000 with a $2M portfolio---85% stocks--and it got decimated down to $1M and I hung in and it is back up to $1.5M. I still have 85% equities. I probably pulled out about 7% a year so if I hadn't done that, it would be a bit higher now. Now I am really cutting back in the hopes of growing the portfolio back up the the original $2M. it has been a hair raising and non sleeping time of it and I have felt my money managers pretty much bailed on me. My portfolio went down like a rock in a lake and no one did one thing but watch. Ride it out is all the advice I heard from them. I am still a wreck but I know a lot are way worse off than I am. Horrible time.