This article was first posted on June 1, 2000.
With the publication of Prof. Shiller's new book Irrational Exuberance, and the release of his new monthly data series on stock market returns (see http://www.econ.yale.edu/~shiller/data.htm ), Retire Early has taken this opportunity to update the safe withdrawal spreadsheet first released in 1998. This new release uses Shiller's data from 1871 to 2000 and allows users to calculate withdrawal rates for pay out periods from 10 to 60 years.
This month Retire Early has expanded its safe withdrawal calculator to include pay out periods from 10 to 60 years. Retirees from age 35 to 80 can now use this spreadsheet to analyze their own asset allocations, investment expenses, and annual withdrawal rates.
The maximum "100% safe" withdrawal rates were calculated for 10, 20, 30 ,40, 50, and 60 year pay out periods.The terminal portfolio values and optimal stock allocation for each pay out period were also determined. The results are summarized below. Click here to see a more detailed explaination of the methodology used in the study, or to download a free copy of the Retire Early Safe Withdrawal Calculator - Millennium Edition.
The table below assumes a $1,000 initial portfolio value and shows the maximum initial inflation adjusted annual withdrawal (as a percent of assets) that allows the portfolio to survive to the end of all pay out periods examined. Annual investment expenses were assumed to be 0.20% of assets, duplicating what an investor would pay for a low cost S&P 500 index fund. The percentage of stocks in the portfolio were varied to determine the asset allocation that maximized the "safe" withdrawal rate. Finally, the range of terminal values for the initial $1,000 portfolio for each pay out period was determined. The terminal value is the value of the portfolio after the final annual withdrawal is taken at the end of the pay out period.
Surviviability is the probability that there will be funds remaining in the portfolio at the end of the pay out period. For example, a survivability of 100% means every terminal value was positive. If we examined 100 pay out periods and found the terminal value of the portfolio was negative in 25 out of the 100 pay out periods, we would say that withdrawal rate was "75% survivable." The maximum 100% survivable withdrawal rate is the highest annual withdrawal rate where all terminal values are positive for the pay out periods examined.
The terminal values shown in the table below are ordered from highest to lowest. For example, there were 100 thirty-year pay out periods examined. With a "100% safe" inflation-adjusted withdrawal rate of 3.81%, the maximum terminal value was $11,133 for an intial portfolio of $1,000 and the minimum was $1. The 25% "Terminal Value" of $2,591 means that in 75 of the 100 pay out periods examined a "100% safe" withdrawal rate resulted in a higher terminal value.
Maximum "100% Safe" Inflation Adjusted Withdrawal Rates.
The maximum "100% safe" withdrawal rate decreases as the pay out period increases. Using the PPI to index withdrawals, a 20-Year pay out period allows for a 4.78% first year, inflation adjusted withdrawal, while a 60-Year pay out period requires that the first year withdrawal be reduced to 3.24% to remain 100% safe. Using the CPI-U increases these "100% safe" withdrawal rates by about 50 basis points. The chart below illustrates these results.
Which Inflation Index to Use?
The earlier version of the Retire Early Safe Withdrawal Calculator used the Producer Price Index (PPI) to adjust annual withdrawals for inflation. Prof. Shiller switched to the CPI-U (i.e., Consumer Price Index for All Urban Consumers) in his most recent monthly data series. Shiller explains, "In the past, there was not much difference between the PPI and the CPI, except for short-run oscillations, but since the mid-1980's the levels of the series have diverged substantially."
Optimal Asset Allocation.
Confirming modern portfolio theory, our study shows that longer pay out periods favor portfolios with heavy concentrations of equities. Readers familiar with the concept of "efficient frontiers" will recognize that the optimal stock allocation for each pay out period closely matches the data from Stocks for the Long Run by Professor Jeremy J. Siegel, Page 37. The results are shown below.
The Crash of 1929 and The Great Depression.
While the Retire Early study uses the December 31st portfolio balance to calculate withdrawals, readers frequently ask, "What would happen if I retired right before the "Crash of 1929" rather than December 31st." Replacing the December 1928 S&P500 value of 24.86 with the September 1929 value of 31.30 allows us to calculate the "100% safe" withdrawal rate for pay out periods starting the month before the October 1929 Crash. For longer pay-out periods, a September 1929 start reduces the "100% safe" withdrawal by about 25 basis points. The graph below illustrates this result using the PPI as the inflation measure.
Here's a table comparing "100% safe" withdrawal rates for retirees using December 1928 vs. September 1929 portfolio values. Withdrawal rates were calculated using both the PPI and CPI as inflation measures.
Terminal Portfolio Value.
Limiting your annual withdrawals in retirement to the "100% safe" level results in a significant portfolio at the end of all pay out periods. For a retiree starting with $1 million and a 50 year pay out period, there is a 50/50 chance of winding up with a portfolio of more than $16 million. That's $16 million after making annual inflation adjusted withdrawals for 50 years. Indeed, there is a 90% chance our retiree will have more than $9 million after 50 years. These surprising results appear in the following chart.
What about "unsafe" withdrawal rates ?
If you are willing to accept a little uncertainty, you can dramatically increase your annual retirement withdrawals -- especially if you have a 50 or 60 year pay out period. For example, for a 50 year pay out period moving from the "100% safe" withdrawal rate to the "90% safe" rate increases your annual withdrawal from 3.35% to 4.50% (using the PPI as the inflation measure.) That's a 34% increase in your retirement income. A chart of several "unsafe" withdrawal rates is shown below.
For more details on retirement withdrawals, check out the 68 page report How much can you safely withdraw from your retirement portfolio? (2nd Edition) available in our Retirement Reports Center
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Copyright © 2000 John P. Greaney, All rights reserved.