These are the links to the papers and articles that I have referenced in this post:
1. https://www.researchgate.net/publication/228707593_Sustainable_withdrawal_rates_from_your_retirement_portfolio
2. https://www.researchgate.net/publication/50211311_Sustainable_withdrawal_rates_of_retirees_Is_the_recent_economic_crisis_a_cause_for_concern
3. https://www.forbes.com/sites/wadepfau/2018/01/16/the-trinity-study-and-portfolio-success-rates-updated-to-2018/#73f347216860
For those of us that are familiar with the (F)inancial (I)ndependence (R)etire (E)arly (FIRE) movement, you would have heard of the 4% rule. To give you some background, it meant that if you withdraw less than 4% of your portfolio every year, you may withdraw it for the rest of your life. This rule has been used as an important benchmark for those of us in the FIRE movement to determine the asset required in our portfolio.
This is when we should be critical. We should look at how is this rule being derived and the condition(s) that this rule is applicable to our financial situations.
Success/Failure: If the value of the portfolio is positive (>0), it is considered a success
Condition: Stock returns are from the S&P 500, bond returns are from the Salomon Brothers Long-term High-grade Corporate bond index and S&P high-grade corporate composite yield.
Overlapping method: As the data is taken from 1926-1997, there are 53 overlapping periods for 20 years payout, 48 overlapping periods for 25 years payout and 43 overlapping periods for 30 years payout.
The success rate is calculated by (No. of overlapping periods considered successful )/ (Total no. of overlapping periods):
With that, let's jump right in to examine if the 4% rule holds up under scrutiny (P.S. I will only examine the inflation adjusted monthly withdrawal and I have also learnt my lessons and decided to screenshot these data.)
The percentage in the first row meant that on an annual basis, x% of the portfolio would be withdrawn. The data below means that for y% success rate between 1926/1946 to 1997. For x and y, the higher the better. A higher y would mean that there is a higher chance that our portfolio has a higher chance of having positive sums of money after a set number of years. A higher x would mean that we can withdraw a higher portion of our portfolio (More money for us when we retire)
Discussion of results:
Here we can see some counter-intuitive results. First of all, as we become older, we are often advised to shift a higher portion of our portfolios into fixed-income assets (bonds). BUT as we can see here, a portfolio that is bond heavy would not do as well as its counterpart as the payout period increase. Surprisingly, a higher portion of success can be seen in portfolios that are more focused in stocks.
The idea of just withdrawing 4% also holds up well, more than 70% success rate for the 100%, 75%, 50% and 25% stock portfolio. But when we look at the 100% bonds portfolio, the saying does not hold up for the period of 1926-1997
The idea of just withdrawing 4% does not hold up as well for the period of 1946-1997. The 70% success rate can only be seen in the 100% and 75% stock portfolio.
Hence, if we were to stick to the 4% rule without thinking of our portfolio allocations, we would be really wrong. Asset allocation does matter and the payout period would affect the success rate that our portfolio can sustain our yearly withdrawal rate.
PS: if you wish to check more recent data, do look at the forbes article. They have updated the table with more recent years and included government bonds into their calculation.
Limitations of data:
1. The results are from historical data, hence, it might not applicable to our portfolio when we retire.
2. The bond portion only takes corporate bonds into calculations and not government bonds,
3. There isn't data available for 35/40 years, which is our idea of retirement (assuming we retire at 40, and death at 80).
4. We do not know how much money we are left with. Hence, for those of us that want to leave money for our family, we would have to find another paper for it.
Conclusion:
Reading the paper has challenged my idea that a 4% withdraw guarantees my payout for the rest of my life, regardless of my portfolio. Furthermore, it surprised me that having more bonds in my portfolio would hinder my retirement rather than enhance it.
A possible follow-up to this might include using monte carlo simulations to have a stochastic approach to the study instead of a deterministic model.
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