What about that 4% “safe withdrawal” rate?

It’s Marci on the blog this week with the age-old question:  “How much can I safely spend from my portfolio without running out of money?”

The 2021 Ameritrade/Schwab annual conference was held late last month, virtually, so we had opportunities to drop in on several different sessions of interest and the session on this topic obviously caught my attention.

Historically, we as investors have relied on four components for income from our portfolios:   bond coupons, stock dividends, capital gains, and principal.  In today’s environment though, with interest rates on bonds and cash at record lows, and stocks at record highs, it’s logical to wonder whether the 4% rate that has been generally agreed upon as the acceptable safe withdrawal rate is reasonable now. 

As we know, past performance is not a guarantee of future results, but the presenter of this session attempted to use historical market returns to determine what a sustainable withdrawal rate would have been over thirty-year spans beginning every year since 1871. The major factor outside of market performance that he considered in his analysis was the sequence of returns.  

As an example, consider the following:  The average market return over the period is 10%.  In the first scenario, the first two years are 0% and the next two years are 20%.  In the second scenario, the first two years are 20% each, and the next two years are 0%.  The 10% average holds in both cases, but the portfolio amount, and therefore the withdrawal amount varies greatly.  So, what did he learn from this analysis to share with all of us?  Going back in history through times that included the Depression, the dot.com bust, the financial crisis of ten years ago, and most recently, the coronavirus-driven downturn, as well as many, many years of double-digit market gains, the safe withdrawal rate that worked through all of that:   4 to 4½%.  And interestingly, that percentage held in his analysis in with stock/bond allocations ranging in some studies from 40/60% to 70/30%.

Obviously, this analysis is not the only consideration when spending from portfolio, but I thought it was interesting and hope you do too!