Piggy
Flickr / 401(k) 2013.

Have you heard the rule about withdrawing 4% of your assets every year in retirement? It sounds like a small enough number to give you stable income for decades, but recent research using current market data shows that the rule could be far from safe. 

How can you plan accordingly?

Changing interest rates, changing yields
As you may have noticed, interest rates and yields are incredibly low right compared to historical averages. This affects how your portfolio grows and the kind of income it generates; lower interest rates mean lower yields, which means your bonds won't pay as much (and your stocks probably won't, either). 

While it's tempting to think of this period as temporary, there is evidence that bond returns don't go back to their averages so quickly. Instead, bond returns today are very predictive of returns over the following decade. That means these yields might persist, whether it's over five years, 10 years, or even longer.

To test whether the 4% rule works in these different environments, the researchers simulated possible returns patterns over the coming 30 years. The results are not promising.

Even if yields bounce back, your portfolio probably won't
With a 50/50 allocation of equities and bonds, and real bond returns of negative 1.4% (which was the case at the time of writing and is still not far off the mark), the failure rate on portfolios was 57%. That means that 57% of the time, the assets didn't last a full 30 years. If you assume real bond returns of 0%, the failure rate was 33%.

Even if bond yields bounce back to their long-term average in five years (a strong assumption), the failure rate was still 18%.

In another paper, the authors incorporated more data to account for stock valuations and fees, but the results weren't that much more promising. In the current market environment and a 40/60 equities and bonds split, a 4% withdrawal rate has over 50% chance of failing over 30 years.

So what do I do?
Wade Pfau, one of the authors, found in a previous study that returns and inflation in the first decade of retirement can predict about 80% of retirement outcomes.

In other words, what happens now is disproportionately important to your financial health over the coming 30 years -- so even if you think that bond yields are going to be right at the long-term average later, it might not make a real difference to your individual retirement.

So what can you do about it? 

One option would be to adjust your portfolio allocation to carry more equities. The authors tested this idea using different stock and bond ratios and various returns on bonds. 

Even with average real bond returns of 1.75%, higher than the current average, and returns on stocks of 5.5%, the portfolio failure rates ranged from 24% (for 30% stocks) to 27% (for 70% stocks). If you adjust the returns to 0% for bonds and 6% for stocks, you're looking at a failure rate of anything from 47% (for 30% stocks) to 28% (for 70% stocks).

That's not terribly comforting. The next obvious idea is to just reduce your withdrawal rate, let's say to 3%. This is definitely helpful, but under current conditions you still might be looking at a failure rate of over 20%. 

To get the failure rate down to 10% in the "worst case" conditions, the authors had to reduce their hypothetical withdrawal rate to 2.5%, with a portfolio mix of 45% stocks and 55% bonds.

In other words, it's not so easy 
This isn't to say there is no way to retire in the current market environment.

It's just that those age-old rules about what is safe or not safe are not set in stone: the market changes, and so should your rules of thumb. Just because 4% was determined to be safe at one point doesn't mean it will stay that way forever. 

So what should you do? Rather than locking into a withdrawal program, perhaps adjust it for the times. Can you reduce your withdrawals somehow, perhaps by freeing up cash in other areas -- downsizing a home, working part time, etc.? 

If such measures seem drastic and paranoid, consider that it would probably be worse to be left in the lurch because of something as mind-numbing as long-term bond yields. It's totally unfair, but the evidence suggests that it might pay to play it safe. 

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