6% is NOT Normal

There are times when you can withdraw 6% of your original balance (plus adjustments to match inflation) safely using a traditional approach. Such times are unusual.

Normal Times

During normal times, P/E10=13 or 14. Today’s P/E10=24 is unusually high.

The Traditional Approach

The traditional approach used in Safe Withdrawal Rate studies sells stock shares as necessary with a stock/bond (S&P500/TIPS) portfolio. You vary withdrawals to match inflation. The withdrawal rate is the original amount withdrawn divided by the original portfolio balance.

Year 30 SWR Retirement Risk Evaluator

I set P/E10=14, TIPS interest rate=1.0% and the Year 30 final amount of 0%. These are the results:

Safe Withdrawal Rate
20% stocks with rebalancing: 4.06%.
50% stocks with rebalancing: 4.82%.
80% stocks with rebalancing: 5.47%.
100% stocks: 5.21%.

Likely Success Rate (50%-50%)
20% stocks with rebalancing: 4.46%.
50% stocks with rebalancing: 5.52%.
80% stocks with rebalancing: 6.47%.
100% stocks: 7.01%.

Almost Certain Failure Rate
20% stocks with rebalancing: 5.06%.
50% stocks with rebalancing: 6.42%.
80% stocks with rebalancing: 8.27%.
100% stocks: 9.01%.

This shows that reaching a 6% (plus inflation) withdrawal rate is a coin toss (close to 50%-50%) in a normal market. In addition, it requires a high stock allocation.

Increasing the TIPS interest rate to 2% does not change this finding.

Scenario Surfer Runs

I invested entirely in stocks and TIPS. I started with a $100000 balance. P/E10=14 Normal Market initially. I withdrew $6000 (plus inflation) each year. I set the TIPS interest rate to 1.0%. Here are the Year 30 balances. I have included fixed allocation results for comparison.

Run 1. 346,526
20% rebalanced: bankrupt in year 21.
50% rebalanced: bankrupt in year 26.
80% rebalanced: bankrupt in year 30.

Run 2. 30,991.
20% rebalanced: bankrupt in year 23.
50% rebalanced: 26,862.
80% rebalanced: 164,550.

Run 3. bankrupt in year 19.
20% rebalanced: bankrupt in year 19.
50% rebalanced: bankrupt in year 19.
80% rebalanced: bankrupt in year 17.

Run 4. 91,290.
20% rebalanced: 69,380.
50% rebalanced: 77,428.
80% rebalanced: 84,314.

Run 5. 123,766.
20% rebalanced: bankrupt in year 21.
50% rebalanced: bankrupt in year 25.
80% rebalanced: 22,519.

Training improves results over mechanically defined algorithms. A high stock allocation improves the chance of success. There are limits. In a normal market, 6% (plus inflation) is likely to fail without training. Even with training, you cannot count on reaching Year 30 safely.

Summary

With an S&P500/TIPS portfolio, withdrawing 6% of the original balance (plus inflation) is not truly safe when P/E10=14. If valuations were to become attractive enough, you would be able to withdraw 6% (plus inflation). It requires P/E10=12 with a high stock allocation (80%). But today, with P/E10=24, the market has a long way to go before you should consider withdrawing 6% (plus inflation).

Read Taken At Face Value: Upside before giving up. Dividend strategies offer great potential. However, I recommend limiting withdrawals to 5% (plus inflation) until you are sure of success.

Have fun.

John Walter Russell
February 7, 2008

Taken At Face Value: Upside