If Only 4%

Early studies claimed incorrectly that the optimized 30-year Safe Withdrawal Rate was 4% of the original balance (plus inflation). It was lower. My research restored the 4% withdrawal rate and it has now lifted the continuing withdrawal rate above 6%.

But what if you are satisfied with a 4% (plus inflation) withdrawal rate? You can reach it today. You need not own any stocks. This is how to reach a 4% (plus inflation) withdrawal rate that lasts 50 years and still does not run out of money. It is easy for the fixed income investor.

Simplified Automatic Allocator

I examined conditions on my Simplified Automatic Allocator. It allows you to enter two portfolios, a TIPS interest rate, an inflation rate and an inflation adjusted (real) withdrawal rate and see how well your account holds up. It uses a TIPS account for cash management. This is necessary in order to make calculations. In reality, you would reinvest surplus funds into your regular investments. Surplus funds in the early years go into the TIPS account. They are drawn down in the later years to cover shortfalls that, in this case, result from inflation.

I assumed an initial balance of $100000 and a withdrawal amount of $4000 (plus adjustments to match inflation). These numbers scale. This corresponds to a 4% withdrawal rate, in this case, lasting 50 years. I never sold the original investment. Only its buying power was reduced by inflation.

Data

TIPS interest rate: 0%.
3% inflation: 7.6%.
4% inflation: 9.0%.
5% inflation: 10.5%.
6% inflation: 12.0%.

TIPS interest rate: 1%.
3% inflation: 7.2%.
4% inflation: 8.4%.
5% inflation: 9.6%.
6% inflation: 10.8%.

TIPS interest rate: 2%.
3% inflation: 6.8%.
4% inflation: 7.8%.
5% inflation: 8.8%.
6% inflation: 9.9%.

TIPS interest rate: 3%.
3% inflation: 6.5%.
4% inflation: 7.3%.
5% inflation: 8.2%.
6% inflation: 9.1%.

Analysis

You can buy investment grade preferred stocks with dividend yields of 7.5% to 8.0% and higher. You can buy TIPS at a 2% real interest rate, assuming that you are patient. This means that you can easily reach a 50-year Safe Withdrawal Rate of 4% (plus inflation) if inflation remains inside a range of 3% to 4%.

I estimate that reinvesting in preferred stocks instead of TIPS is the equivalent of having a 3% or more real TIPS interest rate. I make this estimate based on the typical spread between Treasury debt and corporate debt, which is almost always 1% or more.

Assuming that this estimate is correct, you can come close to reaching a 50-year Safe Withdrawal Rate of 4% (plus inflation) even with an inflation rate of 5%.

Conclusions

A 30-year Safe Withdrawal Rate of only 4% (plus inflation) was much too low. You can reach 50 years without buying any regular (common) stocks. Yet, the early studies stressed high stock allocations. They were wrong. Their specific recommendations turned out to be dangerous.

Have fun.

John Walter Russell
July 9, 2008
July 10, 2008