The Safe Withdrawal Rate Problem

Sad to say, many people have no understanding when it comes to the Safe Withdrawal Rate problem. I am not talking about calculation details. I am talking about the big picture.

People approaching retirement need to know how much to save and what to expect. They cannot recover if they run out of money. They do not want their savings goal to be too high. If it is, they will put off their retirement date unnecessarily.

A continuing withdrawal rate makes sense for early retirees. A 30-year time frame often makes sense with conventional retirees.

There is nothing magical about 30 years. It is a reasonable number for many. It is not for others. The best reason to use this number has to do with data analysis. The stock market cycles in 30 to 40 year increments: from peak to peak and from valley to valley. Using a longer time period causes the data to become multimodal, which leads to confusion.

It is essential that Safe Withdrawal Rate calculations address inflation. It is not overly important that withdrawals match inflation exactly. So long as you can characterize the shortfall accurately, inflation need not be an issue. A brief period of underperformance is fully acceptable so long as the income stream does not run out. A prolonged period would be a disaster.

All methods of calculation have their limitations. Do not be upset with minor details. But understand them. The historical sequence method, for example, treats the fixed income portion of a portfolio as a single year trading vehicle. It does not even consider holding bonds to maturity. In an actual portfolio, a bond ladder gets around this limitation.

Have fun.

John Walter Russell
June 21, 2008