Key takeaways
- For a 4% SWR & 50% equity allocation no one had less than about 35 years before his retirement money was used up.
- For a 3% to 3.5% withdrawal rate even a 50:50 equity debt portfolio always lasted for over 50 years. This is of critical importance to those wishing to retire early.
- At a five-percent level of initial withdrawal, in the worst cases in history, funds lasted only 20 years
- Holding too few stocks does more harm than holding too many stocks.
- Too few stocks in the portfolio shortens the minimum portfolio life
- The 50:50 stock / bond mix appears to be near-optimum for generating the highest minimum portfolio longevity
- From the perspective of the highest minimum portfolio longevity, you give up very little by increasing stocks from 50 percent to 75 percent of the portfolio.
- From the perspective of portfolio value at the end of retirement, the higher your stock allocation, the higher is your end portfolio value. Bengen says the average portfolio value increase from 35-percent stocks to 75-percent stocks was 123%.
- It is appropriate to have a stock allocation as close to 75 percent as possible, and in no cases less than 50 percent.
- Stock allocations lower than 50 percent are counterproductive, in that they lower the amount of accumulated wealth as well as lowering the minimum portfolio longevity.
- Increasing equity allocation above 75% lowers longevity
- As long as the client’s goals remain the same, there is no need to change the initial asset allocation during retirement. It is likely to do more harm than good.
- Portfolio longevity is satisfied primarily by the selection of the initial withdrawal percentage, although asset allocation plays a part.
- Portfolio value at the end of your retirement years is primarily determined by the asset allocation you choose and increases with increased allocation to equity.
- For all insights from Bengen’s paper one must remember the following assumptions as part of his analysis: a) Zero advisor fees AND expense ratios were assumed (i.e. ideally you need to be primarily invested in Direct Index funds), b) you need to re-balance portfolio annually & c) use intermediate term bonds
This article would be particularly useful to someone who is serious about putting together a robust financial plan for retirement. Getting a sense for portfolio longevity can in turn help those who are looking to retire earlier than usual.
In this article, I take a deep dive into Bill Bengen’s paper on the 4% rule to glean insights on how to optimize portfolio value & longevity during one’s retirement years.
Much of retirement planning from a financial perspective in my view is a bit of an art rather than a science. So while you won’t get pin point accurate numbers from this article, you will get a reasonable feel for various factors / aspects that could significantly affect your retirement plan from a financial perspective.
Basic assumptions underlying Bengen’s research to keep in mind
To start with, it’s important to keep the following assumptions in mind as a basis for all that follows:
- Zero advisor fees AND expense ratios were assumed (i.e. ideally you need to be primarily invested in Direct Index funds)
- Annual portfolio re-balancing was assumed
- Intermediate term bonds (between 5 to 10 year maturity) were used
Value of portfolio at start of retirement
In an earlier article of mine, I looked at some research that a couple of people have done to determine to what extent the 4% rule is valid for Indian markets.
As you will see from my article above, based on purely back test data from the Indian markets, Bengen’s 4% rule does seem to hold up.
However, if you don’t feel comfortable with the 4% rate, you could use the research presented in Ravi Saraogi’s or Sayan Sircar’s research to arrive at a figure for your retirement.
Withdrawal rate & longevity
We now look at excerpts from Bengen’s analysis on the extent to which changes in safe withdrawal rates & portfolio asset allocation affected Portfolio Longevity. You can finally determine a safe withdrawal rate for yourself based on the portfolio longevity that works for you.
4% SWR & 50% equity allocation
Bengen’s data (below) showed that for a 4% SWR & 50% equity allocation no client enjoys less than about 35 years before his retirement money is used up.
Early retirement / The safest option: 3% SWR & 50% equity allocation
On the other hand, when Bengen dropped the withdrawal rate to 3% or even 3.5%, he found that even a 50:50 equity debt portfolio always lasted for over 50 years. The chart below from Bengen’s illustrates that.
I quote Bengen from his paper:
“It is clear from Figure l(a) that an “absolutely safe” (to the extent history is a guide) initial withdrawal level is 3 percent, in that it ensures that portfolio longevity is never less than 50 years. (This is also true for withdrawal rates as high as approximately 3.5 percent.)”
This is of critical importance to those wishing to retire early.
Danger zone: 5% SWR & 50% equity allocation
At a five-percent level of initial withdrawal, in the worst cases in history, funds lasted only 20 years
Combined effect of asset allocation & safe withdrawal rate on portfolio longevity
Bengen further researched the effects of asset allocation varying from 0% stocks to 100% in 25% increments and varying withdrawal rates and checked for minimum portfolio longevity in each case. The chart below is the summary of what he found.
Here are excerpts from Bengen’s paper for the above data:
- Holding too few stocks does more harm than holding too many stocks. The “0-percent stocks” bar and “25 percent stocks” bar are consistently shorter than the others, confirming what we already know. The superior returns of stocks versus bonds are essential to maximizing the benefit from a portfolio.
- Too few stocks in the portfolio shortens the minimum portfolio life
- The 50/50 stock / bond mix appears to be near-optimum for generating the highest minimum portfolio longevity
We can see from the above chart that for all withdrawal percentages, the bars for 50-percent stocks and 75-percent stocks are very close in height – a year or less apart. From the perspective of the highest minimum portfolio longevity, that means you give up very little by increasing stocks from 50 percent to 75 percent of the portfolio.
Analysis of trade-offs between 75% & 50% stock allocation
Comparing the 2 charts above you can see that, for a 4% withdrawal rate, 47 out of 50 starting retirement years cross 50 years of longevity if one had a 75% stock allocation as compared to only 40 years that crossed 50 years with a 50% stock allocation
Leaving a legacy for your children: Portfolio value at end of retirement
If leaving a significant legacy for your children at the end of your life is a significant consideration for you, then the following charts should be very helpful. Bengen analysed portfolios with varying asset allocations and looked at portfolio values at the end of 20 years.
Portfolio end values for 35% stock allocation
Portfolio end values for 50% stock allocation
Portfolio end values for 75% stock allocation
Based on the above data, Bengen concluded that the average portfolio value increase from 35-percent stocks to 75-percent stocks is +123 percent.
Summary of conclusions from Bengen’s paper
- It is appropriate to have a stock allocation as close to 75 percent as possible, and in no cases less than 50 percent.
- Stock allocations lower than 50 percent are counterproductive, in that they lower the amount of accumulated wealth as well as lowering the minimum portfolio longevity.
- Increasing equity allocation above 75% lowers longevity
- As long as the client’s goals remain the same, there is no need to change the initial asset allocation. It is likely to do more harm than good.
- Portfolio longevity is satisfied primarily by the selection of the initial withdrawal percentage, although asset allocation plays a part.
- Portfolio value at the end of your retirement years or towards the end of your life is primarily determined by the asset allocation you choose and increases with increased allocation to equity.
Disclaimer: I am not a financial advisor. My articles are meant for people who are not savvy or well versed with personal finance and investing and find it difficult to grasp all the jargon typically used when discussing such topics. I hope to be able to demystify investing and make it as simple as possible for everyone. I’ve invested in Mutual funds for approx. 24 years. I’ve also been a diligent student of the subject of investing over the past 24 years learning & applying the writings of luminaries in the field. In these articles I’m merely sharing my experience & learning from that investing journey and the books of luminaries in the field in the hope that it might help others in some way. I am in no way directly or indirectly claiming to be a hot shot investor who has generated exceptional or even above average returns during my investment journey. However, I am quite confident that even if all you do is learn from my mistakes, educate yourself on sound investment principles & develop good financial habits you will benefit greatly. Please ensure that you consult a financial advisor before taking any decisions or actions concerning your personal finances or investments. I shall not be liable.