![]() However, most people don't hold all of their equities in SPY. ![]() Since our model portfolio is based on the S&P 500, it is sufficient to simply use the 12-month average of the S&P 500 to value the equity portion of the portfolio, with the value of bonds remaining unmodified. In fact, using the 12-month average to value equities increases income for all asset allocations. For reference, the maximum safe withdrawal for a 60/40 allocation becomes 4.11%, which averages $4071. This increases withdrawals to 4.16% of the average portfolio value over the preceding 12 months, which averages $4100 over the 576 retirements evaluated. The asset allocation for the maximum safe withdrawal amount becomes 85% stocks and 15% bonds. ![]() Interestingly, this also changes the optimal asset allocation. This helps smooth out some of the peaks, allowing for a higher percentage to be withdrawn under all market conditions. In order to attempt to locate the point between market peaks and bottoms, the average value of the S&P 500 over the preceding 12 months was used to determine the initial withdrawal amount, rather than the current value at the time of retirement. Ideally, retirement income would be based on a value between the market peak and market bottom, so that retirement income would be the same regardless of whether the market is high or low. While 4% may be appropriate at a market peak, it is overly conservative at other times.Īfter a portfolio has dropped 50% in a recession, the amount of money allowed by the 4% rule will also be cut in half. The problem is that at market bottoms, income is severely reduced even though bottoms are followed by bull markets. At market peaks, the withdrawal rate must be low enough to accommodate the bear market that follows the peak. The 4% rule bases retirement income on the value of the portfolio at retirement. In this range, the maximum safe withdrawal is about $4000, which is 4% of the $100,000 portfolio. ![]() This effect lowers the maximum safe withdrawal to 3.89%, which is actually lower than a mixture of stocks and bonds.įinally, it shows that 60/40 is the optimal asset allocation, but that the curve is pretty flat between 50%-80% equities. Even though an all-stock portfolio provides better returns than a mixture of stocks and bonds, the additional volatility causes some retirement scenarios to run out of money before the 30-year period finishes. Second, it demonstrates the benefits of diversifying between stocks and bonds. For starters, it is unwise to have less than 25% of your portfolio in equities, since the maximum safe withdrawal drops off quickly at this point. The chart demonstrates several principles. As before, the amount of money withdrawn is increased each year by inflation. Equities are represented by the S&P 500 ( SPY), and bonds are represented by a 10-year ladder of 10-year treasuries. The chart assumes a $100,000 portfolio value. The results are shown in the chart below. ![]() This was done for various stock/bond asset allocation strategies. To do this, 576 different 30-year retirements starting each month from 1936 to 1984 were modeled, and the maximum safe withdrawal was calculated such that none of the scenarios ran out of money. We can run this experiment today and get the same results. He calculated the maximum safe withdrawal rate that could be sustained over the 30-year periods without any of the scenarios running dry. In order to come up with this rule, Bengen studied various different 30-year hypothetical retirements beginning at different times from 1926 to 1955. This rule provides a straightforward guideline that is easy to follow for people who aren't financial professionals. It is a simple rule to govern withdrawals from your portfolio in retirement: Given a portfolio of 60% equities and 40% bonds, start by withdrawing 4% of the value of the portfolio the first year of retirement, and increase the amount of money withdrawn each year by the inflation rate, rebalancing annually. In the 1990s, California financial planner William Bengen devised what has become known as the 4% rule. ![]()
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