Beyond The 4% Rule: The science of retirement portfolios that last a lifetime by Abraham Okusanya

Author:Abraham Okusanya [Okusanya, Abraham]
Language: eng
Format: azw3
ISBN: 9781985721647
Publisher: Abraham Okusanya
Published: 2018-03-08T05:00:00+00:00

These strategies use different ways to adjust the withdrawals for inflation.

Fixed withdrawal – no inflation adjustment

A key feature of Bengen’s SWR is that withdrawals are adjusted (up or down) for inflation every year. But there’s abundant research to show that spending in retirement isn’t static in real terms. In fact, spending tends to fall in real terms. Around 90% of annuities purchased are fixed annuities, without any index links or inflation adjustments.

So, what’s the sustainable withdrawal rate if we don’t adjust income for inflation?

The fixed or level withdrawal strategy defines withdrawal as a percentage of the initial portfolio. Subsequent amounts aren’t adjusted for inflation. For instance, a withdrawal rate of 5% from a £100,000 portfolio will produce an income of £5,000 in the first year. The retiree takes an income of £5,000 each year. This happens regardless of the portfolio value and the income isn’t adjusted for inflation. This strategy mimics level annuities.

Fig. 36 opposite compares fixed and inflation-adjusted withdrawals. It shows historical maximum sustainable withdrawal rates over a rolling 30-year period. A gross withdrawal rate of 4.5% (before fees) is the worst historical scenario for retirees opting for fixed withdrawals. This compares favourably with 3.1% for inflation-adjusted withdrawals.

Even after accounting for a 1% fee, the 50/50 UK portfolio still supports a fixed withdrawal of 4% of the initial portfolio over a 30-year period in the historical worst-case scenarios.

Most retirees appear to be comfortable with this approach, because they tend to spend progressively less as they get older.

However, with a fixed approach there’s the danger that the real value of their income will fall faster than what they need. To understand the impact of inflation, we can compare the real income under this fixed withdrawal (FW) with Bengen’s constant inflation-adjusted withdrawal (CIAW) strategy.

For this comparison, consider two hypothetical retirees, James and John. They each have a portfolio of £100,000. The asset allocation is the same 50/50 UK portfolio, with annual rebalancing and total portfolio charges of 1%. Our first retiree James adopts Bengen’s CIAW method. He takes £2,600pa from his portfolio, which is then adjusted for inflation each year. Our second retiree John adopts the FW approach. He takes £3950pa from his portfolio but it’s not adjusted for inflation in future years.

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