Newspaper article Sarasota Herald Tribune

Don't Let Fate Flip a Coin to Decide Withdrawal Rate

Newspaper article Sarasota Herald Tribune

Don't Let Fate Flip a Coin to Decide Withdrawal Rate

Article excerpt

THERE ARE CRITICAL DECISIONS a retiree must make to ensure a financially secure and stress-free retirement. These include:

Determining a prudent maximum annual withdrawal amount from a nest egg.

Determining a prudent asset allocation -- the division of the assets between stocks, bonds and cash.

These decisions are needed to optimize the balance between "longevity risk;" that is, running out of money before running out of life, and the retiree's standard-of-living.

There have been numerous studies to determine a maximum prudent withdrawal-rate. These indicate a typical 60 percent stock and 40 percent bond portfolio should sustain, for 30 years, an initial withdrawal-rate of 3.5 to four percent, and allow for annual increases for inflation. They also suggest that at this withdrawal- rate the chances of success are not too sensitive to the division between stocks and bonds as long as stocks make up about 40 to 60 percent of the portfolio.

A weakness in many of these studies is they ignore the fact that few retirees will live 30 additional years. For example, of 100,000 65 year-old men only about 6000 men will live 30 years. That means that 94,000 men potentially had a less desirable life-style then they might have enjoyed.

Let's look at an extreme example to illustrate the point.

Suppose on his 65th birthday, Fate told a man that on each subsequent birthday Fate would flip a coin, and if it were heads he would live another year and if tails he wouldn't. Would a rational man limit his spending to 4 percent with only a 50-50 chance of living two years?

Consider further that his probability of living more than 10 years is less than one in one thousand. Aware of this, even the most risk-averse man would almost certainly consider spending a bit more than four percent.

The problem with many studies and online retirement withdrawal calculators is that they define success as having the retiree's nest egg last a fixed number of years, typically 20 or 30, rather than just outlasting the retiree.

In the real world, this type of study may be appropriate for the wealthiest or most risk-averse retirees. …

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