Does the prudent withdrawal rate still hold?

Until a few years ago, conventional wisdom held that a 4 percent to 4.5 percent annual withdrawal rate was considered prudent. But in the height of the bull market, some advisors increased the withdrawal ceiling. So have these advisors been humble since the collapse? Surprisingly, Ron Lieber of the New York Times finds the answer is no, and some are advocating a prudent withdrawal rate as high as 6 percent, even in the current environment. So how are they justifying it? Our old friend Michael Kitces is one of the advisors Lieber interviewed:

"Should a person who had the bad luck to retire in March 2009, at the stock market's recent bottom, spend 4.5 percent of, say, $350,000, or could they spend a bit more? After all, people who retired a year or two earlier with the same portfolio, before the bulk of the stock market's decline, might have started with 4.5 percent of $550,000 (and taken inflation-adjusted raises each year from that initial amount until they died).

It didn't seem right to Michael E. Kitces, a financial planner and director of research at Pinnacle Advisory Group in Columbia, Md. He said he was uncomfortable with all the decisions made based on 'the day you happen to come into my office and the balance on that day.'

In fact, he started looking into this before the market collapsed, and his research ended up suiting the conditions of the last year perfectly. He tried to figure out whether one could estimate how much better or worse stock market returns might be in the years after big declines -- and whether the answer might allow for a more generous initial withdrawal rate.

What he concluded was that the overall market's price-earnings ratio -- taking the current price for the Standard & Poor's 500-stock index divided by the average inflation-adjusted earnings for the past 10 years before the date of withdrawal -- was predictive enough to produce guidelines. Then he came up with the following suggestions for a portfolio of 60 percent stocks and 40 percent bonds meant to last through 30 years of retirement.

If the ratio was above 20, indicating that stocks were overvalued, than a 4.5 percent withdrawal rate was prudent given that the stock market was likely to fall. But if it was between 12 and 20 (the historical median is roughly 15.5), a 5 percent rate was safe, tested against every historical period for which data was available. And if it was under 12 -- a level it almost got to earlier this year -- a rate of 5.5 percent would work.

The most recent figure was 17.67, which suggests a 5 percent withdrawal rate for current retirees. It had been above 20 until October 2008.

Mr. Kitces gets his ratios from a set of data that the Yale professor Robert Shiller creates and stores on Yale's Web site . I've provided a link to that data (Mr. Kitces uses column K in the Excel spreadsheet there) and to all of the other research in this column in the online version of this story."

The entire article with explanations is found here.

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