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December 12, 2022 at 11:01 AM
What You Need to Know
- A starting withdrawal rate of 3.8% is “safe” in Morningstar’s model over a 30-year time horizon, meaning it brings a 90% likelihood of not running out of funds.
- Dynamic withdrawal strategies may help retirees consume their portfolios more efficiently, factoring in both portfolio performance and spending.
- However, dynamic strategies bring their own challenges, including significant swings in annual income.
Investors hoping to utilize a “safe” fixed real withdrawal strategy for managing their retirement income can plan to withdraw 3.8% of their portfolio’s value in the first year, according to Morningstar’s newly published report, “The State of Retirement Income: 2022.”
In the newly published analysis, the analysts found that a starting withdrawal rate of 3.8% delivers a 90% success rate (defined here as a 90% likelihood of not running out of funds) over a 30-year time horizon. The analysis assumes a balanced portfolio of 50% stocks and 50% bonds.
While lower than the traditional 4% withdrawal assumption commonly cited by media pundits and financial planners, the new figure is appreciably higher than the 2021 figure, which was 3.3% for a balanced portfolio with a 90% projected success rate.
Taking a Page From Market History
As the Morningstar team explains, history demonstrates that the “right” or “safe” withdrawal rate depends on three key variables: the asset allocation of the portfolio; the market environment that prevails over a retiree’s drawdown period; and the length of the drawdown period. Looking at all of the rolling 30-year periods from 1930 through 2019, the safe rate ranges from 3.7% for the worst period to 6% for the best.
In general, according to Morningstar, portfolios that maintained balanced or more equity-heavy asset allocations delivered higher returns and, in turn, higher withdrawals than those with more-conservative positioning.
That said, in less-forgiving environments, such as the one that prevailed in the second half of the 1960s and early 1970s, investors with excess equities stood a high chance of exhausting their portfolios by the end of the retirement period if they made annual withdrawals of even 4%.
Overall, according to the analysis, employing a more aggressive equity allocation does not meaningfully improve safe starting withdrawal rates. In fact, investors with shorter time horizons of 10 to 15 years can actually employ a higher withdrawal rate if they’re using a more conservative portfolio mix relative to an equity-heavy one.
This is the case because their returns are smoother and subject to meaningfully less sequence of returns risk.
