How Did the Financial Crisis Impact Retirees’ Safe Withdrawal Rate? A Markets-Based Answer

Abstract

Individuals retiring in the aftermath of the financial crisis face an unprecedented market environment. Accommodative monetary policy and below trend economic growth present retirees with historically low interest rates and the longest period of negative real short term interest rates since the Great Depression. The result is likely a period of below-average, modest total portfolio returns that a particular challenge to retirees.Most studies of safe retirement withdrawal rates have concluded that a 4% initial withdrawal adjusted for inflation over subsequent years provides reasonable a reasonable margin of safety over thirty years. However, these studies are generally use historical analysis or forward-looking return analysis based on long-term return estimates and/or average realized returns. Because of this approach an extended period low nominal rates and negative real rates is not captured in traditional methodologies; therefore, they run the risk of overstating safe withdrawal rates.As an alternative, this article presents a market-based methodology for determining appropriate spending policy. Simulation analyses along with market-implied capital market assumptions (CMAs) are used to estimate feasible distribution rates for various portfolios over the next thirty years. The results imply that an initial withdrawal rate of 4% is unlikely to provide investors with a sufficient margin of safety. Instead, lowering initial withdrawal rates to 3.5% is likely to prove prudent.