How Did the Financial Crisis ImpactRetirees’ 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 belowaverage, modest total portfolio returns that present 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 a reasonable margin of safety over 30 years. However, these studies 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 of low nominal rates and negative real rates is not captured in traditional methodologies; therefore, these methodologies 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 30 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.