Maximum Withdrawal Rates: A Novel and Useful Tool

Abstract

Even after accumulating a portfolio of investment assets, retirees still need to know how much of their wealth they can spend each year without risking running out of money before they die. Traditionally, financial advisers use extensive simulation to predict a “failure rate” (i.e. the probability of a retiree running out of money before they die). Unfortunately, the failure rate approach is flawed because strategies with the same failure rate may not be comparable overall. For example, different withdrawal strategies may have the same failure rate but wind up leaving significantly different amounts of wealth behind.Instead of failure rate, this author recommends using the maximum withdrawal rate, or MWR, approach that predetermines a desired bequest (which could be zero or some positive sum), thus enabling an apples‐to‐apples comparison of retirement strategies. In addition to permitting direct comparisons of retirement strategies, the MWR provides a way to assess how likely a retiree is to sustain a target sequence of inflation‐adjusted withdrawals. This is the main advantage of the MWR; it is a single tool that can be used to explore two of the most important issues in retirement analysis.The MWR as presented here is essentially a measure of the best a retiree could have done had he known the future returns of his portfolio. Obviously, one cannot be sure of future rates of return ahead of time, so the MWR does not eliminate all retirement risk. That said, its adoption would be an improvement upon current practice.