Can a retirement portfolio sustain 4% withdrawals in retirement? That’s the generally accepted rule of thumb, but Dr. Wade Pfau, writing in the Journal of Financial Planning, points out some of the complications in that theory.
Bottom line: current valuations might have a big impact on the withdrawal rates, since what happens early in retirement is much more critical than what happens after a portfolio has had an opportunity to grow for many years.
Dr. Pfau’s findings dovetail nicely with work from James Garland. I do think that it’s useful to consider withdrawals in a relative sense. From an earlier article here at Systematic Relative Strength:
Sustainable spending is a tricky concept. Dozens of studies have been performed on historical data that suggest that the proper spending rate is 3 to 5%. A lot of endowments use 4%, for example. In reality, I think the sustainable spending level depends quite heavily on financial conditions at the time. A stock market with a 6% dividend yield is going to support more spending than a market yielding 3%. In other words, I tilt toward a relative calculation first developed by James Garland. He shows that you can generally spend more than just your dividend and interest income, but far less than your total earnings yield. His rule of thumb is that sustainable spending is about 130% of the yield on the major stock indexes. (You can use this link to find the current dividend yield on the major stock indexes.)
Recommended reading for all advisors with clients hoping to retire!
