There are many different strategies for withdrawing income from investments. If clients own interest or dividend bearing securities and can live off that income alone, then odds are their financial security is secure (this article assumes they have made provisions for other possibilities such as rising health care costs, long-tern care and other hazards that can deplete principal). However, most retirees will not find this adequate, especially in years when the market may be down and as inflation takes it bite out of purchasing power.
The question then becomes how much principal can they afford to draw off and still provide for inflation, and not deplete resources before death. Most insurance agents give their clients bad advice on this issue telling them to get conservative and protect money from fluctuation. This advice will help to bankrupt them faster. How can you tell?
The Trinity Study
Enter the Trinity Study. This study was conducted by three professors, at Trinity University, a few years ago to study what withdrawal rates were least likely to deplete an investor’s funds, and how the composition of the portfolio, stocks versus bonds, impacted the withdrawal rate. The study looked at the impact of withdrawal rates that varied from 3 – 12 percent, on 5 different portfolios ranging from 100 percent stock to 100 percent bonds, over all rolling withdrawal periods of 15, 20, 25 and 30 years. One of the important characteristics of this study is that it used real historical market data not average rates of return for those time periods. It also took the effect of inflation into account and adjusted the withdrawal rates upward each year accordingly.
The authors reached these five general conclusions:
1. Younger retirees who anticipate longer retirement payout periods should plan on lower withdrawal rates.
2. Bonds increase the success rate for lower to midlevel withdrawal rates, but most retirees would benefit from a stock allocation of at least 50 percent.
3. Retirees who desire inflation-adjusted withdraws must accept a substantially reduced withdrawal rate from the initial portfolio.
4. Stock-dominated portfolios using a 3 percent or 4 percent withdrawal rate may create rich heirs at the expense of the retiree’s current consumption.
5. For 15-year or less payout periods, a withdrawal rate of 8 to 9 percent from a stock-dominated portfolio appears to be sustainable.
See for yourself
Below are the links to the 4 tables of data created by the study. Note that the best portfolio performance, in terms of how long they lasted during retirement, was from the portfolios with 50%-75% stock positions. That’s not to say stocks are better than bonds or annuities. It is to say that telling clients to get into fixed annuities or safe investments would have bankrupted them faster based on 70 years of actual results. Therefore, before giving financial advice, have the financial facts. This will keep you from getting sued and also doing what’s right by your clients.
• Table 1 illustrates the success rate of various portfolios for different time periods measured against the full time span of the Ibbotson data used, 1926 – 1995.
• Table 2 illustrates the success rate of various portfolios for the time period after WW II, from 1946 – 1995. As expected, market returns were better during that period and thus success rates improved significantly.
• Table 3 illustrates the success rate of various portfolios for different time periods, adjusting for inflation/deflation during the period. As you might expect, this one provides the gloomiest results.
• Table 4 illustrates the variations in the amount of money you might have left at the end of each time period.
Remember, that the success rates of the above tables only show what portion of time a given withdrawal rate avoided depleting the portfolio. In fact, each different time period produced a different result, and the range is enormous. This table best illustrates the risks of using a static assumption for ROR.