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Retirement Withdrawal Rates and Portfolio Success Rates: What Can the Historical Record Teach Us?

Pfau, Wade Donald (2011): Retirement Withdrawal Rates and Portfolio Success Rates: What Can the Historical Record Teach Us?

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Countless current and prospective retirees now rely on portfolio success rates calculated from the historical data for different retirement withdrawal strategies when planning their own retirements. Past history-based studies ushered forth what has become known as the 4 percent rule for retirement withdrawals, as historically 4 percent with inflation adjustments has served as a relatively safe withdrawal rate in the United States. But this study investigates whether the safety of the 4 percent rule achieved with an aggressive asset allocation is an appropriate conclusion to draw from the historical record. Historical portfolio success rates calculated from U.S. data may present a misleadingly rosy picture. In the time period covered by key withdrawal rate studies, financial markets in the United States performed exceedingly well from an international perspective, and such continued successes should not simply be assumed. Second, rolling historical simulations have made high stock allocations look more attractive than may be justified by over-representing a portion of the historical record in which bonds performed exceedingly poorly. Third, and most importantly, historical portfolio success rates teach the wrong lesson from the historical data as they do not account for the changing circumstances facing recent retirees. High earnings multiples, low dividend yields and low nominal interest rates indicate that conservative retirees should adjust their forecasts for future asset returns downward, which further implies lower sustainable withdrawal rates. For prospective retirees, the real lesson provided by the historical data is not past portfolio success rates, but rather to see how maximum sustainable withdrawal rates have related to the underlying sources of asset returns.

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