Spending flexibility and safe withdrawal rates

Finke, Michael and Pfau, Wade Donald and Williams, Duncan (2011): Spending flexibility and safe withdrawal rates.

Abstract

Shortfall risk retirement income analyses offer little insight into how much risk is optimal, and how risk tolerance affects retirement income decisions. This study models retirement income risk in a manner consistent with risk tolerance in portfolio selection in order to estimate optimal asset allocations and withdrawal rates for retirees with different risk attitudes. We find that the 4 percent retirement withdrawal rate strategy may only be appropriate for risk averse clients with moderate guaranteed income sources. The ability to accept greater shortfall probabilities means that risk tolerant investors will prefer a higher withdrawal rate and a riskier retirement portfolio. A risk tolerant client may prefer a withdrawal rate of between 5 and 7 percent with a guaranteed income of $20,000. The optimal retirement portfolio allocation to stock increases by between 10 and 30 percentage points and the optimal withdrawal rate increases by between 1 and 2 percentage points for clients with a guaranteed income of $60,000 instead of $20,000.

• Item Type: MPRA Paper
• Language: English
• Keywords: retirement planning; utility maximization; retirement spending goals; safe withdrawal rates
• Subjects: G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice ; Investment Decisions; C - Mathematical and Quantitative Methods > C1 - Econometric and Statistical Methods and Methodology: General > C15 - Statistical Simulation Methods: General; D - Microeconomics > D1 - Household Behavior and Family Economics > D14 - Household Saving; Personal Finance

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