He then takes into account their age, portfolio size, spending needs, risk tolerance and expected longevity. He'll run that information through a Monte Carlo analysis, and his clients typically fall into the 2% to 6% range for an initial withdrawal rate. He personally favors a 4% rate in most cases. "Setting a withdrawal rate gives me a roadmap for the next 30 years," Dinverno says. "But we re-evaluate things every three or four years because there are always external pressures on a portfolio."
Dinverno had one client who retired at 60 and made it clear that he wanted to enjoy life and not hold back. Based on the client's call, his withdrawal rate came to 11%. It remained that way throughout the go-go 1990s, although Dinverno often reminded the client that a sustained bear market would hammer his portfolio and require a spending reduction.
When the market tanked in 2000, Dinverno got his client to cut his withdrawal rate to 7%. Although that's still too high for Dinverno's liking, there's not much he can do about it. The man is 73 and his money should run out in 15 years under current projections. "This client is comfortable with that," says Dinverno. "Other clients would never go near that."
For Dinverno, the beauty of withdrawal rates is that there is no right answer because it's different for every client. "I think the research going on and the sharing of different approaches is great for the profession."
Jonathan Guyton hoped to foster such discussion when he published the results of his research relating to his 6% withdrawal rate formula in The Journal of Financial Planning. He thought prior research on the topic had shortcomings, such as relying on static pro-rata portfolio withdrawals based on asset allocation rather than asset performance. He also believed that their reliance on automatic inflation-based yearly increases was unrealistic because it ignored the fluid nature of market conditions and how people react to them.
So Guyton devised dynamic rules (the aforementioned three decision rules) that mimic actual advisor and client behavior. For instance, Guyton notes that most people naturally tighten their belts after a bear market. Consequently, he says his rule stipulating that retirees hold the line on withdrawal increases after a year of negative returns is just common sense.
As for his research, Guyton chose 1973 as a starting point because it coincided with the 1973-1974 bear market and the start of a 10-year run of nearly 9% average annual inflation. In doing so, he wanted to prove that his withdrawal rate calculation could withstand "perfect storm" conditions like everything that happened between 2000 and 2002.
But Guyton realizes his calculations aren't foolproof, because there's always the chance for even greater perfect storms. "Hypothetically, there can be even worse scenarios where my numbers won't stand up," he says.
Ultimately, Guyton agrees that there are no magic bullets. "The issue of withdrawal rates is a critical one that's still evolving," he says. "I hope I've contributed a better understanding of the question and some of the nuances than can affect the answers."