Despite the ubiquity of the issue in financial planning circles, most prospective clients I encounter have never heard of the 4 percent rule or “safe withdrawal rates”.  Those that have are often more anxious about retiring. 

In part, this is their nature. They are concerned so they dig into the matter of making their savings last and are exposed to the various takes on the subject. But, I also think some of the anxiety exists because many financial advisors frame the numbers from a perspective that induces fear.

It starts with simple things like terminology. The use of the term “safe withdrawal rate” naturally sets an expectation that there is an unsafe rate as well. Too often, the advisor fails to help out by not getting the client to see that if 4 percent is the “safe” rate, 4.1 percent is not really “unsafe”, its just slightly less safe. 

I run into a couple of folks every year that think that if they exceed the safe rate at all, they are endangering their financial security. Truly unsafe rates are much higher than the safe rates. 

The sample size is small but many of the most anxious people have read an article suggesting that the safe rate is below 4 percent. There are a number of studies that suggest such, many of which use equity valuations to assume below average equity returns or extrapolate current low interest rates over future retirements.

I don’t take any issue with most of these studies or their findings per se. They examined what they examined, the results were what they were, and they provide views from important angles. I take issue with using these lower estimates as a mandate to be extremely conservative and reduce spending early in retirement or postpone retirement.

Of course, just because something has never happened doesn’t mean it never will any more than something that has always happened can be counted on to always occur in the future. Nonetheless, a 4 percent starting rate increased for inflation, survived the worst-case historic scenario for plain vanilla, 50/50 large cap/intermediate government bonds mix annually rebalanced over 30-year time frames. 4 percent has never failed.

According to “What Returns Are Safe Withdrawal Rates REALLY Based Upon?”, by Michael Kitces on his Nerd’s Eye View blog, the worst cases, using publicly available Shiller data going back to 1871, actually had decent nominal average returns over the 30-year periods. There was no correlation between the average 30-year returns for stocks or bonds and the corresponding initial withdrawal rates.

It was the real returns over the first 15 years that was more telling. Correlation between the real returns over the first 15 years and the safe rates was quite high making today’s valuations and interest rates an important consideration. The average real return for the first 15 years of the four worst case scenarios averaged a mere .86 percent and one of them had a negative real return. It has taken far below average returns to create problems not merely weaker returns.

Worst case. That also means all other cases were better. How much so?  Bill Bengen used a 50/50 mix in his 1994 paper credited with the birthing the “4 percent rule” but the lowest initial withdrawal rate that worked from the 60/40 mix from the Shiller data was closer to 4.5 percent. The average safe starting rate was roughly 6.5 percent. 

Moreover, there was a 96 percent probability that starting at 4.5 percent resulted in a portfolio balance that was at least equal to the balance on day one of retirement even after 30 years of inflation adjusted withdrawals. The median balance after 30 years was 4.6X the initial balance. In inflation adjusted terms the ending value exceeded the start value in nearly 70 percent of the periods and the median result was 1.6X. 

I’m not saying that a 4.5 percent starting rate will again end up being a safe rate over the next 30 years.  No one knows that. Valuations are high and interest rates are low. Maybe the next thirty years will be the first in which that rate failed.

Still, the possibility of weaker returns due to valuations does not necessarily mean that we should advise a new 65-year-old retiree with $1,000,000 that they better spend less than $40,000 over their first year or they are endangering their financial security.

Typical safe withdrawal rate framing assumes more than just a set of returns.

First, it assumes a 30-year time frame. Yes, we are expected to live longer than our parents and grandparents on average but most people 65 and older are still not expected to survive 30 years. A significant number will, but they are still a minority.

Last year, I counselled a healthy 80-year-old widow who had stopped going out or playing golf. She cut back after reading an article that skipped the 30-year assumption when covering what a safe rate of spending would be. She had been spending about 4.8 percent of her nest egg, but the article scared her.

Now, she may live to be 110. She will surely try. But once she understood that what she had read omitted an assumption of a 30-year time frame, she went back to what she had been doing.

Second, of those that do survive 30 years, many will not be spending at the same inflation adjusted level at which they started retirement. Studies back up what I have seen anecdotally over the last quarter century advising retirees. Most people spend differently (more health care, less recreation for instance) and spend less as they age in real terms. Few need to increase spending in lockstep with inflation like the safe withdrawal studies usually assume.

Third, the safe withdrawal framework assumes no changes to spending are made regardless of how the portfolio does. That is just not how people behave. When accounts get hit hard by markets or even when they just muddle along, people adapt their spending to accommodate their wealth level. 

During the 08/09 markets, many clients had reduced spending long before any numbers were crunched to assess to what extent that was a good idea. It was not us telling them they had to cut back. It just came instinctively and naturally to them to make that choice.

One thing all this suggests to me is that the quest to determine a universal safe rate is interesting and has value but may not be critical for a lot of clients. I suspect getting more clarity on what each particular client’s adaptation plan should look like is a more powerful exercise.

Instead of saying that the Monte Carlo simulation gives them a 10 percent chance of failure, I think it is more accurate to say they have a 10 percent probability that they will need to change something from what is illustrated. The conversation should be about what exactly those changes could be and when they would be instituted.

I have yet to meet anyone who doesn’t feel some negative feelings during bear markets. They are lousy for everyone. However, I have seen how those that had a plan to adapt to bad markets were able to keep control of their finances until the bear stopped growling.

For those that are about to retire, we spend some time looking at what they plan to spend their money on and how that would change when (not if) markets are bad. For those saving for retirement many years in the future, we want them to understand that how much they need to accumulate is affected by the nature of their spending. If they retire with many committed expenses and few discretionary, they have less flexibility and should accumulate more all things being equal.

Retirement can be scary and we shouldn’t sugar coat it. The next 30 years could be awful. By educating clients about what they can do in adverse situations, they may still feel anxious, but they can also feel empowered and are more likely to make sound decisions when the time comes. So, by all means, take the safe withdrawal rate studies seriously, but please, try not to use the results in a way that adds to your client’s angst about one of the biggest decisions of their lives. 

Dan Moisand, CFP® has been featured as one of America’s top independent financial advisors by Financial Planning, Financial Advisor, Investment Advisor, Investment News, Journal of Financial Planning, Accounting Today, Research, Wealth Manager, and Worth magazines. He practices in Melbourne, Fla.  You can reach him at www.moisandfitzgerald.com.