Some concepts take on a life of their own and grow far bigger than the original idea.  William Bengen's paper, "Determining Withdrawal Rates Using Historical Data," from the October 1994 Journal of Financial Planning answered one question, spawned a slew of further research and has even become a rule of thumb--the "4% rule." Subsequent work by Bengen himself coined the term SAFEMAX and produced a terrific book, Conserving Client Portfolios During Retirement (FPA Press). I lost track a long time ago of all the papers written about safe withdrawal rates, portfolio sustainability and similar issues.  

Last month, I had the pleasure of receiving a not yet published paper from Wade Pfau, an associate professor at the National Graduate Institute for Policy Studies (GRIPS) in Tokyo. Pfau earned his Ph.D. in economics at Princeton in 2003 and has contributed to the body of knowledge most recently through a Journal of Financial Planning contribution examining how well (or poorly) the 4% rule held up in other countries.

His latest work examines the retirement issue in a different way. Pfau noticed that the preponderance of research has sought a safe withdrawal rate, which is then used to compute a target for how much wealth needs to be accumulated so that desired retirement spending can be funded from this wealth at the desired withdrawal rate.  Research on preretirement is mostly about how to achieve a wealth accumulation target. Most consumer-oriented discussions about retirement similarly examine accumulation separately from decumulation.  

Pfau wondered what would happen if he linked the accumulation and decumulation phases together in an integrated whole. "My findings suggest that a fundamental rethink about retirement planning is needed. When linking the accumulation and decumulation phases together, the concepts of 'safe withdrawal rates' and 'wealth accumulation targets' end up serving as almost an afterthought. Focusing on them is the wrong way to think about retirement planning."

Pfau's paper "Safe Savings Rates: A New Approach to Retirement Planning over the Lifecycle" wanted to bring some framing to the question of how much one needs to save that recognized both one's saving for retirement and one's spending through retirement.  If there is a "safe withdrawal rate" there should be a "safe savings rate."  At what rate of savings does it always work out?  

To get to this rate, he set up the problem like this: "The baseline individual wishes to withdraw an inflation-adjusted 50% of her final salary from her investment portfolio at the beginning of each year for a 30-year retirement period. Prior to retiring, she earns a constant real salary over 30 working years, and her objective is to determine the minimum necessary savings rate to be able to finance her desired retirement expenditures. Her asset allocation during the entire 60-year period is 60/40 for stocks and bills. Data is from Robert Shiller's Web page for the S&P 500 and Treasury bills."

Put another way, consider a person making $100,000 today who expects that salary to increase with inflation and who wants to withdraw $50,000 in today's dollars from their portfolio to supplement any other income, adjusting for inflation over a 30-year retirement. Based on market behavior since 1871, a 60/40 mix, and ignoring taxes, there was never a time where saving at least X% of their salary for 30 years prior to that retirement didn't achieve those goals. Pfau solved for X.

The term "replacement rate" is used throughout the paper but this is not to be confused with how that term has been used often in the past, that is "one needs 80% of pre-retirement income to be comfortable in retirement." As financial planners know, that rule-of-thumb replacement ratio approach is often meaningless because some people will need more than a particular rate while others less. It can be tricky to incorporate that idea properly into research. Pfau is focusing only on the amount needed to come from the portfolio, not an overall replacement rate.  

With Schiller's data going back to 1871, Pfau could examine 30 years of savings followed by 30 years of withdrawals.  Retirements would therefore have beginning dates ranging from 1901-1980. He also could extend the time frames of Bengen's SAFEMAX examination.  

This second look at SAFEMAX highlighted to Pfau the extreme volatility of the withdrawal rates. Maximum withdrawal rates ranged from just over 4% to 10% in some periods. As one might expect, the higher withdrawal rates correlated to better markets and the lower rates to weaker markets during retirement.  

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