It is pretty astonishing to me, having dealt with recommended withdrawal rates in the 4% to 4.5% range for many years, to observe that certain lucky retirees could have withdrawn 25% from their portfolios for 30 years by taking extreme measures with their asset allocation.
Even withdrawal rates in the teens amaze me. But the data evinces that about one-third of all retirees could have safely withdrawn 13% or better over their lifetimes. And another one-half of all retirees could have safely withdrawn between 8% and 12%.

One source of this plenty is, of course, the strong long-term returns of small-cap stocks, which have exceeded the returns of large-cap stocks by 2 full percentage points over the last 90 years. And, of course, the elimination of bonds, a low-return asset, also dramatically elevates portfolio returns and, consequently, withdrawal rates.

Now, please understand me: I am not recommending that advisors abandon diversified portfolios and blindly adopt the asset allocations of Figure 1. After all, the gaudy withdrawal rates of the all-in allocation are backward-looking. Who could have accurately foreseen whether someone could withdraw 12% one year, or that the next year 5% would be the limit? But I do believe that the dramatic improvements in withdrawal rates illustrated should give the advisor community pause. Are retirement clients being allowed to leave too much money on the table in the interests of “absolute safety”? (Perhaps you never thought you would read such a statement from me.)

I suspect that there is a “middle ground” that would permit advisors to use some of the hidden potential in small-cap stocks to enrich client retirements. Perhaps it involves a slightly unbalanced allocation, tilted toward small-cap stocks but not wallowing in them.

Or perhaps it might incorporate an approach such as that devised by Cornerstone Wealth Advisors’ Jonathan Guyton, which permits higher withdrawals initially but with a safety valve in case returns are disappointing. Alternatively, the allocation might take into consideration current market valuations, as Michael Kitces did so brilliantly in relating Shiller P/E to safe withdrawal rates in a 2008 paper (see the May 2008 issue of “The Kitces Report.”) Wade Pfau’s investigations would almost certainly yield kernels of other ideas.

Of course, we must be mindful that, compared with large-cap stocks, small-cap stocks represent a relatively small market capitalization. Should large numbers of investors adopt an allocation strategy heavy in small caps, they might fail to achieve the expected improvement in withdrawal rates because there would be excessive demand for the asset class that creates unprecedented price distortions. (Come to think of it, shouldn’t I be keeping this to myself?)

One thing seems fairly clear to me: This is likely a poor time to be frisky with one’s retirement withdrawal strategy. Valuations seem so stretched, and economic prospects so limited, that a sizable stock market correction seems likely. When that correction will occur, I can’t say. But given the cyclicality of markets, an opportunity will inevitably present itself, and the best time for implementing these asset allocation concepts might be following such an adjustment in prices.

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