There’s a decent chance that anyone who has considered retirement with some amount of self funding has heard of the concept of the safe withdrawal rate — the amount of money that one can safely spend every year without prematurely running out of money. First proposed by William Bengen in 1994, the math is pretty well established by now and many well-respected authors have written extensively on the subject dissecting it from different angles.
There’s also a pretty good chance that that the average person following a safe withdrawal rate does not actually understand how it works, and that lack of context can cause quite a bit of confusion. You see, the various studies and calculators that determine SWRs do so based on a myriad of very narrow assumptions, and breaking from those assumptions also breaks the conclusions. I’ve written quite a bit about the asset allocation assumption and the withdrawal method assumption, and I recently realized that I’m due for a discussion on another key assumption — how long do you plan to be retired?
When it comes to retirement duration, almost any resource you find today defaults back to the same assumption that William Bengen used — that a typical person retires at 65 and lives another 30 years. Furthermore, they define success as never going broke over 30 years based on the known historical performance of a portfolio. When talking about the average retiree that’s really not a bad assumption, but statistically speaking there’s a very good chance you are personally not average. Maybe good genes run in your family and you’ll live for more than 30 years, or maybe you’d like to retire early. Which begs the question:
What is the safe withdrawal rate for a very long retirement?
I personally think that’s asking the wrong question, and that attempting to answer it using the same methodology misses the larger point. To explain, let’s start by visually exploring how safe withdrawal rates change based on retirement duration. Here’s a chart that shows the SWRs for the Classic 60-40 portfolio.
The column in blue is the result you would find simply by using the default 30-year assumption of most retirement studies (you can read about small variations in numbers here). Clearly that doesn’t tell the whole story, and SWRs vary a lot based on the timeframe you’re interested in. They do, however, start to approach a single long-term number the longer out you look. Like an airplane gliding into a smooth landing, this portfolio looks to have a floor of about 3.5%. Wouldn’t it be nice to be able to calculate that value directly?
Well you can! It’s called the “perpetual withdrawal rate” and it acts like the runway the plane is aiming for. Check out the dark green perpetual rates for the same portfolio.
So what is a perpetual withdrawal rate, anyway?
By definition, safe withdrawal rates plan for failure. They are explicitly defined to cause you to just barely not run out of money under certain historic conditions. In contrast, perpetual withdrawal rates follow the first rule of investing — don’t lose money! These are the withdrawal rates that preserved the original inflation-adjusted principal even at the end of the single worst investing timeframe of a given duration. By weathering the storm and leaving you with the same amount of money you started with, you’re prepared not to quietly pass away with a few dollars remaining but to start all over again. Even if you’re unlucky and the worst-case scenario repeats, your portfolio is still protected. Perpetual withdrawal rates are designed to last forever, which is why they are popular among college endowments and other institutional investors.
One can see from the chart that instead of coming in for a landing, perpetual withdrawal rates take a little time to reach their ultimate cruising altitude. However, they have a nifty quality of reaching a steady-state level quite a bit more quickly than SWRs, and depending on their consistency some portfolios manage it faster than others. Here are the Withdrawal Rates charts for several different portfolios. Ignore the absolute numbers for a moment, and note the relative differences in the dark green PWR columns.
This quality of perpetual withdrawal rates to manifest relatively quickly even for volatile portfolios and more so for consistent ones has two important implications for early retirees.
First, it is not necessary to run a 50 or 60 year simulation to determine the ultimate SWR floor for a portfolio. Calculating the withdrawal rate that consistently perpetuates the inflation-adjusted principal is a more direct method to arrive at the same number. This allows us to expand our planning tools to include many more types of investment assets that may simply not have been around 50 years ago.
And second, high short-term PWRs are very valuable from the perspective of investing psychology. One of the biggest problems with traditional safe withdrawal rates is that it’s really difficult to know in real-time (without the benefit of hindsight) when a significant drop in your portfolio value is normal or if it indicates that the plan is fundamentally broken. That understandable fear can cause you to lose sleep or even abandon a perfectly good plan. How can PWR information be used to fix that? Let’s look at an example.
Picture yourself as a retiree with 100% of your money in a total US stock market fund such as VTI and using a conservative 3.5% SWR. Because that’s close to the historical perpetual rate, you can see in the data that this would have lasted pretty much forever.
Now look at the 10-year PWR, and imagine you were one of the unlucky retirees with this portfolio who watched your inflation-adjusted portfolio drop an average of 7% (including market losses and withdrawals) every year for a decade. If you hung on and stayed the course you would have survived thanks to a late stock market push, but would you have had the intestinal fortitude to make it that long without changing portfolios?
In contrast, imagine you had the exact same SWR with the Golden Butterfly.
Look again at the 10-year PWR. Even in the single worst-case decade that we have data for, you would have spent your 3.5% a year and come out the other side with your original inflation-adjusted principal intact. Both portfolios would have ultimately succeeded in funding a long-term retirement at that withdrawal rate, but which experience would you have preferred?
Perpetual withdrawal rates designed to maintain principal serve as effective guideposts along the retirement journey to reassure that you’re on the right path. I would argue that this last point is especially important for early retirees, as remaining grounded in the real-world will ultimately make any plan much easier to sustain for an investing lifetime than relying on faith in a retirement study looking only at distant endpoints and very long term averages to come to your rescue.
Of course, there’s a lot more that goes into early retirement planning than picking a portfolio that supports a suitable perpetual withdrawal rate. Once you’re a little older, it may make sense to loosen up a bit and pay more attention to the sub-30 year SWRs as you look to finally spend down your money. There are also other withdrawal methods than the simple constant dollar method, and perhaps an alternative method may pair well with a portfolio you like.
And speaking of portfolios, some people simply don’t trust certain assets or portfolios and I have absolutely no problem with that. Every portfolio has different perpetual withdrawal rates, so study them for yourself and decide what works for you. I’m not trying to force any one system on you, but to offer a new thought process that maybe you didn’t know was available.
When studying options for a long and happy retirement, don’t box yourself in with safe withdrawal rates. Reset your mindset from planning for failure to planning for success, and look for the underlying perpetual runway that SWRs approach over time. Consistent portfolios with high short-term perpetual rates can not only support your long-term financial needs but also your short-term happiness, so understanding how asset allocation affects the journey is a critical step in making a sustainable decision. The Withdrawal Rates calculator is my contribution to that asset allocation conversation, and I hope you find it useful.
You’ve done a wonderful job saving for retirement. Plan for how to make your portfolio last in perpetuity, and that will allow you to spend less time fretting about the markets and more time getting on with enjoying the new life you worked so hard for. You’ve earned it!