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By Christine Benz and David Blanchett | 02-21-2013 09:00 AM

Mind Fees in Your Withdrawal Rate

Retirees should be aware of how costs can eat into their portfolio balances, and consider making withdrawal adjustments every year, says Morningstar's David Blanchett.

How to set a sustainable withdrawal rate is a crucial topic for retirees. With bond yields as low as they are, a recent study by David Blanchett, Michael Finke, and Wade Pfau suggests that a 3% withdrawal rate--rather than the so-called 4% rule--will help improve retirees' probability of success. Click here to read the paper in its entirety.

Christine Benz: Hi, I’m Christine Benz for I'm here at the Morningstar Ibbotson Conference, and I had the opportunity to sit down with David Blanchett. We discussed withdrawal rates in retirement, a topic that we have discussed in previous Morningstar videos.

David, thank you so much for being here.

David Blanchett: Thanks for having me.

Benz: You and I did a video a couple of weeks ago, where you talked about a research paper that you had written that looked at where bond yields are today--[they are] very low--and talked about the old 4% withdrawal rate rule and actually suggested that maybe a lower withdrawal rate strategy--3%--was in order given where bond yields are today. I'd like to address some of the feedback we’ve gotten, since we did the video. It’s obviously very controversial, and people don’t like to hear the suggestion that they should be spending less.

So one question that we got was about how costs fit into all of this and you modeled out a 1% cost assumption. Let’s talk about what would happen if in fact, your costs were lower, if you’re able to keep your costs down.

Blanchett: Sure. It’s important to note that every investor pays some kind of fees. If you are a super-low-cost investor, you’re going to pay maybe 10 or 20 basis points a year in terms of exchange-traded fund expense ratios. Obviously, fees matter; they are very important. The more you pay in fees, the more it negatively affects your outcome. So, if you can invest well--and that means, you know, buying good investments and holding them for the long term--you can materially improve your situation even with today’s low yields because you’re reducing that kind of negative outfall on your portfolio.

Benz: Does it mean that if I subtract that 1% fee and I'm able to get away with 10 or 20 basis points, could I maybe take a 3.8% [withdrawal rate]?

Blanchett: I think it’s more like 3.5%. Yes, I mean, it does have a pretty big impact. It’s shocking what fees can do over the long haul for a portfolio withdrawal.

Benz: Another thing I wanted to follow up on is this idea of the static-dollar-amount withdrawal. So the 3% rule or the 4% rule is assuming that you take out a fixed amount in year one of your retirement and then you just ratchet that amount up by the inflation rate?

Blanchett: Yes.

Benz: You actually are in favor of what you call a more dynamic withdrawal strategy. We’ve talked about this before, but I’d like to go over it again because I think it’s important. If I’m doing a dynamic updating of my withdrawal rate, what are the key things I should be looking at? So maybe, I start with 4% in year one and I want to be dynamic, what would I focus on when making those adjustments?

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