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By Christine Benz | 10-17-2013 01:30 PM

Key Variables in Your Retirement Withdrawal Plan

Withdrawal percentage, success rate, asset allocation, and time horizon are important levers in formulating your retirement drawdown plan, says Vanguard's Colleen Jaconetti.

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. I recently visited Vanguard where I sat down with Colleen Jaconetti, a senior investment analyst in the firm's Investment Strategy Group. We discussed some of the key swing factors involved in setting your portfolio withdrawal rate during retirement.

Colleen, thank you so much for being here.

Colleen Jaconetti: Sure, it's a pleasure.

Benz: You have done a lot of work on spending rules, whether it's the 4% rule or some other strategy, and so I'd like to drill into your research a little bit. Retirees have heard about the 4% rule. Let's discuss the assumptions that underpin that rule. What's the asset allocation of the portfolio that can supposedly support a 4% distribution rate per year? What kind of time horizon are we looking at? And also what sort of success rate is presupposed in the 4% rule?

Jaconetti: In the original 4% rule it was actually probably a moderate asset allocation, somewhere between 40% in stocks and 60% in stocks over a 30-year time horizon, and it basically claimed that people will have a high likelihood of not running out of money. So, they didn't put an exact success rate on it, I would say, but just that there will be a high likelihood investors would not run out of money before their 30-year horizon.

Benz: I know that investors often want to tweak some of those variables, so perhaps they can take more of their portfolios. Let's cycle through those variables. Time horizon, I know, is one where investors say, "Well, if I can shorten my time horizon perhaps by working longer, does that mean I can take more from my portfolio later on?"

Jaconetti: Yes, that's actually a good question. The amount of time that you are taking withdrawals from the portfolio is actually probably the most impactful about how much you could spend from the portfolio. If you were to decrease your time horizon by five years or even 10 years, you would definitely increase the amount you could spend by even 1% or 2%.

Benz: I guess the problem is, though, once you've started those distributions your time horizon at the end is really unknowable, so it's kind of tricky from that standpoint.

Jaconetti: Absolutely. But I think it's important to note that a lot of people don't realize if you started at 70 or 75 years old and your time horizon is actually maybe 15 to 20 years, even a 10-year horizon actually could be spending upward of 9% of the portfolio. I think that's a really important thing that people don't realize, that going from 4% to 9% is a lot bigger jump than maybe, say, changing their asset allocation.

Benz: Success rate is another variable that investors can look at. The Bill Bengen research, I don't know if it assumed a 100% success rate, a 100% chance of not running out of money during the retiree's lifetime. What about investors who say, "Well, I'm comfortable with a little more variability, or perhaps, I'm comfortable with the risk that I will in fact run out of money." How does that affect the overall withdrawal rate?

Jaconetti: That's probably the second most impactful lever. What happens is, we normally assume, say, an 85% success rate. So, in 85% of the scenarios the investor would not run out of money from the planning horizon. But if you would drop down to, say, a 75% success rate, a one-in-four chance [the investor runs out of money], the 3.8% initial spending rate would actually jump up to 4.4%. So, you could actually increase the amount that you can spend from the portfolio, knowing on the other end you're also increasing the amount of likelihood that you will run out of money prior to your planning horizon.

Benz: So, if you were to say, "I'm comfortable with that possibility that I will run out of money," you could potentially support a slightly higher withdrawal rate?

Jaconetti: Absolutely.

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