William P . Bengen
William P . Bengen
THE BIG PICTURE
49.5 %, more than triple that of the standard allocation . It was achieved with an allocation of 95 % to micro-cap stocks . Imagine withdrawing at a 50 % rate during retirement ! This lucky individual was the person who retired on July 1 , 1932 — almost exactly at the bottom of the market after the 90 % stock decline of 1929-1932 . Great timing !
Furthermore , the worst-case “ universal ” safe withdrawal rate , achieved by the person who retired on October 1 , 1968 , was 6.0 % when the allocation was unconstrained , while the standard allocation allowed the 4.7 % rate we ’ d previously determined .
Does this mean we can now talk about “ the 6 % rule ”? Unfortunately , it ’ s not that easy . Being a retiree myself , I wish it were .
The fly in the ointment is that , to the best of my knowledge , we have no way to predict what the optimum asset allocation will be for any retiree . It ’ s as difficult a proposition as market timing — selling equities near a major market top and buying them back at almost exactly the succeeding market bottom . I don ’ t know of anyone who has succeeded in doing so , on a consistent , long-term basis . Some have gone broke trying .
Plus , the stakes are much greater here . If a retiree mistimes the market , they may get another chance to get it right in five to seven years . But if a retiree fails in their choice of initial asset allocation , they may have killed their retirement . That ’ s because the asset allocation decision is for 30 years , not five to seven . Our “ unconstrained allocation ” is thus largely an illusion .
Still , the allure of such stellar withdrawal rates is nigh irresistible . Isn ’ t there a way we can adjust our approach so as to enjoy some fraction of these extraordinary outcomes ? Could we , for example , increase our safe withdrawal rate by adopting an allocation that slightly favors the best-performing asset classes , namely U . S . micro- and small-cap stocks , but still appears reasonably balanced ? For example , what if we were to change the allocation to what ’ s shown in Table 2 . The “ test allocation ” reduces the percentage of low-returning bonds in ex- change for an increased fraction of higher-returning stock classes . Overall , the portfolio is converted from a 55 %/ 45 % stock / fixed income allocation to 63 %/ 37 %. It ’ s a relatively modest change overall , but in retirement investing , small differences in inputs can lead to large changes in outcomes . The primary uncertainty here is whether the increase in return is offset by a loss of favorable asset class correlation , as both are important to improving portfolio performance .
To evaluate the effectiveness of this change , I recomputed the individual SAFEMAX for each of the 269 people retiring from January 1 , 1926 , through January 1 , 1993 , using the test allocation . The results are depicted in Figure 5 , and we can compare them with our earlier computations for the “ standard ” allocation .
The test allocation affords a higher SAFEMAX in the vast majority of cases , while suffering only a mild degradation in the rest , including the universal safe withdrawal rate .
Although not as spectacular as the results in Figure 4 , in the vast majority of cases ( 95 %), the test portfolio produces a higher SAFEMAX . In many cases , it ’ s considerably higher . The average safe rate for the test allocation is 7.9 %, whereas it ’ s about 7.4 % for the “ standard ” allocation , an increase of about 7 %. Would you like to have 7 % more to spend every year in retirement ? ( That ’ s a rhetorical question !)
There are limited periods where the test allocation is inferior or offers only a very modest improvement in SAFE- MAX . Its results weren ’ t as good in the late 1920s ( just preceding the massive stock bear market of the 1930s ) or during the “ worst case ” scenario of the late 1960s ( when there were back-to-back bear markets and high inflation ). However , it nev- er falls behind by more than 3 %, and the average dip is less than 1.5 %. During the early 1980s , the two allocations give virtually the same results .
The last concern I had was the effect of the new allocation on the “ universal ” SAFEMAX , or the “ worst-case ” scenario . By adopting the test allocation , we shifted the date of the worst-case scenario from October 1 , 1968 , retiree to someone with an adjacent retirement date , January 1 , 1969 . The value of the universal SAFE- MAX declined in the process from 4.676 % to 4.600 %, a reduction of only about 1.5 %.
What It Gets Us
To sum up , the test allocation affords a higher SAFEMAX in the vast majority of cases , while suffering only a mild degradation in the rest , including the universal safe withdrawal rate . I would say that this approach looks extremely promising , as it offers the prospect of significantly higher withdrawal rates to a large percentage of retirees .
However , I am not yet ready to give this approach my wholehearted endorsement , because I have a few other concerns . For one , increasing the concentration of small and micro-cap stocks in a portfolio will notably increase its volatility , something that might be upsetting to the investor . Furthermore , if many people were to adopt the test allocation , it would significantly increase the demand for smaller company stocks , which are never in great supply to begin with . That could affect their prices and eliminate their historical edge in investment returns .
Despite my reservations , I rate this experiment a considerable success . It affords a third “ free lunch ” ( improved results with no additional risk ) to retirement investors , when it ’ s considered alongside the general principle of diversification and the concept of “ glide path ” allocation . It ’ s made me aware of some intriguing possibilities , which might be further enhanced by additional research .
WILLIAM P . BENGEN is a retired financial advisor , who first conceived the 4.7 % SAFEMAX withdrawal rate . He lives north of Tucson , Ariz .
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