How much can you spend in retirement?

Nine years ago I took the legendary Peter Lynch to task for giving bad advice on that question. He had told readers of Worth magazine they could invest 100 percent of their money in common stocks and safely withdraw an initial 7 percent a year, adjusting for inflation. Working with Ken Bingham, a friend and stockbroker at UBS, we showed that such withdrawals had a major chance of leaving you dead broke.

We weren't alone in our concern about portfolio withdrawal rates. Financial planner William P. Bengen had addressed the subject in the Journal of Financial Planning early in 1994, demonstrating that the maximum safe initial withdrawal rate from a retirement portfolio was about 4 percent. A few years later, three researchers at Trinity University tested different portfolios and found that initial withdrawal rates of 4 to 5 percent were about the best you could do.

Needless to say, no one likes to hear this.

We all want to be told they can have a starting withdrawal rate of 6, 7, 8, or 9 percent from our savings, adjust upward for inflation each year, and never run out of money. Many readers have suggested that you can withdraw more than four percent if you are flexible, e.g. not increasing your withdrawals when values are down, etc.

Well, some new research suggests you can take more than 4 percent.

In the October Journal of Financial Planning Certified Financial Planner Jonathan T. Guyton tests a variety of spending rules during one of the worst periods for retirement imaginable—1973 through 2003. The period includes two major meltdowns and early years of heavy-duty inflation. Searching for a withdrawal rate that would be safe for a period of 40 years, he found withdrawals limited to 4.7 percent with an 80 percent equity portfolio and no rules. Apply two simple rules, however, and your initial withdrawal rate can be 6.2 percent.

  Here are the rules.

Rule Number one: There is no increase in withdrawals after any year with a negative total return and there is no "catch-up" for any missed increase in any subsequent year.

Rule Number two: Regardless of the inflation rate, the maximum annual income increase is limited to 6 percent and you cannot "catch-up" in later years.

Retirees can apply those rules and safely increase their initial retirement spending by one-third!

Alas, before you start lining up for the spending parade there is something you need to know. Other research, published in the September/October issue of the Financial Analysts Journal, will rain on your parade.

Starting with the idea that future portfolio returns are influenced by valuation levels when you start, researcher Robert Arnott examines returns of typical portfolios and finds that real returns have averaged about 4.2 percent in the post war period. A portion of that real return, however, came from rising valuation levels.

When valuation level changes are stripped out, the average real return on a 60/40-stock/bond portfolio has been only 3.4 percent since World War II. Since valuation levels are currently high and we can't count on them rising still further, Mr. Arnott believes pensions and endowments may be heading for trouble.

"Sustainable return and real return, not counting changes in valuation levels or yields, have averaged, respectively, 3.3 percent and 1.9 percent," Mr. Arnott writes. "This return is nowhere near the 5 percent spending required of foundations, nor does it approach the 5-6 percent spending rules that prevail for most endowments."

Since foundations, endowments, and retirees are trying to do essentially the same thing--- maintain constant spending power over a long period of time--- it's very likely Mr. Guyton's rules give a dangerous sense of safety.

Bottom line:   Withdraw more than five percent a year at your peril.

Sunday, October 1, 1995: Dangerous Advice from Peter Lynch

Tuesday, July 27, 1999: When $2 Million Isn't Enough

The Spender's Portfolio: Columns on Retirement Spending

Columns on Portfolio Survival