William Bengen’s SAFEMAX (Updated To 2018)

&l;p&g;For sustainable spending from an investment portfolio, William Bengen&a;rsquo;s work is the next natural stop on our journey. Bengen&a;rsquo;s seminal study in the October 1994 &l;em&g;Journal of Financial Planning&l;/em&g;, &a;ldquo;Determining Withdrawal Rates Using Historical Data,&a;rdquo; helped usher in the modern area of retirement withdrawal rate research by codifying the importance of sequence-of-returns risk. The problem he set up is simple: a newly retired couple plans to withdraw an inflation-adjusted amount from their savings at the end of every year for a thirty-year retirement period. What is the highest annual sustainable percentage of retirement date assets that can be withdrawn with inflation adjustments for a full thirty years?

To answer this question, Bengen obtained a copy of Ibbotson Associates&a;rsquo; &l;em&g;Stocks, Bonds, Bills, and Inflation&l;/em&g; yearbook, which provides monthly data for a variety of U.S. asset classes and inflation since January 1926. He decided to investigate using the S&a;amp;P 500 index to represent the stock market and intermediate-term government bonds to represent the bond market.

He constructed rolling thirty-year periods from this data (1926 through 1955, then 1927 through 1956, and so on), using a technique called &a;ldquo;historical simulations.&a;rdquo; He calculated the maximum sustainable withdrawal rate for each rolling historical period. Such an approach helps illustrate the role of market volatility in a way that assuming a constant portfolio return does not. Though he did not create the following illustration, his spreadsheet calculations would provide something similar to what is seen in Figure 1.

&l;a href=&q;https://blogs-images.forbes.com/wadepfau/files/2018/01/forbes-1-figure-1.png&q; target=&q;_blank&q;&g;&l;img class=&q;size-large wp-image-1521&q; src=&q;http://blogs-images.forbes.com/wadepfau/files/2018/01/forbes-1-figure-1.jpg?width=960&q; alt=&q;&q; data-height=&q;723&q; data-width=&q;960&q;&g;&l;/a&g; Figure 1 Maximum Sustainable Withdrawal Rates&l;br&g;For 50/50 Asset Allocation, 30-Year Retirement, Inflation Adjustments&l;br&g;Using SBBI Data, 1926&a;ndash;2017, S&a;amp;P 500 and Intermediate-Term Government Bonds

To bring greater realism to the discussion of safe withdrawal rates in retirement, he focused his attention on what he later called the &a;ldquo;SAFEMAX&a;rdquo; &a;mdash; the highest sustainable withdrawal rate for the worst-case retirement scenario in the historical period. With a 50/50 allocation for stocks and bonds, the SAFEMAX was 4.15%, and it occurred for a new hypothetical retiree in 1966 who experienced the 1966&a;ndash;1995 market returns. Searching for this &a;ldquo;worst-case scenario&a;rdquo; puts the focus on spending conservatively.

The highest sustainable withdrawal rate was only a little more than 4% in spite of the fact that from 1966 to 1995, a 50/50 portfolio provided a 4.7% average inflation-adjusted return. With this simple average, the compounded real growth rate for the portfolio in these thirty years was 4.2 percent after accounting for the impacts of volatility. If the portfolio could have grown at a fixed 4.2% for thirty years, someone withdrawing funds at the end of the year would have been able to use a sustainable withdrawal rate of 5.9% of initial assets. Why was the withdrawal rate barely over 4%?

A 1.3% return assumption is needed to make the 4 percent rule work. The further amplifying effects of sequence risk on investment volatility made it seem like the compounded return was only 1.3% for retirees that year, instead of the actual 4.2%. The difference between the 4.15% and 5.9% spending rates is another illustration of the specific impact of market returns sequence in that thirty-year period. The early part of the 1966 retiree&a;rsquo;s retirement was a tough time, with market losses in 1966, 1968, and 1973&a;ndash;74. This early period set the course for sustainable spending and caused spending to fall below what was implied by the average over the whole period. The markets boomed in the second half of this retirement period, but by then it was too late. The portfolio was already on an unsustainable trajectory, leading to the lowest withdrawal rate in this historical period.

Bengen showed that, historically, a 4% initial withdrawal turned out to be much more realistic than higher numbers found when ignoring market volatility. Hence, 4% became the rule of thumb for retirement withdrawals.


For the following discussion, I mostly will use the same assumptions as Bengen&a;rsquo;s original research, with one exception: I assume retirees make their withdrawals at the start of each year, while Bengen assumes end-of-year withdrawals. I think withdrawals at the start of the year are more realistic, since retirees need the funds in order to be able to spend them, and this assumption causes my SAFEMAX to be 4.03 percent, compared to Bengen&a;rsquo;s 4.15 percent.

One other important factor from William Bengen&a;rsquo;s original study is asset allocation. In particular, he recommended that retirees maintain a stock allocation of 50&a;ndash;75%, writing in his 1994 article, &a;ldquo;I think it is appropriate to advise the client to accept a stock allocation as close to 75 percent as possible, and in no cases less than 50 percent.&a;rdquo;

Figure 2 illustrates of how Bengen reached this conclusion by showing the time path of maximum sustainable withdrawal rates for different asset allocations. It is hard to see exactly what is going on in the 1960s, but the general idea is that higher stock allocations tended to support higher withdrawal rates, with little in the way of downside risk. The SAFEMAX does not appear to be that much lower with higher stock allocations, though the potential for upside with higher stock allocations is quite striking as higher sustainable withdrawal rates are possible with all but the worst-case outcomes.

&l;a href=&q;https://blogs-images.forbes.com/wadepfau/files/2018/01/forbes-1-figure-2.png&q; target=&q;_blank&q;&g;&l;img class=&q;size-large wp-image-1520&q; src=&q;http://blogs-images.forbes.com/wadepfau/files/2018/01/forbes-1-figure-2.jpg?width=960&q; alt=&q;&q; data-height=&q;723&q; data-width=&q;960&q;&g;&l;/a&g; Figure 2Maximum Sustainable Withdrawal Rates&l;br&g;For Various Asset Allocations, 30-Year Retirement, Inflation Adjustments&l;br&g;Using SBBI Data, 1926&a;ndash;2017, S&a;amp;P 500 and Intermediate-Term Government Bonds

This point can be seen more clearly in Figure 3, which shows the SAFEMAX across the range of stock allocations. Low stock allocations resulted in lower SAFEMAXs, with an all-bonds portfolio falling below 2.5 percent. But there is a sweet spot between about 35 percent stocks and 80 percent stocks where higher stock allocations have no discernable impact on the SAFEMAX. A 4 percent withdrawal rate tended to work no matter what stock allocation was chosen in this range. On the downside, retirees would have been just as well-off with 80 percent stocks as with 35 percent stocks.

&l;a href=&q;https://blogs-images.forbes.com/wadepfau/files/2018/01/forbes-1-figure-3.png&q; target=&q;_blank&q;&g;&l;img class=&q;size-large wp-image-1519&q; src=&q;http://blogs-images.forbes.com/wadepfau/files/2018/01/forbes-1-figure-3.jpg?width=960&q; alt=&q;&q; data-height=&q;508&q; data-width=&q;960&q;&g;&l;/a&g; Figure 3 Connection between SAFEMAX and Stock Allocation&l;br&g;30-Year Retirement, Inflation Adjustments&l;br&g;Using SBBI Data, 1926&a;ndash;2017, S&a;amp;P 500 and Intermediate-Term Government Bonds

Why, then, did William Bengen recommend 50&a;ndash;75% stocks? The answer lies in Figure 4, which shows the median remaining inflation-adjusted real wealth after thirty years as a multiple of retirement date wealth when using a 4 percent withdrawal rate. In this exhibit, we can see a general upward trajectory in remaining wealth as the stock allocation increases. In the average case, retirees using at least 45 percent stocks would have found that the real inflation-adjusted value of their portfolio remained after thirty years. And with higher stock allocations, wealth tended to continue to grow in the median outcome. So while Figure 3 shows little in the way of downside spending risk with higher stock allocations, Figure 4 shows that there is plenty of upside potential available with higher stock allocations, which justifies Bengen&a;rsquo;s recommendation.

&l;a href=&q;https://blogs-images.forbes.com/wadepfau/files/2018/01/forbes-1-figure-4.png&q; target=&q;_blank&q;&g;&l;img class=&q;size-large wp-image-1518&q; src=&q;http://blogs-images.forbes.com/wadepfau/files/2018/01/forbes-1-figure-4.jpg?width=960&q; alt=&q;&q; data-height=&q;508&q; data-width=&q;960&q;&g;&l;/a&g; Figure 4 Connection between Median Remaining Real Wealth after 30 Years and Stock Allocation&l;br&g;For a 4% Withdrawal Rate, Inflation Adjustments&l;br&g;Using SBBI Data, 1926&a;ndash;2017, S&a;amp;P 500 and Intermediate-Term Government Bonds

To learn more, &l;a href=&q;http://mcleanam.ontraport.com/tl/2&q; target=&q;_blank&q;&g;register for my upcoming webinar on Monday, January 15, 2018 – &q;How Much Can I Spend in Retirement?&q;&l;/a&g;&l;/p&g;

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