Retirement Income Redesigned: Master Plans for Distribution: An Adviser's Guide for Funding Boomers' Best Years

Chapter 13. Sustainable Withdrawals

william p. bengen

There's a certain reasoning about retirement income that can be very seductive for many clients. It goes like this: in retirement I need a blend of growth and income investments. Over long periods, common stocks have averaged approximately 10 percent returns annually, and bonds about 5 percent. A portfolio allocated to 60 percent stocks and 40 percent bonds will have an expected average annual return of 8 percent. Returns should be augmented by about 10 percent by annual rebalancing of the portfolio, providing a compound annual return of about 8.8 percent. I want to increase my withdrawals annually by inflation. Assuming that inflation averages about 3 percent, I should be able to withdraw 5.8 percent from my portfolio the first year, give myself a 3 percent cost-ofliving adjustment each year after that, and my money will last forever.

Or maybe not.

Outliving a Portfolio

The flaw in this reasoning is revealed in the chart in FIGURE 13.1, which reconstructs the investment experience of two individuals, one retiring on January 1, 1963, and the other on January 1, 1961. Both retirees employed a portfolio allocation of 63 percent large-cap stocks, with the remainder in intermediate-term (five-year) government bonds. They both withdrew 6 percent of their initial portfolio value at the end of the first year of retirement, then gave themselves a cost-of-living adjustment (based on the consumer price index, or CPI) each subsequent year. ...