When You Assume...

Over the years, so-called personal finance experts have provided valuable information—but also a smattering of misinformation—but I can think of none quite as egregious as some remarks recently made by Dave Ramsey.

By now I’m sure you’ve heard—or heard about—his “counsel” with regard to acceptable retirement withdrawal rates—and his disparagement of the “supernerds” who would dare to disagree with him. As for that counsel, at a high level, Ramsey maintains that an 8% withdrawal rate is not only doable, but sustainable. All you have to do is be invested 100% in equities—oh, and assume a 12% return.[i]

Of course, such machinations have always been predicated on assumptions—about inflation, about market returns and, most notably, about the length of life itself. That said, this didn’t become a specific focus—a so-called “rule of thumb”—until 1994, when financial planner William Bengen[ii] claimed[iii] that over every rolling 30-year time horizon since 1926, retirees holding a portfolio that consisted 50% of stocks and 50% of fixed-income securities could have safely withdrawn an annual amount equal to 4% of their original assets, adjusted for inflation without… running out of money.

That said, even though it was predicated on a number of assumptions that might not be true in the real world—a 30-year withdrawal period, a 50/50 portfolio mix of stocks and bonds, assumptions about inflation—oh, and a schedule of withdrawals unaltered by life’s changing circumstances—well, with the return of inflation as a reality (rather than a theoretical construct), it now seems that there’s an annual scramble to reassess that “safe” withdrawal rate. Indeed, a couple of years back a Morningstar paper challenged its conclusions in view of “current conditions”—opining that “using forward-looking estimates for investment performance and inflation,” the Morningstar authors said that the standard rule of thumb should be lowered to 3.3% from 4%.

That said, this is something of a moving target, and a few weeks ago Morningstar moved the target back to 4% (after having opined that a starting safe withdrawal rate for a 30-year horizon with a 90% probability of success was 3.3% in 2021 and 3.8% in 2022). Enter Dave Ramsey and HIS assumptions that allegedly support a much higher rate (though I don’t recall him offering a probability figure of savings lasting as long as your life[iv]).

Now, in fairness, even the Morningstar folks allow for some variance in “safe” withdrawal rates—explaining that the increase from 2022 in this “highest safest starting withdrawal percentage” for a 30-year horizon with a 90% probability of success “owes largely to higher fixed-income yields, along with a lower long-term inflation estimate.” Moreover, they assert that it’s predicated on assumed portfolios that hold “between 20% and 40% in equities and the remainder in bonds and cash”—which is, in itself, a fairly sizeable range.

There’s been plenty of evidence—both empirical and anecdotal—that retirement “spends” aren’t nice, even streams. Life’s circumstances change, of course—and our health care, and health care costs, are notoriously variable. There’s a sense that the pace of spending earlier in retirement is more like that anticipated in most retirement education brochures—travelling and such—but that pace slows down as we do.

At its core, once you stipulate certain assumptions about the length of retirement, portfolio mix/returns, and inflation, a guideline like the 4% “rule” is really just a mathematical exercise. A 4% “rule” may be simplistic, but it’s also simple—and when it comes to getting your arms around complex financial concepts and distant future events, there’s something to be said for that.

But—and as Dave Ramsey’s response should remind us—when you “assume” … (or when others assume on your behalf) make sure you understand the assumptions required to make it “work”—and perhaps more importantly, the likelihood/probability that those assumptions will be a reality. 

- Nevin E. Adams, JD

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[i] One of the more humorous—and insightful—rebuttals on all this came from SRP’s Jeanne Sutton: https://www.linkedin.com/feed/update/urn:li:activity:7130951358609838080/

[ii] https://www.forbes.com/advisor/retirement/four-percent-rule-retirement/

[iii] See www.portfolioconstruction.com.au/obj/articles_perspectives/retailinvestor.org_pdf_Bengen1.pdf

[iv] That said, Morningstar’s John Rekenthaler has—and you can read that analysis here

 

The 4% "Solution?"

A recent white paper has garnered a lot of discussion by casting “shade” on a traditional premise about retirement plan withdrawals.

The premise—a so-called “rule of thumb[i]”—isn’t all that old, actually; it dates back only to 1994, when financial planner William Bengen[ii] claimed that over every rolling 30-year time horizon since 1926, retirees holding a portfolio that consisted 50% of stocks and 50% of fixed-income securities could have safely withdrawn an annual amount equal to 4% of their original assets, adjusted for inflation without… running out of money. 

That said, even though it was predicated on a number of assumptions that might not be true in the real world—a 30-year withdrawal period, a 50/50 portfolio mix of stocks and bonds, assumptions about inflation—oh, and a schedule of withdrawals unaltered by life’s changing circumstances (not to mention a 90% probability of success)—a recent Morningstar paper challenged its conclusions in view of “current conditions.”

The controversy, if it warrants that name, was that Morningstar said that 4% might no longer be “feasible”—that there might be a better number—more specifically that the “confluence of low starting yields on bonds and equity valuations that are high relative to historical norms, retirees are unlikely to receive returns that match those of the past”—and thus, “using forward-looking estimates for investment performance and inflation,” the Morningstar authors said that the standard rule of thumb should be lowered to 3.3% from 4%. 

Said another way, your retirement savings likely won’t last as long as you might have thought they would, and with surging inflation in the headlines, that conclusion certainly engendered a lot of media attention.

Now, in fairness, the paper states at the outset that they are not recommending a withdrawal rate of 3.3%, which they characterize as “conservative.” How so? Well, they note that it is based on four factors: 

1. a time horizon that exceeds most retirees’ expected life spans; 
2. it fully adjusts all withdrawals for the effect of inflation; 
3. it does not react to changes in the investment markets; and 
4. it’s based on a “high projected success rate”—90%.

Moreover—and significantly, despite the ensuing headlines of other publications—they explain that “by adjusting one or more of those levers, current retirees can safely withdraw a significantly higher amount that the 3.3% initial projection might suggest.”

Now, there’s been plenty of evidence—both empirical and anecdotal—that retirement “spends” aren’t nice, even streams. Life’s circumstances change, of course—and our health care, and health care costs, are notoriously variable. There’s a sense that the pace of spending earlier in retirement is more like that anticipated in most retirement education brochures—travelling and such—but that pace slows down as we do. 

In fact, I remember my one and only conversation with my father about retirement income. He had already decided to quit working, and had gathered his assorted papers regarding his savings, insurance, etc. for me to review. Determined to “dazzle” Dad with my years of accumulated financial acumen, I proceeded to outline an impressive array of options that offered different degrees of security and opportunities for growth, the pros and cons of annuities, and how best to integrate it all with his Social Security.

And yet, when I was all done, he looked over all the materials I had spread out before him, then turned to me and said—“So how much will I have to live on each month?”

At its core, once you stipulate certain assumptions about the length of retirement, portfolio mix/returns, and inflation, a guideline like the 4% “rule” is really just a mathematical exercise. A 4% “rule” may be simplistic, but it’s also simple—and when it comes to getting your arms around complex financial concepts and distant future events, there’s something to be said for that. 

But looking for a 4% ”solution” is arguably looking to solve the wrong problem.  

- Nevin E. Adams, JD

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[i] And the origins of that phrase are likely different from what you’ve been told—see https://www.phrases.org.uk/meanings/rule-of-thumb.html.

[ii] Who, interestingly enough, opined earlier this year that it might now be a 4.5% rule… 

Means 'Tested'

Pundits have long worried that retirees wouldn’t have accumulated enough to live on in retirement, but the data suggests that most retirees aren’t exactly burning through their retirement savings.

I remember my one and only conversation with my father about retirement income. He had already decided to quit working, and had gathered his assorted papers regarding his savings, insurance, etc. for me to review. Determined to “dazzle” Dad with my years of accumulated financial acumen, I proceeded to outline an impressive array of options that offered different degrees of security and opportunities for growth, the pros and cons of annuities, and how best to integrate it all with his Social Security.

And when I was all done, he looked over all the materials I had spread out before him, then turned to me and said – “so how much will I have to live on each month?”

See, my dad, like many in his generation, were accustomed to living within their means. And, according to new research, he isn’t the only one.

The study shows that retirees generally exhibit very slow decumulation of assets. More specifically, the nonpartisan Employee Benefit Research Institute (EBRI) found that within the first 18 years of retirement, individuals with less than $200,000 in non-housing assets immediately before retirement had spent down (at the median) about one-quarter of their assets; those with between $200,000 and $500,000 immediately before retirement had spent down just 27.2%. Retirees with at least $500,000 immediately before retirement had spent down only 11.8% within the first 20 years of retirement at the median.

Those with pensions were much less likely to have spent down their assets than non-pensioners. During the first 18 years of retirement, the median non-housing assets of pensioners (who started retirement with much higher levels of assets) had declined just 4%, compared with a 34% decline for non-pensioners.

The median ratio of household spending to household income for retirees of all ages hovered around 1:1, inching slowly upward with age – a finding that the EBRI researchers said suggests that majority of retirees had limited their spending to their regular flow of income and had avoided drawing down assets, which explains why pensioners, who had higher levels of regular income, were able to avoid asset drawdowns better than others.

Not that that’s necessarily a heartening result, since those pensioners, arguably having guaranteed income for life, such as a pension, doesn’t lead them to spend down their assets. Indeed, of all the subgroups studied, pensioners have the lowest asset spend-down rates – though one might well expect that, with that pension “cushion” they might be more inclined to dip into their savings and “splurge.”

Why are retirees not spending down their assets? The EBRI report offers a number of reasons:

• People don’t know how long they are going to live or how long they have to fund their retirement from these assets.
• Uncertain medical expenses that could be catastrophic if someone has to stay in a long-term care facility for a prolonged period.
• A desire to pass along assets to heirs.
• A lack of financial sophistication – people don’t know what is a safe rate for spending down their assets, and are thus erring on the side of caution.
• A behavioral impediment – after building a saving habit throughout their working lives, people find it challenging to shift into spending mode.

Now, the EBRI research was based on government data from the U.S. Health and Retirement Study to track retirees born between 1931 and 1941 with assets ranging from stocks, bonds, mutual funds, real estate and CDs to savings and checking accounts (individual homes were excluded). That’s “greatest generation” territory – retirees who were, as my father, accustomed to living within their means. Even then, it’s not all sunshine and unicorns; some retirees are indeed running out of money in retirement – though, at the same time, instead of spending down, a large – and to my ears, largely unacknowledged ­– number of retirees are continuing to accumulate assets throughout retirement.

But I’d still argue that the question “how much will I have to live on each month” winds up being a lot easier to answer at retirement – if you’ve been thinking about it pre-retirement.

- Nevin E. Adams, JD

The “New” Math?

One of my more frustrating memories of parenthood was trying to help my kids with their homework. Not because I hadn’t covered the territory once upon a time myself, or because I couldn’t manage to refresh my recollection(s) of the subject. It wasn’t enough to teach my kids a method sufficient to arrive at the correct answer, and to help them understand how we got there. No, it didn’t “count” unless I could arrive at the answer by adhering to what struck me as a weirdly inefficient and complicated regimen upon which their teachers insisted.

If this was the “new math,” I remember thinking at the time, I fear for the sanity of the next generation.

This past weekend The New York Times ran an article aptly, if somewhat awkwardly, titled, “New Math for Retirees and the 4% Withdrawal Rule.” The focus of the article, like the 4% rule itself, was how to pace withdrawals in retirement so that you don’t run out of money before you run out of retirement. However, like so many other things these days, it’s apparently not as simple as it once was, complicated by the low interest rate environment and the current high stock market values.

Though a lot of time, thought and attention has been paid to the 4% rule (and its progeny), to me it’s basically just math. After all, once you stipulate certain assumptions about the length of retirement, portfolio mix/returns, and inflation, a guideline like the 4% “rule” is really just a mathematical exercise.

‘Drawing’ Board

But if those rules purport to tell us how much we can draw from our retirement savings without running out, how does that compare with what people are actually withdrawing? The Employee Benefit Research Institute (EBRI) has previously examined withdrawal patterns in their IRA database, and found that the median IRA individual withdrawal rates amounted to 5.5% of the account balance in 2010, though among those 71 or older (when required minimum distributions kick in) were much more likely to be withdrawing at a rate of 3-5%.

Those median numbers don’t tell the whole story, of course. A separate EBRI analysis, this one based on data from the University of Michigan’s Health and Retirement Study (HRS), found that lower-income workers were withdrawing money from their individual retirement accounts in much greater numbers, earlier, and at much larger percentages, than other workers. In fact, the report noted that nearly half (48%) of the bottom-income quartile of those between the ages of 61 and 70 had made such an IRA withdrawal, and that their average annual percentage of account balance withdrawn was 17.4% — higher than the rest of the income distribution. In sum, a number of individuals, again, notably lower-income workers, were withdrawing more from their retirement savings accounts than those in higher income groups — and apparently more than the 4% “rule” would suggest would allow them to avoid running out of money in retirement.

Will these drawdown rates create a problem down the road? Will these individual run short of funds in retirement? Will those withdrawals, along with other resources that may be available, be sufficient to live on? The answers, of course, depend on the individuals, their circumstances, health, needs, expectations — and preparations.

Those ultimate realities may be new for some — but the “math” won’t be.

- Nevin E. Adams, JD