Thursday, August 1, 2013

The Power of Diversification and Safe Withdrawal Rates

Geoff Considine (, July 30,2013)
Mr. Considine argues that the 4% Rule is still a valid decumulation strategy provided the retiree's assets are invested in a more diversified portfolio than originally anticipated by Bill Bengen, the rule's inventor.

The 4% Rule keeps resurfacing like a vampire in a bad horror movie. As I have said many times in this blog, the 4% Rule (and most other Safe Withdrawal Rate approaches) have just too many weaknesses to be considered an optimal decumulation strategy. I will briefly summarize the 4% Rule and what I believe to be its major weaknesses below.

The 4% Rule. In the first year of retirement, withdraw 4% of your accumulated savings. In each year thereafter, withdraw no more and no less than the first year amount increased by measured inflation since the first year. Make no adjustments for actual investment performance and hope that the assumptions underlying the Monte Carlo analysis performed to determine the "safeness" of the rule pan out and that you die prior to exhaustion of accumulated savings (without leaving too much behind). 

Weaknesses of the 4% Rule

  • It doesn't accommodate a payout period other than 30 years without adjustment.
  • It doesn't accommodate a different investment approach without adjustment.
  • It doesn't accommodate a desire to leave a specific bequest at death
  • It doesn't accommodate a flexible spending schedule (for example if needed for unanticipated medical expenses or to use more assets early as a means to delay Social Security benefits as discussed in the previous post)
  • It doesn't coordinate with other fixed income payments such as immediate or deferred life annuities or payments from defined benefit plans
  • It doesn't adjust for actual emerging experience.
Of course if I didn't believe that the actuarial decumulation strategy set forth in this website wasn't superior to the 4% Rule, I probably wouldn't be here blogging away.