Perspectives : DC Retirement | May 06, 2022

When the investment environment changes, so do withdrawal rates

For close to 30 years, the conventional retirement distribution wisdom has followed financial advisor William Bengen's 4% rule: Withdraw 4% of your portfolio's value in year one of retirement and then inflation-adjust that amount during each subsequent year. That rule of thumb was a sufficient starting point for many investors, particularly as the past few decades have been marked by strong returns, low inflation, and rock-bottom correlations of stock and bond returns. But how would that distribution strategy fare now, in early 2022, when return expectations are muted, inflation has spiked, and returns for stocks and bonds increasingly are correlated?

A changing tide calls for a deeper understanding of the history

Vanguard research found that market return—which is the basis for much of Bengen's research—is just one driver in what turns out to be a much more complex calculation. Indeed, Vanguard research has shown that three additional factors should play a prominent role in retirement withdrawal rate decisions: inflation, volatility, and stock-bond correlation.

"Much of Bengen's research was conducted when bond yields were five to six percentage points higher than they are today," says Andrew Clarke, CFA, a Vanguard senior investment strategist who focuses on retirement research. "Now they hover around 2.6%."

Other researchers have explored the impact of lower yields on sustainable spending but have relied on long-term historical averages for projections on correlations and volatility. But in reality, these averages are grouping together several distinct return environments.

Clarke's colleague, senior investment strategist Kevin Khang, Ph.D., agrees: "For our research to be relevant, it's essential that we put ourselves in the minds of the retirees who have to think about the investment horizons that matter to them. What matters is what the return environment might look like in the next 10 to 20 years; not just a year or two out, and certainly not 80 years out."

In short, decisions that investors make in the first decade right after retirement often matter the most—and market conditions during that time can have a massive impact on a portfolio's long-term viability.

Different return environments could call for different withdrawal rates

To understand the return-environment history from this perspective, Khang, Clarke, and their colleague David Pakula, CFA, applied a time-varying Bayesian analysis to identify three distinct return environments since 1960. Then, looking backward, they established the systematic withdrawal rate that would have sustained a retiree's portfolio for 30 years during each of those return environments. This is a novel application of a Bayesian analysis, a high-powered statistical tool commonly used by central banks. (Their research, "Sustainable Withdrawal Rates by Return Environment: A Time-Varying Bayesian Analysis," will be published in The Journal of Retirement, later this year.)

When measured collectively, these three factors can significantly affect a systematic withdrawal rate. For example, for the latest return environment, from 1997 to 2020, favorable changes in inflation, volatility, and stock-bond correlation from the previous period (1981-1996) accounted for 1.5 percentage points of the estimated sustainable withdrawal rate of 5.4%.

These factors may be even more relevant now than during previous return environments. Navigating these dynamics is especially important as retirees increasingly rely on assets accumulated in defined contribution plans, rather than a traditional pension, to finance retirement.

Adjusting a withdrawal strategy with inflation volatility in mind

So, what might be a more realistic withdrawal number? The Vanguard scenario analysis, which is built on the Philadelphia Federal Reserve's 10-year projections for higher inflation and moderate to low returns for both stocks and bonds, forecasts the sustainable inflation-adjusted annual withdrawal rate to be between 2.8% and 3.3%.

Each projection—upside, baseline, and downside—reflects a different potential outcome for asset-class correlations and volatilities, based on historical market regimes identified by the Bayesian framework used by Khang, Pakula, and Clarke (2022).

Sustainable portfolio withdrawal scenarios for 2022 retirees—three scenarios

Annual inflation-adjusted withdrawal rates (estimated for the 30 years ending 2052)

Notes: The sustainable withdrawal rate assumes a percentage withdrawal from the portfolio's initial balance that can be increased by the inflation rate over the 30 years starting in 2022. At this rate, the portfolio would avoid depletion over that period in 85% of all simulations.

Sources: Authors' calculations, based on data from the Survey of Professional Forecasters, Morningstar, Inc. (intermediate-term U.S. government bond returns), Kenneth French's Data Library (U.S. total stock market return), and Robert Shiller's website (CPI). Kenneth French's Data Library:; Robert Shiller's website:

A risk-management mindset for everyone

Of course, a forecast helps us identify a squall in advance so we can swerve, stall, or batten down the hatches, even when sunny skies might appear to prevail. "We have lived through a period of really strong markets. It's helpful to remember that these modified withdrawal rates would be applied to a portfolio whose balance has swelled during the bull market of the past 10 years," says Clarke.

Even more important, perhaps, is understanding that many investors and advisors use a systematic withdrawal rate not as a hard-and-fast rule, but as a jumping-off point. As the return outlook changes, they can slowly revise their withdrawal rate.

"The need to make sound financial decisions does not go away when folks retire. I might say it actually goes up because now they have to think about not outliving their portfolio, potentially leaving bequests, and changing return environments. I would encourage retirees and advisors to adopt a more strategic mindset toward managing these risks," says Khang.


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