A burning question many retirees have when they cease work and start drawing down on their retirement capital is: “How much can I safely draw each year while ensuring that my retirement capital won’t run out before I do?”
In March 2014 Finsia published the first Australian study into exactly this question. The authors surveyed the annualised performance of different investments in a number of countries over a period of 112 years. From this, they calculated the portfolio success rates of different asset allocations considering different withdrawal rates.
The research aims to challenge the efficacy of the simplistic and long standing “Golden Rule of 4%”.
Whilst the findings illustrate that a 4% draw is no guarantee of success, the research also shows that in the Australian context at least, a drawings rate of 4% in the first year of retirement followed by inflation indexed drawings thereafter, provides a reasonable probability of success.
The data finds that if an Australian retiree runs a portfolio that is 50% stocks (growth assets) and 50% cash/bonds (defensive assets), and they have a 30 year retirement horizon, then at a drawdown rate of 4% they have an 82% chance of success (ie not running out of money). At a 3% draw the chance of success increases to 99% and at a 5% draw it decreases to 60%.
The numbers improve somewhat if we reconfigure the investment portfolio to a 75/25 mix of stocks to bonds. In this case a 4% draw over 30 years provides a 95% success rate, while a 5% draw provides a 77% success rate.
A clear finding is that the 4% needs to be adjusted to take account of the amount of investment risk being taken (insufficient exposure to growth assets can result in capital being exhausted earlier), and the expected duration of retirement (meaning people retiring in their 70s may be able to draw a little more, while people retiring in their 50s may need to draw less).
The study also finds that the sequencing of returns in retirement can have a substantial bearing on the success or failure of the retirement strategy. Meaning, a bad investment year earlier on can have a devastating effect, whereas a bad year later on will have relatively less impact.
The report also points out that the Australian experience is rather unique in the international context as Australia has had the best performing stock market in the world over the past 112 years (in a sample covering 19 countries).
The success rates achieved at 4% in other countries are less comforting. For instance, a 4% draw in Italy over thirty years with a 50/50 portfolio only had a 24% success rate. Whereas in New Zealand it was 88% and in the Netherlands 70%.
This is a point of concern for me. I have always felt Australian investors have had a hint of the ‘rose coloured glasses’ in the way that they approach spending in retirement. Often false comfort is drawn from looking at the dividend yields from the banks. Whilst our banks have provided 5-6% dividend yields plus healthy growth for a long time, this experience is far from the norm. If we compare the performance of banks in the UK or US over the last decade the difference is stark. Moreover, we are entering a period where Australia may no longer be in the sweet spot of global growth, and returns could potentially be lower than they have in the past.