Predicting Sustainable Retirement Withdrawal Rates Using Valuation and Yield Measures
AbstractThis study attempts to quantify whether a 4 percent withdrawal rate can still be considered as safe for U.S. retirees in recent years when earnings valuations have been at historical highs and the dividend yield has been at historical lows. We find that the traditional 4 percent withdrawal rule is likely to fail for recent retirees. The maximum sustainable withdrawal rate (MWR) for retirees may continue declining even after the peak in earnings valuations in 2000. Our lowest point estimate for an MWR with a 60/40 allocation between stocks and bonds is 1.46 percent for new retirees in 2008. We also discuss confidence intervals for these predictions. The regression framework with variables to predict long-term stock returns, bond returns, and inflation (the components driving the retiree's remaining portfolio balance) produces estimates that fit the historical data quite well, and we use backtesting for a further robustness check. Nevertheless, there are important qualifications for these predictions. In particular, they depend on out-of-sample estimates as the circumstances of the past 15 years have not been witnessed before, and there is always potential for structural changes which could leave recent retirees in better shape than suggested by the model. Looking forward, this methodology can guide new retirees toward a reasonable range for their MWR so that the 4 percent rule need not be blindly followed.
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Bibliographic InfoPaper provided by University Library of Munich, Germany in its series MPRA Paper with number 27487.
Date of creation: 16 Dec 2010
Date of revision:
safe withdrawal rates; retirement planning; market valuation; price-earnings ratio; dividend yield. stock returns; bond returns;
Find related papers by JEL classification:
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
- C20 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - General
- N22 - Economic History - - Financial Markets and Institutions - - - U.S.; Canada: 1913-
- D14 - Microeconomics - - Household Behavior - - - Household Saving; Personal Finance
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- Wade D. Pfau, 2010. "An International Perspective on Safe Withdrawal Rates from Retirement Savings: The Demise of the 4 Percent Rule?," GRIPS Discussion Papers 10-12, National Graduate Institute for Policy Studies, revised Oct 2010.
Blog mentionsAs found by EconAcademics.org, the blog aggregator for Economics research:
- Trinity Study Updates
by Wade Pfau in Pensions, Retirement Planning, and Economics Blog on 2011-04-01 12:46:00
- Pfau, Wade Donald, 2011. "Safe Savings Rates: A New Approach to Retirement Planning over the Lifecycle," MPRA Paper 28796, University Library of Munich, Germany.
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