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Decumulation, Sequencing Risk and the Safe Withdrawal Rate: Why the 4% Withdrawal Rule leaves Money on the Table

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  • Andrew Clare
  • James Seaton
  • Peter N. Smith
  • Stephen Thomas

Abstract

We examine the consequences of alternative popular investment strategies for the decumulation of funds invested for retirement through a defined contribution pension scheme. We examine in detail the viability of specific ‘safe’ withdrawal rates including the ‘4%-rule’ of Bengen (1994). We find two powerful conclusions; first that smoothing the returns on individual assets by simple trend following techniques is a potent tool to enhance withdrawal rates. Secondly, we show that while diversification across asset classes does lead to higher withdrawal rates than simple equity/bond portfolios, ’smoothing’ returns in itself is far more powerful a tool for raising withdrawal rates. in fact, smoothing the popular equity/bond portfolios (such as the 60/40 portfolio) is in itself an excellent and simple solution to constructing a retirement portfolio. Alternatively, trend following enables portfolios to contain more risky assets, and the greater upside they offer, for the same level of overall risk compared to standard portfolios.

Suggested Citation

  • Andrew Clare & James Seaton & Peter N. Smith & Stephen Thomas, 2017. "Decumulation, Sequencing Risk and the Safe Withdrawal Rate: Why the 4% Withdrawal Rule leaves Money on the Table," Discussion Papers 17/06, Department of Economics, University of York.
    • Handle: RePEc:yor:yorken:17/06
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    References listed on IDEAS

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    1. Clare, Andrew & Seaton, James & Smith, Peter N. & Thomas, Stephen, 2016. "The trend is our friend: Risk parity, momentum and trend following in global asset allocation," Journal of Behavioral and Experimental Finance, Elsevier, vol. 9(C), pages 63-80.
    2. 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.
    3. Michael E. Drew & Anup Basu & Alistair Byrnes, 2009. "Dynamic Lifecycle Strategies for Target Date Retirement Funds," Discussion Papers in Finance finance:200902, Griffith University, Department of Accounting, Finance and Economics.
    4. Pfau, Wade Donald, 2011. "Can We Predict the Sustainable Withdrawal Rate for New Retirees?," MPRA Paper 30877, University Library of Munich, Germany.
    5. Ivica Dus & Raimond Maurer & Olivia S. Mitchell, 2005. "Betting on Death and Capital Markets in Retirement: A Shortfall Risk Analysis of Life Annuities," NBER Working Papers 11271, National Bureau of Economic Research, Inc.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Sequence Risk; Perfect Withdrawal Rate; Decumulation; Trend Following.;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies

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