The 4% withdrawal rate has long been the recommended withdrawal rate from investment savings for people in retirement. Based on today’s lower investment returns, it may be time to reconsider this rate.
The 4% rate was determined by financial planners in 1994. This was based on historical returns from a typical balanced portfolio at that time with 60% exposure to equities and 40% to debt. Those rates of return were averaging 9% to 10% for Canadian equities and 6% to 7% for Canadian bonds. But let’s look at the last 10 years. Returns are significantly lower, averaging 5% to 6% for Canadian equities and 2% to 3% for Canadian bonds.
It’s now time to adjust long-term return expectations for balanced portfolios to a lower withdrawal rate. The main reason is that during the past nine years the downward trend for fixed income rates has resulted in decreased valuations with the forecasted return for long-term Canadian bond yields now at 2.5%.
So, the take away from this is that even though future withdrawal rates are expected to increase over the long run, the forecasted expected rates may not go higher than 2.8% to 3%. This is still lower than the historical withdrawal target of 4% used in the past.
Plus, consider that with equities, a combination of lower return rates and our aging demographic in developed markets are resulting in lower expected returns for equities in general and, therefore, lower expected returns for balanced portfolios.
Risky business: As well as these lower expected returns, an individual’s risk tolerance profile has a bearing on their potential withdrawal rate. For someone with a medium-risk profile and is willing to accept the probability of their portfolio running out, the new recommended withdrawal rate ideally should be between 3.5% and 3.75%.
Research done by Financial Advisor magazine in 2015 found that over 50% of respondents ages 50 to 65 wanted zero risk of outliving their retirement savings. So, for someone with a medium-risk profile to ensure they do not outlive their savings, their withdrawal rate has to be substantially lower; between 2.25% and 2.75%. So, depending on a person’s risk appetite, the recommended withdrawal rate can vary anywhere between 2.25% and 4%.
Investors who are willing to take on additional risk can increase their target withdrawal rates but they also have to accept a greater failure probability; above 10%. In my opinion, such people are few and far between, considering that most retirees’ primary fear is that of outliving their money.
An alternative is to continue working past 65, maybe on a part-time basis to supplement one’s CPP and OAS pensions and waiting to take withdrawals from one’s personal retirement savings until age 71. There is no right or wrong way, and every person’s retirement goals and dreams are different. Just don’t expect your financial advisor to work miracles if you haven’t saved enough for a comfortable retirement.
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