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A couple of months ago I published new research here. The topic was retirement withdrawal strategies. I was trying to answer a question that had long puzzled me. It’s one that I hadn’t seen addressed elsewhere: What is the best way to liquidate the asset classes in your retirement portfolio? For example, if you have a simple portfolio of stocks and bonds, and you need to generate cash, when do you sell the stocks and when do you sell the bonds?
I built a computer model and simulated the problem using historical data. I found that certain strategies did far better than others. “Success rates” (not running out of money) varied by more than 15%. Ending portfolio values varied by more than $4 million. This was all using the same simple portfolio, based solely on how you withdrew from the major asset classes.
When I clicked “Publish” on that original post, I was taking a chance, dabbling in financial research. I’m a civil/software engineer by trade. But I felt the question of valuation-based retirement withdrawals was important, and hadn’t been explored fully elsewhere. I hoped my article would raise awareness of the issue, offer some useful data, and generate some questions.
And it did. The response was huge. I received more email on that single post than any other that I’ve done. Lots of positive feedback, lots of good questions, and some interesting observations. I’ll try to respond to many of those now, while leaving the rest for future posts….
For starters, how have my findings stood up, a few months after that initial publication?
Well, nobody has contacted me yet to identify similar research or to disprove my findings. To the contrary, several readers, some with professional credentials in the field, said my work was news to them. Another technically savvy reader with experience in financial modeling wrote to say he had partially confirmed my results for the Equal Withdrawals and CAPE Median strategies. (Thanks Will.)
But I’m an engineer, trained to verify. And I wasn’t fully satisfied. I also had a full plate of new reader questions that I couldn’t easily answer with my original model, dedicated to a single type of simulation. So, I’ve spent a good chunk of these past winter months, home by the fire, building a new and much more powerful personal finance model. It will let me research and answer these and many other related questions. You’ll be seeing the fruits on this blog going forward.
The new model is 100% new code from the ground up, carefully tested at each step of construction against other leading financial tools. And, I’m happy to say, when re-calculating the results for my previous research, it produces precisely the samemedian portfolio values, to the dollar. So, while there could still be questions about my methodology, or my input data, I’m highly confident that my math is correct.
Given the complexity involved, I did find one minor mistake in my earlier results: There was a small rounding error in one of my original functions that led to misclassifying a few failing scenarios as “successful.” So the success ratio for the CAPE Median strategy was overstated by 1.7% (probably not statistically significant), and the success ratios for some of the momentum-based strategies were overstated anywhere from 2-7% (those strategies were already lagging). I have corrected the numbers in my first article. And none of the corrections change my overall conclusions.
Using the new model, I proceeded to generate a batch of new results to answer some of the many questions you’ve posed. For this new research, I kept the basic scenario from my original article: a $1 million portfolio, with a 4% initial withdrawal rate ($40,000), adjusted annually for inflation, over a 30-year retirement.
Given their lagging performance I dropped the three momentum-based strategies (Last Year, 3-Year, 7-Year) from consideration. I also renamed the “Equal Withdrawals” strategy to “EqualTarget,” reflecting that this strategy is really about withdrawing in proportion to the target asset allocation, which was no longer constrained to 50/50.
Next, by reader request, I added a new withdrawal strategy for consideration: “Proportional.” This is likely the withdrawal strategy you’d be using if you weren’t thinking about this issue at all. It simply withdraws in the same proportion as your portfolio’s current asset allocation, however it has grown. So, if your portfolio is at 65/35 stocks/bonds, so is your withdrawal.
Also by reader request, I began studying rebalancing strategies, in addition towithdrawal strategies. Here is the difference between the two: A withdrawal strategy executes during the year, and specifies the logic for how much or in what proportions to withdraw money from your portfolio for living expenses. A rebalancing strategy executes at the end of the year (or years), after your portfolio has grown, and specifies the logic for transferring money between holdings solely to adjust their proportions.
For starters I added the options to rebalance annually, or not at all. (In future research I expect to look at rebalancing at longer intervals, or based on a “percent band.”)
Lastly, again by reader request, I generated data for a range of starting portfolio asset allocations. Because, not everybody is served by a 50/50 portfolio. So, this time around, I looked at starting portfolio asset allocations of 80/20, 60/40, 50/50, 40/60, and 20/80 stocks/bonds. (One of those should be a fairly close match to your desired allocation.)
I’ve also calculated and reported the average asset allocations over the length of the simulation. This is so you can get a sense for how closely the portfolio’s risk/return profile stays to its starting allocation, depending on the different strategies.
Overview of Results
A bunch of numbers are posted on my blog. For those who aren’t inclined or interested, I’m summarizing the main points here, so you can skip the data….
The CAPE Median strategy — choosing to liquidate stocks or bonds based on Robert Shiller’s Cyclically Adjusted Price-to-Earnings ratio (CAPE) — continues to stand out. Variations on this strategy occupy the top three slots in my results for success rate, and the two top slots for ending portfolio value.
The data reminds us of a general principle when progressing from higher to lower stock allocations: holding more stocks generally increases your success rate, and your ending portfolio value. But it also increases volatility. Likewise, the unmodified CAPE Median strategy produce higher average stock allocations, along with higher success rates and ending portfolio values. The odds are for coming out ahead, but it may be a bumpier ride!
One strategy for smoothing out that ride is to add “rebalancing.” Notably, combining CAPE with Annual rebalancing produces impressive success rates and ending values, while reducing volatility and risk.
Contrary to conventional wisdom, rebalancing is not about juicing performance. (Helping you to buy low and sell high.) Rather, rebalancing reduces risk. In my simulations, adding rebalancing always reduces volatility (stock allocation), at the price of reducing your ending value, while having relatively little impact on success rates.
Annual rebalancing is like the Last Year strategy I studied before. It assumes that last year’s outperformance should be liquidated, but in fact we know that most stock market trends last far longer than one year. So it’s inefficient. It becomes obvious from my simulations, as well as a recent article from Michael Kitces, that rebalancing is actually suboptimal for long-term returns. But you might prefer the safety….
My original article discussed the simple steps for using the CAPE Median strategy. According to my research, if you apply this strategy consistently, you’ll come out ahead, possibly way ahead, of other withdrawal strategies.
But, if you intend to pursue a CAPE strategy, there is one practical limitation for locating your assets: Much as I love and advocate and own balanced funds, holding separate stock and bond index funds will be necessary to enable selling one or the other asset class at a time.
That said, you can simplify in one area. My research implies that cash/bond “buckets” could be overrated. Bucket strategies are often just alternative views of your asset allocation. Refilling buckets may reduce to the same problem my research tries to address: When and how to sell assets. Rather than stockpiling one asset class, it may be perfectly safe to simply sell whichever one (stocks/bonds), is in favor. Though, personally, I will probably always keep at least a year of cash living expenses on hand in retirement.
My ongoing research into retirement withdrawal strategies continues to underline the importance of consistency. Reliably following any of my top withdrawal strategies will beat the momentum-inspired moving average strategies, and will almost surely trounce any emotion-driven attempts at market timing. Starting from the same portfolio, the top strategies can put you years, and millions, ahead of the lesser alternatives….
Darrow Kirkpatrick is a software engineer and author who lived frugally, invested successfully, and retired in 2011 at age 50. He writes regularly about saving, investing and retiring on his blog CanIRetireYet.com. His first book is Retiring Sooner.