What Returns Are Safe Withdrawal Rates REALLY Based Upon?

What Returns Are Safe Withdrawal Rates REALLY Based Upon?

As retirees and their planners adjust to the ‘new normal’ – a world of lower-than-average returns for the foreseeable future, many have questioned whether the historical safe withdrawal rate research is still valid. After all, if returns will be below average in the coming years, doesn’t that imply safe withdrawal rates must be below average as well? In point of fact, though, safe withdrawal rates do not depend on average returns in the first place; the worst safe withdrawal rates in history that we rely upon are actually associated with 15-year real returns of less than 1%/year from a balanced portfolio! Accordingly, given current bond yields, dividend yields, and inflation, if the current environment for today’s retirees will result in a “new record low” safe withdrawal rate, the S&P 500 would still have to be no higher in 2027 than it was in 2007 or even 2000! On the other hand, merely projecting equities to recover to new highs by the end of the decade or generating a mid-single-digits return would actually represent an upside surprise, allowing for higher retirement spending than 4.5% safe withdrawal rates!

The inspiration for today’s blog post is some recent conversations I’ve had with other planners, who have questioned whether the safe withdrawal rate research is still relevant in today’s low return environment. “In the ‘new normal'”, the planner usually states, “returns are likely to be lower than historical averages for both stocks and bonds. Doesn’t that mean historical safe withdrawal rates are unrealistic?”

“Not at all,” I reply, “Because historical safe withdrawal rates aren’t based on historical averages. They’re based on historical worst case scenarios.”

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