The 4% Shocker

The 4% Shocker
or
Withdrawing 4% of the Current Balance
or
How 4% turns out to be less than 2.5%!

I duplicated a previous study except that I withdrew 4% of the portfolio’s current balance instead of 5%. I had anticipated steadier income streams during times of portfolio stress. Instead, I found that the income stream fell just as far, actually farther, as with 5%.

Portfolios were safer at a 4% withdrawal rate. Their minimum balances stayed higher.

Conditions

I have tabulated the amounts withdrawn when one removes 4% of his portfolio’s current balance after adjusting for inflation (i.e., using real dollars). These are based upon an initial balance of $100000. Expenses were set at zero. I used TIPS with a 2% real interest rate for allocations other than stocks.

With 50% stocks and 50% TIPS at 2% interest, these are the 5-year rolling averages of the amounts withdrawn at years 5, 10, 20 and 30. Each year’s withdrawal is 4% of the current balance.

[Tables]

With 80% stocks and 20% TIPS at 2% interest, these are the 5-year rolling averages of the amounts withdrawn at years 5, 10, 20 and 30. Each year’s withdrawal is 4% of the current balance.

[Tables]

Remarks

Withdrawing a constant percentage of the current balance prevents a portfolio’s balance from falling to zero. The buying power of the amounts withdrawn drops quite a bit.

All initial balances were $100000 in this study.

The mid-1960s, especially 1964-1966, were the worst case.

Previously, when withdrawing 5% of the portfolio’s current balance, with 50% stocks, the buying power dropped between $2600 and $2700 at year 20 before rising later. With 80% stocks, there was a lot of variation. Previously, the 5-year average withdrawal amount at year 20 fell to $2375 during the worst case (1965) sequence.

This time, when withdrawing 4% of the portfolio’s current balance, the buying power of a 50% stock portfolio fell between $2500 and $2600 at year 20. The worst case sequence with 80% stocks was still in 1965. The 5-year average withdrawal amount at year 20 was $2269.

There are many examples of higher returns at year 20, but not when starting with stocks at high valuations. [Today’s valuations are even higher.]

Withdrawing a percentage of a portfolio’s current balance instead of its initial balance (plus inflation) extends its lifetime indefinitely, but only at a cost. The buying power drops substantially by year 20. We are talking about drops of 40%.

The old adage, which I am guilty of repeating, that withdrawing 5% of a portfolio’s current balance is roughly equivalent to withdrawing 4% of its initial balance (plus inflation) is false. Even withdrawing 4% of a portfolio’s current balance reduces one’s buying power in later years. It gives the illusion of being a safer, simpler method. It doesn’t work out that way. This approach may reduce one’s buying power so much that he abandons his original plan. He may withdraw more out of necessity.

You can view the full version of The 4% Shocker, complete with data tables, in its own folder in my Yahoo Briefcase.

Yahoo Briefcase

Have fun.

John Walter Russell
Modified on December 13, 2005